Hypoblog has moved to www.hypo.org

Dear Readers,

Following the launch of the new EMF-ECBC website in June 2017, this blog has moved.

Please visit www.hypo.org for regular updates on our activities and for more blog posts by EMF-ECBC Members and stakeholders, which we will continue to publish in the News section of the website.

For more information on our Energy Efficient Mortgages Initiative, please visit also the Energy Efficient Mortgages Action Plan (EeMAP) project’s website at: energyefficientmortgages.eu.

For any questions or feedback, please contact the EMF-ECBC Secretariat at info@hypo.org.

We thank you for your interest in our activities and hope to welcome you to one of our websites soon!


Energy Efficient Mortgage Initiative: Second Stakeholder Meeting

EE 2nd Meeting

On the 16th of February 2017, the EMF-ECBC hosted the Second Stakeholder Meeting of its Energy Efficient Mortgage Initiative at the Bibliothèque Solvay in Brussels where over 80 key stakeholders convened to discuss the Initiative’s progress to date and agree the next steps to be taken.

To recap, in September 2016, the European Mortgage Federation – European Covered Bond Council (EMF-ECBC) launched its ground-breaking mortgage financing initiative (see here) to support energy efficiency improvements in buildings, representing the first time a group of major banks and mortgage lenders, as well as businesses and organisations from the building and energy industries have come together to address the concept of energy efficient mortgages. The Initiative explores ways to mobilise private mortgage financing to boost energy efficient building renovation in Europe. The aim of the project is to create a suitable framework for a standardised Energy Efficient Mortgage product, which mortgage lenders in Europe can offer to borrowers seeking to purchase and retrofit an energy efficient property.

Supporting Energy Union, Growth and Jobs

Paul Hodson

The Energy Efficient Mortgage Initiative responds to the European Commission’s Energy Union agenda, which places energy and resource efficiency at the heart of achieving the EU’s energy and climate goals. In the EU, buildings are responsible for 40% of total energy consumption and 36% of CO2 emissions. By improving the energy efficiency of buildings, the EU’s total energy consumption could be reduced by 5-6% and CO2 emissions by 5%. Furthermore, the Initiative has significance for the larger growth and jobs agenda in Europe, as more funding to boost energy renovation rates can lead to a significant increase in jobs in the building sector.

EE 2nd Meeting KatainenFor banks and investors, a lower risk profile of green mortgages and a potential increase of value linked to more energy efficient properties can bring about tangible benefits, such as mitigation of risk and therefore a better capital treatment of banks’ green assets and protection against ‘brown discount’ of loan and investment portfolios. To this end, the Energy Efficient Mortgage Initiative seeks to develop a better understanding of how to differentiate between ‘green’ and ‘conventional’ funding, and how to capture energy efficiency within financial institutions’ lending practices.

In this context, the EMF-ECBC was delighted to open the event with a speech from Paul Hodson, Head of Unit, DG Energy, European Commission and to draw proceedings to a close with an address by Jyrki Katainen, European Commission Vice-President responsible for Jobs, Growth, Investment and Competitiveness.

Energy Efficiency Financing Key Parameters Survey

The EMF-ECBC also took the opportunity of the event to formally present its preliminary analysis of its recent survey on banks’ existing green lending practices in Europe.

Speaking at the event, Luca Bertalot, Secretary General of the EMF-ECBC said:

“We recognise that we have an ambitious task ahead of us; our work on Energy Efficient Mortgages has now gained clear support from market participants and in particular from the European Commission. Indeed, stakeholder consensus and institutional coordination are essential pre-conditions to enable us to move forward. We believe this Initiative to be crucial to help bridge the gap in investment needed to improve the energy efficient renovation of buildings in Europe.

The feedback from our survey on banks’ ‘green’ lending practices reveals a strong interest in further developing the green market and underlines the importance of standardisation for energy efficient mortgages. We look forward to working together with our partners across the key sectors in developing solutions to meet these needs.”

More information about the Energy Efficient Mortgages Initiative, including the preliminary survey analysis report and the agenda of the Second Stakeholder Meeting, can be found here.

Partners of the Energy Efficient Mortgages Initiative are the Ca’Foscari University of Venice, RICS, European Regional Network of Green Building Councils, E.ON, and SAFE Goethe University Frankfurt. The Second Stakeholder Meeting was supported by European DataWareHouse, a key stakeholder of the project.

The Third Stakeholder Meeting is scheduled to take place in Rome, Italy on the 9th of June 2017.

This article was originally published in the February 2017 edition of the EMF-ECBC Newsletter Market Insights & Updates.

Unlocking Private Investment to Deliver Building Renovation and Clean Energy for All

ulrich_bang_velux-blogBy Ulrich Bang, Senior Director, Public Affairs & Corporate Responsibility, VELUX Group

Last year the VELUX Group celebrated its 75th anniversary – three quarters of a century creating better living environments with daylight and fresh air. Our main product consists of energy-efficient roof windows, together with a range of other products such as blinds, roller shutters and remote controls. The VELUX Group has manufacturing and sales operations in more than 40 countries, with the EU being our most important market.

Improving energy efficiency in buildings is an important topic for the VELUX Group. It represents a huge, untapped potential, not only in terms of using resources in a smarter way, but also in terms of boosting economic activity, growth and jobs.

In the EU, buildings are responsible for 40% of total energy consumption and 36% of CO2 emissions. As 75% of existing buildings are not energy-efficient, it is easy to see why energy renovation is a key target area.

VELUX’s particular contribution to increasing energy efficiency and reducing greenhouse gas (GHG) emissions in buildings is through the installation or replacement of highly energy-efficient windows. Nevertheless, there are general barriers to building renovation, especially when it comes to financing and unlocking private investment. Many homeowners leave energy renovation projects at the idea stage, as they imagine them to be both complex, with multiple providers required to carry out the project, and also overly expensive.

The BetterHome Initiative – A Way of Overcoming Barriers to Renovation

To overcome this, the VELUX Group has teamed up with three other global companies within the building industry who also provide energy-efficient solutions¹ and in April 2014 launched a new initiative called BetterHome. The idea with this concept is to provide a service which simplifies the process of an energy renovation project for homeowners. By visiting BetterHome’s webpage, homeowners can get an overview of the energy saving potential of their renovation project, and see concrete examples of different energy-efficient solutions depending on how much they want to invest.

Through the BetterHome webpage, it is also possible to get in contact with accredited local installers who are part of the BetterHome initiative. The installer will provide guidance around the required improvements, the energy saving potential and also financing options. The concept is that the installer will be the homeowner’s single point of contact for the whole renovation process – therefore making it simpler and more convenient. Banks and mortgage institutions in Denmark are supporting partners in the BetterHome initiative, and they provide guidance and help to secure the correct financial services, thereby reducing uncertainty.

BetterHome provides further peace of mind by showing ways in which the investment will increase the value of the property due to improved comfort, energy savings and living conditions.

A “Pick and Click” approach to selecting approved providers and services puts the customer centre stage, and the approach has given positive results so far. The BetterHome initiative reached its targets in Denmark and has been subsequently extended to Sweden in 2016.

The Velux Group and the EMF-ECBC Energy Efficient Mortgage Initiative

One of the principal barriers preventing homeowners from renovating is financing – even though energy renovation has a positive impact on property value, while savings on energy bills increase disposal income.

Therefore, the VELUX Group is also interested in the new Energy Efficient Mortgages Action Plan announced by European Mortgage Federation – European Covered Bond Council (EMF-ECBC). This aims to help the market recognise and price in the value of energy efficient homes. We believe that the EMF-ECBC initiative has the potential to further increase the renovation rate and thereby contribute towards greater energy efficiency in the EU.

It is clear that we need cooperation across sectors and industries if we are to unlock private investment in European home renovation. As a responsible company, we have to step up to the challenge.

¹ Danfoss, Grundfos and ROCKWOOL.

This article was originally published in the January 2017 edition of Market Insights & Updates, the EMF-ECBC Monthly Newsletter.

