* EU liquidity proposals at odds with Basel
* Spanish and Italian banks to be greatest beneficiary
* Real money investors fear crowding out by banks
By Anna Brunetti and Aimee Donnellan
FRANKFURT/LONDON, May 15 (IFR) - Europe's top banking
regulator is poised to provide covered bonds with the highest
liquidity status in the coming days, potentially giving a huge
boost to the asset class by creating a captive investor base.
Covered bonds are expected to be included alongside
sovereign assets in the top tier of the Liquidity Coverage Ratio
(LCR), which requires banks to hold enough highly liquid assets
to cover a 30-day credit crunch. If they achieve this status,
banks will be pushed to buy covered bonds to meet their
"The banking industry has put forward a very strong argument
that banks need to diversify away from buying their own
government debt," said Luca Bertalot, Head of the European
Covered Bond Council (ECBC) on the sidelines of the ICMA covered
bond conference in Frankfurt. "This will be achieved by putting
covered bonds in the Level 1 category."
Covered bonds are debt instruments backed by prime
residential mortgages and public sector assets that, due to
their dual recourse and top ratings, became the backbone of
European bank funding in the height of the financial crisis.
If the European Commission's draft circulated among national
finance ministries in the past week goes through, it would mark
a victory for both covered bonds and asset backed securities,
that could be included in the Level 2 bracket.
According to parts of the drafts seen by IFR, it would allow
certain covered bonds to be included in the Level 1 class, which
they could cover by up to 70%, with a 7 % haircut on their
As a concession to both Northern European players and
peripheral ones, covered bonds of at least EUR500m and AA-
rating - which include Swedish, Germans and Danish bonds - would
now make it to the Level 1 class, while bonds of minimum EUR250m
and single A rating - such as Italian and Spanish notes - would
count as Level 2 buffers.
It would also recognise ABS other than RMBS as highly liquid
assets, under Level 2 class and with a 25 % haircut.
This compares favourably with significantly stricter rules
outlined by the Basel Committee on Banking Supervision, which
allows covered bonds to form only 40% of the liquidity buffer
with a 15% discount, and would have included only some type of
RMBS, while leaving all other ABS class out of the scope of the
"The battle is in Brussels but the war is with Basel," said
the ECBC's Bertalot. "I have to salute the efforts of the
Commission to not stick to what Basel said and instead decide to
The inclusion of covered bonds in the top liquidity bucket
is expected to have a measurable pricing impact on banks'
funding. Bank treasuries will be incentivised to diversify away
from buying their own government bonds in favour of secured bank
"This will of course drive spreads tighter but it's all
about how the regulation is phrased and how they select what
banks are eligible," said Armin Peter, head of debt capital
markets EMEA syndicate at UBS.
"It may work out that it only helps the Danish banks because
they don't have enough access to eligible assets and therefore
need help with liquidity," he said.
However, speaking on the sidelines of the ICMA covered bond
conference in Frankfurt, bankers pointed to the 61% bank
treasury allocation of Swedbank's 1bn seven-year covered bond
that was sold this week as evidence of the impact the LCR could
have on demand.
"We'll see the real impact of all of this when a AA- rated
issuer comes to the market with a bit of yield and then we'll
see enormous order books from bank investors that will pile into
the market," said a covered bond banker.
Italian and Spanish banks are expected to be the greatest
beneficiary of the LCR decision despite the fact that their
covered bonds already often price significantly through their
However, not everyone is excited about the upgrade of
covered bonds to Level 1 assets. Georg Grodzki, head of
pan-European credit research at L&G believes that covered bonds
have enough preferential treatment and any further support may
prevent real money investors from buying the product.
"To the extent that covered bonds become very attractive to
banks they may become less attractive to real money accounts
because they will become too expensive. Regulators need to make
sure that certain investors are not adversely effected by the
cost of covered bonds going up." he said.
(Reporting By Aimee Donnellan and Anna Brunetti, editing by
Helene Durand and Anil Mayre)