European Union: Capital Markets Union - Part 2: Two Options For A Pan-European Covered Bond Framework

As part of the European Commission's plan to build a Capital Markets Union (CMU), the Commission has launched a consultation on the possibility of establishing a pan-European covered bond framework. Two policy options for advancing a reform agenda towards integration are outlined in the Commission's consultation document (Consultation Paper) on covered bonds. One option contemplates the voluntary convergence of national covered bond laws, and the other, the introduction of a dedicated EU legislative framework regulating covered bonds as a product.

This reform project will be one of the most significant, and potentially contentious, developments in the history of the covered bond market in Europe. This update, the second in our series of updates on the CMU, outlines the options for reform discussed in the Consultation Paper and the merits of market integration in relation to covered bonds.

The Unique Features of Covered Bonds

Covered bonds provide investors with both the security of a segregated portfolio of collateral as well as recourse to the issuer. They are highly rated and commonly offer an attractive short-to mid-term maturity rate (2-10 years), as well as attractive yields provided by the cashflow on the cover pool (often comprised of high-quality assets such as mortgage loans and public sector debt which conform with certain eligibility criteria).

There have been no defaults since the inception of the market in the 18th century. The dual recourse mechanism gives bondholders direct recourse to a cover pool of high-quality assets as preferred creditors, and a claim against the issuer (or an affiliated entity of the issuer) as ordinary creditors for any residual amounts not fully settled by the liquidation of the cover pool. The safety of covered bonds is further reinforced by the duty of issuers to ensure that the value of the assets in the cover pool always matches, or exceeds, the liabilities in respect of the covered bonds. During the financial crisis, the security and reliability of covered bonds was evident when issuance of covered bonds remained resilient compared to other financial instruments (for example, unsecured debt and asset-backed securities).

Strong Market Performance

Part I of the Consultation Paper summarises and assesses the main, recent market trends in European covered bond markets. It notes that European covered bond markets are one of the largest private debt markets in Europe, having performed strongly since 2003 (with only a decline in issuance in 2013, reflecting general contraction of banks' balance sheets). The strong performance is evidenced by the steady growth in global covered bond issuance, the increase in the geographic scope of the covered bond market and the increase in global covered bonds outstanding (the European market currently exceeds €2.5 trillion).

Existing National Covered Bond Frameworks

Part II of the Consultation Paper considers how the national legal frameworks and supervisory approaches across the Member States that have covered bond legislation differ significantly and have contributed to fragmentation of the covered bond markets along national lines. The national laws relating to covered bonds regulate matters such as credit institution authorisation, supervision, types and qualitative standards of eligible cover assets and disclosure.

Despite this disparity, however, a certain level of harmonisation unifies the covered bond markets in Europe as an indirect result of the prudential treatment of covered bonds under EU law. Covered bonds already benefit from favourable risk weightings and special bankruptcy protection pursuant to the Directive for Undertakings for Collective Investments in Transferable Securities,1 the Capital Requirements Regulation2 and the Bank Recovery and Resolution Directive.3 Nevertheless, the Commission adds that the national laws remain quite different and issuers often have to enhance the product's credit quality in order to make the covered bonds programme adhere to best practice.

Given the sizeable covered bond markets in Europe, some market participants have expressed the concern that implementing a new regime could disrupt an already well-functioning system. While the Commission acknowledges the positive track record of covered bonds, it believes that a more unified framework that introduces common safeguards of robustness and credit quality, and enhanced product definition, would increase the European investor base.

The Reform Agenda and Policy Options

As outlined in Part 1 of our series of briefings on the CMU, the integration of financial markets and services is at the heart of the plan for a CMU and is an essential element for growth and competition in Europe. While the covered bond market in Europe is already strong, the further integration of the European covered bond markets falls within the scope of the plan for a CMU, as fragmentation of the covered bond market is a barrier to an integrated single market for capital.

The "Covered Bond Label" of the European Covered Bond Council has been instrumental in promoting reform of covered bonds. As a market-led initiative, the Commission is concerned that it cannot fully address matters such as public supervision or the insolvency remoteness of the cover pool. If the future of reform involves legislation, then the Commission proposes two contrasting approaches for moving towards an integrated framework for covered bonds:

Option 1: Voluntary convergence of national covered bond laws

This option would leave in place the current covered bond framework, which relies on national laws and prudential treatment at EU level, but would "encourage greater convergence in covered bond laws through voluntary, non-legislative coordinative measures". The Commission would issue recommendations to Member States to implement, in their national legal frameworks, the EBA's best practices in relation to the issuance of covered bonds. In order to encourage Member States to implement the best practices, the Commission feels that it would need to consider strengthening the eligibility criteria of the cover pool assets for the existing preferential treatment under the CRR.

Option 2: EU-wide dedicated legislative framework for covered bonds

This option consists of promoting convergence "directly through a dedicated EU covered bond legislative framework which would regulate covered bonds as a legal instrument, rather than just their prudential treatment". The Commission highlights "high level elements" that could be the subject of further regulation:

  • the definition of covered bond and protection of the term;
  • covered bond issuers, supervision, and licensing requirements;
  • monitoring or supervision of the cover pool prior to the onset of the issuer's insolvency;
  • the dual recourse and insolvency/resolution regime, including the definition of the dual recourse principle;
  • segregation of the cover pool and its administration and supervision post-insolvency of the issuer;
  • eligibility requirements for the cover pool and coverage requirements;
  • market and liquidity risk mitigation requirements (e.g., with respect to hedging);
  • management of cashflow mismatches; and
  • transparency requirements.

The Consultation Paper contemplates the possibility of introducing a new European directive to harmonise the above-mentioned matters in national laws. It is worth noting that the Commission provides for a non-prescriptive approach, where it specifically suggests that the directive might combine high level principles for some matters and detailed requirements with respect to others.

Furthermore, the Commission appears to dismiss the option of introducing a directly applicable regulation that would replace some national laws on covered bonds as "challenging" at this stage "given that covered bond laws are well developed and deeply-rooted in the legal tradition of many Member States."

The Commission also seeks feedback as to whether it is preferable, as a substitute for harmonisation of the above-mentioned matters in national laws, to have an EU law framework for covered bonds. (referred to as a 29th Regime). This regime would allow issuers of covered bonds to turn voluntarily to a separate integrated framework instead of its own national laws, thus providing optionality to both issuers and investors.

Key Proposed Elements of an EU Covered Bond Framework

The Commission seeks feedback as to which option for a pan-European integrated covered bond framework is to be preferred, by 6 January 2016. Building a 29th regime that is designed to work in every Member State, despite the differences in national insolvency, tax, collateral and other relevant regimes, represents a significant task. Part III of the Consultation Paper sets out the key proposed elements for a hypothetical EU law covered bond framework.

The next update in our series of updates on the CMU will discuss some of these key elements in detail and highlight the main questions for stakeholders. If you would like to learn more about the issues in this alert, please contact any of the attorneys listed below or your usual Ropes & Gray advisor.

Footnotes

1 Directive 2009/65/EC
2 Regulation (EU) No 575/201
3 Directive 2014/59/EU

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.