A Closer Look At The Brazilian Covered Bond Framework

antonio-farinaroberto-paciottiBy Antonio Farina, Senior Director & Roberto Paciotti, Managing Director – Analytical Manager Covered Bonds, S&P Global Ratings

In October 2014, Brazil enacted Provisional Measure No 656, which outlined the framework for Brazilian covered bonds (letra imobiliária garantida; LIGs). This measure became Law No. 13,097 in January 2015.

S&P Global Ratings has reviewed this legislation. From the standpoint of the legal protection afforded to covered bondholders by the Brazilian framework in the event of the issuer’s insolvency, we conclude that the new regime could allow a covered bond programme to be rated above the issuer credit rating (ICR). However, we also see several aspects that the law leaves unclear. We expect that secondary legislation, which the Brazilian Monetary National Council (CMN) should approve in 2017, will address these loose ends.

When assessing the underlying legal framework of a covered bond issuance, we focus primarily on the degree to which the cover pool assets are isolated from the risk of issuer bankruptcy and whether a bankruptcy is likely to have other detrimental effects on the timely and full satisfaction of the covered bondholders’ claims.

We have reviewed five key aspects of Brazil’s covered bond legislation:

1) Segregation of the cover pool assets and cash flows

We examine whether or not the cover pool assets are fully available to meet the obligations under the covered bonds. Law No. 13,097 qualifies the cover pool as a segregated portfolio subject to a fiduciary regime. This means that the cover pool assets are deemed legally separate and independent from the issuer’s own assets. In particular, the cover pool and its underlying assets will not be available to any of the issuer’s creditors other than the bondholders, except if the issuer commits fraud or illegal activities when it creates the cover pool.

Third-party execution risk. An LIG’s cover pool is earmarked for the settlement of payment obligations of the issuer under the corresponding LIG. It cannot be seized, attached, or otherwise affected in case of default, intervention, extrajudicial liquidation, or bankruptcy of the issuer or because of any judicial lien resulting from the issuer’s other obligations. The issuer is legally prevented from using, disposing, or encumbering any assets backing a cover pool. Therefore, such underlying credit rights and remaining assets cannot be subject to any lien, burden, or encumbrance other than those related to the rights of LIG holders, and they shall only be released from the fiduciary regime upon the full payment of principal, interest, and other charges related to the LIGs.

Commingling risk. This refers to the possibility that collections received on the cover pool assets from the debtors fall into the general estate of the bankrupt issuer and are thereby either lost or frozen for the covered bondholders.

Since the cover pool assets are deemed legally separate and independent from the issuer’s own assets, we understand that collection cannot be released from the cover pool until the issuer’s obligations under the LIG are fulfilled. Thus, if the issuer defaults on its obligations under the LIG, any amounts arising from the collection of the assets – either under a pre-insolvency or a post-insolvency scenario – would belong to the bondholders.

Set-off risk. We consider the extent to which borrowers are entitled to set-off amounts owed to them by the issuer against their repayment obligations under the loans, in particular deposits that the borrowers may have with the issuer.

The amounts owed by the borrowers to the issuing bank are part of the segregated portfolio, specially created for the LIG’s bondholders. Therefore, we understand that such assets should not be deemed as being part of the issuing bank’s assets and should not qualify for set-off risk.

Eligibility criteria and replacement of ineligible assets.
The issuer is authorised to replace the assets backing a cover pool on a revolving basis upon fulfilment of certain replacement criteria that are yet to be promulgated by the CMN. The CMN has yet to implement a rule on eligibility criteria, portfolio composition, sufficiency, term, cover pool liquidity requirements, and the conditions for the replacement of assets that become ineligible.

The law does not clarify whether or not an asset that becomes ineligible should be maintained, excluded, or replaced from the pool of assets, under either a pre-insolvency or a post-insolvency scenario. We expect future regulations to address these issues.

2) The risk of acceleration of payments to bondholders, a payment moratorium, or forced restructuring

Acceleration of payments. Notwithstanding the issuer’s default, intervention, extrajudicial liquidation, bankruptcy, or the acknowledgement of the issuer’s insolvency by the Brazilian Central Bank, acceleration of the LIGs is forbidden as long as the cover pool is “solvent,” as defined according to the criteria to be implemented by the CMN. Consequently, it is still not possible to determine how and when the cover pool shall be deemed “solvent” or “insolvent” and who should do so and if the acceleration risk is effectively mitigated.

Moratorium and forced restructuring. The pool will not be directly or indirectly available to satisfy any other issuer obligations, no matter how privileged they might be, until the full payment of the amounts due for the LIG holders. Therefore a moratorium or forces restructuring would not be imposed upon the cash flows from the cover pool assets.

3) Limits to the amount of overcollateralisation

Law 13,097 provides for minimum overcollateralisation thresholds for the cover pool and related credit enhancement mechanisms. However, the law does not regulate how any overcollateralisation – above the minimum threshold – should be treated in terms of replacement. Third parties may question this overcollateralisation, especially if, for any reason, the parties are not able to prove that the overcollateralisation ratio chosen is reasonable for the relevant programme. We expect future regulations will clarify the treatment of overcollateralisation over the legal minimum.

4) Treatment of hedging arrangements

The cover pool may contain derivatives contracted through a central counterparty acting as guarantor (for example, stock exchanges or clearing houses), while over-the-counter derivatives are not eligible for the cover pool. Swaps contracted through a central counterparty acting as guarantor are subject to the specific rules issued by the respective stock exchange or any other central counterparty acting as guarantor, especially for insolvency and termination-related issues. Such roles might not follow our criteria and could limit our ability to give credit to derivative agreements included in the cover pool. Notwithstanding the above, the CMN could authorise over-the-counter derivatives to be eligible for the cover pool pursuant to Article 66, Item IV, of Law No. 13,097.

5 ) Access to funding after the issuer’s bankruptcy

Law 13,097 establishes that in case of default, intervention, extrajudicial liquidation, or bankruptcy of the issuer, the trustee shall be vested with powers to manage the cover pool assets, pursuant to the conditions and duties to be further regulated by the CMN. The cover pool assets cannot be subject to any lien, burden, or encumbrance other than those related to the LIG holders’ rights, so they would be freely transferable. In this sense, the trustee is empowered to raise liquidity. Upon the adjudication of an insolvency estate, the trustee shall convene a general bondholders meeting, with the authority to take any appropriate measure regarding the management of the asset pool.

Any and all actions taken by the trustee require prior approval by the committee of general bondholders in order for the trustee to call upon the issuer’s insolvency and decide how the pool of assets should be managed. However, this may cause liquidity issues if a bondholders’ meeting cannot be held before the maturity date of the covered bonds. We will consider if this risk is mitigated in the secondary legislation.

A Preliminary Assessment

At this stage, the views we’ve outlined remain preliminary, particularly because we have not yet seen the secondary legislation.

We believe that new legislation could allow a covered bond programme to be rated above the issuer’s ICR, but we also note several aspects that the law still leaves unclear. Among other things, we look forward to seeing if and how secondary legislation will:

  • Further clarify the concept of cover pool solvency and mitigate acceleration risk;
  • Define the eligibility criteria for the cover pool assets and their inclusion in the cover pool once those criteria are not met;
  • Clarify the treatment of voluntary overcollateralisation; and
  • Mitigate the liquidity risk arising from the fact that the trustee must call an investors’ meeting before managing the cover pool.

We also note that the current definition of eligible derivative agreements may prevent S&P Global Ratings from giving credit to swap agreements in our analysis.

This article was originally published in the December 2016 edition of Market Insights & Updates – EMF-ECBC Monthly Newsletter.

Scope’s Covered Bond Outlook 2017: Credit contraction unlikely to unravel

karlo_fuchs_scope-ratingsBy Karlo Fuchs, Head of Covered Bond Ratings, Scope Ratings

Scope Ratings expects in its 2017 outlook that the credit performance of covered bonds will continue to improve, thanks to the enhanced regulation and supervision that is strengthening the credit fundamentals of European banks, the anchor point for this asset class’ credit quality. The regulatory improvements lead not only to safer business models for issuers, but to stronger capital and liquidity profiles as well. At the same time, the European Central Bank’s (ECB) quantitative easing continues to support financial stability in Europe and benefits borrowers’ asset quality, and ultra-low interest rates are prompting issuers to lengthen the maturities of new covered bonds, thereby reducing their covered bonds’ main risk – the asset-liability mismatch.

