Covered bonds are debt instruments secured by a cover pool of mortgage loans (property as collateral) or public-sector debt to which investors have a preferential claim in the event of default. While the nature of this preferential claim, as well as other safety features (asset eligibility and coverage, bankruptcy-remoteness and regulation) depends on the specific framework under which a covered bond is issued, it is the safety aspect that is common to all covered bonds.
Covered bonds are increasingly used in the marketplace as a funding instrument, in addition to savings deposits, senior issuances, mortgage-backed- securities, etc. The issuance of covered bonds enables credit institutions to obtain lower cost of funding in order to grant mortgage loans for housing and non-residential property as well as, in certain countries, to finance public debt. The portfolio investor has the advantage of investing in safe bonds with a relatively high return. Thus, covered bonds play an important role in the financial system.
The internationalisation of formerly domestic covered bond markets began more than 15 years ago with the introduction of a new benchmark product attracting international institutional investors and providing the necessary market liquidity.
As a consequence, many European countries have introduced new covered bond legislation or have updated existing rules to be a part of this development and to also respond to the considerable growth of mortgage lending activities in the European Union.
This evolution led to the issuance of the Covered Bond Directive which enshrines the key characteristics of the instrument and which acts also as international standard-setter.
With over EUR 2.9 trillion outstanding at the end of 2020, covered bonds play an important role in European capital markets, contributing to the efficient allocation of capital and, ultimately, economic development and recovery.
The ECBC sets out below what it considers to be the essential features of covered bonds, together
with explanatory notes.
It is intended that they be read independently from any other definition or interpretation of covered
bonds, such as those set out in the Covered Bond Directive and Article 129(1) of the Capital Requirements Regulation (CRR).
These common essential features should be understood as the ECBC’s minimum standards for covered
bonds.
Covered bonds are characterised by the following common essential features that are achieved under
special-law based frameworks or general-law based frameworks:
The CBD regulates the requirements for covered bonds, which, up to now, were only laid down in a rudimentary fashion in Article 52(4) of the UCITS Directive; this provision has been accordingly amended and now refers to the CBD, as has the Bank Recovery and Resolution Directive (BRRD). Given that the CBD will become the new single reference point for regulation related to covered bonds, various other provisions on covered bonds in other directives that refer to Article 52(4) of the UCITS Directive are thus also indirectly amended.
The regulatory discussion on the creation of the CB harmonisation package was characterised by the “principle based harmonisation” aimed at by the EU regulatory framework. This means that the EU provisions lay down the minimum requirements for secured bonds issued by credit institutions and, in a number of ways, leave room for particularities and detailed regulations at the national level; this has also been the (almost) unanimous petition of CB issuers and other market participants. This is of fundamental importance both for understanding the regulatory package and for interpreting the individual provisions.
While the CBD builds on the essential traditional quality features of covered bonds, it leaves national legislators a wide margin of leeway in shaping their national CB laws. This is also illustrated by the fact that the CBD contains both mandatory and optional provisions. Some mandatory provisions also contain optional elements, and vice-versa
The CBD consists of the following Titles:
I. Subject matter, scope and definitions (Articles 1-3)
II. Structural features of covered bonds (Articles 4-17)
III. Covered bond public supervision (Articles 18-26)
IV. Labelling (Article 27)
V. Amendments to other Directives (Articles 28-29)
VI. Final provisions (Articles 30-34)
Further information can be found in the Article 2.1 Overview of Covered Bonds of the ECBC Fact Book 2021
The delegated act of Solvency II secures a favourable treatment under Solvency II for covered bonds. A low-spread risk factors is in fact assigned to covered bond—i.e. preferential treatment under the spread risk module and concentration risk module.
1. Exposures in the form of bonds referred to Article 52(4) of Directive 2009/65/EC (covered bonds) which have been assigned to credit quality step 0 or 1 shall be assigned a risk factor stressi according to the following table.
| Credit Quality Step Duration (dur) |
0 | 1 |
| Up to 5 | 0.7% dur | min (3.5% + 0.5% · (duri – 5) ; 1) |
| More than 5 years | 0.9% dur | min (4.5% + 0.5% · (duri – 5) ; 1) |
The BRRD has important direct and indirect implications for covered bonds, particularly as it exempts CBD-compliant (or grandfathers UCITS-compliant) covered bonds from the scope of the bail-in tool, under specific conditions (Article 44(2)).
