22 October 2019

By Joost Beaumont, ABN AMRO N.V.

The journey towards harmonisation of European Union (EU) covered bond frameworks reached a milestone in April 2019 when a political agreement about the new Directive and Regulation was struck in EU Parliament. This completed a process that had started in 2014. Harmonising covered bond frameworks on a EU level has been a hot debate within the covered bond community in recent years, and is likely to remain high on the agenda. This is because the next phase will be for individual countries to incorporate the new Directive into their national covered bond laws. In this article, we discuss the main details of the new legislative package.


The path towards harmonisation started in July 2014 when the European Banking Authority (EBA) published its view on the preferential risk weight treatment of EU covered bonds. The EBA concluded that the preferential risk weight treatment of covered bonds was warranted, but it also recommended that more convergence was needed. This in order to increase the safety and robustness of the covered bond instrument, which would enhance financial stability as well as safeguard the preferential risk weight treatment. The EBA identified the following key areas for convergence:
1. Dual recourse mechanism.
2. Segregation of cover assets.
3. Bankruptcy remoteness of covered bonds.
4. Cover pool features.
5. Valuation of cover assets and LTV limits as well as other requirements on cover assets.
6. Coverage principle and legal overcollateralisation (OC).
7. Asset and liability risk management.
8. Covered bond monitoring.
9. Role of supervisor.
10. Investor reporting.

The European Commission (EC) took the discussion on covered bond harmonisation to another level in 2015, when it published a consultation paper on covered bonds in the EU, which was part of the EC’s action plan to build a Capital Markets Union. In September 2016, the EC decided to request a study on the costs and benefits of introducing a legislative EU framework on covered bonds. That report (‘Covered Bonds in the European Union: Harmonisation of legal frameworks and market behaviours’) was published in May 2017. In the meantime, however, the EBA had published a follow-up report in December 2016, outlining the EBA’s recommendations on harmonising covered bond frameworks in the EU.

In this report, the EBA proposed a three-step approach towards harmonisation of covered bonds, taking into account that EU covered bond frameworks differ in particular in regard to legal, regulatory, and supervisory issues, while acknowledging that the final framework should build on the strengths of existing frameworks. This would still leave room for national discretion. This was in line with the industry’s preference that any convergence of national frameworks should be of high-level, and principle-based.

Overall, the EBA proposes a three-step approach to harmonisation:
1. Step 1 focused on the regulatory recognition of covered bonds (i.e. to rewrite the UCITS Directive (Article 52(4) of Directive 2009/65/EC) and get to one point of reference of covered bonds for regulatory purposes);
2. Step 2 addressed issues related to the preferential capital treatment of covered bonds (i.e. amending CRR Article 129);
3. Step 3 included voluntary measures at a national level.

The EC’s proposed legislative package, which was published in 2018 Q1 and consisted of a new Directive and an amendment of CRR Article 129, took into account most of the EBA recommendations. It was also based on a report by EU Parliament that included its ‘own initiative’ on the harmonisation of covered bond frameworks. Following the publication of the EC’s legislative proposals, the Economic & Monetary Affairs Committee (ECON) of EU Parliament had to agree with the proposals as well, while the EU council also had to form an opinion. Finally, these three authorities needed to agree on a final text during the so-called trilogue negotiations. The whole process was completed when the political agreement on the text of the legislative package was found by EU Parliament on 18 April 2019. The final text will be officially approved in autumn 2019, when official translations into all languages of the Union will be available.


The legislative package includes a new Directive (i.e. rewrite of Article 52(4) of Directive 2009/65/EC) and a new Regulation (i.e. amendment of Article 129 of the CRR). The Directive will become the new single reference point for regulation related to covered bonds. It provides a common definition of covered bonds, while defining all core features of covered bonds, as well as defining the tasks and responsibilities of supervisors. Overall, it regulates the covered bond product with a focus on protecting investors. Having said that, the Directive has remained of high-level and principle based. On the one hand, it strengthens the definition of covered bonds, while on the other hand, it prevents to harm the existing well-functioning market. Furthermore, member states can take into account country-specific features when implementing the Directive in national covered bond frameworks.

The new Directive consist of the following chapters (or 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 (Articles 27)
V. Amendments to other Directives (Articles 28-29)
VI. Final provisions (Articles 30-34)

The articles of the Directive start off by defining the dual recourse principle and bankruptcy remoteness of covered bonds, also noting that covered bonds can only be issued by EU credit institutions. Below we touch upon the most eye-catching features of the new Directive.

Cover assets

Article 6 deals with the type of assets that can be allowed in cover pools. It notes that only high-quality assets can be used as collateral for covered bonds, referring to points (a) to (g) of CRR Article 129 (1). This includes the ‘traditional’ cover pool assets, such as public sector loans, residential mortgages, commercial mortgages, and ship loans.

However, the Directive leaves room to include other high-quality assets as long as their market value can be derived, while being enforceable in one way or the other. Furthermore, there needs to be a kind of registration in the case of physical assets. In addition, assets in the form of loans to, or guaranteed by, public undertakings are allowed as cover assets under certain conditions (e.g. a minimum level of overcollateralisation of 10%). Although this suggests that we might see the creation of covered pools with non-traditional cover assets, the numerous conditions attached make this increasingly unlikely.

The articles following Article 6 describe that issuers might include cover assets outside the EU in cover pools as long as they meet the criteria set out in Article 6, while the level of protection should be similar to assets from the EU. Another condition related to the cover assets is that member states should assure that there should be sufficient homogeneity of the cover assets regarding, for instance, their lifetime and risk profile. Finally, the Directive includes articles regarding the cover assets that address intragroup structures, joint funding, the use of derivative contracts, segregation of assets, and the cover pool monitor.

Joint Funding

Interesting to highlight is the Article about joint funding, which allows the pooling of cover assets by several credit institutions. Joint funding should reduce the costs of setting up covered bond programmes for smaller credit institutions, while it should allow them to issue covered bonds in reasonable size, which improves their liquidity. As such, joint funding should support smaller credit institutions to join forces, paving their way to the covered bond market. The aim is also to create covered bond markets in countries where there is currently no well-developed market. The Baltic region is a good example in this respect, as Estonia, Latvia, and Lithuania are in the process of setting up a pan-Baltic covered bond framework, which would allow credit institutions from these countries to issue covered bonds with underlying assets from all these countries.

Reporting, OC requirements and liquidity risk

The Directive continues with proposals about the information that covered bond issuers need to provide in order to allow investors to carry out their due diligence properly. The Directive requires that issuers provide information related to the outstanding covered bonds, cover assets, market risks, maturity structures, and coverage, on a quarterly basis.

Meanwhile, there are also requirements for coverage and liquidity. The Directive states that the ‘total nominal amount of all assets in the cover pool are at least of the same value as the total nominal amount of the outstanding covered bonds’. This is the so-called ‘nominal principle’. However, the amended CRR Article 29 also stipulates that a 5% minimum level of OC is required, based on a nominal calculation. Member states are allowed to reduce this level to a minimum of 2% under certain conditions (i.e. the calculation of OC is either based on a model which takes into account the assigned risk weights of the assets or a model where the valuation of the assets is subject to mortgage lending value). This seems to align the new legislation with common practice in Germany/Austria. The minimum level of OC is one of the new highlights of the proposal.

Regarding liquidity, investors will be protected from liquidity risk by the requirement in the Directive to keep liquid assets to cover the net liquidity outflow for 180 calendar days. However, the liquidity buffer has some overlap with other EU legislation, and that about the LCR in particular. To reduce regulatory costs, national authorities will be able to align the different forms of EU legislation, so to avoid that the same outflows will be covered with different liquid assets for the same period. What is more, liquidity risk can also be addressed by the possibility to extend the maturity date of the covered bonds in case of liquidity shortage. The Directive allows issuers of covered bonds with extendable maturity structures to use the final maturity date rather than the scheduled maturity of principal payments when calculating the liquidity buffer.

