The EBA in its 2016 report speaks out clearly against granting preferential regulatory treatment to CBs whose cover pools include more risky types of assets, e. g. SME loans, infrastructure loans or loans to other non-public debtors. The EBA is also sceptical towards movable assets such as ships (and aircrafts), which, if moved out of the EU, may be difficult to repossess.
On the other hand, given the successful role CBs have played and continue to play in financing mortgages or public sector loans, it is suggestive to make the institutional framework (2) available also to riskier types of assets such as SME finance or infrastructure investment. A sound legal framework providing for dual recourse, segregation of cover pools and special public supervision may provide – for both issuers and investors – an attractive alternative to securitizations or other forms of debt finance. Contractual arrangements underlying securitizations are often costly to set up, difficult to monitor and subject to legal disputes in the case of issuer default or resolution.
More transparency, more public supervision, and more legal certainty can be achieved by extending the institutional principles of CBs (2) to debt instruments which finance important and growth-enhancing economic activities (e. g. SME or infrastructure investments). But financial stability must not be compromised. Exemptions from general capital requirements in banking regulation or from the bail-in tool should not be granted to securities whose collateral does not satisfy.
Therefore, your rapporteur proposes a European directive which clearly defines and distinguishes two types of assets: Covered Bonds (CBs) and European Secured Notes (ESNs). Common to both types of securities would be the principles of a legal and supervisory framework. The label “covered bond” would be used if and only if the securities also satisfy and, hence, only CBs would be able to qualify for preferential regulatory treatment. To avoid unnecessary disruptions in smoothly working CB markets, your rapporteur further suggests to define CBs building closely on Article 129 of the CRR(5).
The CRR is silent on the admissibility of CBs with conditional maturity extensions (soft bullets and conditional pass-through (CPT) structures). These types of CBs have greatly increased in recent years. While maturity extensions may serve as useful contractual provisions for predictability and for risk management, particularly in cases of issuer default or resolution, they clearly shift part of the risks from the issuer to the investor. This may, if no attention is paid thereto, cause broader systemic risks. Preferential regulatory treatment should therefore not be granted to CBs with maturity extensions except for cases of default or resolution, i. e. for cases in which the alternative to a maturity extension would be a default of the issuer on the CB. Moreover, to protect investors and safeguard financial stability, the issuer should not have discretion in the triggering of maturity extensions. Rather, any extension of CB maturities in the case of default or resolution should be contingent on approval by the competent supervisory authority.
Covered bond regimes are deeply rooted in national insolvency laws. Cover pools and the dual recourse principle are safeguards against insolvency of the issuer, where the legal proceedings necessary to satisfy creditors’ claims against an illiquid CB issuer depend on national laws and vary considerably between Member States. European legislation should cause no disruption for frameworks which are well embedded in national law and which have enabled CB markets to operate smoothly and successfully over decades. This is why European legislation should be limited to a directive which sets the principles of CB and ESN markets. The development of technical standards should be left to the competent national supervisory authorities after in response to the transposition to national law.
Maximum loan-to-value ratios for mortgages form an important part of the eligibility criteria laid out in Article 129 CRR. Given the substantial price fluctuations which some real estate markets have experienced, LTVs must be considered a defining property of collateral for CBs which enjoy regulatory preference and not a technical standard that might be decided freely by Member States. Your rapporteur therefore proposes to continue setting maximum LTVs by European legislation and to monitor closely if these LTVs are in line with independent assessments of pricing conditions which might prevail in the relevant real estate markets under stress.
Finally, any action at the European level should also take into account three important developments not mentioned so far:
• Strong market-led initiatives are already in progress. For example, the Covered Bond Label developed by the issuer community in cooperation with investors and regulators has been agreed in 2013 and has reached in 2016 a coverage of 60% of outstanding CBs worldwide. Where those initiatives exist, they should be encouraged and either replace public intervention or be the basis for optional or mandatory standards. In particular, the Harmonised Transparency Template established since 2016 under the CBL could be a basis for common disclosure standards applicable to CB issuers.
• CBs are gaining popularity in a number of non-EU countries, e. g. Australia, Canada, Chile, New Zealand, Singapore, South Korea, Turkey and Russia. Other major jurisdictions (including Brazil, India, Japan, Mexico, Morocco, Panama, Peru, South Africa and the United States) may soon follow suit. A careful approach of European legislation limited to basic principles combined with sufficient flexibility for the idiosyncrasies of national laws and legacies will allow to integrate European CB and ESN markets with similar markets for similarly safe financial products elsewhere in the world and will therefore reinforce the long-run prospects for economic growth in the EU and in third countries. Moreover, EU standards would have the potential to function as a blueprint for developing CB markets worldwide.
• The market has been living, to some extent, under public support in recent years. The ECB asset purchase programme (again most recently via the CBPP3 since October 2014) has had a significant effect on primary and secondary markets of CBs, contributing, along with regulatory treatment, to increasing issuance of CBs since 2013. However, this has caused significant crowding out of private investors and stakeholders have warned that this crowding out may continue and eventually destroy the market unless the ECB disengages from CB markets in the near future. Any legislative or regulatory initiative should therefore be carefully weighted. Significant change of rules would create uncertainty for markets which need to win back investors they have lost.
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