ARTICLE 44(2) – SCOPE OF BAIL-IN TOOL
“[…]
2. Resolution authorities shall not exercise the write down or conversion powers in relation to the following liabilities whether they are governed by the law of a Member State or of a third country:
[…]
(b) secured liabilities including covered bonds and liabilities in the form of financial Instruments used for hedging purposes which form an integral part of the cover pool and which according to national law are secured in a way similar to covered bonds;
[…]
Member States shall ensure that all secured assets relating to a covered bond cover pool remain unaffected, segregated and with enough funding. Neither that requirement nor point (b) of the first subparagraph shall prevent resolution authorities, where appropriate, from exercising those powers in relation to any part of a secured liability or a liability for which collateral has been pledged that exceeds the value of the assets, pledge, lien or collateral against which it is secured.”
Central to the covered bond regulations at EU Level is the Liquidity Coverage Requirement (LCR) treatment, which was specified by the European Commission through a Delegated Act under the Capital Requirements Regulation. The LCR Delegated Act—which entered into force on 1 October 2015 and will be fully implemented at the beginning of 2018 and which represents EU-wide implementation of the Basel’s LCR rules—introduces a favourable treatment for covered bonds. The treatment is specific to EU and aims to reflect credit quality, liquidity performance and the role of covered bonds in the funding markets of the EU. It allows covered bonds to be included in Level 1, 2A and 2B liquid assets for the purposes of calculating their LCR under specific criteria. Furthermore, covered bonds can be included up to 70% in the liquidity buffer (leaving 30% for the highest liquid Level 1 assets such as Level 1 government bonds).
1.
Level 1 assets shall only include assets falling under one or more of the following categories and meeting in each case the eligibility criteria laid down herein:
[…]
(f) exposures in the form of extremely high quality covered bonds, which shall comply with all of the following requirements:
(i) they are covered bonds as referred to in Article 3, point 1, of Directive (EU) 2019/2162 or they are issued before 8 July 2022 and meet the requirements set out in Article 52(4) of Directive 2009/65/EC, as applicable on the date of their issue, which makes them eligible for preferential treatment as covered bonds until their maturity;
(ii) the exposures to institutions in the cover pool meet the requirements set out in Article 129(1), point (c), and in Article 129(1a) of Regulation (EU) No 575/2013;
(iv) their issue size is at least EUR 500 million (or the equivalent amount in domestic currency);
(v) the covered bonds are assigned a credit assessment by a nominated ECAI which is at least credit quality step 1 in accordance with Article 129(4) of Regulation (EU) No 575/2013, the equivalent credit quality step in the event of a short term credit assessment or, in the absence of a credit assessment, they are assigned a 10 % risk weight in accordance with Article 129(5) of that Regulation;
(vi) the cover pool meets at all times an asset coverage requirement of at least 2 % in excess of the amount required to meet the claims attaching to the covered bonds;
[…]
1. Level 2A assets shall only include assets falling under one or more of the following categories and meeting in each case the eligibility criteria laid down herein:
[…]
(c) exposures in the form of high quality covered bonds, which shall comply with all of the following requirements:
(i) they are covered bonds as referred to in Article 3, point 1, of Directive (EU) 2019/2162 or they are issued before 8 July 2022 and meet the requirements set out in Article 52(4) of Directive 2009/65/EC, as applicable on the date of their issue, which makes them eligible for preferential treatment as covered bonds until their maturity;
(ii) the exposures to institutions in the cover pool meet the requirements set out in Article 129(1), point (c), and in Article 129(1a) of Regulation (EU) No 575/2013;
(iv) their issue size is at least EUR 250 million (or the equivalent amount in domestic currency);
(v) the covered bonds are assigned a credit assessment by a nominated ECAI which is at least credit quality step 2 in accordance with Article 129(4) of Regulation (EU) No 575/2013, the equivalent credit quality step in the event of a short term credit assessment or, in the absence of a credit assessment, they are assigned a 20 % risk weight in accordance with Article 129(5) of that Regulation;
(vi) the cover pool meets at all times an asset coverage requirement of at least 7 % in excess of the amount required to meet the claims attaching to the covered bonds. However, where covered bonds with a credit quality step 1 credit assessment do not meet the minimum issue size for extremely high quality covered bonds in accordance with point (f)(iv) of Article 10(1) but meet the requirements for high quality covered bonds laid down in points (i), (ii), (iii) and (iv), they shall instead be subject to a minimum asset coverage requirement of 2 %;
(d) exposures in the form of covered bonds issued by credit institutions in third countries, which shall comply with all of the following requirements:
(i) they are covered bonds in accordance with the national law of the third country which must define them as debt securities issued by credit institutions, or by a wholly owned subsidiary of a credit institution which guarantees the issue, and secured by a cover pool of assets, in respect of which bondholders shall have direct recourse for the repayment of principal and interest on a priority basis in the event of the issuer’s default;
(ii) the issuer and the covered bonds are subject by the national law in the third country to special public supervision designed to protect bondholders and the supervisory and regulatory arrangements applied in the third country must be at least equivalent to those applied in the Union;
(iii) the covered bonds are backed by a pool of assets of one or more of the types described in Article 129(1), points (b), (d), (f) and (g), of Regulation (EU) No 575/2013. Where the pool comprises loans secured by immovable property, the requirements set out in Article 6(2), Article 6(3), point (a), and in Article 6(5) of Directive (EU) 2019/2162 must be met;
(iv) the exposures to institutions in the cover pool meet the requirements set out in Article 129(1), point (c), and in Article 129(1a) of Regulation (EU) No 575/2013;
(v) the credit institution investing in the covered bonds and the issuer meet the transparency requirement laid down in Article 14 of Directive (EU) 2019/2162;
(vi) the covered bonds are assigned a credit assessment by a nominated ECAI which is at least credit quality step 1 in accordance with Article 129(4) of Regulation (EU) No 575/2013, the equivalent credit quality step in the event of a short term credit assessment or, in the absence of a credit assessment, they are assigned a 10 % risk weight in accordance with Article 129(5) of that Regulation; and
(vii) the cover pool meets at all times an asset coverage requirement of at least 7 % in excess of the amount required to meet the claims attaching to the covered bonds. However, where the issue size of the covered bonds is EUR 500 million (or the equivalent amount in domestic currency) or higher, they shall instead be subject to a minimum asset coverage requirement of 2 %;
[…]
1. Level 2B assets shall only include assets falling under one or more of the following categories and meeting in each case the eligibility criteria laid down herein:
[…]
(e) exposures in the form of high quality covered bonds which shall comply with all of the following requirements:
(i) they are covered bonds as referred to in Article 3(1) of Directive (EU) 2019/2162 or they are issued before 8 July 2022 and meet the requirements set out in Article 52(4) of Directive 2009/65/EC, as applicable on the date of their issue, which makes them eligible for prudential treatment as covered bonds until their maturity;
(iv) their issue size is at least EUR 250 million (or the equivalent amount in domestic currency);
(v) the covered bonds are collateralised exclusively by the assets referred to in points (a), (d)(i) and (e) of Article 129(1) of Regulation (EU) No 575/2013.
(vi) the pool of underlying assets consists exclusively of exposures which qualify for a 35 % or lower risk weight under Article 125 of Regulation (EU) No 575/2013 for credit risk;
(vii) the cover pool meets at all times an asset coverage requirement of at least 10 % in excess of the amount required to meet the claims attaching to the covered bonds;
(viii) the issuing credit institution needs to publicly disclose on a monthly basis that the cover pool meets the 10 % asset coverage requirement;
[…]
The RTS on risk mitigation techniques for OTC derivative contracts not cleared by a CCP, developed under the European Market Infrastructure Regulation, provide for a specific treatment of cover pool derivatives (derivatives entered into by covered bond issuers for the hedging of the cover pool’s market risks and included within the scope of the protective measures established by the respective covered bond regime). The RTS set out a specific set of conditions under which such cover pool derivatives, which are concluded with regard to covered bonds compliant with Article 129 of the CRR, are exempted from margin requirements in the context of bilateral clearing (i.e. clearing not executed through a CCP).
