LONDON, Jan 27 (IFR) - European regulators’ latest draft of CRD4 looks set to give structured covered bonds a shot in the arm as it indicates that they will be recognized as eligible assets to be used in banks’ liquidity buffers.
CRD4 will implement the Basel 3 framework into European law and, just like the Basel agreement, will require European banks to adopt a Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio from 2015.
A final text is expected to be published in September or October this year but the potential inclusion of structured covered bonds within the LCR would boost the potential demand for these instruments.
European banks have been seeking to structure covered bond instruments that would fall outside stringent legal frameworks as they look to take advantage of unused collateral and lower their funding costs.
Deutsche Pfandbriefbank has been looking at the possibility of using structured covered bonds for 2012. “High over-collateralisation requirements highlight the need for alternative approaches, for example using non-encumbered assets and analysing the possibility of structured covered bonds,” the issuer said in an investor presentation in September last year.
Meanwhile, Italian banks are also said to be among the candidates.
European Finance ministers are meeting in April and could approve the CRD4 text then, but sources have told IFR that the ministers were likely to focus more on discussing the various national finishes and how these can be accommodated within CRD4.
“I don’t know exactly when the final text will be published, but the latest draft casts more light on regulation and I think it will be great for spurring banks’ demand. That way it will also jump start the structured covered bond market,” a banker said.
A second banker said that covered bond issuers could benefit across the board as banks’ demand for the asset-class grows.
“However, many will hold back with issuance as the final details of the regulation are not totally clear,” he said.
While covered bond syndicate bankers welcome the news, it deals a blow to ABS professionals, who had hoped that securitisation might finally be seen positively be regulators too.
“The new draft gives flexibility which appears to be intended to potentially widen the range of eligible assets to certain structured covered bonds, but, based on the words on the page, ABS would be excluded,” said Nicole Rhodes, a Consultant Counsel with Allen & Overy’s London securitisation group, said.
The CRD4 draft makes a distinction between ABS issued directly by banks, that is eligible, and ABS issued by special vehicles, that is ineligible.
The latter type is the norm, as it enables to de-link the pool from the originator and achieve the bankruptcy-remoteness demanded by rating agencies.
ABS professionals, however, wonder why the draft would bother discussing securitisation if it was fully ineligible.
JP Morgan analyst Gareth Davies believes that the clause of the draft, which mentions “asset-backed instruments of high liquid and credit quality” is “designed to capture covered bond-type instruments which currently fail to meet the prescriptive definition of a covered bond outlined in Article 124 (3) and (4) (and coincidently include a significant amount of traditional Danish covered bonds)”.
Moreover, he thinks that the regulators have gone one stage further by explicitly excluding ABS with the insertion in the draft of a clause which includes, among the assets that should not be considered liquid, a securitisation special purpose entity and assets otherwise constituting securitisation positions.
Rhodes agrees: “The revised draft clearly excludes securities issued by SPVs and this is not the positive signal for the ABS market that market participants were hoping for.”
What is worse for securitisation professionals is that the current wording does not leave any room for the high-quality label that are preparing under the PCS initiative. This label could become a reality in the second quarter of this year.
Investors involved in the PCS discussions commented that regulators have stated that there would be an observation period -- over several months, possibly over a year -- to review how liquid the new product is.
According to them, this means that the door will remain open for a while for the inclusion of the PCS product into the liquidity buffer, irrespective of the Danish presidency draft.
But Rhodes is sceptical: “The text is not final and there is scope for change, but currently ABS -- including bonds issued with the proposed PCS label -- would appear not to be eligible because they would be issued by an SPV in general.” (Reporting By Josie Cox and Jean-Marc Poilpre)