Mutual recognition of equivalent regimes. (2) Equivalent?

31 May 2016 | Richard Kemmish

In my previous post I mentioned the possibility of European Union rules recognising covered bonds from non-EEA countries. There is an important qualification though – they must be good assets to invest in, which can be approximated as being at least equivalent to covered bonds from the European Union. But what does that mean in practice?

The definitions of what a good covered bond is within Europe clearly fall short of ideal. The UCITS definition – in particular the requirement to maintain a supervisory regime to protect covered bond holders – is a good starting point. But it is overladen in practice with many inferences. A special supervisory regime implies more than it says.

The other main definition – article 129 of the Capital Requirements Regulations is both heavily negotiated (the fact that France is mentioned three times in an article that is supposed to be non-country specific is a giveaway) and susceptible to different interpretations (see my post of 10th May).

Commission of course recognises this and a future definition will most likely heavily refer to a definition that is not currently enshrined in law – the EBA’s best practice guidelines. This seems increasingly more likely than a more proscriptive ‘29th regime’ definition (which would clearly be even less suitable for bonds from outside the Union).

Would these EBA guidelines be sufficient to define a non-EEA covered bond too?

To the extent that they define high quality covered bonds with good supervision, without implicit support or an assumption of systemic importance – both big differences from the pre-crisis assumptions - and without proscribing specific details about how to achieve these outcomes, probably yes.

They certainly work far better than alternatives such as a specific credit rating requirement. For the record – before anyone suggests it – this really fails because it is bond specific, not regime specific and therefore introduces ‘cliff risk’ in the event of a rating downgrade of the specific issuer.

Importantly the EBA guidelines do not assume a civil law / proscriptive regulation approach (they could easily have done). It is telling that the vast majority of non-European covered bonds so far are from common law jurisdictions where supervisory practices tend to be ‘principles based’.

Using the EBA guidelines as a criteria also enshrines its status as the definitive text book on ‘how to structure a new covered bond law’ in new jurisdictions (for which I personally am eternally grateful).

Perhaps the only area where the EBA guidelines would need to be augmented if they are to form the basis of ‘mutual recognition’ would be in the area of sovereign risks. Are safeguards needed to ensure that a sovereign default or the introduction of capital controls would not trigger a covered bond default? For example, additionally requiring that derivatives have transfer and convertibility language in them.

Hardly a problem in the existing jurisdictions, but good to put in place for when the non-European issuer base gets more diverse. Which it will.

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