Treatment of covered bonds with extendable maturities

The Directive pays special attention to covered bonds with extendable maturities. This likely reflects that many banks have changed the structure of hard bullet covered bonds to soft bullet structures, with most banks allowing the possibility to extend the maturity by maximum 12 months. Meanwhile, conditional pass-through covered bonds, which have a much longer theoretical maturity extension, have seen the light of day. The Directive stresses the need to harmonise extendable maturities across the EU by setting specific conditions for these structures, while avoiding them to become too complex and to expose investors to higher risks. The main focus is on the triggers that allow for the maturity extension. These should be objective and well-defined, and must be established in national law, while the maturity extension should be outside the discretion of the issuer.

Public supervision

The new Directive continuous with many pages about the public supervision of covered bonds. This contrasts heavily with the current Directive, which does not define the nature, content and authorities that should be responsible for supervision. It is therefore essential to further harmonise public supervision of covered bonds, making clear the tasks and responsibilities of national supervisors on covered bonds. Furthermore, it should be ensured that supervisors have all the capabilities and means to carry out their role in a proper way.

Unsurprisingly, issuers need to register their covered bond programme before getting approval issuing covered bonds. Meanwhile, the articles on public supervision address issues such as reporting requirements to authorities, the powers that supervisors have in case of non-compliance of issuers, and the role of the supervisor when an issuer is insolvent or in resolution. In the end, strengthened supervision is likely to provide more comfort to investors.


The Directive introduces two new labels to the covered bond universe, although the use will be facultative. Issuers can use the ‘European Covered Bonds’ label for covered bonds that only comply with the Directive, while they can use the ‘European Covered Bonds (Premium)’ label when the covered bonds also comply with the CRR. This should make it easier for investors to assess the quality of the covered bonds, which should increase their attractiveness inside and outside the EU, according to the Directive. Although it could help to identify the quality of different covered bonds, the impact of the labels will not be very large in our view. Actually, the Directive allows for the labels to be used in combination with national labels as well as that of the already existing ECBC Covered Bond Label. As a result, the new labels could also create confusion.

Indeed, in 2012, the European Mortgage Federation and European Covered Bond Council already introduced the ECBC Covered Bond Label. This label established a clear perimeter for the asset class and has resulted in the introduction of the harmonised transparency template (HTT), which has improved transparency (and reporting standards). As such, we think that the labelling in the Directive seems somewhat superfluous, with the existing labels already providing sufficient information to investors.

Transition measures
The aim is to get a smooth transition towards the new Directive, which should prevent any unwanted market distortions. Therefore, the Directive includes generous grandfathering provisions. Actually, all existing covered bonds that currently comply with the UCITS Directive and the CRR will be grandfathered, while covered bonds issued before 2007 will also be grandfathered, keeping all existing regulatory benefits. As such, current outstanding covered bonds will not be treated differently, which should indeed result in a smooth transition.

Furthermore, it will be possible to tap already outstanding covered bonds under certain conditions (e.g. maximum of 5y remaining maturity, total issue size of taps less than twice the outstanding amount) to 24 months after the Directive becomes effective.


The new Directive will be fully effective 30 months after the Directive enters into force. As there was some delay in translating the texts of the Directive and Regulation voted on in April 2019, these are expected to only pass a formality vote in EU parliament in October 2019. Thereafter, they need to be published in the Official Journal. It will then take 20 days before the legislative package enters into force. This seems therefore scheduled to be towards the end of 2019. Then, there will be a 18 month implementation period, after which issuers will get 12 months to comply with the new legislation. Overall, it seems that the new legislative package will be fully effective around mid-2022.

Third country covered bonds and extendable maturities assessment

The Directive also includes calls for reviews and reports after the Directive has become effective. The regulatory treatment of covered bonds issued by credit institutions from third countries is one worth mentioning. The EC shall, in close cooperation with the EBA, publish a report, including legislative proposals, about whether and how an equivalent regime could be introduced for third-country credit institutions issuing covered bonds.

