November 26, 2018

European Parliament, or EP, published report on the proposal for a regulation of the European Parliament and of the Council regarding exposures in the form of covered bonds. The proposed regulation would amend the Capital Requirements Regulation (Regulation No 575/2013). The report was tabled for the first reading at the Plenary session. It includes draft of European Parliament legislative resolution, procedure of the committee responsible, and information on final vote by roll call in the committee responsible.

In light of the opinion of EBA, it is appropriate to amend CRR by adding additional requirements for covered bonds, thus strengthening the quality of covered bonds eligible for favorable capital treatment, as provided for in Article 129 of that Regulation. Article 129 of CRR grants, under certain conditions, preferential treatment to covered bonds. The report states that only a limited number of national covered bond frameworks allow the inclusion of residential or commercial mortgage-backed securities. The use of such structures is decreasing and is considered to add unnecessary complexity to the covered bond programs. It is thus appropriate to eliminate the use of such structures as eligible assets altogether. 

Moreover, Article 129(1) of CRR establishes the loan-to-value (LTV) limits for mortgage and ship assets but does not specify how those limits are to be applied, which may lead to uncertainty. The LTV limits should be applied as soft coverage limits, meaning that while there are no limits to the size of an underlying loan, such a loan can only act as collateral within the LTV limits imposed on the assets. It is appropriate to specify that the LTV limits determine the portion of the loan contributing to the coverage of the covered bond. To ensure greater clarity, the report states that it should also be specified that the LTV limits are applicable throughout the entire maturity of the loan. The actual LTV should not change but remain at the limit of 80% of the value of the property for residential loans and at the limit of 60% of the value of the property for commercial loans and ships.

To further enhance the quality of the covered bonds that receive the preferential capital treatment as provided for in Article 129 of CRR, that preferential treatment should be subject to a minimum level of overcollateralization, meaning a level of collateral exceeding the coverage requirements as referred to in Article 15 of the EU directive on the issue of covered bonds and covered bond public supervision. Member states can decide to apply a higher minimum level of overcollateralization to covered bonds issued by credit institutions located in their territory, without preventing other covered bonds with a lower minimum level of overcollateralization that comply with this Regulation from benefiting from its provisions. Such a requirement serves the purpose of mitigating the most relevant risks arising in case of the issuer’s insolvency or resolution. As per the report, CRR should be amended accordingly.

This report also states that the proposed regulation should be applied in conjunction with the EU Directive on the issue of covered bonds and covered bond public supervision and amending the Undertakings for Collective Investment in Transferable Securities Directive (2009/65/EC) and the Bank Resolution and Recovery Directive or BRRD (2014/59/EU). To ensure the consistent application of the new framework establishing the structural features of the issue of covered bonds and the amended requirements for preferential treatment, the application of this proposed Regulation should be deferred to coincide with the date from which member states are to apply the provisions transposing that Directive.

 

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Keywords: Europe, EU, Banking, Securities, CRR, Covered Bonds, BRRD, UCITS, Report for Plenary, European Parliament

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