30 July 2018
On 24 July 2018, the European Banking Authority (EBA) published a report presenting the outcome of its assessment on the European Commission’s call for advice on the European Secured Notes (ESNs).
The report highlights recommendations on key aspects for the European Commission to consider when possibly designing the legislative framework for SME ESNs.
The Reports puts forward five main policy recommendations:
The EBA considers that SME ESNs could be structured as a dual recourse instrument, however, in contrast to covered bonds backed by real estate, the cover assets of SME ESNs would probably not be secured by a real estate-underlying security. Due to the high-risk profile of SME exposures, the EBA suggests a more restrictive framework should be applied to SME ESNs in relation to certain best practices,especially with respect to the coverage, the liquidity and the disclosure requirements and suggests strict eligibility criteria at both loan and pool level and a minimum level of over-collateralisation of at least 30%.
In terms of capital requirement, it is advised that no preferential treatment (i.e. similar to covered bonds) is granted. However, a differentiated risk-weight treatment compared to unsecured notes could be considered subject to certain considerations.
The EBA does not recommend the creation of an infrastructure ESNs. A dual recourse structure for Infrastructure loans is not appropriate given the lack of granularity in a cover pool, the complexity of the loan structures and the specific and different nature of infrastructure projects making it very difficult to create a high quality dynamic cover pool of infrastructure loans.
As the EBA advises against the dual-recourse feature for infrastructure ESNs, no assessment of its potential regulatory treatment has been carried out.
Although the EBA does not consider a dual recourse ESN appropriate for project finance loans, the EBA is of the view that a new distinct class of off-balance-sheet funding instruments for highquality project finance loans could be considered in the form of an EU infrastructure bond
The EBA is of the view that the introduction of SME ESNs will not give rise to asset encumbrance implications for the EU banking system as a whole that cause concern in the current financial environment. However, overreliance on secured funding and increasing levels of asset encumbrance may pose additional risks at national level or to individual institutions.
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