Rating Stability: The New Normal for Covered Bonds?

The credit quality of the large European banking groups that we rate continues to converge into the single A range. This reflects not only the increasingly level playing field on which banks operate, but also the converging prudential requirements, which leads to more uniform regulatory metrics. Scope’s European banking outlook for 2017 notes that: ultra-low rates will continue to challenge earnings; existing overcapacity remains the industry’s Achilles’ heel; and better capital levels are not matched by higher earnings.

Most banks have started to adapt to the new environment, and changes to issuers’ credit quality in 2016 have been very limited. Also, the bank rating changes have not affected our covered bond ratings. On aggregate, we see relative stability for the banks’ credit quality to continue in 2017.

At the same time, the widened national implementation of MREL guidelines and the resulting ability to bail-in certain parts of a banks’ liability structure, will result in further upgrades of the bank rating as preferred creditors will benefit from a more ample capital structure in a default like scenario.

Our ratings of banks in Germany, Belgium, the UK and Switzerland already reflect this ability to bail-in certain forms of senior bank debt. We expect ICSRs of banks in France, Spain, Italy and Sweden to also improve once national regulators have clarified their view on MREL liabilities and banks have the ability to issue this new type of senior unsecured – but bail-inable – debt.

Improved ICSRs will bolster the resilience of existing covered bond ratings against issuer downgrades and recourse to the cover pool, and its importance for the covered bond rating, will further reduce. Already today most covered bonds rated by Scope are based on ‘fundamental support’. A bank rating in the single A range, combined with our favourable view on the countries’ legal frameworks and resolution regimes, supports covered bond ratings without taking recourse to the cover pool.

Only two of the 23 covered bond programmes we rate (Bankia SA’s Cedulas Hipotecarias, AAA/Stable, and Dexia Kommunalbank Deutschland AG’s Öffentliche Pfandbriefe, AA-/Stable) rely on the cover pool recourse to achieve and maintain current ratings.

Covered Bond Volumes to Stabilise in 2017

Our expectation of the continuation of net negative supply for covered bonds in 2016 has largely been confirmed. We expect the European covered bond market to end 2016 at close to EUR 2.3tn, following the height of EUR 2.7tn in 2012.

We do not believe that a return to sustainable growth is already likely in 2017. European credit demand remains soft and headline risk will persist in 2017. The ECB’s monetary policy continues to provide ample liquidity to the banking system and, although the deleveraging of balances sheets has slowed, it is not over. Further, French, Italian, Spanish or Swedish banks are likely to start issuing bail-inable senior debt in 2017, which will also reduce the need for covered bond funding.

Our baseline assumption is that the European economy will continue to grow – albeit at a slow and potentially volatile pace. The 2016 Brexit vote has already provided uncertainty and closed the markets for some time, and its method of execution remains unclear. Socio-political risk will persist, and it remains to be seen whether the unexpected (e.g. Donald Trump winning the US elections) will also become the new normal for 2017. The results of the 2016 referendum in Italy and the 2017 elections in France and Germany will be important European milestones in that context. It is still unclear whether the results will introduce stability and certainty for the eurozone and its GDP growth, or amplify volatility and dampen growth prospects.

The persistent uncertainties, in combination with low growth prospects, make our issuance outlook bearish, and we expect that current volumes of outstanding covered bonds will stabilise – at best.

Low Interest Rates Unlikely to Spur Innovation

A long-term funding market is not the most likely candidate for product innovation, and the ultra-low interest rates are even less conducive in this respect. As long as spread differentials between asset classes remain low, we do not believe incentives for issuers are high enough to establish new dual-recourse funding alternatives using the covered bond blueprint.

In 2016, we have not seen any repeat of a real covered bond for small and mid-sized enterprises (SMEs), and the concept of a covered bond like the European Secured Note (ESN) only remains a theoretical option. Also, the first-time issuance of the
export-credit-based Cédulas de Internacionalización has not yet been repeated in Spain, and we do not think that structured covered bonds by Deutsche Bank will find followers in Germany.

We see merit in innovations that improve the credit quality of covered bond products but currently most innovations are driven by issuer-specific situations, and thus are unlikely to see a more widespread use. We hope that the EBA’s harmonisation proposal, and the changes to the ECB’s collateral policies do not discourage issuers from further improving the product or allowing banks to establish dual-recourse funding products with a high credit quality.

Improving Covered Bond Frameworks

Fundamental support factors, such as national legal frameworks that govern covered bond issuance, have great importance for a covered bond’s credit quality. Changes to existing covered bond frameworks over the last two years have been cosmetic in nature and were not material enough to lead us to reassess the fundamental support we take into account in our covered bond ratings.

We expect the European Commission’s harmonisation agenda to increase the number of changes to national  covered bond legislations – with first movers already starting to appear in 2017. While some legislation may only need subtle amendments, others might be forced into more fundamental changes when trying to translate the EBA’s core covered bond principles into national frameworks. A full alignment across Europe will be a lengthy process and unlikely to be completed before the end of the decade.

Differences in Legal Frameworks Highlight Need for Harmonisation

In November 2016 the European Banking Authority (EBA) held a hearing on the harmonisation of covered bonds. They presented a legal framework analysis which illustrated that differences in the frameworks persist – also highlighting that investors need to be aware of these when investing on a pan-European basis.

In some European countries, e.g. Slovakia, the bankruptcy remoteness of the cover pool is not a given, and investors could face an acceleration of covered bonds upon the insolvency of the issuer. In others, e.g. Spain, the collateral provided in the cover pools might no longer comply with loan-tovalue limits, as compliance is tested at origination and no cover pool revaluations based on house price development are required by law. Further, in most European covered bond countries investors have to rely on the voluntary disclosure of issuers, which can be infrequent and not comparable across countries, making it difficult for investors to compare the pools’ resilience.

The EBA’s November 2016 draft of their harmonisation proposal addresses many of these issues and provides a sound basis for the further development of this asset class. In contrast to the European commission’s initial idea of a prescriptive 29th regime, the proposal provides a mix of core principles applicable to all covered bonds that seek regulatory recognition and allows some further voluntary convergence.

The European Commission is ultimately in the driver’s seat to put harmonisation into practice. In our view, a lot of the EBA proposals will eventually be adopted by all the Member States. We believe investors will welcome the lower degree of divergence in the credit quality of covered bonds issued in the Member States, and harmonisation might even help encourage covered bond investment across borders, without the risk of surprises. However, harmonisation might also result in an underestimation of prevailing differences in risks: the diverging economic situation in Member States, diverging dynamics of bank fundamentals, as well as the dynamics driven by the management of risks between covered bond programmes of different issuers.

EBA’s Harmonisation Proposal to Improve Minimum Credit Quality

The EBA’s covered bond harmonisation proposal addresses diverging practices in legal frameworks and will help to provide a clearer definition for the asset class in three steps:

‘The cake’

To avoid a covered bond being affected by a potential restructuring of its issuer, the EBA proposes the following key features to establish a covered bond:

  1. A clearly defined dual-recourse principle, the clear and valid segregation of cover assets, and the bankruptcy-remoteness of the covered bond
  2. Requirements on the coverage of covered bond repayments, mitigation of liquidity risk, and cover pool derivatives
  3. A more clearly defined system of special public supervision and administration
  4. Transparency requirements for the issuer, including specific conditions for ‘soft bullet’/ conditional pass-through (CPT) covered bonds.

From a rating perspective, we view positively the heightened awareness for a cover pool’s inherent liquidity provision. In particular, we consider as credit-positive the requirement to provide liquidity for the first six months within the covered bond
structure. It will reduce pressure for the cover pool administrator to sell parts of the cover pool at distressed
prices – effectively destroying value.

Soft-bullet structures are likely to become the issuance format of choice for most issuers as they allow issuers to reduce the amount of ‘liquid’ assets held within the covered bond structure.

We understand that the enhanced clarity surrounding the special supervision and administration will provide investors with more clarity surrounding the worst case: a ‘stand-alone’ cover pool having to service outstanding covered bonds. We believe that enhanced transparency and homogeneity will be welcomed by investors. They often lack resources to commission legal opinions or engage in discussions with regulators or insolvency practitioners – elements that typically allow rating agencies to gain sufficient comfort on the cover pools status upon an issuer’s insolvency.

