EBA's recommendation to harmonise EU-wide regulatory framework for covered bonds

On 20^th December 2016 the European Banking Authority (EBA) published a Report on Covered Bonds which includes recommendations on harmonisation of covered bond framework in the EU. This Report attempts to strengthen the covered bonds across the EU and underlines that only those financial instruments that comply with the harmonised structural, credit risk and prudential standards can be branded as ‘covered bonds' and have access to special regulatory and capital treatment as provided in the current EU financial regulation.

Covered bonds play an important central role in the funding of EU’s credit institutions and are becoming increasingly used also outside the EU. Until now the relevant EU regulation has been principle-based and the details have been regulated at national level. The EBA has analysed regulatory developments in covered bond frameworks in individual Member States comprehensively as well as the latest market trends. Based on that analysis the EBA proposes a ‘three-step approach’ to the harmonisation of covered bond frameworks in the EU:

• Step I – EU Covered Bonds Directive
  The EBA recommends developing a new covered bond regulatory framework based on the minimum harmonisation principle (i.e. Member States are obliged to implement the minimum standard as provided for by the directive, but are allowed to retain or introduce higher national standards). The directive would define the ‘covered bond’ as an instrument recognised by EU financial regulation. Moreover, it would harmonise minimum quality standards of covered bonds.
• Step II – Amendments to the CRR
  The EBA suggests that all covered bonds across the EU that seek preferential risk weight treatment according to Article 129 CRR should comply with the requirements specified in the covered bond framework and with the conditions in the CRR which should be strengthened. The criteria for preferential risk weight treatment in CRR should include four elements: (i) requirements on eligible cover assets; (ii) limits on substitution assets; (iii) LTV limits for mortgage cover pools; and (iv) minimum effective overcollateralisation at the covered bond level.
• Step III – Voluntary convergence
  The EBA believes that some specific areas of the covered bond business should be subject to voluntary convergence as legal tools are less relevant and might have unintended disruptive effect on the functioning of national markets. The proposed areas of voluntary convergence include especially composition of the cover pools, requirements for cover pools with underlying assets/obligors located in jurisdictions outside the European Economic Area, LTV measurement and frequency of revaluation, and stress testing by the covered bond issuer.