Shearman & Sterling LLP | Financial Regulatory Developments Focus | European Commission Proposes EU Covered Bonds Legislative Package
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  • European Commission Proposes EU Covered Bonds Legislative Package
    The European Commission has published legislative proposals for a new EU covered bonds framework. The legislative package consists of a proposed Directive on the issue of covered bonds and covered bond public supervision and a proposed Regulation to amend the prudential treatment of covered bonds under the Capital Requirements Regulation. The proposals are part of the EU's Capital Markets Union project and follow from the work of the European Banking Authority in this area, in particular, its 2016 recommendations for an EU covered bonds framework.

    The proposed Covered Bonds Directive will apply to covered bonds issued by EU credit institutions, which means that only EU credit institutions will be able to issue covered bonds governed by the framework. Issuers using the EU covered bonds label will need to comply with the proposed Directive but can also use the label with national labels. Covered bonds are debt obligations issued by credit institutions and secured against a ring-fenced pool of assets to which bondholders have direct recourse as preferred creditors. The proposed Directive provides requirements for issuing covered bonds and the structural features of covered bonds, including dual recourse and bankruptcy remoteness. There are also provisions to address liquidity risk through the imposition of a liquidity buffer related to the cover pool and transparency provisions requiring information to be disclosed to covered bond investors. In addition, the proposed Directive provides for supervision at national level of covered bonds.

    An equivalence regime for covered bonds issued by third-country credit institution issuers has not been included in the proposed Covered Bonds Directive. The European Commission must report by the end of three years after the proposed Directive applies on whether an equivalence regime could be introduced.

    The proposed Covered Bonds Directive will also amend the EU Bank Recovery and Resolution Directive regarding the treatment of covered bond programmes in the case of the insolvency or resolution of the issuer. The reference to covered bonds in the Undertakings for Collective Investment in Transferable Securities Directive for covered bonds issued before the proposed Directive becomes applicable will remain and a new reference to the new Directive is added for those after it becomes applicable.

    For banks investing in covered bonds that meet certain criteria, the CRR sets preferential risk weights with reference to the definition of covered bonds in the UCITS Directive. The proposed amendments to the CRR would introduce additional requirements on covered bonds for banks to be able to benefit from that preferential capital treatment by reference to the definition, governance and transparency provisions in the new Covered Bonds Directive. In particular, it is proposed that a new requirement on a minimum level of over-collateralization would be introduced, the level of which is in line with the EBA's advice - although lower than Basel standards. In addition, provisions allowing, under certain conditions, covered bonds to be collateralized by senior units issued by French Fonds Communs de Titrisation or equivalent entities governed by a Member State's laws that securitize residential or commercial property exposures would be repealed along with the related national derogation to waive the own funds requirement for certain covered bonds. This derogation was only made permanent in November 2017, although it was indicated in the recitals to that legislation that the derogation could be revoked under the revised EU covered bonds framework.

    It is intended that the proposed Directive and the proposed amendments to the CRR would apply from the same date, proposed to be one year after the Covered Bonds Directive enters into force. Both legislative proposals are now subject to consideration by the EU co-legislators. Transitional measures in the proposed Directive will allow covered bonds issued before the Directive applies and which comply with the UCITS Directive not to be subject to new requirements. However, those covered bonds will be able to continue to be referred to as covered bonds in accordance with the new Directive until their maturity.

    Feedback on the proposed legislative package can be provided through the Commission's website until May 11, 2018.

    View the proposed Covered Bonds Directive.

    View the proposed amendments to CRR.

    View the EBA's 2016 recommendations.