We also view positively that the EBA positions covered bonds as a ‘credit product’. Quarterly cover pool reporting will become obligatory for issuers highlighting that the evolution of risks needs to be regularly monitored by investors.

‘The icing’

To achieve preferential risk weightings under the CRR/CRD IV as well as Solvency II, the EBA proposes to add: more-detailed credit measures into the regulation (including definitions for eligible cover assets); the requirement to keep the loan-to-value thresholds current; and a one-size-fits-all minimum overcollateralisation of 5%.

We believe the exclusive definition of eligible cover assets does not bode well for the acknowledgement that covered bonds are a credit product. From a credit-risk standpoint, we firmly believe that even SMEs can support high credit quality instruments – in particular when originated in the normal course of business and maintained on the balance sheet of the issuer. The absence of a clear Europe-wide definition of what constitutes an SME, and the challenge to establish a similar, transparent credit-risk indicator for SME’s (as e.g. the LTV for mortgages) currently does not facilitate the restriction of cover assets to the prime segment – for now. In light of the European Commission’s Capital Markets Union (CMU), which aims to foster SMEs, and our view that markets might agree on comparable creditrisk indicators for SME’s over time, we believe the final proposal should not rule out the widening of eligible assets to granular pools of assets with a predictable risk profile.

Further, an increased one-size-fits-all overcollateralisation creates a false sense of security for investors. Even within the same jurisdiction and within the limits of the same covered bond regime, the combination of and interaction between risks (credit risk, residual market risk and, notably, asset-liability mismatch risk) can significantly vary between issuers and their covered bonds. We do not believe that uniform requirements across issuers will provide the same credit protection. Similar to the Pillar II requirements in normal banking regulation, supervisors should have the ability to establish and publish individual overcollateralisation levels that allow a cover pool to withstand a pre-defined level of stress.

‘The cherry on top’

The proposal highlights areas that national regulators could focus on to improve their frameworks, in order to foster investor acceptance. This includes the restriction to a single asset type or geographic focus, or the way and frequency that loan-to-value is measured (difference between market value and prudent mortgage-lending value).

We believe the additional stress-testing requirements, currently only part of the voluntary convergence, should become an integral part of preferential risk weightings.

The ECB: A Role Model for Investors?

As of end November 2016, the ECB was the single largest covered bond investor, with holdings of more than EUR 200bn accumulated during the third covered bond purchase programme (CBBP3). The ECB already holds 30% of eligible covered bonds on its balance sheet (up from about 18% a year ago), and its holdings in individual issuances can be as high as 70% of the outstanding volume. Any ECB action will have a significant impact on the market and liquidity of this asset class.

The CBBP3 has already had a significant impact on the covered bond market, resulting in a significant spread compression between ‘core’ and ‘peripheral’ markets. In the view of many investors the missing credit spread differentiation has converted covered bonds into a ‘rates’ product. The ECB has almost siphoned off primary and secondary markets and itself needed to reduce the volume of monthly purchases under the programme. Still, the programme has been extended by nine months, to end in December 2017.

Investors feel crowded out. They cannot replace maturing covered bonds as the ECB is active in primary and secondary markets. The end of the CBBP3 will have a significant impact on the covered bond market, and a well-timed and well-managed end is of crucial importance.

The ECB’s annual update of the collateral framework seems simple as the changes are rather subtle, for example, to collateral haircuts. However, we believe the update provides something to consider for traditional covered bond investors. The ECB highlights two aspects that diligent covered bond investors should always monitor: 1. how does the credit quality of covered bonds evolve over time; and 2. what is the impact of maturity extensions (soft bullets, as well as conditional-pass-through covered bonds – CPTs).

The ECB’s changes will make more information available to investors, who will then become able to validate their credit views. The enhanced transparency will benefit the market, as pricing will eventually again have to reflect credit differences rather than the current supply-demand imbalances.

  1. New disclosure requirements for rating agencies

    Regulators generally try to reduce reliance on ratings, but these still play a crucial role for the ECB’s haircuts in the collateral framework. Forming an independent credit opinion for covered bonds is, in contrast to ECB-eligible securitisations, not really facilitated, as issuers do not provide a very high level of transparency on their cover pool risk structure. Regular and very detailed reporting is not required in most covered bond legal frameworks, and the industry has only recently made progress with the introduction of the ECBC’s Covered Bond Label as well as a more standardised reporting format (the Harmonised Transparency Template – HTT).

    Most investors rely on the credit assessment performed by credit rating agencies (CRAs), and the level of sophistication investors apply for their own assessments can vary significantly. Monitoring the composition of the cover pool is a starting point, but what matters is the impact of those changes on the covered bonds’ credit quality. While CRAs might have diverging views on the level of credit risk and the impact of market risk, we believe that the regular provision of different views will give investors the needed insight into a covered bond programme’s resilience against adverse shocks.

  2. Consultation on the treatment of soft bullets and CPTs

    The ECB also announced that in the second half of 2017, it will look into soft-bullet or conditional pass-through covered bonds, including those issued at floating rates.

    Retained covered bonds have been a lifeline for some banks in terms of providing liquidity, and we welcome that the ECB currently does not intend to go as far as the Swedish central bank, which disallowed the use of ‘self-issued’ covered bonds as collateral.

    In terms of financial stability, we view positively that the use of such instruments will not become prohibited, and will only become an economically less-interesting liquidity option. At the same time, we view the widened application to publicly placed soft bullets or CPTs as a double-edged sword.

    Soft bullets and CPTs allow a mitigation of liquidity risk, and we expect their use to become the new standard. We believe the ECB needs to find a well-balanced change to its haircut framework to facilitate the increased use of such credit-positive issuance formats.

Scope Ratings’ full covered bond outlook can be accessed here. This Article was originally published in Market Insights & Updates – EMF-ECBC Monthly newsletter in December 2016.

Driving a Thriving Energy Renovation Market Through Stable Financial Incentives

riccardo-viaggi_blogBy Riccardo Viaggi, Secretary General, European Builders Confederation

The construction sector is one of the main pillars of the European economy and provides solutions for social, climate and energy challenges. By making up for 9% of the GDP of the European Union (EU) with its total turnover of €1,241 billion in 2015, it is in fact the single industrial sector with the highest contribution to the EU’s GDP. There are 3 million enterprises active in this sector, 92% of which have less than 10 workers. Furthermore, construction companies employ a direct workforce of 18 million people, adding to the sectors’ vital importance for our society.

However, the construction sector and its SMEs were severely hit by the financial crisis, suffering from the double-dip recession close to the 2008 meltdown. Since then the construction industry has been shrinking. But businesses are seeing some encouraging signs, which would benefit both the sector and the European Union as a whole, because every job created in construction results in two additional jobs elsewhere, as a Commission analysis claims. Hence it is of vital importance to bring the construction sector back on track.

The Renovation Market as a Key Opportunity

The most promising way to put the construction sector up to its old strength is by stimulating the renovation sector, which represented 57% of the construction sector’s turnover in 2015, a strong increase from 47% in 2005. A constantly growing part of this work is made up by energy renovation works. In fact, buildings are responsible for about 41% of total energy consumption and thus form an integral part in reaching the goals set within the 2030 framework for climate and energy, and in achieving the COP21 commitments. Compensating for other sectors where it is even more difficult or less cost effective to reduce emissions, buildings need to move towards being “nearly-zero carbon”. A promising chance for the construction sector to return to its state before the crisis hit Europe and even excel it.

In 2015 energy efficiency improvement works were worth over €100 billion, roughly 15% of the total turnover of construction activities in the EU. The vast majority of this turnover is created in the housing sector. A continuous increase in the coming years has the potential to boost the EU’s energy performance and to increase employment numbers, especially among young people in local areas. In 2015 energy renovation works employed directly close to 900,000 people.

Financing Energy Efficiency is the Biggest Challenge

However, one of the biggest issues hampering the increase of energy renovations lies in the structure of the existing building stock and its related financing possibilities.

