ESAs’ EMIR consult offers swaps hope for covered bond industry

European Supervisory Authorities EBA, ESMA and EIOPA launched a consultation on draft Regulatory Technical Standards for EMIR on Monday, which they said provide some flexibility for covered bonds, with one source cautiously welcoming the proposals as “looking quite positive”.

EBA offices in London

The Regulatory Technical Standards (RTS) address risk management procedures for OTC-derivative contracts not cleared by a central counterparty, after the European Market Infrastructure Regulation (EMIR) introduced a requirement to exchange a margin on non-centrally cleared derivatives.

The risk mitigation techniques for non-centrally cleared derivatives are one of two main sets of obligations set out in EMIR that have alarmed the covered bond industry, which has been calling for exemptions for the asset class given some of its specificities, such as that covered bond posting requirements are always unilateral in favour of the issuer due to rating agency requirements and operational considerations.

Swaps are used in covered bond programmes to hedge interest rate and foreign exchange risk.

A covered bond market participant said that, at first glance, the proposals put forward by the European Supervisory Authorities (ESAs) in the consultation look “quite positive”.

“It feels like they have listened to the market,” he said. “On the face of it, at least they included the possibility to have a carve-out for initial and variation margin posting requirements.”

However, he noted that one of the conditions for such an exemption is that the covered bond programme in question is subject to a minimum legal collateralisation requirement (102%), and that not all European covered bond frameworks have such a statutory OC requirement.

Florian Eichert, senior covered bond analyst at Crédit Agricole CIB, said that Nordic frameworks would need to be changed to comply with this, for example, but that that doing so would be in line with moves by other jurisdictions, such as France and the Netherlands, to either increase legal minimum OC or introduce such a requirement.

France is planning to up statutory minimum OC from 2% to 5%, while Dutch covered bond legislation is being amended to include a 5% requirement.

Explaining the approach set out in the draft RTS with respect to margining requirements of derivatives in relation to covered bonds, the ESAs said that they took into account a requirement, set out in recital 24 of EMIR, to take into account certain impediments faced by covered bond issuers or cover pools in posting collateral that this refers to.

“As a consequence covered bonds issuers or cover pools are not required to post collateral under a specific set of conditions, including a requirement to use the derivatives for hedging purposes and a legal overcollateralisation requirement,” they said. “This will ensure that the risks on the counterparties of covered bonds issuers or cover pools are limited, while ensuring some flexibility for covered bonds issuers or cover pools.”

An “alternative market-based solution” could supplement the above solution, they added, and be available to covered bond programmes not fulfilling the conditions mentioned in the proposed RTS.

The consultation runs until 14 July.