However, this will take time, as the deadline has been set two years after the new Directive will be effective, suggesting that this will be around mid-2024. Still, the prospect of third country covered bonds eventually receiving a similar regulatory treatment could support the further development of covered bonds outside the EU. Also around mid-2024, the EC should submit a report, and if appropriate a legislative proposal as well, about the risks and benefits of covered bonds with extendable maturity structures. This study should also be conducted in close cooperation with the EBA.

Finally, three years after the date that the new Directive has become effective, a report should be submitted about the implementation of the Directive and the developments of the covered bond market more generally. That report should also include recommendations for further action. Worth mentioning is also the request to the EC to adopt a report on the possibility of introducing a dual recourse instrument called European Secured Notes (see also chapter 1.11).

Amending article 129 of the CRR

The legislative package also includes amendments to article 129 of the CRR. These changes will be two-fold. On the one hand, some parts of the CRR Article 129 will be deleted. This is for instance true for the reporting requirements, which will be shifted towards the Directive. Furthermore, it will no longer be allowed to use as cover assets RMBS/CMBS or senior units issued by French Fonds Communs de Titrisation securitising residential or commercial property exposures.

Regarding the inclusion of substitution assets in the cover pool, it will be allowed to use exposures to credit institutions substitution assets qualifying as credit quality step 2 for a maximum of 10% of outstanding covered bonds and also short-term deposits qualifying as credit quality step 3 for a maximum of 8% of outstanding covered bonds. Before, only assets with credit quality step 1 were allowed (up to 15%), while now the substitution assets with credit quality step 1,2 and 3 together cannot exceed 15%. This amendment was due to the increased difficulty to comply with the former stricter rule.

Meanwhile, the minimum required level of OC has also been specified in the CRR (see above). Furthermore, the amendments address the issue of LTV limits. Overall, the authorities stick to the 80% LTV limit for residential mortgages, 60% for commercial mortgages, and 70% for ship loans. However, the CRR is more explicit in saying that these are soft limits, implying that a loan in the pool can only act as collateral within the LTV limits.

Alignment with proposals

It is likely that all EU Member States need to adjust their covered bond frameworks to fully align them with the new Directive and Regulation. Already a few countries put the update to their national frameworks on hold waiting for the details of the legislative package (among others: France and Spain). We do not expect major issues regarding the implementation of the new Directive in different countries. Having said that, the package leaves room for national discretion. It will therefore be interesting to follow developments in this respect, as different countries might interpret the Directive in different ways. In order to reach the most consistent possible outcome throughout the continent, the ECBC has put in place an Implementation Task Force which aims at providing support in the national implementation processes in the various Member States and acts as intelligence hub of market participants and stakeholders at large.

Response of the sector and rating agencies

The covered bond community gave the new legislative package a warm welcome, saying it was extremely pleased with the outcome. The ECBC noted that ‘The Package provides a basis for enhanced harmonisation of the European covered bond market, in line with the objectives of the CMU, reinforcing a European common qualitative benchmark for international investors and respecting well-functioning traditional markets.

It moreover paves the way for the smooth introduction of this asset class in newer and emerging covered bond markets in the Union, such as those in the Baltic regions, Poland, Slovakia and Romania, and will also serve as an important legislative benchmark on a global level for countries such as Australia, Brazil, Canada, Japan and Singapore’. The rating agencies also welcomed the new package, also stressing that it will further strengthen the quality of covered bonds, which is credit positive.


In our view the new Directive indeed strikes a good balance between strengthening the covered bond product by setting minimum standards, while also keeping room for national differences. We welcome the principle based approach of the package. When in place, the Directive is likely to support the covered bond market, offering even more protection to investors. The Directive will probably also result in more issuance of covered bonds, as it will induce more jurisdictions to setup covered bond frameworks, while there will most likely also be new covered bond issuers in existing covered bond jurisdictions. Finally, the Directive can act as a blueprint for countries outside the EU when setting up covered bond frameworks.