Thoughts from Barcelona: Parliament’s response

28 Sep 2017

In my previous post I commented on the speech by Didier Millerot, the man responsible for the forthcoming covered bond directive. Another keynote in Barcelona was a response to this by Bernd Lucke MEP, the rapporteur for the directive in the European Parliament.

Mr Lucke pointed out that the fact that he was the rapporteur for parliament on this topic already suggested that parliament was ‘relaxed’ (his word) about a more principles based approach to covered bond regulation. He contrasted the natural tendency of parliament to harmonise and centralise rules to his political group’s greater emphasis on national sovereignty in law making. In this he was in line with Mr Millerot’s emphasis on a covered bond directive, rather than covered bond regulations.

Many of Mr Lucke’s comments were supportive of the EBA’s paper and Commission’s position as outlined by Mr Millerot. For example, there seems to be an emerging consensus with regard to new rules for liquidity extensions (which will not be popular with a lot of issuers) and a reluctance, but not total refusal, to accept ships as collateral.
One of the biggest areas of disagreement was on minimum over-collateralisation where he, like many others, consider a standard level to be overly simplistic. I did not find that opinion particularly surprising.
But one new suggestion which I haven’t heard elsewhere before is that the distinction between tiers of covered bonds (premium, ordinary or ESN) should be ‘encouraged’ in the national legislation – rather than merely be a function of EU law. Of course some national legislations make minor distinctions already between asset classes, for example to require more over-collateralisation for one asset class.

But none to my knowledge have ever enshrined the idea of a two-tier covered bond in national laws. I admit that I don’t fully understand. For me the ‘tiering’ of covered bonds only makes sense in prudential treatment, which is an EU not a national-level competency. What is the point in dividing asset classes by quality tiering in national level rules? But we should as an industry think through the proposal and its implications properly.
Risk weight differentials
Another new line of thought, rarely heard in covered bond discussions recently, was also an explanation for one of the more enigmatic passages in the European Parliament paper: the passing comment that risk weights should reflect underlying risks. Yes of course they should, why was this passage in there?
It seems that this was all that was left of a more detailed discussion on the distortion caused by the risk weight differential between covered bonds and government bonds. This, the biggest distortion between risk weights and market assessment of risks, is something that was deemed too politically difficult for now but there is apparently growing support to reconsider this topic in parliament, including interestingly from the greens. I suspect we might be revisiting this topic soon.

On the subject of green, another comment that Mr Lucke made is about the eligibility of green covered bonds for prudential treatment. But that is worth an entire separate article, to follow.

In the meantime, I highly recommend that you listen to the full speech, available here.

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