1. By way of derogation from Article 2(2) and where the conditions set out in paragraph 2 of this Article are met, counterparties may, in their risk management procedures, provide the following in relation to OTC derivative contracts concluded in connection with covered bonds:
(a) variation margin is not posted by the covered bond issuer or cover pool but is collected from its counterparty in cash and returned to its counterparty when due;
(b) initial margin is not posted or collected.
2. Paragraph 1 applies where all of the following conditions are met:
(a) the OTC derivative contract is not terminated in case of resolution or insolvency of the covered bond issuer or cover pool;
(b) the counterparty to the OTC derivative concluded with covered bond issuers or with cover pools for covered bonds ranks at least pari passu with the covered bond holders except where the counterparty to the OTC derivative concluded with covered bond issuers or with cover pools for covered bonds is the defaulting or the affected party, or waives
the pari passu rank;
(c) the OTC derivative contract is registered or recorded in the cover pool of the covered bond in accordance with national covered bond legislation;
(d) the OTC derivative contract is used only to hedge the interest rate or currency mismatches of the cover pool in relation to the covered bond;
(e) the netting set does not include OTC derivative contracts unrelated to the cover pool of the covered bond;
(f) the covered bond to which the OTC derivative contract is associated meets the requirements of paragraphs (1), (2) and
(3) of Article 129 of Regulation (EU) No 575/2013;
(g) the cover pool of the covered bond to which the OTC derivative contract is associated is subject to a regulatory collateralisation requirement of at least 102 %.
Another cornerstone is the Capital Requirements Regulation (CRR). It is based on a proposal
from the Basel Committee on Banking Supervision to revise the supervisory regulations
governing the capital adequacy of internationally active banks. The package entered into
force on 17 July 2013 and replaced the Directives 2010/76/EU, 2006/48/EC and 2006/49/EC.
Covered bonds are defined in Article 129 of the CRR.
1. To be eligible for the preferential treatment set out in paragraphs 4 and 5 of this Article, covered bonds as defined in point (1) of Article 3 of Directive (EU) 2019/2162 of the European Parliament and of the Council shall meet the requirements set out in paragraphs 3, 3a and 3b of this Article and shall be collateralised by any of the following eligible assets:
(a) exposures to or guaranteed by central governments, the ESCB central banks, public sector entities, regional governments or local authorities in the Union;
(b) exposures to or guaranteed by third country central governments, third-country central banks, multilateral development banks, international organisations that qualify for the credit quality step 1 as set out in this Chapter, and exposures to or guaranteed by third-country public sector entities, third-country regional governments or third-country local authorities that are risk weighted as exposures to institutions or central governments and central banks in accordance with Article 115(1) or (2), or Article 116(1), (2) or (4) respectively and that qualify for the credit quality step 1 as set out in this Chapter, and exposures within the meaning of this point that qualify as a minimum for the credit quality step 2 as set out in this Chapter, provided that they do not exceed 20 % of the nominal amount of outstanding covered bonds of the issuing institutions;
(c) exposures to credit institutions that qualify for credit quality step 1 or credit quality step 2, or exposures to credit institutions that qualify for credit quality step 3 where those exposures are in the form of:
(i) short‐term deposits with an original maturity not exceeding 100 days, where used to meet the cover pool liquidity buffer requirement of Article 16 of Directive (EU) 2019/2162; or
(ii) derivative contracts that meet the requirements of Article 11(1) of that Directive, where permitted by the competent authorities;
(d) loans secured by residential property up to the lesser of the principal amount of the liens that are combined with any prior liens and 80 % of the value of the pledged properties;