75% of the square meters in the existing housing stock in the EU lie in residential buildings. Considering that about 65% of the energy renovation works are done in this kind of housing stock, it is also the most important sector for construction companies. In fact, by looking at the data in a bit more detail it becomes visible that 70% of people in the EU live in a self-owned flat and about 60% of the EU population in an individual house. It is also worth noting that about 43% of the people who own a house don’t have a mortgage on it. Therefore, split incentive issues between landlords and tenants are less of a problem. Instead, providing private landlords with information and adequate as well as attractive financial incentives to enhance the energy efficiency of their building is one of the main tasks ahead.

The challenge of boosting the energy efficiency of existing buildings can only be met if sufficient and stable financial incentives are made available and easily accessible. Indeed, energy efficiency in housing is an interesting issue for homeowners as European households spend on average 6% of their expenses on heating/cooling. Nonetheless, it is slowed down by the fact that upfront costs are often high with a long return on investment. Therefore, it is essential that private owners/tenants are put in a position where they can afford to start retrofitting works to improve the energy performance of their building.

The European Builders Confederation Supports the Energy Efficient Mortgage Initiative

The European Builders Confederation thus considers the European Energy Efficient Mortgage initiative (see here) of the European Mortgage Federation – European Covered Bond Council (EMF-ECBC) an effective way to unlock the market potential and supports its launch. This initiative offers better borrowing rates on mortgages in return for either purchasing more energy efficient homes or committing to implement energy saving works within properties via the use of preferential interest rates. In this way it gives incentives to new homeowners to invest in energy efficiency measures and thus to strongly reduce the total energy consumption of buildings in the EU.

Boosting the energy renovation market is indispensable to help the EU reach its ambitious energy and climate goals. Additionally, it offers the chance to develop a true energy renovation market that can boost the economy, because the renovation of the building stock is a labour-intensive activity. A prediction by Ehrhardt-Martinez and Laitner (2008) for example states that 8.1 jobs, directly and indirectly related to the construction sector, are created per €1 million invested in energy renovation: a fact that does not only help the construction sector out of the still tangible crisis but also gives a push to the EU economy as a whole.

riccardo-viaggi_blog_infographicThis article was originally published in the November 2016 edition of the EMF-ECBC Market Insights and Updates newsletter.

Negative Yields & Negative Net Supply of Euro Benchmark Covered Bonds

bernd-volkBy Bernd Volk, Director, Deutsche Bank

Given the current environment, fixed income assets are undoubtedly expensive. As of the 24th of October 2016, the share of negative yielding bonds in the iBoxx EUR Covered index was 74%. This compares to 45% in the case of the iBoxx EUR Sovereign index. Peripheral countries account for 23.7% in the iBoxx EUR Covered (Spain 15.5%, Italy 6.5%, Ireland 1%, Portugal 0.6%) compared to 38.6% in the iBoxx EUR Sovereign (Italy 23.9%, Spain 12.8%, Ireland 2%).

Even though a part of the difference in the share of negative yielding bonds between the iBoxx EUR Covered and the iBoxx EUR Sovereign can be explained by the country distribution (and also by differences in duration), most euro area covered bonds trade tight versus underlying sovereign bonds. Moreover, on top of historically low absolute yields, also versus swaps, covered bonds trade close to historically tight levels. However, with no covered bond investor having suffered a loss in recent history, in contrast to sovereign bonds, relative value remains an open discussion, particularly in the case of covered bond markets that are relatively small and therefore easier to exempt from losses.

volk-fig-1     volk-fig-1-2

CBPP3 tapering happening already

Generally, settlements under the European Central Bank’s (ECB) covered bond purchase programme (CBPP3) were significantly lower after the summer break compared to settlements before the summer break. In recent weeks, the CBPP3 purchase rate was at the lowest since the programme started. Mainly driven by low issuance of EUR benchmark covered bonds by euro area banks, average weekly purchases under CBPP3 have amounted to EUR 1bn since July compared to EUR 1.7bn in the first half of the year.

Hence, there is some kind of covered bond tapering, which might be due to lack of available bonds or due to relative value considerations by the ECB. The volume of covered bonds purchased by the ECB under CBPP3 as a percentage of volume purchased under PSPP was only 6% in September 2016, the second lowest monthly level since the start of PSPP in March 2015 (after 4.7% in July 2016), comparing to a high of 26.2% in March 2015, 24% in April 2015, and 19.4% in May 2015.

In total, the ECB held EUR 196.5bn of covered bonds under CBPP3 as of the 21st of October 2016. Together with CBPP1/2, the ECB held EUR 218bn of covered bonds. As this compares to EUR 550bn of covered bonds issued by euro area banks in the iBoxx EUR Covered, the ECB holds 40% of the thereby defined public market. However, the total volume of euro denominated covered bonds “issued” by euro area banks registered in the ECB collateral database, including retained covered bonds and private placements, amounts to EUR 1050bn. Consequently, in this respect, the ECB holdings under CBPP1-3 account for only 21%.

Uncertainty regarding CBPP3 duration

The ECB press conference on the 20th of October 2016 did not provide new insights regarding quantitative easing (QE) extension or tapering. Technical changes to enable the ECB to continue sourcing the significant monthly QE volume it targets could be announced at the December 2016 meeting. However, ECB Governing Council member Ewald Nowotny is quoted as saying on the 24th of October (at a speech on wider policy issues at the Vienna University of Economics & Business regarding covered bonds): “That is an individual area where we have reached limits. In the meantime, we have enough other investment options.

The question remains if the ECB will formally end CBPP3 before the ending of ECB QE or during tapering of ECB QE. On the one hand, CBPP3 started four months’ earlier than PSPP. Moreover, the ECB may want to save itself from what happened with CBPP2, which was closed due to lack of available bonds. On the other hand, as long as ECB QE is running and the ECB does not see CPI inflation moving closer to its target level of “close but below 2%”, the ECB may want to keep its flexibility regarding asset purchases. In this respect, exiting CBPP3 earlier than ECB QE would take away a comfortable purchase channel, i.e. purchasing covered bonds in the primary market for euro benchmark covered bonds. Moreover, at the introduction of CBPP3, the ECB highlighted that the programme is “very different” to CBPP 1 and CBPP2. Hence, any comparison between CBPP3 and CBPP1/2 seems challenging.

Reinvestments of ECB CBPP3 holdings

In December 2015, the ECB announced the reinvestment of maturing bonds. Given the wording (“reinvest the principal payments on the securities purchased under the APP as they mature, for as long as necessary”), the announcement seems to refer only to CBPP3 and not to the ECB holdings under CBPP1 and CBPP2 (amounting to EUR 14.281bn and EUR 7.115bn respectively as of the 21st of October). Given that the ECB holds EUR 196.5bn of covered bonds under CBPP3 as of the 21stof October, reinvestments are likely to amount to over EUR 10bn in 2017 and over EUR 15bn from 2018 to 2022.

Negative net supply of euro benchmark covered bonds YTD

With only EUR 15bn of new EUR benchmark covered bonds, primary market activity regarding euro benchmark covered bonds in Q3 2016 was at the lowest Q3 level in euro area history, followed by EUR 15.2bn in Q3 2012, EUR 17.2bn in Q3 2002 and EUR 17.5bn Q3 2008.

As of the 24th of October, euro benchmark covered bond issuance amounted to EUR 7.2bn compared to EUR 16.7bn in October 2015. Total year-to-date (ytd) issuance of euro benchmark covered bonds amounted to EUR 115.1bn compared to EUR 122bn in 2015 ytd. Net supply amounted to minus EUR 14.5bn ytd compared to positive net supply of EUR 6bn in 2015 ytd. Overall, the high negative net  supply supported tight spreads of covered bonds.


With a share of 18%, German issuers rank highest regarding ytd issuance of euro benchmark covered bonds, followed by French issuers (17%), Canadian (11%) and Spanish issuers (9%). While non-euro area banks provided a remarkable share of 38.2%, with 61.8%, euro area banks still dominated.

