Proposal to create an EU legislative framework for covered bonds

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In Sept 2015, the European Commission circulated a consultative proposal for a harmonized legal framework in member countries for covered bonds[1]. The Consultation Paper was inspired by a July 2014 study, by the EBA, of legislative and capital requirements framework on covered bonds in the EU.[2]

The Consultation Paper notes that there is no generally-accepted definition of covered bonds currently, and the most commonly cited definition is that in Para 52 (4) of the UCITs Directive. The most important one among the 3 features as contained in the UCITs Directive is this: “sums deriving from the issue of the covered bonds must be invested in accordance with the law in assets which, during the whole period of validity of the bonds, must be capable of covering claims attaching to the bonds and which, in the event of failure of the issuer would be used on a priority basis for the reimbursement of the principal and payment of accrued interest.” Hence, the key condition is the availability of the assets in the cover pool to cover the claims on account of interest and principal on the bonds, on a priority basis.

In view of the fragmented and disparate nature of covered bonds laws in different member countries, the Consultation Paper proposes a “convergence of national laws towards a truly integrated and comprehensive covered bond framework, thus capable of delivering a recognisable “European covered bond instrument”.

As a part of the legislative proposal, the Consultation Paper proposed a framework of an EU law on covered bonds consisting of the following items:

I.               Covered bond definition and protection of the term;

II.             Covered bond issuers and system of public supervision:

a.     issuer models and licensing requirements;

b.     on-going supervision and cover pool monitoring (pre-insolvency);

c.     covered bonds and the single supervisory mechanism (SSM).

III.           Dual recourse and insolvency/resolution regime:

a.     definition of dual recourse principle;

b.     segregation of the cover assets;

c.     administration and supervision of the cover pool post-insolvency;

d.     interaction between cover pool and issuer in insolvency/resolution;

IV.           The cover pool:

a.     eligible assets: qualifying criteria and requirements;

b.     coverage requirement and overcollateralisation;

c.     cover/assets liabilities risk mitigation: market and liquidity risks;

V.             Transparency requirements.

The Consultation Paper also sought views on whether the SPV model should be recommended as the general basis for ring-fencing of assets.

Consultation period on the paper ended in 1st week of January 2016. A total of 72 responses have been received.  In a public address[3], Commissioner Hill seems to have said that the Commission will continue to maintain the diversity of covered bonds legislations – however, some degree of harmonization may be helpful.

You may also view our page on Covered bonds legislation here

By, Vinod Kothari