19 March 2012

ECBC response to ESMA Discussion Paper on OTC Derivatives, CCPs and Trade Repositories

The ECBC supports the special treatment of hedging derivatives within covered bond cover pools with regard to the clearing obligation as specified in Recital 12 of the Regulation on OTC Derivatives, CCPs and Trade Repositories.

When establishing appropriate exchanges of collateral, the ECBC calls on the European Securities and Markets Authority (ESMA) to take into account the legal and technical obstacles faced by covered bonds issuers and in particular the unilateral collateral posting as provided by law in certain European jurisdictions.

The European Covered Bond Council (ECBC) is supportive of the goal of improving the resilience, transparency and efficiency of the OTC derivatives market, and welcomes the effort of European regulators to take into account the specificities of covered bonds’ legal frameworks which would unfortunately make derivatives in the cover pool of a covered bond ineligible to be cleared through a Central Clearing Counterparty (CCP).

Covered bond issuers have approached CCPs in order to discuss whether cover derivatives could be cleared through the latter (CCPs). However, at present, CCPs are unable to differentiate between the derivative contracts of the insolvent issuing bank and those of the covered bond cover pool. Derivatives within the cover pool would then be automatically terminated in the event of default of the covered bond issuer.

The ECBC supports the inclusion of covered bonds within the list of assets accepted as collateral by a CCP. Covered bonds’ consistently strong performance and quality features have attracted the attention of regulators and market participants worldwide which, has in turn, led to an increasing recognition of the macro-prudential value of this asset class. The high liquidity of this asset class has already been acknowledged within the Recommendations of the Basel Committee (Basel III) and the CRD IV package proposed by the European Commission in July 2011 and currently under discussion at European level.

The ECBC believes that covered bonds should be included within the definition of highly liquid financial instruments with minimal market and credit risk, considering the excellent track record of this asset class. Covered bonds also comply with the criteria listed under item 135 of this Discussion Paper, except for point (vii) (debt instrument issued or guaranteed by a government, central bank or multilateral development bank).

The strong supervision of and the underlying regulatory and legislative framework of governing covered bonds, designed properly to assign collateral in case of resolution, have attracted over the years a broad and stable investor base. This has enabled covered bonds to perform strongly over the past years and even in times of stress, as witnessed during the recent financial turmoil where covered bonds had shown performance close to sovereign bonds in terms of credit risk, volatility and liquidity. Therefore, the ECBC invites ESMA to consider a higher recognition of this asset class to fully reflect their safety features, i.e. dual recourse, high quality assets cover pool and strong supervision, their excellent track record and their resilience and to include covered bonds within the definition of highly liquid financial instruments in which a CCP shall invest its financial resources.

Full ECBC response paper

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