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EBA Report on Covered Bonds: Summary

Core Content

The European Banking Authority (EBA) published a report on 20 December 2016 titled Recommendations on Harmonisation of Covered Bond Frameworks in the EU, building on its 2014 work. The report aims to enhance the regulatory consistency and resilience of covered bonds across the European Union by proposing a three-step harmonisation approach. Covered bonds remain a key long-term funding instrument for EU credit institutions and are increasingly used outside the EU, demonstrating their importance in the financial system.

Main Viewpoints

The EBA report highlights the following main viewpoints:

• Divergent National Implementations: Despite the adoption of principle-based EU regulation, there is significant variation in the implementation of covered bond frameworks across EU member states.
• Need for Harmonisation: The EBA recommends a structured, multi-step approach to harmonise the regulatory treatment of covered bonds, ensuring consistent standards and enhanced product quality.
• Market and Regulatory Developments: The report identifies key trends in the covered bond market, including increased issuance, central bank involvement, and the shift towards more flexible amortisation structures like soft bullet and CPT.
• Regulatory Prudential Objectives: Harmonisation should ensure that only covered bonds meeting specific structural, credit risk, and prudential standards can access preferential treatment and risk weights.

Key Information

Step I – EU Covered Bonds Directive

• Objective: To define covered bonds as instruments under EU financial regulation and establish harmonised minimum quality standards.
• Key Areas:
  • Dual recourse
  • Segregation of cover assets
  • Bankruptcy remoteness
  • Coverage principle
  • Liquidity risk mitigation
  • Cover pool derivatives
  • Special public supervision and administration
  • Transparency and disclosure

Step II – Amendments to the CRR

• Objective: To enhance the conditions for preferential risk weight treatment of covered bonds.
• Recommended Changes:
  • Limits on substitution assets
  • Minimum effective overcollateralisation
  • Clarification of LTV limits for mortgage cover pools
  • Standardisation of disclosure requirements across all covered bonds
• Recommendations on Eligible Cover Assets:
  • Exclude SME loans, infrastructure loans, and loans to additional non-public debtors from preferential treatment
  • Reassess the eligibility of ship loans

Step III – Voluntary Convergence

• Objective: To allow for voluntary convergence in specific areas that are not critical to the core robustness of covered bonds.
• Areas Covered:
  • Composition of cover pools
  • Cover pools with underlying assets/obligors in non-EEA jurisdictions
  • LTV measurement and frequency of revaluation
  • Stress testing by the covered bond issuer

Market Trends and Regulatory Developments

• Increased Issuance: Covered bonds are being issued more frequently both in the EU and globally, with first issuances in Asian countries in 2015.
• Central Bank Involvement: The Eurosystem's CBPP3 has significantly increased central banks' holdings of covered bonds.
• Liquidity and Resolution Frameworks: Covered bonds are included in the LCR and are exempt from bail-in under the BRRD, making them attractive for banks.
• Rating Agencies: Rating methodologies have evolved, with improvements in sovereign ratings and the emergence of new rating agencies.
• Structural Innovations: A shift from traditional 'hard bullet' structures to more flexible 'soft bullet' and 'conditional pass-through' (CPT) structures.
• Transparency Initiatives: The development of the Harmonised Transparency Template (HTT) by the European Covered Bond Council (ECBC) has improved market transparency.

EBA Recommendations

1. Three-step Harmonisation Approach:

   • Step I: Development of a new covered bond directive to define and harmonise minimum quality standards.
   • Step II: Amendments to the CRR to strengthen the conditions for preferential risk weight treatment.
   • Step III: Voluntary convergence in non-critical areas, leaving flexibility for national frameworks.

2. Covered Bond Directive:

   • The directive should cover structural quality requirements, including dual recourse, segregation of cover assets, bankruptcy remoteness, coverage principle, liquidity risk mitigation, and transparency.

3. Amendments to the CRR:

   • Introduce new conditions on substitution assets and overcollateralisation.
   • Clarify and maintain LTV limits for mortgage cover pools.
   • Shift disclosure requirements to the covered bond framework.
   • Exclude certain types of loans from eligible cover assets.

4. Voluntary Convergence:

   • Encourage voluntary alignment in areas such as cover pool composition, cross-jurisdictional cover pools, LTV measurement, and stress testing.

Conclusion

The EBA report outlines a comprehensive strategy to harmonise covered bond frameworks in the EU, aiming to strengthen the product's resilience, transparency, and regulatory consistency. It proposes a three-step approach, combining regulatory definition, preferential treatment conditions, and voluntary convergence, to ensure that covered bonds continue to play a vital role in the EU's financial system.