Euro benchmark covered bond redemptions until year-end amount to EUR 15.3bn, with EUR 13.3bn being from euro area banks. There seems also no indication for a massive increase of supply until year-end. In 2017, euro benchmark covered bond redemptions will be by EUR 30bn lower than in 2016 (EUR 147bn), amounting to EUR 116.5bn.With EUR 26.1bn, Spanish issuers again face the highest redemptions in 2017, even though declining significantly from the EUR 38.5bn in 2016. French and German issuers follow with EUR 23.5bn and 15.4bn respectively. Overall, given the lower redemptions in 2017 and assuming primary market activity in 2017 would be similar to 2016, 2017 could become a year of positive net supply.


Extendible covered bonds – increasingly important

Besides ECB purchases under CBPP3 and new issuance volumes, also covered bond structures remain in focus. Given the increasing issuance and also numerous conversions due to consent solicitations in recent years, the share of extendible covered bonds in the iBoxx EUR Covered Index is at is at 42% already comparable to 27% in 2013.

Soft-bullet structures are already well established in the covered bond market. However, until a few years ago, public issuance of conditional pass-through (CPT) covered bonds was hardly accepted by investors. In the meantime, the issuance of CPT covered bonds has become more and more usual. Supported by the ultra-low yields and structural enhancements in prospectuses, most investors have accepted investing in CPT covered bonds. In contrast to soft-bullet covered bonds, a sale of cover pool assets during extension is an option and not an obligation in case of CPT covered bonds.

Even though some details of CPT covered bonds are similar to asset backed securities, a main strength is that CPT covered bonds can typically only be extended in case of issuer insolvency. Moreover, issuer insolvency is typically only a necessary but not a sufficient condition for pass-through (PT).

In the case of resolution of the bank issuing CPT covered bonds, the main risk seems to be that the covered bonds end up in the winding-down entity.  The switch to PT can apply to one or all series of outstanding CPT covered bonds depending on
the trigger breached. CPT covered bonds typically become PT sequentially if the issuers and the cover pool fail to pay principal at the scheduled bond maturity whereas a breach of contractual tests (amortisation/asset coverage test) triggers the switch of all outstanding series. It seems noteworthy that the PT in the case of CPT covered bonds only refers to the principal but not the interest. Covered bonds continue to pay interest during extension.

With an inaugural euro benchmark covered bond out of Poland issued in October 2016, the first legal framework based CPT covered bond had a successful market appearance. In the case of Polish CPT covered bonds, non-payment of the covered bonds at scheduled maturity leads to a mandatory legal framework based on 12 months’ maturity extension. A breach of the liquidity test or the coverage  balance test during extension would trigger the PT for all outstanding series.

Overall, the share of extendible covered bonds in the euro benchmark covered bond market is likely to increase further. While soft-bullet structures will continue to dominate the extendible covered bonds, also CPT covered bonds are likely to become more important.


This article was originally published in the October 2016 edition of the EMF-ECBC Market Insights & Updates newsletter.

EU Regulation – Different Games on a Level Playing Field

trineke-borch-jacobsenBy Trineke Borch Jacobsen, Danish Mortgage Banks’ Federation

In recent years the European financial sector has been the subject of cascades of EU regulation which has directly and indirectly impacted on the sector and its customers. The key issues include capital requirements, consumer protection, the anti-money laundering regime and the supervision of all of these various pieces of legislation.

There is no doubt that the common EU regulation of the provision of goods and services on a crossborder basis is a precondition for establishing and further developing the EU Internal Market – one of the core goals of the Union. Uniform legislation ties the Union closer together and opens up the Internal Market for goods, services and, most importantly for consumers and enterprises, market efficiency and more competition.

Not all legislation in the Union can or should be uniform, however. But issues decided by the Union for the Union must be dealt with in the same way everywhere – if not by the letter then in substance. Ideally, the issues under discussion should be carefully thought through with regards to need and proportionality, and impact assessed before being proposed by the European Commission, negotiated and balanced in the Council, democratised by the European Parliament and implemented in Member States, without goldplating or technical “improvement”.

This principle also applies when the purpose of the common efforts is to maintain financial stability through intense regulation of the financial sector. Uniform means that the legislation applies everywhere with as few adjustments as possible and is only adjusted in the pursuit of a uniform result in terms of impact of the regulation on the market.

It is, however, vital that close attention is paid to ensuring that EU regulation is proposed with a focus on issues of common interest which Member States cannot handle (better) on their own. If measures are not prioritised and are not proportional to their objective, they may prove counterproductive to the overall aim of cross-border activity and the development of the products available to European consumers.

National issues should be addressed by national legislators and targeted to the national market and national market players respectively. Issues concerning fundamental national legal infrastructure such as social services, health service and land registration and the interaction with related legislation are policy themes that probably should be reserved for national initiatives. Grey zones will emerge and be the subject of discussion, but it is important that political awareness of the distinction between national and EU legislative competence is in place.

This distinction requires self-discipline from both national legislators, with a tendency to escalate national challenges to the European level, as well as the European Institutions focusing on particular problems in one or two Member States and spreading the cure to the entire EU – whether an overall remedy is needed or not.

The level of harmonisation is often central when negotiating EU legislation. In reality any agreed level of harmonisation, whether minimum or maximum, can be bypassed by national legislators, whether intentional or not, if attention is not constantly paid to the need for the Union-game to be played on a level playing field.

This underlines the need for legislators of all kinds to recognise their mandate and its limits and also to recognise what the EU is all about, whether seen from the national perspective or the European one.

Key for the EU is the development of the Internal Market with a common market policy that aims to secure the four freedoms for citizens and businesses of the 28 Member States: to settle, work, travel and invest in other Member States.This sounds easy but it is not.

“European legal structures meet national structures in the process of implementation and strange things happen, often in rather peculiar ways which are quite unhelpful to the European principles and to the Commission’s vision of better regulation”

Sometimes common legislation becomes too detailed, and impacts on practices or conditions in Member States in unforeseen ways. In other instances, national legislators consider EU legislation to be incomplete and add layers of national legislation. Finally, on occasion, national legislators and authorities are not aware that national initiatives and practices technically convert EU legislation into something unintended and counterproductive.

The need for awareness can probably be illustrated by examples from every Member State in the EU, but I have picked some examples from Denmark covering the categories mentioned in the section above.

  1. The Mortgage Credit Directive addresses, among other things, risks for borrowers when taking out loans in a foreign currency. Developments in relation to currencies and interest rates have been a serious problem for borrowers in some Member States, but not everywhere in the Union. In some Member States, consumers took out mortgage loans in a foreign currency prior to the financial crisis. The loan was issued in a different currency to the national currency and also to the currency that the consumer’s salary was paid in.

    During the crisis, currencies evolved differently, resulting in defaults by borrowers when payments on the loan stopped converging with salary payments, and outstanding debt increased because of the development in currency exchange rates.

    A practice that was correctly assessed as a serious threat in some Member States ended up being addressed in the Mortgage Credit Directive as a general problem. The Directive defines any loan that is not in the same currency as the consumer’s income as a foreign currency loan. It introduces special requirements for the lender regarding monitoring and other measures such as an obligation to provide an alternative currency to the consumer. Many of these measures are, practically-speaking unfeasible, and give rise to problems not seen prior to this legislation.

    In border regions where citizens are employed on a cross-border basis and commute between Eurozone and non-Euro-zone countries, employees are paid in a currency which is different from that of their domestic currency and different from the currency of their loan. This means that a Dane taking out a loan in DKK on a property situated in Denmark and taxed in DKK is a foreign currency borrower when his Swedish employer pays his salary in SKR. Danish mortgage banks cannot issue loans in SKR, meaning that a Danish mortgage loan can no longer be offered to this kind of borrower. This is a problem with no upside.

    As a result mortgage banks and other mortgage loan providers in primarily border regions, but also in other instances where the currency of the income and the loan is not the same, now face legal problems and transaction difficulties when offering loans that are otherwise uncontroversial. This is not the way to encourage cross-border activities, but Member States will have to deal with it. This example illustrates what happens when specific issues are dealt with by general measures.

  2. In Denmark lenders have a special obligation to mark loans with a risk indication – a ”Traffic Light” – in green, yellow or red warning the borrower in degrees about the risky characteristics of any loan on offer.

