Swedes critical of covered harmonisation, Danes in warning

The Association of Swedish Covered Bond issuers (ASCB) has criticised the proposition that harmonisation of covered bond frameworks, as outlined in a European Commission paper, would be beneficial, as market participants responded to the consultation ahead of an originally-scheduled deadline of Wednesday.

The Commission has extended the consultation period until 31 January, citing “the broad scope of the exercise”.

The consultation was launched on 30 September as part of the Commission’s Capital Markets Union (CMU) project. It set out three options for moving towards a more integrated European covered bond market: 1. Voluntary convergence of Member States’ covered bond laws in accordance with non-legislative coordination measures such as a Commission recommendation; 2. Direct harmonisation of national laws through EU law (Directive or Regulation) on covered bonds; 3. 29th regime as an alternative to existing national laws.

The Swedish association said that the negative effects of harmonisation far outweigh the positive effects.

“ASCB is critical [of] the idea of harmonisation because it will not, and cannot, cover all legal frameworks that surround and support a covered bond regulation,” it said. “The national covered bond regulation is part of a bigger package of regulations which together makes the issuance of covered bonds possible.

“If the covered bond legislation were to be harmonised it is possible that the harmonised rule would not function together with national insolvency or resolution regulations or the rest of the associated rules. This would likely end up in a less functional legal system.”

The industry body said it disagrees with the hypothesis in the consultation paper that differences in frameworks contributed to market fragmentation after the onset of the financial crisis, citing “real differences in credit risks” as being behind spread divergence.

“In a completely harmonised regulation it would have been more obvious that the credit risk in certain countries would have been worse and therefore the value of those bonds would have been lower.”

This view was backed up by the ICMA Covered Bond Investor Council, which argued in a response to the Commission that indeed covered bond frameworks had moderated the impact of the crisis.

“The observed spread divergence and subsequent convergence within the covered bond market was evidence of fragmentation between markets, not between different classes of covered bonds per se [emphasis in original],” said the investor body. “On the contrary, the strength of covered bond regimes in many distressed countries, for example in Spain or Portugal, was a mitigant to the effect of widening sovereign risk premia in those countries.”

“A regulatory response from the European Commission should only seek to eliminate those risk characteristics which are a function of differences between regimes in Member States,” it added, “not risks that are a function of, for example, different underlying risk characteristics of the assets or different commercial models. A market where all covered bonds price at the same level independent of issuer specific and asset specific risk factors is neither a practical nor a desirable outcome of this process.”

The CBIC also said that while there are potential benefits to a more integrated EU framework, the Commission should be careful not to water down existing strong national frameworks.

“Covered bonds represent a unique asset class with peculiar characteristics emanating from specific national laws built around it, unlike other fixed income asset classes,” it said. “The financial services industry has committed significant resources over many years to create covered bond standards in EU and non-EU countries.

“Whichever option the European Commission chooses to pursue to harmonise markets, the Commission must be careful not to needlessly disrupt a well functioning market given the history of the asset class.”

The ASCB said it is important that harmonisation does not endanger existing covered bond structures in various jurisdictions, including those in local currency markets.

In a joint response on 18 December, the Association of Danish Mortgage Banks (Realkreditrådet), the Danish Mortgage Banks’ Federation (Realkreditforeningen) and the Danish Bankers Association (Finansrådet) said that a mistaken approach to harmonisation could have “grave consequences” for Member States where covered bonds are an important tool in funding growth and maintaining financial stability. The Danes nevertheless acknowledged that the promotion of fundamental principles based on sound mortgage credit models could strengthen international investors’ understanding of the European concept of covered bonds, and argued against any dilution of their high quality.

Various bodies representing issuers, such as the ASCB, have also referred the Commission to an extensive response from the European Covered Bond Council, which cited a preference for option 1 but also support for a combination of options 1 and 2.

Fitch on Monday meanwhile noted in a report that, of the topics raised by the Commission in its consultation paper, liquidity provisions upon the switch from the issuer to the cover pool as the source of payments would most affect the difference between issuer and covered bond ratings, adding that there would be most potential for upgrades in this area for countries with no mandatory liquidity protection embedded in legislation, such as Austria, Spain and Sweden.