December 6, 2013
Denmark’s $530 billion mortgage-backed covered bond industry is facing uncertainty because the European Banking Association is planning to urge the European Commission not to give the covered bonds the stamp of Level 1 assets, but that only sovereign debt is given the highest liquidity status. According to the Denmark’s Economy Ministry, the European Banking Authority is planning to recommend covered bonds not be treated as highly liquid assets, dealing a blow to the nation’s $530 billion mortgage bond market. In doing so, the EBA was ignoring the findings of its own report, which suggested covered bonds have all the key characteristics of the most liquid assets, the ministry said. Denmark’s central bank also rejected the EBA’s recommendation that covered bonds should not be given the highest liquidity status. It would lead to a paradox if highly rated, very liquid covered bonds get a lower status than lower-rated, illiquid sovereign bonds. It contends that the EBA’s recommendation not to treat covered bonds as highly liquid assets ignores its own findings, which show the securities are at least as safe as government debt.
If approved by the European Commission, the EBA’s recommendation would limit banks’ ability to use covered bonds to fulfil their liquidity requirements. That might trigger a sell-off of the securities and send mortgage rates higher. While banks may have alternatives to building their liquidity buffers, the biggest fallout would be felt by the Danish mortgage market. This would also cause a situation where the banking sector would place more reliance on sovereign debt and might hamper the objective of delinking the sovereign from the banking sector.
Germany and Norway have also questioned the logic of the EBA’s recommendation. The EBA isn’t due to publish its final recommendations until later this month, with draft technical standards set to be finalized by March. Fitch Ratings announced that it is going to closely monitor the outcome of the EBA’s proposal.