EBA launches harmonisation of European covered bonds rules

Orrick, Herrington & Sutcliffe LLP


On 20 December 2016, the European Banking Authority (the "EBA") published the final version of a report entitled "EBA Report on Covered Bonds - Recommendations on Harmonisation of Covered Bond Frameworks in the EU" (the "Report"). The Report builds on previous work and provides additional recommendations on how to further harmonise the national legislative frameworks on the covered bond instrument.

In response to Recommendations of the European Systemic Risk Board (ESRB) and following the publication by the EBA of their Report on EU Covered Bond Framework and Capital Treatment*, the EBA began an extensive analysis of the regulatory and legal framework for covered bonds in individual Member States, with a specific focus on alignment with the EBA's best practices.
More recently, in March 2017 the European Covered Bond Council (ECBC) announced that it supported the Report's recommendations and offered its collaboration to implement the harmonisation of covered bonds across the EU in the most effective way.

The Report

The aim of the Report was to:

  1. summarise the activity of regulatory investigation which was carried out following publication of the Report on EU Covered Bond Framework and Capital Treatment (July 2014);
  2. develop four key recommendations (the "Recommendations") to implement a common regulatory framework for covered bonds; and
  3. set out three key steps for the implementation process of the Recommendations and define the necessary activities for each of them.

The Recommendations issued by the EBA are as follows:

Recommendation n. 1 – Three-step approach to the harmonisation of the European regulatory framework for covered bonds.
Recommendation n. 2 – Development of a covered bonds directive (the "CB Directive").
Recommendation n. 3 – Amendment of EU Regulation 575/2013 (the "CRR").
Recommendation n. 4 – Voluntary convergence of national rules governing covered bonds.
The Report suggests implementation of the above four Recommendations in three key steps which are summarised below.

STEP I: EU Covered Bonds Directive

The proposed three-step approach builds on the strengths of the existing national frameworks, but allows better regulation of covered bonds in order to achieve a broad harmonisation throughout the EU. The adopted model provides for the development and implementation of framework legislation ensuring more a consistent approach, particularly as regards prudential standards, generally applicable in all Member States, and which replaces the discipline currently contained in Article 52, paragraph 4, of Directive 2009/65/EU (Undertakings for Collective Investment in Transferable Securities – UCITS) (the "UCITS Directive"))** .

In particular, European legislation should define structural requirements for covered bonds with specific reference to:

  • requirements on the dual recourse of a covered bond, segregation of cover assets and bankruptcy remoteness;
  • requirements on the coverage principle, liquidity risk mitigation and cover pool derivatives;
  • requirements on a system of special public supervision and administration related to covered
  • bonds, including requirements for a cover pool monitor, supervision of the issuer on an ongoing basis, supervision in the event of the issuer’s insolvency/resolution, and administration of the covered bond programme following the issuer’s insolvency/resolution;
  • transparency requirements — i.e. scope, format and frequency of disclosure of information; and
  • conditions for soft bullets and conditional pass through covered bonds.
  • The EBA recommends developing a new covered bonds framework, which primarily deals with providing a single and organic definition of the instrument. The definition, obtained in light of the experience of market players as well as the work of the competent authorities, should:
  • define both minimum requirements and characteristics that covered bonds must have in all Member States;
  • facilitate the achievement of a good level of harmonisation;
  • differentiate covered bonds from other financial instruments with similar characteristics;
  • replace and supercede all previous definitions, including for example those contained in the UCITS Directive.

The CB Directive would become the new European regulatory framework, ensuring a uniform development of the same legislation in all Member States, granting each Member State sufficient flexibility to safeguard its specific needs.

STEP II: Amendments to the CRR

The second step of the process provides for amendments to the sections of the CCR dealing with covered bonds. Currently, the CRR deals with the regulation of covered bonds with reference to the following three main aspects:

  • Criteria for investors (credit institutions and investment firms) in covered bonds for preferential risk weight treatment of their covered bond investments, being the eligibility requirements for collateral and the disclosure requirements for an issuer (Article 129);
  • Risk weight treatment under the standardised approach (Article 129), preferential LGD (loss-given default) treatment of exposures in the form of covered bonds under the (foundation) IRB approach (Article 161(1)(d)), as well as preferential specific risk treatment (Article 336(3)); and
  • Criteria for the valuation of immovable property collateralising mortgages in cover pools (Article 208 and Article 229(1) via Article 129(3)).

