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.
1. HARMONISING TRANSPARENCY
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.
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.
2. HARMONISATION OF LEGAL FRAMEWORKS
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:
- Voluntary convergence of Member States’covered bond laws in accordance with non-legislative coordination measures such as targeted recommendations from the Commission.
- An EU covered bond legislative framework seeking to harmonise existing national laws.
- 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: