A New Regulatory Landscape for Covered Bonds

24 August 2017

By Niek Allon, NIBC Bank & ECBC Chairman


The Basel IV and Capital Markets Union (CMU) discussions are more than ever opening new “frontiers” for the covered bonds. This instrument, the most traditional and European asset class in the European financial landscape, is being exposed to critical evolutions which can bring new risks and new opportunities: on the one hand, the covered bond market is faced with the continuous process of globalisation while, on the other hand, market innovation and an overarching new regulatory umbrella and national implementation of the covered bond concept will arguably leave its mark on the asset class.


The Industry recognises that adaptation to the regulatory environment and evolution in the light of new market conditions has been the secret for the success of this asset class over centuries. However, the Industry firmly believes that, in any evolution, there is a clear need to preserve the key nature of the product as a crisis management tool rooted in robust qualitative and macroprudential characteristics which are the basis for ensuring a regulatory recognition at global level. The Industry’s development of a strong quality Label since 2012 is the most recent testament to its ability to “keep-up” and even proactively lead when it comes to market needs.


This long-term financing asset class represents a strategic financial resource able to enhance macro prudential banking practices and guarantee vital access to capital markets and a solid investor basis in stressed and distressed market conditions. It is a crucial cog in the European baking machine and represents the nexus between funding strategies of banks and the capability of originating high quality assets, which in turn enable lending to the real economy with cost-efficient funding. In fact, covered bonds serve not only as a crucial mechanism of monetary policy transmission but more importantly as a fundamental financial mechanism which gives a helping hand to European citizens – we should not forget that one mortgage out of four in the Old continent is financed on balance-sheet via covered bonds.


Policy Agenda


Looking back over the last year, it is clear that the covered bond space has been fundamentally impacted by major waves of monetary policy, supervisory review and regulatory change which is having a significant impact on the long-term financing and housing finance sectors.


To return to the CMU mentioned earlier, this Project is a key pillar of the Commission’s Investment Plan for Europe, the so-called Juncker Plan. Through a mix of regulatory, non-regulatory reforms and market initiatives, this project seeks to better connect savings to investments. It aims to strengthen Europe’s financial system by providing alternative sources of financing and more opportunities for consumers and institutional investors. The rebooted CMU puts a strong focus on sustainable and green financing: as the financial sector begins to help sustainability-conscious investors to choose suitable projects and companies, the Commission is determined to lead global work on supporting these developments.


When considering how best to shape the future European banking landscape and build the CMU that will ensure the capability of the Industry to support the growth agenda and provide long-term financing to the real economy, several areas of reflection can be identified:


  • Striking the right balance, in terms of a level playing field, between international banks operating in the European Union and European actors operating both internationally and domestically.
  • Carefully examining the market impact of several key regulatory developments and trying to secure the European banking pillars in the Basel Committee debates: i.e. Net Stable Funding Ratio (NSFR), risk weighting, capital floors framework, leverage ratio.
  • The role of European lenders in the framework of housing and small and medium sized enterprise (SME) financing, and lending to the real economy is becoming increasingly multi-faceted with the introduction of the Capital Markets Union.
  • The role of covered bonds and the Industry’s firm commitment to achieve a higher level of harmonisation, in line with EU objectives and market preferences.
  • Developing energy efficient mortgages and green covered bonds for the benefit of EU citizens and the environment.


Over the last twelve months, several developments have animated the covered bond regulatory landscape:


In November 2016, the European Banking Authority (EBA) announced its proposal for a three-step approach to harmonisation of covered bond frameworks in the EU focussing on (i) the development of a covered bond framework with the introduction of a new covered bonds directive (Step 1); (ii) amendments to the Capital Requirements Regulation (CRR) relating to the preferential risk-weight treatment (Step 2) and voluntary convergence (Step 3). These three steps to harmonisation were proposed after the European Commission concluded the analysis of the responses received to their public consultation on the topic from September 2015 which had the aim of gathering stakeholders’ views on whether and how to best develop a pan-European covered bond framework. In this respect, the ECBC provided the Commission, via the national legal experts participating in the ECBC Supervisory Task Force, with a detailed industry feedback calling for a balance to be struck between maintaining well-functioning national covered bond legislative frameworks and establishing a common European framework by means of (i) a recommendation to encourage Member States to increase convergence and (ii) a high-quality principle-based directive ensuring harmonisation of certain minimum standards. Shortly after the publication of the EB’s conclusions, the European Commission commissioned a detailed study on this proposal, assessing the potential costs and benefits of moving ahead with a legislative framework for the Covered Bond space.