(e) residential loans fully guaranteed by an eligible protection provider referred to in Article 201 qualifying for the credit quality step 2 or above as set out in this Chapter, where the portion of each of the loans that is used to meet the requirement set out in this paragraph for collateralisation of the covered bond does not represent more than 80 % of the value of the corresponding residential property located in France, and where a loan-to-income ratio respects at most 33 % when the loan has been granted. There shall be no mortgage liens on the residential property when the loan is granted, and for the loans granted from 1 January 2014 the borrower shall be contractually committed not to grant such liens without the consent of the credit institution that granted the loan. The loan-to-income ratio represents the share of the gross income of the borrower that covers the reimbursement of the loan, including the interests. The protection provider shall be either a financial institution authorised and supervised by the competent authorities and subject to prudential requirements comparable to those applied to institutions in terms of robustness or an institution or an insurance undertaking. It shall establish a mutual guarantee fund or equivalent protection for insurance undertakings to absorb credit risk losses, whose calibration shall be periodically reviewed by the competent authorities. Both the credit institution and the protection provider shall carry out a creditworthiness assessment of the borrower;
(f) loans secured by commercial immovable property up to the lesser of the principal amount of the liens that are combined with any prior liens and 60 % of the value of the pledged properties. Loans secured by commercial immovable property are eligible where the loan‐to‐value ratio of 60 % is exceeded up to a maximum level of 70 % if the value of the total assets pledged as collateral for the covered bonds exceed the nominal amount outstanding on the covered bond by at least 10 %, and the bondholders’ claim meets the legal certainty requirements set out in Chapter 4. The bondholders’ claim shall take priority over all other claims on the collateral;
(g) loans secured by maritime liens on ships up to the difference between 60 % of the value of the pledged ship and the value of any prior maritime liens.
For the purposes of points (c), (d)(ii) and (f)(ii) of the first subparagraph, exposures caused by transmission and management of payments of the obligors of, or liquidation proceeds in respect of, loans secured by pledged properties of the senior units or debt securities shall not be comprised in calculating the limits referred to in those points.
1a. For the purposes of point (c) of the first subparagraph of paragraph 1, the following shall apply:
(a) for exposures to credit institutions that qualify for credit quality step 1, the exposure shall not exceed 15 % of the nominal amount of outstanding covered bonds of the issuing credit institution;
(b) for exposures to credit institutions that qualify for credit quality step 2, the exposure shall not exceed 10 % of the nominal amount of outstanding covered bonds of the issuing credit institution;
(c) for exposures to credit institutions that qualify for credit quality step 3 that take the form of short‐term deposits, as referred to in point (c)(i) of the first subparagraph of paragraph 1 of this Article, or the form of derivative contracts, as referred to in point (c)(ii) of the first subparagraph of paragraph 1 of this Article, the total exposure shall not exceed 8 % of the nominal amount of outstanding covered bonds of the issuing credit institution; the competent authorities designated pursuant to Article 18(2) of Directive (EU) 2019/2162 may, after consulting EBA, allow exposures to credit institutions that qualify for credit quality step 3 in the form of derivative contracts, provided that significant potential concentration problems in the Member States concerned due to the application of credit quality step 1 and 2 requirements referred to in this paragraph can be documented;
(d) the total exposure to credit institutions that qualify for credit quality step 1, 2 or 3 shall not exceed 15 % of the nominal amount of outstanding covered bonds of the issuing credit institution and the total exposure to credit institutions that qualify for credit quality step 2 or 3 shall not exceed 10 % of the nominal amount of outstanding covered bonds of the issuing credit institution.
1b. Paragraph 1a of this Article shall not apply to the use of covered bonds as eligible collateral as permitted pursuant to Article 8 of Directive (EU) 2019/2162.
1c. For the purposes of point (d) of the first subparagraph of paragraph 1, the limit of 80 % shall apply on a loan‐by‐loan basis, shall determine the portion of the loan contributing to the coverage of liabilities attached to the covered bond, and shall apply throughout the entire maturity of the loan.
1d. For the purposes of points (f) and (g) of the first subparagraph of paragraph 1, the limits of 60 % or 70 % shall apply on a loan‐by‐loan basis, shall determine the portion of the loan contributing to the coverage of liabilities attached to the covered bond, and shall apply throughout the entire maturity of the loan.
2. The situations referred to in points (a) to (f) of paragraph 1 shall also include collateral that is exclusively restricted by legislation to the protection of the bond-holders against losses.
3. For immovable property and ships collateralising covered bonds that comply with this Regulation, the requirements set out in Article 208 shall be met. The monitoring of property values in accordance with point (a) of Article 208(3) shall be carried out frequently and at least annually for all immovable property and ships.
