EC stresses EU-specific factors to raise Level 1 LCR hopes

The European Commission will take into account “features specific to the EU banking system and financial markets” in addition to European Banking Authority (EBA) reports and international standards when deciding on covered bonds’ status in the LCRs, according to an EC spokesperson.

Confirming statements included in a Bloomberg article published last Friday (10 January), Chantal Hughes, spokesperson for the European Commission (EC), Internal Market and Services, told The Covered Bond Report that “the Commission is aware of the crucial importance of the covered bond market”.

The comments were sought from the Commission after the European Banking Authority (EBA) in December recommended against covered bonds being treated as extremely high quality liquid assets (Level 1 under Basel III) for the purposes of Liquidity Coverage Ratio (LCR) requirements in forthcoming EU legislation, despite a technical analysis it had conducted showing covered bonds to be as liquid as government bonds. Instead, the EBA’s report to the Commission recommends covered bonds as Level 2, high quality liquid assets, only.

However, the final decision on covered bonds’ LCR status will be taken by the Commission, by the end of June, a fact noted by the Commission spokesperson in an e-mail to The CBR.

“The EBA recommendations do not have any legal force of themselves,” said Hughes (pictured above with Commissioner Michel Barnier). “The Commission will consider these recommendations when preparing the secondary legislation on liquidity coverage which it is required to adopt by 30 June 2014. This secondary legislation should, inter alia, specify which assets qualify as being of high and extremely high liquidity/credit quality.

“When adopting that delegated act, in accordance with Article 460(2) of the Capital Requirements Regulation (CRR), the Commission shall take into account not just the reports submitted by EBA and the international standards but also features specific to the Union banking system and financial markets.” [Commission’s own emphasis.]

In recommending that covered bonds not be Level 1 assets, the EBA had stressed the “great importance” of alignment with Basel Committee on Banking Supervision rules.

The EBA’s recommendation was met with dismay and frustration by covered bond market participants in general, but in Denmark the reaction was particularly strong and the EC spokesperson mentioned the Danish case.

“The Commission also recognises the long tradition and solidity of Danish covered bonds, in particular, and their good liquidity characteristics, even in times of acute stress.

“This is also confirmed by the technical report of the European Banking Authority.”

Danmarks Nationalbank has meanwhile said that it would strongly recommend permitting countries with a shortage of extremely high quality liquid assets to allow more covered bonds in LCRs as a new CRR derogation if they are ultimately excluded from Level 1.

It took the position in a response released last Friday to an EBA consultation on derogations for currencies with constraints on the availability of liquid assets under Article 419(5) of the CRR that was held from 22 October to 22 December and discussed measures that can be taken by banks in countries such as Denmark where there are insufficient Level 1 assets.

Danmarks Nationalbank points out that the two derogations already proposed have drawbacks for Denmark with regard to the conduct of monetary policy and its currency peg towards the euro.

“The use of derogation A with foreign denominated assets in the buffer is not seen as an appropriate option, since it introduces currency risk,” it said. “The use of derogation B — credit lines from the central bank — is not seen as a viable solution either, since Denmark maintains a fixed-exchange rate policy vis-à-vis the euro area.”

The central bank instead proposed a new derogation that would better accommodate the country’s needs.

“If Danish covered bonds are not classified as extremely liquid in the Commission’s delegated act, and if the Commission furthermore introduce a cap on the amount of assets of high liquidity and credit quality in the liquidity buffer, we would strongly recommend the introduction of the third derogation in the BCBS (Basel Committee on Banking Supervision) to allow additional use of assets of high liquidity and credit quality (e.g. certain covered bonds) in the liquidity buffer,” it said.

“This third derogation could allow banks to hold a more diversified liquidity buffer than mainly government bonds and central bank reserves. Furthermore the use of the derogation could assist in breaking the link between governments and banks.”

In its consultation response the Danish central bank also reiterated the country’s position that covered bonds should be eligible as Level 1 assets as well as highlighting that this favoured scenario remains a possibility.

“First of all, we would like to point out that the results of the EBA’s empirical analysis across asset classes confirm that some covered bonds achieve the same average ranking as government bonds,” it said. “We agree with this analysis and see no reason to discriminate against such covered bonds based on other criteria.”

“If this finding is taken into account when the Commission decide on the final definition of the LCR in June 2014, Denmark would no longer be classified as a country with insufficient liquid assets.”