Further to this, in June 2017, the European Commission published its Midterm review of the Capital Markets Union, and announced, among planned actions, its intention to propose legislation in the covered bond space in the form of a directive in Q1 2018. In parallel to this, the European Parliament developed an own-initiative report on the covered bonds file which was finalised in July 2017.


The ECBC would like to take this opportunity to express its appreciation of the careful market analysis which has been undertaken by the European Parliament, the European Commission and the European Banking Authority over recent months.


The ECBC is closely monitoring related developments and stands ready to provide market insights and support the legislative process by acting as market think tank. With regard to the most recent legislative developments, we believe that a principal based approach for a qualitative framework of the covered bond asset class could reinforce investor confidence and preserve the key macroprudential and qualitative characteristics of the Covered bond. For more detailed information in this regard, please refer to the key theme 1.1 article on covered bond harmonisation of the ECBC Fact Book 2017.


The EMF-ECBC also fully supports the CMU’s goal of strengthening investment and funding for the long-term, and recognises the need to build a truly single market for capital in order to “ensure easier access to finance for businesses and to support investment in the real economy”. This commitment to helping build the CMU was evidenced in June 2017 by the EMF-ECBC’s signature, alongside European Commission Vice-President Dombrovskis, of the High-Level Principles for Banks’ Feedback on declined SME Credit Applications.


With these two important policy discussions in mind, the ECBC has established two dedicated task forces, the Task Force on the EU Framework for Covered Bonds and the Task Force on European Secured Notes (ESN), to support the relevant institutions at national and European level in their work – and in this way help to avoid any unintended consequences – and to develop the new ESN asset class.


Market developments


Covered bonds are at the heart of the European financial tradition, having played a central role in funding strategies for the last two centuries. The strategic importance of covered bonds as a long-term funding tool is now recognised at a global level. Outside Europe, Australia, Canada, New Zealand and South Korea have already implemented covered bond legislation in recent years. Major jurisdictions including Brazil, Chile, India, Japan, Mexico, Morocco, Panama, Peru, South Africa and the United States, are either in the process of adopting covered bond legislation or are investigating the introduction of covered bonds.


In 2016 the outstanding covered bond market remained virtually stable at around EUR 2.5 tn with respect to the previous year, while issuance figures contracted by 10% with respect to 2015 reaching around EUR 485 bn. The most common collateral used for covered bonds is a mortgage which accounts for EUR 2.1 tn or nearly 85% of the outstanding market and this share has been constantly increasing since in 2003, when the figure was at 40%. The major players remain Denmark, France, Germany and Spain, which account for 53% of the outstanding in the market. One interesting development in 2016 was that Denmark surpassed Germany for the first time as the largest covered bond market in Europe.


Outstanding Covered Bonds from non-EU countries accounted for more than 17% of the total in 2016, a 1.7 pps increase with respect to previous year. In recognition of the global spread of covered bonds and with a view to ensuring that the key quality characteristics of the asset class remain its foundation around the world, in late 2015 the ECBC established a Global Issues Working Group (GIWG), which held its first meeting in Singapore in March 2016. This year’s ECBC Fact Book provides comprehensive coverage of new global legislative frameworks and developments, and shows how the ECBC, through the GIWG amongst other channels, is further strengthening its role as THE voice of covered bonds, not just in Europe but globally.


As mentioned above, the commitment to contribute to European efforts to enhance financial stability and transparency led the covered bond industry to launch a quality Label in 2012. The Covered Bond Label was developed by the European issuer community working in close cooperation with investors and regulators, and in consultation with all major stakeholders such as the European Commission and the European Central Bank. The Label is based on the Covered Bond Label Convention, which defines the core characteristics required for a covered bond programme to qualify for the Label. The Covered Bond Label and its transparency platform ( have been operational since January 2013, providing detailed covered bond market data, comparable cover pool information and legislative details on the various national legal frameworks designed to protect bondholders. As of August 2017, 110 labels have been granted to 93 issuers from 16 countries, covering over EUR 1.5 trillion of covered bonds outstanding, where 4.800 covered bonds include information on the Liquidity Coverage Requirement (LCR) maturity structures, regulatory treatment, etc.