3a. In addition to being collateralised by the eligible assets listed in paragraph 1 of this Article, covered bonds shall be subject to a minimum level of 5 % of overcollateralisation as defined in point (14) of Article 3 of Directive (EU) 2019/2162.
For the purposes of the first subparagraph of this paragraph, the total nominal amount of all cover assets as defined in point (4) of Article 3 of that Directive shall be at least of the same value as the total nominal amount of outstanding covered bonds (‘nominal principle’), and shall consist of eligible assets as set out in paragraph 1 of this Article.
Member States may set a lower minimum level of overcollateralisation for covered bonds or authorise their competent authorities to set such a level, provided that:
(a) either the calculation of overcollateralisation is based on a formal approach where the underlying risk of the assets is taken into account, or the valuation of the assets is subject to the mortgage lending value; and
(b) the minimum level of overcollateralisation is not lower than 2 %, based on the nominal principle referred to in Article 15(6) and (7) of Directive (EU) 2019/2162.
The assets contributing to a minimum level of overcollateralisation shall not be subject to the limits on exposure size set out in paragraph 1a and shall not count towards those limits.
3b.
Eligible assets listed in paragraph 1 of this Article may be included in the cover pool as substitution assets as defined in point (13) of Article 3 of Directive (EU) 2019/2162, subject to the limits on credit quality and exposure size set out in paragraphs 1 and 1a of this Article.
4. Covered bonds for which a credit assessment by a nominated ECAI is available shall be assigned a risk weight in accordance with Table 6a which corresponds to the credit assessment of the ECAI in accordance with Article 136.
Table 6a
| Credit quality step | 1 | 2 | 3 | 4 | 5 | 6 |
| Risk weight | 10 % | 20 % | 20 % | 50 % | 50 % | 100 % |
5. Covered bonds for which a credit assessment by a nominated ECAI is not available shall be assigned a risk weight on the basis of the risk weight assigned to senior unsecured exposures to the institution which issues them. The following correspondence between risk weights shall apply:
(a) if the exposures to the institution are assigned a risk weight of 20 %, the covered bond shall be assigned a risk weight of 10 %;
(b) if the exposures to the institution are assigned a risk weight of 50 %, the covered bond shall be assigned a risk weight of 20 %;
(c) if the exposures to the institution are assigned a risk weight of 100 %, the covered bond shall be assigned a risk weight of 50 %;
(d) if the exposures to the institution are assigned a risk weight of 150 %, the covered bond shall be assigned a risk weight of 100 %.
6. Covered bonds issued before 31 December 2007 shall not be subject to the requirements laid down in paragraphs 1, 1a, 3, 3a and 3b. They shall be eligible for preferential treatment under paragraphs 4 and 5 until their maturity.
7. Covered bonds issued before 8 July 2022 that comply with the requirements laid down in this Regulation as applicable at the date of their issue shall not be subject to the requirements laid down in paragraphs 3a and 3b. They shall be eligible for preferential treatment under paragraphs 4 and 5 until their maturity.
A Sustainable Covered Bond includes a formal commitment by the issuer to use an amount equivalent to the proceeds of that same covered bond to (re)finance loans in clearly defined environmental (green), social or a combination of environmental and social (sustainable) criteria. Covered Bond Labelled sustainable covered bond programs are based on their issuer’s sustainable bond framework which has been verified by an independent external assessment.
The issuer strives, on a best efforts basis, to replace sustainable assets that have matured or are redeemed before the maturity of the bond through the (re)financing of new eligible sustainable assets.
On the Covered Bond Label sustainable covered bonds are flagged with a green leaf which you find here.
Against this background, please note that the EMF-ECBC is currently working on market initiatives which will ultimately define European criteria for energy efficiency covered bonds and sustainability standards.
Further details relating to sustainable bonds and the associated regulations and standards established to promote sustainable finance, together with research relating to this area, can be found in the section here.
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The European Covered Bond Council (ECBC) is the platform that brings together covered bond market participants including covered bond issuers, analysts, investment bankers, rating agencies and a wide range of interested stakeholders.
