02 April 2013

ECBC response to EBA discussion paper on Defining Liquid Assets in the LCR under the draft CRR

The European Covered Bond Council responded to EBA's report which aims at providing appropriate uniform definitions of high and of extremely high liquidity and credit quality of transferable assets and appropriate haircuts for the purpose of the LCR requirements as specified under CRR.

ECBC understands that comments are most helpful if they respond specifically to questions stated. However, before doing so, ECBC would like to make some general comments on the two step methodology proposed by the EBA which will consist of:

• establishing a ranking of asset classes based on their aggregate liquidity properties; and
• identifying explanatory characteristics of individual securities that explain observed liquidity differences within asset classes.

Firstly, ECBC welcomes the efforts made by the EBA to broaden the scope of its report. Although the analysis of the set of quantitative metrics prescribed within Article 481(2) of the draft CRR will remain the central pillar of its report, the EBA proposes to take a broader approach and assess an expanded list of liquidity metrics and explanatory characteristics. However, the ECBC remains very much concerned about the lack of available sources of data. As described in point 4.2 – Data on Asset Classes, covered bonds are generally traded over the counter (OTC) which, although proving to be a crucial commercial asset during the recent financial turmoil, impedes the production of a comprehensive data set. Hence, ECBC fears that this lack of reliable and comparable data could result in an empirical analysis with distorted results and misleading outcomes. ECBC, therefore, invites the EBA to have a critical view on the results of its liquidity analysis.

Moreover, ECBC considers that the analysis of explanatory characteristics of individual securities should not lead to a granular definition of high and of extremely high liquid assets. As far as covered bonds are concerned, the ECBC strongly supports an integrated and European approach. ECBC deems that it would be inappropriate to differentiate between covered bonds with similar regulatory and credit protection and which, under European Union (EU) rules and European Central Bank (ECB) criteria, are subject to equal treatment. ECBC also believes that a regulatory differentiation between covered bonds could slow down the convergence of the current covered bond model and jeopardise the level playing field in regards to the funding of European banks. The preferential risk-weight of covered bonds is justified by its high quality features, i.e. strong supervision, strict regulatory and legislative framework, solid safety features (in form of tight eligibility criteria and dual recourse), large and dynamic cover pool, broad and stable investor base and excellent track record. A differentiation based only on the existence of information disclosure would create unjustified cliff effects that may negatively impact the European covered bond market. Along the same lines, the ECBC does not support the inclusion of a rating threshold for covered bonds. Credit quality can have implications on liquidity and, hence, is one of the quantitative based liquidity metrics required by the CRR. Although a large majority of covered bond programmes in Europe still satisfy the highest rating standards (sometimes even above their respective sovereign), ECBC believes that artificial rating thresholds would introduce a hazardous cliff effect which, in times of turmoil, could have serious pro-cyclical effects. In this context, it is worth noting that one of the objectives of regulators as well as investors is to reduce the reliance on ratings and ECBC considers that such thresholds would be a step in the wrong direction.

More generally, ECBC would like to stress that some of the metrics proposed in Article 481(2) of the draft CRR should be interpreted broadly. For instance, credit ratings, especially when it comes to specific assets such as covered bonds, do not always reflect fully the credit quality of the product. They are considered as only one indicator amongst others and, as a matter of fact, investors tend to steer away from the pure ratings and focus primarily on the additional information provided by the rating agencies that goes beyond the mere ratings assigned. Similarly, a low turn-over could highlight either a stable investor base with a “buy and hold” strategy or a liquidity shortage.

Last but not least, ECBC would like to draw the EBA’s attention to the position paper published by the ECBC in September 2012 (ECBC Position Paper on the Treatment of Covered Bonds in the Liquidity Coverage Ratios, here). This paper presents not only quantitative arguments to support the extremely high liquidity of covered bonds but also qualitative criteria (e.g. credit quality, depth of the investor base, repo eligibility and haircuts, etc.) which ECBC believes should be fully taken into account by the EBA when drafting its final report. In this regard, ECBC also invites the EBA to consider the recent establishment of a Covered Bond Label which, in particular, substantially improves transparency in the covered bond market.

ECBC-Website

Full response

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