In this context, covered bond issuers from these 16 different jurisdictions have come together to develop a Harmonised Transparency Template. Since 2016 this has been providing cover pool information in a harmonised format, which allows for both the recognition of national specificities, with the National Transparency Tabs, and the comparability of information required to facilitate investors’ due diligence.


The critical mass achieved by this initiative (c. 60% of covered bonds outstanding globally hold the Label) is a clear sign that the Industry recognises the need to respond to the requirements of new classes of investors by providing higher levels of transparency to aid investment decisions. Equally, it is important to highlight the progress that has been made in recent years in terms of collating and distributing relevant macro-level information on the covered bond sector:


  • The ECBC website continues to be the primary site for aggregate covered bond market data and comparative framework analysis; and
  • The ECBC Fact Book, now in its 12th edition, remains the most widely read source of covered bond market intelligence.


Looking ahead


During the years of market turmoil, covered bonds demonstrated a strong degree of resilience. Throughout the crisis, they played a pivotal role in bank wholesale funding, providing lenders with a cost-effective and reliable long-term funding instrument for mortgage and public-sector loans. The Industry continues to build on the lessons learnt from the financial crisis while maintaining a focus on the essential features and qualities that have made the asset class such a success story.


The success of covered bonds also lies in the Industry’s capacity to respond to the challenges of the current crisis and its ability to share market best practices. This allows for a continuous fine-tuning of European covered bond legislation and facilitates a strong level of transparency for the asset class. The instrument has enabled Member States in Europe to continue to channel private sector funds to housing markets and maintain efficient lending activity without an additional increase of burden for taxpayers or public debt. Furthermore, the on-balance sheet nature of covered bonds is an efficient and simple alternative to complex originate-to-distribute products ensuring financial stability.


The Industry has demonstrated that through market initiatives such as the Covered Bond Label and the ESN instrument, developed by the market experts of the ECBC Long-Term Financing Task Force (now renamed the ECBC ESN Task Force as mentioned earlier), it is possible to build, from the bottom up, proposals based on market consensus in order to initiate pan-European solutions which enhance transparency, comparability, convergence of markets and best practices. Furthermore, it has been possible to do this without over-regulating and, thereby, potentially jeopardising the capabilities of lenders to support the growth agenda.


Most recently, the EMF-ECBC has initiated and is taking the lead in discussions among stakeholders on developing a mortgage finance mechanism to support property owners in the acquisition of energy efficient properties or in the energy efficient renovation of existing properties. Banks can play a game changing role in providing long-term financing for energy improvements to the European housing stock and in this way contribute to meeting the EU’s ambitious energy savings targets for 2020 and 2030. Banks intervene at the most critical moment, when citizens purchase a property, and can make a significant contribution to improving the quality and energy performance of housing so as to free-up disposable income and, in parallel, reduce credit risk for borrowers, lenders and investors. A pan-European energy efficiency mortgage initiative in this area will also help to coordinate market interventions and create synergies in the mortgage and covered bond value chain, delivering a virtuous circle between lenders, borrowers and investors from the origination of the mortgage to the pooling of energy efficient collateral that would be the underlying collateral for “green” covered bonds. See Key Theme Article 1.9 of the ECBC Fact Book 2017 for more details on this initiative, in particular regarding the link with covered bonds.


Taking stock of where we have come from, where we are now and where we are heading, it is clear that the market and the environment in which it operates is constantly evolving and as such the work of the ECBC is never done. This provides us with an ongoing challenge and we believe that the initiatives underway will strengthen the asset class and facilitate the convergence of market and supervisory best practices. We are ready to support the creation of a common regulatory framework for covered bonds which is fit for purpose and enables the market to flourish further to the benefit of all, to help build the CMU and do everything we can to support the EU in meeting its vital energy savings targets for now and for the future. These will be our objectives for the coming years.