With reference to the risk weight treatment of covered bonds, the EBA recommends that the CRR is amended to be aligned with the provisions of the newly introduced CB Directive. In particular, with reference to Art. 129 of the CRR:

  • eligible assets: the EBA believes that the current level of eligible assets for Cover Bonds should not be extended. Funding for small and medium-sized enterprises (SMEs) and infrastructure financing should not be included among eligible assets; furthermore, they recommend further analysis on ship loans guarantees which are currently included in Art. 129 of the CRR as eligible assets) would be needed. In addition, the EBA recommends not extending the exemption for the inclusion of RMBS and CMBS beyond December 2017;
  • limit on substitution assets: the EBA recommends to amend the CRR in order to provide for the rules on composition of both replacement assets and limits within which replacement may be expected (this limit should be set at 15% of the minimum required coverage);
  • LTV limits: the EBA considers that the current LTV (loan to value) limits set out in the CRR are appropriate, however, the CRR should specify that they are "soft coverage" LTV limits and should be applied on an ongoing basis throughout the life of the programme;
  • overcollateralisation: the EBA suggests setting the minimum effective overcollateralisation at 5%; the percentage limits on exposures as currently set out in Art. 129 of the CRR should continue apply but should not be relevant to the voluntary overcollateralisation; and
  • improving the disclosure policy for the issuer, so that the dissemination of transparent information can become a standard requirement for all regulated covered bonds, rather than a specific condition for obtaining a preferential prudential weighting factor.

STEP III: Voluntary convergence

The third and final phase seems to be less binding than the others; in any case, it will depend on the actions taken by individual Member States. In this respect, the EBA recommends and encourages voluntary convergence between national frameworks also for other aspects (i.e. portfolios of assets constituted by underlying homogeneous activities or debtors located in jurisdictions not belonging to the European Economic Area).
Taking a long-term view, the EBA believes that such spontaneous and non-binding approach to legislative reform could lead to extended homogeneity across the Member States.

The table below provides a summary of main principles of the harmonisation programme recommended by the EBA described above.


Development of a covered bond framework (directive


Amendments to the CRR (related to preferential risk weight treatment)


Voluntary convergence

Establishment of the base-line definition of the covered bond for EU financial regulation

Replacement of the covered bond-related provisions in UCITS Directive

Focus on structural features

Point of reference for prudential regulatory purposes (e.g. BRRD, LCR)

Applicable across sectors

Requirements in Step I obligatory for all covered bonds seeking regulatory recognition  

Enhanced conditions for preferential risk weight treatment

Focus on credit risk related features

Requirements in Step I as well as Step II obligatory for all covered bonds seeking preferential risk weight treatment 

Voluntary convergence of national frameworks through non-binding instruments

Specific areas with less material impact on the overall robustness of the covered bond frameworks

Areas covered:

1. Dual recourse, segregation of cover assets and bankruptcy remoteness of the covered bonds

2. Requirements for coverage, liquidity risk mitigation and cover pool derivatives

3. Requirements for the system of special public supervision and administration:

(i) Cover pool monitor

(ii) Supervision of covered bond issuer

(iii) Supervision in the event of issuer’s insolvency/resolution

(iv) Administration post issuer’s insolvency/resolution

4. Transparency requirements

5. Conditions for soft bullet and CPT covered bond structures 

Areas covered:

All requirements in STEP 1


1. Requirement for eligible cover assets

2. Limits on substitution assets

3. LTV limits for mortgage cover assets

4. Minimum overcollateralisation

Areas covered:

1. Composition of the cover pools

2. Cover pools with underlying assets/obligors located in jurisdictions outside the EEA

3. LTV measurement and frequency of revaluation

4. Stress testing by the covered bond issuer




* This consultation also dealt with the issue related to the development of a harmonised European framework for covered bonds, admitting that legislative divergences between countries may pose a major obstacle in terms of liquidity and investment opportunities and highlighting the importance of several recommendations on best practices suggested by the EBA.

** In accordance with paragraph 1, first subparagraph. Member States may raise the limit of 5% up to a maximum of 25% if the obligations are issued by credit institutions having their registered office in a Member State and subject to a special public supervision for protection of bonds' holders. In particular, sums deriving from issue of such bonds are invested, conforming to the law, in assets able to cover receivables linked to the bonds for the entire duration and that, in case of insolvency of the issuer, would be used on a priority basis for both repayment of capital and payment of accrued interest. Where a UCITS invests more than 5% of its assets in bonds referred to in the first paragraph, issued by a single issuer, the value of such investments will not exceed 80% of the value of UCITS' assets. Member States shall communicate to the Commission the list of bonds categories referred to in the first subparagraph, as well as the categories of issuers authorised under the law and supervisory arrangements to issue obligations complying with criteria set out in the Report. These lists shall be accompanied by a description of the offered guarantees. The Commission shall immediately submit this information to the other Member States, along with appropriate comments, and make it accessible to the public. Such information may be exchanged with the European Securities Committee referred to in Article 112 (1).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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