    This comes on top of the EU information requirements in the Consumer Credit Directive (SECCI) and the Mortgage Credit Directive (ESIS), plus their respective marketing rules. The mortgage industry has never succeeded in obtaining a definition of risk in this context, but all loans are nonetheless marked with a risk warning.

  3. In recognition of the huge volume of information that lenders are obliged to provide to borrowers wanting to take out a mortgage loan, an expert committee under the previous government – in the process of assessing the mobility in the Danish mortgage market – made a recommendation that mortgage banks should agree on and comply with “common principles for the compilation of loan documents”. Considering that 22 different legal acts – EU and national – impact on the communication between lender and borrower, there is a lot of complex material to deal with. The industry has highlighted this as a concern for years.

    But with this recommendation, the government and FSA have obliged the industry to negotiate another layer of information with the consumer representatives. The objective is to explain to the borrower how to navigate through the information and to require the lender to organise the documents so that they are provided in the same way.

    The measure makes good sense but this area is already heavily regulated by the EU. Nonetheless the FSA chaired the negotiations and will oversee the implementation of and compliance with the agreement, as with any other piece of legislation. It enters into force in February 2017.

  4. By January 2017, a new price-portal for mortgage loans will be launched in Denmark. It will enable borrowers to compare loan prices at the time of entering into the contract and by way of a simulated model (based on real data collected by the mortgage banks and reported to the National Bank, which will be responsible for doing the calculations and maintaining the data in the portal) showing how the loan performs over time in terms of costs. Technically, this is challenging and costly too and requires the design of new IT-systems for the postcontractual monitoring of loans.

    It is a legal requirement to report the data in the correct format to the National Bank and to provide the technical infrastructure in order to be able comply with the requirements. This would also be required from a new market player.

All three of these Danish innovations will make it considerably more difficult for a new EU-market player to penetrate the Danish market. They would be considered as technical hindrances and rightfully so.

To conclude – there is still some room for improvement. In the meantime different mortgage games are being played on un-level playing fields.

This article was originally published in the October 2016 edition of the monthly EMF-ECBC  Market Insights & Updates newsletter.

Covered Bond Harmonisation: Where do we stand?


This article addresses recent developments in the two areas dominating the discussion on harmonisation in the covered bond market: (1) data disclosure and transparency and (2) legal frameworks.


By Alexander Batcharov and Anne Caris, Bank of America Merrill Lynch

In the covered bond community, disclosure and transparency have been key topics in the spotlight in recent years. On the 16th of June 2015, following on from intense discussions and debates initiated in 2010 under the umbrella of the ECBC Technical Issues Working Group, the Covered Bond Label Foundation (CBLF) and the European Covered Bond Council (ECBC) announced the decision to implement the Harmonised Transparency Template (HTT) across jurisdictions for all covered bond issuers that hold the Covered Bond Label.

The HTT has come into force since 1st of January 2016 and is a binding requirement for the granting and renewal of the Covered Bond Label with a phase-in period of one year. Once fully implemented, it will have a direct impact on more than 70% of eligible covered bonds – in Europe but also globally. Singapore was the first to launch the HTT, an initiative seen as a positive and important step by market participants and regulators.

 Why the Harmonised Transparency Template (HTT)

The HTT is replacing the 14 National Transparency Templates (NTT) established for the Covered Bond Label. While they contributed to enhanced reporting practices, the NTTs have been heterogeneous and have not fully met market expectations. The HTT was put together by a Transparency Task Force (TTF) organised by the ECBC in November 2014 which consisted of 20 individuals from different countries and backgrounds (issuers, analysts, covered bond associations, data providers, etc.).

The TTF’s approach was pragmatic, keeping in mind the costs and benefits for the industry as a whole. The TTF debated at length national differences, an obstacle to full harmonisation, and ultimately reached a consensus in order to harmonise data disclosure and further enhance transparency in the covered bond market. Market participants were consulted extensively during the process – among which investors.

The HTT is notably addressing the following investors’ needs and wish list regarding disclosure:

  • Harmonised data in a more user-friendly downloadable format (i.e., available in Excel).
  • Harmonised definitions by issuers – ideally across jurisdictions and, if not possible, at least within a jurisdiction (definitions should be disclosed).
  • Harmonised timing as issuers should disclose relatively recent data.
  • Disclosure of key details – e.g. regulatory treatment, maturity structures, involved counterparties, levels of committed over-collateralisation and covered bond structures.
  • No loan by loan data was required however, being used only by a small minority of investors. The availability of historical series was seen as more important.

Work done so far

After a few months, the HTT is already global. While Singapore was the first country to adopt the HTT in February 2016, the HTT initiative was followed by several issuers across Europe shortly after – e.g. France, Italy, Spain, the UK. More countries, both European and non-European, are in the pipeline. Implementation has been smooth and has entailed:

  • An in-depth review of each new HTT to ensure consistency across countries.
  • An active dialogue with the issuers e.g., on how to improve reporting or answer any uncertainty.
  • A new logo for the HTT to flag to investors when an issuer has switched to the HTT from the NTT.

Positively, the HTT format allows issuers to further reflect their national specificities – thus enabling a flexible and exhaustive reporting as need be, in an efficient way with all the data being typically disclosed in one single file. A dual format has been highly encouraged and typically made available, or at least the Excel version, even though the later should not be a barrier to the HTT implementation.

What’s next

The HTT will remain a dynamic process in order to meet investor and issuer requirements and ensure its appropriateness as the covered bond industry further develops. For example, during the first few months of 2016, some Labelled Issuers as well as investors presented requests for minor modification of the HTT. For example, some market participants would like to have additional information on interest rate risks (i.e., before and after hedging like for currency risks), counterparty risk for swaps or conditional pass through triggers.

Any modification of the HTT will be presented to the Covered Bond Label Committee, which will consider and analyse their merits and any potential modifications agreed will be implemented in 2017. As such, with a view to collecting feedback and/ or concerns raised by Labelled Issuers during the implementation phase in 2016, the ECBC has launched a Review Process which will allow market participants to comment while minimise the sudden shifts of the HTT by only introducing changes in 2017. Such review process will guarantee that all feedback is taken into account and help preserve harmonisation efforts.


By Joost Beaumont, ABN AMRO Bank

Another key issue that is currently topping the agenda of the covered bond community is the drive for harmonisation and/or convergence of national covered bond frameworks in the EU. Back in 2014, the European Banking Authority (EBA) noted that more convergence was needed among covered bond frameworks in the EU in order to increase the safety and robustness of the covered bond instrument. It would also strengthen the EU covered bond market more generally, in the end supporting financial stability as well. Overall, the EBA identified some areas where convergence of frameworks was needed in the medium to longer term, also to continue to warrant the preferential risk weight treatment of covered bonds. The key areas were:

  • Dual recourse mechanism;
  • Segregation of cover assets and bankruptcy remoteness of covered bonds;
  • Cover pool features
  • Valuation of cover assets and LTV limits as well as other requirements on mortgage cover assets;
  • Coverage principle and legal over-collateralisation;
  • Asset and liability risk management;
  • Covered bond monitoring;
  • Role of supervisor;
  • Investor reporting.

European Commission consultation on Covered Bonds

The discussion on covered bond harmonisation was taken to another level last year, when the European Commission (EC) published a consultation paper on covered bonds in the European Union (EU). This was part of the EC’s Action Plan to build a Capital Markets Union.

The consultation paper was published at the end of September 2015 and responses could be submitted until the 6th of January 2016. It was the EC’s aim to‘evaluate signs of weaknesses and vulnerabilities in national covered bond markets as a result of the crisis, with a view to assessing the convenience of a possible future integrated European covered bond framework that could help improve funding conditions throughout the Union and facilitate cross-border investment and issuance in Member States currently facing practical or legal challenges in the development of their covered bond markets’.

The consultation was driven by the fact that covered bonds are regulated by national laws, which has resulted in fragmentation as well as inefficiencies according to the EC (and especially fragmentation between the core and peripheral countries). In order to reduce fragmentation/inefficiencies, the EC proposed several options for convergence of covered bond frameworks. These were:

  1. Voluntary convergence of Member States’covered bond laws in accordance with non-legislative coordination measures such as targeted recommendations from the Commission.
  2. An EU covered bond legislative framework seeking to harmonise existing national laws.
  3. A new EU law framework for covered bonds (29th Regime), as an alternative to national laws.

Having said that, the EC also mentioned in the consultation paper that it would take a cautious approach. Indeed, it did not want to disrupt existing covered bond markets, which have actually functioned well.

The Industry’s response to the consultation

By the 6th of January 2016, the EC had received 72 responses. In this article, we would like to highlight the response of the ECBC, as it is the main representative of the covered bond industry, including issuers, analysts, bankers, investors, rating agencies and other stakeholders.

The ECBC welcomed the EC’s cautious approach, noting that the subjects addressed in the consultation paper are of ‘crucial importance to the very different legislative frameworks that exist in Europe’. It further stressed that the reason of national differences are a ‘consequence of historical national differences in terms of mortgage markets, housing policies, consumer behaviour, insolvency law, credit and valuation regulation etc.’, and that full harmonisation of EU covered bonds laws was an ‘utopia’.

Nevertheless, the ECBC noted further that it saw room for improvement and further convergence in specific areas, as this would continue to justify the preferential regulatory treatment of covered bonds, while also enhancing transparency, which would be beneficial for investors.

Overall, the ECBC was of the view that the EC should find a balance between maintaining national covered bond legislative frameworks and establishing a common European framework. It could do so ‘by means of (i) a recommendation to encourage Member States to increase convergence and (ii) a high quality principle-based directive ensuring harmonisation of certain minimum standards’.

According to the ECBC, ‘a combination of a rec ommendation and a principle-based directive will ensure that national markets continue to function, whilst safeguarding the prominent role of covered bonds as a crisis management tool able to promote: (i) investors’ confidence; (ii) financial stability; and (iii) long-term financing’. Such a solution would also maintain competition among EU covered bond markets, which can be beneficial for investors that will then still have some different flavours to choose from.

The public hearing on 1 February

On the 1st of February 2016, a one-day public hearing on the EC’s consultation process was held in Brussels. The EC reiterated that it had no intentions to overhaul the covered bond market. Indeed, EC Commissioner Lord Hill said in his opening speech that the aim is not to have a harmonised framework, but that the goal is to see whether best practices can be used to create a more integrated market and to assess what legal barriers stand in the way. He added that the EC does not want to hurt a well-functioning market, which was in line with general feedback from most participants. The general message from participants at the conference was that an integrated EU framework for covered bonds would not result in a material change in pricing or increase in the investor base. Therefore, a pan-EU framework should be flexible and principle-based, if any.

It seems that the EC has taken aboard these considerations, although it said in its first CMU Status Report that harmonisation would result in better comparability of national covered bond frameworks, which could result in deeper, more liquid and more robust national markets. Meanwhile, it also mentioned that participants had ‘encouraged the Commission Services to explore further the potential for greater market integration based on high-level principles, respecting national specificities and building on frameworks that are currently working well’. At the time of writing, the EC considers the next steps, which are expected later in 2016.

Convergence: where do we need to go?

We, the authors, agree the view that if established, a harmonised covered bond framework should be high-level and principle based. Overall, however, we wonder whether it is really necessary to move to an integrated EU covered bond framework. In our view, the EBA best practices already provide a sufficient incentive for convergence of covered bond frameworks, while also harmonising reporting standards. The EBA has been clear that jurisdictions need to implement the best practices in some key areas in order to keep warranted the preferential risk-weight treatment of covered bonds. If imple mented, we expect that this will be a sufficient incentive for countries to properly implement these, lessening the need for additional EU wide regulation. The update of the Dutch covered bond law as of the 1st of January 2015 was for instance according to the lines of the EBA best practices, and could be an example for other countries.

What is more, we see a risk that the setup of a pan-EU covered bond framework could create some uncertainty, harming an already well-functioning market. More important is that covered bond frameworks will continue to show differences, which we do not see as a bad thing. It often reflects national specifics (e.g. legal, housing) and it also offers room for diversification. In the end, harmonisation/strengthening covered bond frameworks is a good thing, but it is no panacea.

This article is taken from the 2016 edition of the ECBC’s European Covered Bond Fact Book, the full copy of which can be accessed here.

The state of play of covered bond harmonisation was also discussed at the 24th ECBC Plenary Meeting in Düsseldorf in September 2016. Our video presents the highlights of the discussions:

The Green Side of Success

bodo-winkler2By Bodo Winkler, Head of Investor Relations & Credit Treasury, Berlin Hyp AG

Following the successful issue of the first Green Pfandbrief in April 2015, Berlin Hyp placed its first senior unsecured green bond in benchmark format on the market on the 19th of September 2016, making the bank the first issuer to offer green bonds in more than one asset class. Berlin Hyp is also the first bank to document and publish a green bond programme that foresees and defines issues in both asset classes. The proceeds from the bond are always used to refinance loans for the acquisition, renovation or development of green buildings.

Over the last few years, the market for green bonds, where the proceeds from the issue are used for defined projects with a positive impact on the environment, has seen a rapid development. The market segment was only established in 2007 when the European Investment Bank (EIB) issued its first Climate Awareness Bond. Multilateral and national aid and development institutions initially dominated the market, with the first banks not appearing on the scene with euro benchmark bonds until 2015, when Berlin Hyp issued its first Green Pfandbrief. Since then, various other banks have followed suit, primarily from Europe and China, but only with unsecured bonds. The volume of outstanding bonds on the green bond market has at least doubled on an annual basis since 2012 and now exceeds the USD 150 billion mark.

Hardly any other market is experiencing such dynamic growth. In the current year, green bonds with a value of around USD 60 billion have been issued, well above the issue volume of around USD 48 billion for the full year 2015. The breakdown of issuers is also an indication of the huge growth potential of the market. For the first time, development banks rank second only behind banks which accounted for more than one third of the issues to date.

The reasons why not even more banks have yet entered the market are varied. The fact that green bonds require much more preparation than conventional bonds appears to be a key factor for many banks. In addition, the intended use of the proceeds of the issue must be clearly defined in detail. Processes for selecting projects must be established and it must be ensured that the proceeds are only used for suitable projects. Investors also demand an annual report on the actual use of the proceeds and the specific impacts of the projects on the environment. Finally, the sustainable effect of a green bond needs to be verified by an independent body or auditing company, usually a sustainability rating agency in the form of a second opinion. The issue of green covered bonds is also restricted by the artificially distorted and low spread as a result of the European Central Bank’s (ECB) purchase programme.

“The benefits of green bonds are evident – especially in the real estate sector.”

Real estate, depending on the source quoted, accounts for 30-40% of the energy needs and is responsible for around one third of CO² emissions. The bank supports the financing of energy-efficient buildings by granting a discount of between five and 10 basis points for loans. It thereby actively contributes to reducing energy needs and CO² emissions. The issue of sustainability is also an integral part of Berlin Hyp’s corporate culture. The financing of green buildings and their refinancing via green bonds represents some of the sustainability measures that directly relate to its core business: commercial real estate financing. After all, it offers investors added value that considerably exceeds the interest rate and own creditworthiness. In return, green bonds offer the bank the opportunity to broaden its own investor base.

While Berlin Hyp has attracted 15 new investors with its Green Pfandbrief and generated an order book that was oversubscribed by a factor of four, the order book for the green unsecured bond had as many as 35 investors who had never subscribed to a Berlin Hyp bond before. The composition of the order book, almost oversubscribed by a factor of two and a half, was more international than any other of the bank’s previous unsecured benchmark bonds. While German investors generally account for around 80 of such issues, almost half of the green bonds went abroad.

These facts could also encourage other banks to refinance loans secured by suitable real estate via green bonds. This would be highly welcome. If this is achieved through covered bonds, then all the better! The Initiative on Energy Efficient Mortgages launched by the EMF-ECBC on the 21st of September 2016 could make another important contribution towards this.

This article was originally published in the September 2016 edition of the EMF-ECBC Market Insights & Updates newsletter.

Bodo Winkler spoke about green financing at the 24th ECBC Plenary meeting in Düsseldorf on the 14th of September 2016. Watch the highlights of the panel debate below: