EUROPEAN COMMISSION Brussels,12.3.2018 SWD(2018) 50 final COMMISSION STAFF WORKING DOCUMENT



IMPACT ASSESSMENT

Accompanying the document Proposal for a Directive of the European Parliament and the Council on the issue of covered bonds and covered bond public supervision and amending Directive 2009/65/EC and Directive 2014/59/EU



And Proposal for a Regulation of the European Parliament and the Council on amending Regulation(EU) No 575/2013 as regards exposures in the form of covered bonds



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1.Introduction One of the Commission's most important objectives is to stimulate investment and create jobs. To achieve that, the Commission has launched a number of initiatives to ensure that the financial system contributes fully in that regard. First among those is the Capital Markets Union (CMU), which contains a series of initiatives aimed at unlocking funding for Europe's growth. The key objective of CMU is to stimulate market financing. However, as bank financing is currently by far the most important funding channel in Europe, one of the actions of the CMU is to further leverage banking capacity to support the wider economy. One way to achieve that is to ensure that banks have a broad range of safe and efficient funding tools at their disposal. Covered bonds are important in that respect. Covered bonds are bonds issued by banks that are secured by earmarked assets on which investors have a priority claim. They are an important source of cheap and long-term funding for banks. They facilitate the financing of mortgage loans and public sector loans, thereby supporting lending more broadly. However, covered bonds are unevenly developed across the Single Market. They are very important in some Member States, less so in others. Furthermore, covered bonds are only partially addressed in EU law. Whereas covered bonds benefit from a preferential prudential and regulatory treatment in several respects in light of their lower risks – e.g. banks investing in covered bonds do not have to set aside as much regulatory capital as when they invest in other assets – what constitutes a covered bond is not comprehensively addressed in EU law. Instead, the various preferential treatments are granted to covered bonds as defined in the UCITS directive (2009/65/EC). That definition was, however, not drafted with this broader purpose in mind but had a more limited scope (limiting what UCITS could invest in). The desire to further leverage banking capacity, the uneven market development of covered bonds and their incomplete regulatory treatment at EU level has given rise to questions as to whether a review of the EU legislative framework is needed. The Commission carried out a public consultation on covered bonds between September 2015 and January 2016, which already gave cautious support to EU wide harmonization. Since then, there has been a convergence of views on the merits of EU action. In December 2016, the EBA published recommendations on how to harmonise rules governing covered bonds. In March 2017, the Commission received a study commissioned from a third party (ICF) highlighting the benefits and costs of a possible legislative framework on covered bonds. The co-legislators have also expressed their support for addressing covered bonds. The European Parliament (EP) has called for the establishment of a European legislative framework on covered bonds. Member States have also been supportive of further action subject to it being principle-based and in line with the EBA advice. As a result, the Commission announced as part of the CMU Mid-term Review its intention to propose a legislative framework for covered bonds. In his latest State of the Union speech, the President of the European Commission confirmed that an enabling framework for covered bonds was part of the initiatives to be launched or completed by end-2018. The purpose of this impact assessment is therefore to assess the case for action (chapter 2), set the objectives that a new framework should aim to achieve (chapter 3) and to assess and compare different options for achieving those objectives (chapters 4-6). 2.Policy context, problem definition and subsidiarity 2.1.Background and context What are covered bonds? Covered bonds are debt obligations issued by credit institutions and secured on the back of a ring-fenced pool of assets (the "cover pool" or "cover assets") which bondholders have direct recourse to as preferred creditors. Bondholders remain at the same time entitled to claim against the issuing entity or an affiliated entity of the issuer as ordinary creditors for any residual amounts not fully settled with the liquidation of the cover assets. This double claim against the cover pool and the issuer is denominated the "dual recourse" mechanism. Furthermore, the cover pool usually comprises high quality assets (e.g. mortgage loans and public sector debt). The issuer is under an obligation to ensure that the value of the assets in the cover pool at least matches at all times the value of the covered bonds and to replace assets that become non-performing, or otherwise do not meet the relevant eligibility criteria. These features reduce the risk of investments in covered bonds, thus providing a rationale for the beneficial regulatory capital requirements as set out in Article 129 CRR and for other favourable treatments envisaged in other pieces of EU legislation. Covered bonds are among the largest debt markets in the EU. They represent an important source of cheap and long-term funding for banks. They facilitate the refinancing of mortgage loans and public sector loans, thereby supporting lending more broadly. For investors they represent a safe investment, as in case of repayment problems they are covered by both the assets in the cover pool and by the issuer (dual recourse). The lower risk profile of the asset pool and the dual recourse mechanism reduce the required rate of return for investors and enable mortgage banks to raise finance more cheaply than by just issuing unsecured bonds. This should normally increase the supply of funding available to the economy, in particular mortgages. Although residential mortgages finance predominantly real estate, entrepreneurs can also use their residential property as collateral for financing their professional activity; commercial mortgages finance business facilities (offices, productive capacity and shopping malls, etc); public sector loans finance local infrastructure (like schools, hospitals etc) and possibly guarantee SME loans; finally, covered bonds in some cases also refinance other assets such as SME loans and infrastructure loans. Covered bonds have therefore wider financing benefits beyond banks and are important to fulfil broader CMU objectives. Moreover, covered bonds proved to be a stable source of funding for banks during the financial crisis compared to the more volatile senior unsecured debt issued by banks. The EBA mandates and Reports On 1 July 2014, the EBA issued a ‘Report on EU covered bond frameworks and capital treatment’ (2014 EBA report) which, in line with the mandate given to the EBA in the ESRB recommendation on the funding of credit institutions from December 2012 (ESRB recommendation), identified best practices with a view to ensuring robust and consistent frameworks for covered bonds across the EU. The report also contained the EBA’s opinion on the adequacy of the current prudential treatment of covered bonds, following a call for advice from the Commission from December 2013 based on the Article 503 of the CRR. As a follow-up to the identification of best practices, the ESRB recommended to the EBA to monitor the functioning of the market for covered bonds by reference to these best practices for a period of 2 years. By 2016, the EBA was requested to deliver a final report to the ESRB and to the Council and the Commission containing an assessment of the functioning of the market for covered bonds under the best practice principles and its view on recommended further action if deemed desirable. In response to this recommendation, in December 2016 the EBA issued a "Report on covered bonds - Recommendations on harmonisation of covered bond frameworks in the EU". The report was the subject of a public hearing on November 2016. This Report includes a comprehensive analysis of regulatory developments in covered bond frameworks in individual Member States, with a particular focus on the level of alignment with the EBA’s best practices. It also provides an assessment of the latest market trends, as well as regulatory developments that have taken place at the European level. Building on the results of the analysis, the report advocates for EU legislative action for harmonizing covered bonds at EU level and presents a comprehensive proposal to this purpose. The EP Report On 4th July 2017, the European Parliament approved an own-initiative report on covered bonds titled "Towards a pan-European covered bonds framework". The Report has been presented before the Committee on Economic and Monetary Affairs (ECON) and the Plenary by the Rapporteur Bernd LUCKE (ECR/DE). The report supports the harmonisation of covered bonds at EU level, calling the Commission to present a principles-based Directive for a European Covered Bonds framework. The report recognizes that covered bonds are sound financial products and that some national frameworks are already very successful. It also raises the concern that a fully-fledged harmonisation aiming at a one-size-fits-all European model would have negative consequences. It therefore proposes a principle-based approach based on high quality standards and best practices but leaving means and ways to Member States to adapt the EU framework to their national specificities.

The ICF study In 2016 the Commission launched a tender for a study on covered bonds to assess their current market performance and the costs and benefits of potential EU action. The study has been awarded to the consultancy ICF, which delivered their final report in March 2017. The Commission published it in May 2017. On the basis of a literature review; qualitative and quantitative analysis and stakeholder interviews (issuers, investors, supervisors…), the study documents a number of costs and benefits of EU action. In terms of costs, these relate to: i) costs for issuers to establish new covered bond programmes; ii) transition costs; and iii) risks of undermining well-functioning national markets. As regards benefits, one key benefit of the new EU framework would be a reduction of the overall default probability of covered bonds due to the strengthening of the credit characteristics of the instrument. This credit strengthening would translate into materially lower borrowing costs for EU credit institutions issuing covered bonds of several basis points. The study also highlights other benefits (e.g. reducing regulatory fragmentation; facilitating reduction of asset and liability mismatches; and, facilitating capital market access to small and medium-sized issuers), though it does not quantify them. Overall, the study finds that benefits exceed costs and therefore EU action is justified. The European Secured Note (ESN) initiative The European Secured Note (ESN) is defined as a dual-recourse financial instrument on an issuer's balance sheet applying the basic structural characteristics of covered bonds to two non-traditional cover pool assets - SME bank loans and infrastructure bank loans. The Communication on the Mid-term Review of the Capital Markets Union (CMU) Action Plan of June 2017 announced that along with an EU framework on covered bonds, the Commission will assess the case for ESNs in order to strengthen the banking sector's lending capacity and support the wider economy. While the covered bond and ESN initiatives are closely linked (as the ESNs make use of most structural features of covered bonds and transfer the covered bond technology to non-mortgage cover pools), it has been decided to follow a separate parallel path for ESN in order to protect the strong reputation covered bonds earned in the last decades in European financial markets. As ESNs are backed by more risky assets, they would inevitably represent a riskier instrument and their perceived higher risk could affect the perception of traditional covered bonds. Member States, supervisors and market stakeholders all have expressed their reserves against connecting the two instruments. The opportunity of an EU initiative on ESN will therefore be subject to a separate impact assessment. This approach is shared by the co-legislators. Following the ECOFIN Council Conclusions of 11 July, Member States discussed ESNs at the Financial Services Committee meeting on 12 July based on a non-paper prepared by the Commission. Member States were overall supportive of the ESN initiative subject to clear differentiation of ESNs from covered bonds and further analysis. In its report on a pan-European covered bonds framework issued in July, the European Parliament (EP) has expressed support for the establishment of ESNs and called on the Commission to develop principles of a legal framework for ESNs. In order to prepare a specific impact assessment, the ESN work stream will build on the EBA advice (to be delivered by 30 April 2018), on a feasibility study by an external contractor (to be delivered on 30 April 2018) and on data collected with the help of the ECBC Task Force on ESNs. The Commission will also launch an open public consultation on ESNs by the end of 2017. 2.1.1.Nature and size of the market concerned As outlined above, covered bonds are an important funding tool that has been subject to significant policy attention recently. This section further describes covered bond markets in terms of the size of the market; who issues and invests in covered bonds; and, the type of assets used as collateral. This section also compares covered bond issuance with another funding tool of banks, i.e. securitisation. Outstanding volumes According to information compiled by ICF, as of December 2015, the outstanding volume of covered bonds reached EUR2.5 trillion at the global level, of which EUR2.1 trillion has been issued by EU resident institutions. To put it into perspective, this figure amounts to about 1.2 times the outstanding volume of corporate bonds issued by non-financial institutions in the EU (which stood at EUR1.8 trillion in 2015) and 4.8 per cent of the aggregate balance sheet of EU banks (EUR43.3 trillion in 2015). Covered bonds are predominantly an EU instrument. The EU represents 84 per cent of the global outstanding volumes, followed by 11 per cent of non-EEA countries and 5 per cent of non-EU EEA countries. Although still comparatively small in absolute terms, the non-EEA markets have recently been growing rapidly: between 2003 and 2015, non-EEA markets posted a compound annual growth rate of 20 per cent compared to 3 per cent for the EU. One of the reasons why the EU has a comparatively large market for covered bonds is the fact that many Member States have longstanding enabling legal framework for covered bonds in place. Figure 0.Evolution of Total Outstanding Covered Bonds [2003-2015, in EUR billion] Source: ICF, 2017 As shown in Figure 1, the global covered bond market has grown steadily for more than 20 years, in particular since 1995. From roughly 2003 until the financial crisis, the twin drivers of overall market growth were the introduction of covered bond regimes in many new jurisdictions and the tightening spread environment. During the financial crisis the issuance level was relatively high as issuers relied more heavily on covered bond funding than on unsecured bonds. Some of the increase in market size from 2007 to its peak in 2012 can be attributed to issuers switching their funding sources from unsecured to secured funding. The other main driver of higher reported levels of covered bonds outstanding in the same period was the increase in bonds issued purely for use as collateral to access the funding made available by the ECB. Since 2012, the global market size has shrunk slightly: outstanding bonds contracted by 7 per cent in 2013 before declining more slowly to €2.5 trillion in 2015. This global decrease was driven by a decline in EU covered bonds, with the rest of the world still experiencing a slow but steady increase in the size of covered bond markets. Anecdotally, the main reasons for the decline in the EU covered bond market have been a normalisation of the spread differential between covered and unsecured bank bonds, less use of central bank emergency funding facilities (therefore less need for covered bonds as collateral), low levels of growth in bank lending in general, and mortgage lending in particular, and regulatory developments including the need for banks to raise more funding in the form of capital (and other bail-in eligible liabilities). As shown in figure 2, within the EU, Germany remains the largest market in terms of outstanding volume (384 bn EUR), closely followed by Denmark (383 bn EUR), France (323 bn EUR), Spain (281 bn EUR), Sweden (222 bn EUR), Italy (131 bn EUR) and the UK (121 bn EUR). The four largest markets still account for almost two-thirds of the EU market in 2015 (vs. 97 per cent in 2003). Figure 1.Size of the seven largest markets in terms of outstanding volumes (2015) Source: ICF, 2017 Issuance

As of 2015, there were 317 active covered bond issuers globally (261 in the EU) and 434 covered bond programmes, in 30 countries. Within the EU, there has been an increase in the number of issuers from 139 in 2003 to 261 in 2015. Germany is still the top EU country in terms of the number of credit institutions issuing covered bonds (79). Spain has 31 active issuers, followed by Austria (27), France (19), the UK (15) and Italy (13). There are also substantial differences between the countries in terms of the typical size of the issuer. Up until 2012, the annual level of issuance in the EU increased substantially, rising from €394 billion in 2003 to €613 billion in 2011. This upward trend halted temporarily in 2012 and 2013 (-2 per cent and -39 per cent respectively). The market quickly recovered – with year-on-year growth rates standing at +4 per cent and +20 per cent in 2014 and 2015 respectively – to reach a level of €454 billion. Denmark is the country with the largest new gross issuance volumes in 2015 (EUR164bn). Other major issuers are Sweden (EUR61bn), Germany (EUR58bn), France (EUR45bn), Spain (EUR42bn) and Italy (EUR29bn). Non-EEA issuers are catching up and their share increased from 1 per cent in 2003 to 11 per cent in 2015. The number of countries outside the EEA with active covered bond markets has grown: Singapore is the latest 2015 addition to a list already containing Australia, Canada, New Zealand, Switzerland, South Korea and Turkey. The US is not active in the market of covered bonds due to the different structure of their mortgage market which is dominated by the two public agencies Fannie Mae and Freddie Mac. Composition of the cover pool In terms of outstanding volumes, the two traditional asset classes still dominate the EU market: mortgages represented 80 per cent of the cover pool in outstanding covered bonds in 2015 and public sector debt 16 per cent, the rest accounting for other assets such as ships. Figure 2.Composition of the cover pool in EU countries’ outstanding covered bonds [2003-2015], figures in bars are in € billion Source: ICF, 2017 As shown in figure 3, the composition of the cover pool in the EU is gradually shifting away from public sector debt towards mortgage debt. Public sector debt represented 59 per cent of total assets in 2003 and fell to 16 per cent in 2015, while mortgages increased from 38 per cent in 2003 to 80 per cent in 2015. This trend is confirmed by the composition of the cover pool of new issuances. Investor base Banks and central banks are the most important investors in covered bonds, accounting for almost two-thirds of the markets (32 per cent and 31 per cent each in 2016), as shown in Figure 4. Asset managers’, insurance companies’ and pension funds’ investment in this market account for the remaining third (about 36 per cent in 2016). Retail investors do not play a significant role in this market (they are included in the category others which itself represents only 1%). This is mainly explained by the fact that in most cases the minimum denomination of covered bonds is 100.000 EUR. The two countries with the largest covered bond markets (Germany and Denmark) allow retail investors to directly invest in covered bonds. While in Denmark, in spite of this possibility, retail investors do not invest in covered bonds, in Germany saving banks sell covered bonds to their customers in the secondary market only (there are no retail investors in primary markets). However, the share of retail investors in secondary markets is quite modest, slightly higher than 1%, but in any case not exceeding 10%. Based on the above, the covered bond market does not look suited to retail investors. Therefore, the possible role of covered bonds as potential retail investment products and the related possible adaptations of the disclosure requirements are not assessed in this impact assessment. Whilst retail investors play no significant direct role, they are nevertheless important players by (indirectly) providing funds to insurance / asset managers that then invest in covered bonds on their behalf. Figure 3.Investor distribution by investor group (by year) Source: ICF, 2017 Two factors dominate recent trends in the investor distribution of covered bonds: ·Firstly, negative or very low absolute yields have reduced the purchases of covered bonds by asset managers, pension funds and insurance companies. Their shares among investors declined from 44 per cent in 2010 to 36 per cent in 2016. ·Secondly, central banks have significantly increased their investments in covered bonds over the past years (12 per cent in 2010 to 31 per cent in 2016) – as a consequence of the successive Covered Bond Purchase Programmes (see next section). ECB purchasing programme

Covered bonds are an important instrument in the conduct of monetary policy in the euro area. The Eurosystem has taken a number of extraordinary measures in support of covered bond markets during the financial crisis, becoming the larger buyer of covered bonds in the EU (nearly a third of the market). CBPPs are successive interventions of the Eurosystem and represent key elements of the ECB's asset purchase programmes, initially aimed at restoring liquidity in the inter-banking market and facilitating the monetary policy transmission, and recently being part of the quantitative easing policy. Concretely, the Eurosystem purchases covered bonds, both in primary and secondary markets. The first two CBPPs, both one-year programmes, were implemented in 2009/10 and 2011/12 respectively. The third, CBPP3, began in October 2014 and is ongoing. By the end of 2016, CBPP3 holdings stood at €203 billion, 70 per cent of which was on secondary markets. Recent data suggest that by early 2017, the Eurosystem has already bought €210 billion of bonds under its third programme. CBPP3 substantially impacted the composition of covered bonds’ investor base – with the share of central banks reaching 31 per cent in 2015/16 (up from 16 per cent in 2014 and 8 per cent in 2013). CBPP3 has also impacted supply and translated into an expansion of the covered bond issuer base. Covered bonds and the real estate market The importance of covered bonds for the real estate market is exemplified by the following numbers (ECBC data). Covered bonds cover an average of 30% of residential mortgages lending in the EU in 2015. There is a high degree of variability across countries. In Denmark all residential mortgages are financed through covered bonds. In other Northern countries (Sweden and Finland) the percentage is also quite high (between 37 and 60%). Slightly lower, but still above one third is the share in Mediterranean countries (Spain, Italy, Portugal). The percentage is 23% in France and 16% in Germany. There is a close relationship between the level of development of covered bond markets and the interest rates on mortgages. The country with the lowest interest spreads on mortgages is Denmark with an average short-term interest rate spread of 1.28% in 2015. Denmark is also the country in the EU with one of the best developed covered bond markets and with the highest proportion of covered bonds in terms of banking assets (37.4%, see table 2). Figure 5 shows that an inverse relationship between short-term interest rate spreads on mortgages and development of covered bond markets exists for all EU countries with available EMF data (a similar, slightly less negative relationship can be seen on long-term rates). Figure 4.Relationship between short-term mortgage spreads and level of development of covered bond markets (outstanding covered bonds as a share of bank assets), 2016. Sources: EMF, ECBC, ECB, Eurostat This negative correlation between covered bond market development and mortgage spreads does of course not imply a causal relationship as there are a large range of other factors that influence spreads in different countries that cannot easily be controlled for. However, a high level of development of covered bond markets and a lower cost of funding for banks can be considered conducive to expand the availability of credit to the real economy and to lower lending rates. There is a relative consensus in the economic literature that bank's funding costs gradually pass through to lending rates. More specifically, research suggests that policy and market interest rates get to a large extent reflected in retail lending rates over a longer term horizon, while the short-term adjustment may be sluggish (see a review in De Bondt, 2002). A breakdown in the relationship between policy rates and lending rates has been observed in the aftermath of the global financial crisis in some euro area countries (Darracq-Paries et al, 2014). However, Illes et al. (2015) show that the pass-through has been comparably high in the pre- and post-crisis periods, once we account for banks' actual funding costs. Covered bonds vs securitization Another source of funding for banks which has similar features to covered bonds is securitization. The Commission's objective is to provide the widest possible panoply of safe and efficient funding instruments for the banking sector to support banks' lending to the real economy. In spite of their similarities, covered bonds and securitization feature different characteristics which make them suitable for different purposes and strategies both for issuers and for investors. The main difference between the two is the dual recourse mechanism: in securitization the holder of the securitized product does not hold any claim towards the issuer. The originate-to-distribute model which mainly underpins securitization can be tempered in order to ensure the issuer keeps some "skin in the game". By contrast, by keeping a full enforcing claim towards the issuer, covered bonds ensure full "skin in the game" by design. That is one of the reasons why historically EU legislators have been ready to grant a significant preferential prudential treatment to covered bonds (see next section) which is not matched by the treatment granted to securitization. Thus the same underlying assets enjoy a better prudential treatment if they are used as collateral in the cover pool of a covered bond than if they are securitized. This means holding covered bonds is more convenient for investors in terms of capital requirements (especially for banks) than holding securitized products. The special treatment covered bonds enjoy appears justified if one considers how differently the two products fared during the financial crisis. Whereas covered bonds proved to be a less pro-cyclical product during that period of stress, as they offered a long-term and stable funding source for banks at a moment when funding channels were drying up, securitization fared differently. Though securitization in the EU did not fare as badly as in the US, it still suffered the stigma of the crisis which led to the collapse of the market. To respond to this market failure, the Commission proposed rules for a simple and transparent securitization. This is another important difference between the two instruments: while the market for securitization was broken after the crisis and needed to be fixed, in the case of covered bonds the market continued to work well. The rationales underpinning action in these two areas are therefore of a different nature. Overall, the two products both present advantages and disadvantages. It is up to banks and investors to assess them and choose the more appropriate funding/investing tool for them at a specific point in time based on their balance sheet and risk/liquidity requirements. The objective of the Commission is to ensure that banks have a wide range of safe and efficient funding tools at their disposal. This is why it proposed legislation on simple, transparent and standardised securitisations and is the reason why it is assessing the case for action as regards covered bonds. 2.1.2.Overview of legislative framework Covered bonds are mainly regulated at national level. Most Member States have working covered bond markets in place. Others either do not have covered bond frameworks in place, or their frameworks are outdated, the effect being that there is virtually no active covered bond market in those Member States. The national regimes in place are different, e.g. in terms of public supervision, disclosure, composition of the cover pool. The different national covered bond regimes impact on the credit strength of the instrument and, therefore, on the degree to which instruments issued under different jurisdictions are eligible for EU wide preferential treatment. There is currently no EU-wide dedicated legislative framework for covered bonds. There is, however, a body of EU law that regulates the prudential treatment for investments in covered bonds (Figure 6). Figure 5.EU rules regulating covered bonds

Source: Commission services, 2017 The treatment of covered bonds under EU law differs from the Basel rules (or other international standards, for example IOSCO), which do not grant specific preferential treatment to covered bonds. The remainder of this section outlines the different aspects of preferential treatment in further detail. Higher investment limits for UCITS Under the UCITS Directive, a “UCITS” (i.e. certain investment funds) cannot invest more than 5 per cent of its assets in transferable securities issued by the same entity. Article 52(4) of the UCITS Directive, however, allows Member States to raise this investment limit to 25 per cent for investments in “UCITS compliant covered bonds” issued by a single entity. Article 52(4) specifies the following minimum requirements for covered bonds as the basis for easing of prudential investment limits: ·The covered bond issuer must be a credit institution with a registered office in an EU Member State; ·The issuer should be subject, by law, to special public supervision designed to protect bond-holders; ·The cover asset pool must provide sufficient collateral to cover bondholder claims throughout the whole term of the covered bond; and ·Bondholders must have priority claim on the cover asset pool in case of default of the issuer. Article 52(4) also obliges Member States to send the Commission a list of covered bonds that comply with the above criteria together with the categories of issuers authorised to issue such bonds. Article 52(4) accordingly de facto defines a covered bond for EU regulatory purposes, serving as a reference for several other pieces of EU legislation. Lower capital requirements for banks investing in covered bonds According to the Capital Requirements Regulation (CRR), credit institutions must hold regulatory capital in respect of debt securities held on their books, risk-weighted according to the type of issuer and obligation. However, article 129 CRR allow those investing in covered to hold lower levels of regulatory capital in relation to these instruments as compared to other debt such as senior unsecured bank debt. These lower capital requirements are referred to by the CRR as "preferential risk weights". These preferential risk weights are, however, only available for "qualifying covered bonds”. To qualify for preferential treatment, covered bonds must be (a) UCITS compliant [Art. 129 (1) CRR]; (b) secured by specific cover assets [Art. 129 (1) CRR]; and (c) satisfy various transparency requirements [Art. 129 (7) CRR]. Art 129 is addressed to bank investors who use the standard approach to capital risk weight allocation. While the internal ratings based approaches are substantially more complex they also allow similar levels of preferential risk weighting treatment. Special treatment in recovery and resolution Article 44(2) of the Bank Recovery and Resolution Directive (BRRD) exempts UCITS-compliant covered bonds from the scope of the bail-in tool. It should be highlighted, however, that the BRRD limits this exemption up to the level of collateral in the cover pool. Apart from bail-in, the application of other resolution tools might also have implications for covered bonds, particularly in the context of partial transfer of assets/liabilities to bridge institution or asset management vehicles. The BRRD also provides for safeguards to be applied in the case of partial transfers (Article 76), and Article 79 requests Members States to ensure— in the event of the partial transfers—appropriate protection of covered bonds and to prevent the assets, rights and liabilities from being separated under a partial transfer, or being terminated or modified through the use of ancillary powers. Lower solvency capital requirements for insurance undertakings investing in covered bonds Article 180(1) of the Solvency II Delegated Regulation lays down the capital requirements for (re)insurance undertakings investing in covered bonds. The term 'covered bond' is not defined within the Solvency II Delegated Regulation itself. The definition is derived from the UCITS Directive Article 52(4). The Delegated Regulation contains certain risk calibrations in its standard formula which is used by many insurers to compute their solvency capital requirement. The Delegated Regulation contains a preferential treatment for covered bonds in comparison with similar rated corporate bonds. The risk calibrations for covered bonds are in between those applicable to corporate bonds and government bonds, provided the covered bonds are highly rated.

Favourable treatment in banks' liquidity requirements The LCR Delegated Act requires that banks hold enough high quality liquid assets to cover the difference between the expected outflows and inflows over a 30-day stressed period. It provides favourable treatment to covered bonds by allowing credit institutions to hold covered bonds as part of their liquidity requirements i.e. it allows credit institutions to treat covered bonds as liquid assets of level 1, if they qualify as "extremely high quality", or as level 2, if they are so called "high quality", for the purposes of calculating their liquidity coverage ratio (LCR). The LCR Delegated Act sets out a number of specific criteria to differentiate between covered bonds of level 1 and 2 and also incorporates by reference the well-established covered bond definition contained in Article 52(4) of the UCITS Directive. Specific treatment of cover pool derivatives as regards clearing Under the EMIR, derivatives should normally be cleared through a central clearing counterparty. As covered bond derivatives contain certain non-standard clauses they are typically not eligible for CCP clearing. The Regulatory and Implementing Technical Standards (RTS) under this regulation for risk mitigation for derivatives that are not cleared provide for a specific treatment of cover pool derivatives. Under a specific set of conditions, covered bonds issuers or cover pools should not be required to post collateral for the derivatives held to hedge risks inherent to the cover pool. To obtain this treatment, the derivatives must meet certain conditions including compliance of the covered bonds to whose cover pool they belong to with Article 129 of the CRR and with a minimum level of overcollateralization of 2%. 2.2.Problem definition Covered bonds are an important funding tool for banks. Their markets are well-developed in some Member States and less so in others. Given their particular risk features, they also benefit from a preferential prudential treatment in several respects. This treatment rests on a definition of covered bonds set out in UCITS, which originally was developed with a more limited purpose in mind. Taken together, this gives rise to two sets of concerns. The first is related to the untapped CMU potential. Covered bond markets are currently fragmented along national borders, and national regulatory frameworks differ significantly. This creates legal uncertainty and gives rise to the following problems: (1)covered bond markets are unevenly developed across the EU: not all banks from different countries and of different size are able to exploit the cheap and stable source of funding that covered bonds represent; (2)the investor basis is not sufficiently diversified; (3)there is untapped potential for cross border investments; (4)investments from outside the EU are low. The second regards prudential concerns and related risks to e.g. investor protection. The main problems in this area are the following: (1)misalignment between the fact that EU law does not directly lay down the structural characteristics of the product, which mostly derive from national law, and the favourable treatment granted to investments in covered bonds at EU level; (2)inadequate current capital preferential treatment envisaged in art 129 CRR; (3)ongoing financial innovation which could pose threats in terms of investor protection. 2.2.1.Untapped CMU potential This section outlines how markets are unevenly developed in terms of issuance, the limited range of investors, and the limited range of cross-border investments both within the Single Market and beyond. Unevenly developed markets Covered bonds are unevenly developed across the EU as shown in tables 1 and 2. Covered bond issuance is dominated by a few Member States. Approximately 80% of global covered bond issuance is represented by six Member States (Denmark, France, Germany, Italy, Spain and Sweden). The four largest outstanding markets (Germany, Denmark, France, and Spain) accounted for almost two-thirds of the EU market in 2015. At the same time, nine Member States do not have any covered bond markets. Table 1 – Uneven development of covered bond markets

Member State Legal framework Compliance with EBA Best Practices Active market Size of the market

(relative to total EU market) AT ✓ Low ✓ Medium BE ✓ Medium ✓ Medium BG ✓ NA ✗ NA HR ✗ NA ✗ NA CY ✓ Medium ✗ Small CZ ✓ Low ✓ Medium DE ✓ Medium ✓ Large DK ✓ High ✓ Large EE ✗ NA ✗ NA EL ✓ High ✓ Small ES ✓ Medium ✓ Large FI ✓ High ✓ Medium FR ✓ High ✓ Large HU ✓ NA ✓ Small IE ✓ Medium ✓ Medium IT ✓ Medium ✓ Large LT ✓ NA ✗ NA LV ✓ NA ✗ NA LU ✓ Low ✓ Small MT ✗ NA ✗ NA NL ✓ High ✓ Medium PL ✓ Medium ✓ Small PT ✓ Medium ✓ Medium RO ✓ High* ✗ NA SK ✓ Low ✓ Small SI ✓ Medium ✗ NA SE ✓ Medium ✓ Large UK ✓ High ✓ Large Source: Commission Services elaborations based on EBA (2016) and ECBC Fact Book (2016). Legend: Small < €10 bn, Medium < €100 bn, Large > €100 bn. *After recent amendments, Romanian framework can be considered highly compliant with EBA best practices. The uneven development of covered bond markets is also apparent if one compares the size of national covered bond markets with the size of national banking sectors (see table 2). In 19 out of 28 Member States this ratio is below 4.4% (the EU average), while in three the ratio is at or above 10% (Denmark, Sweden and Spain). Table 2 – Ratio of outstanding covered bonds / banking assets (2015) EU country Ratio CB/ bank assets Total CB outstanding (EUR mln, 2015) Total banking assets (EUR mln, 2015) Denmark 37,4% 383.124 1.024.778 Sweden 17,3% 221.990 1.281.511 Spain 9,9% 280.888 2.828.440 Portugal 7,8% 34.961 450.063 Finland 6,1% 33.974 556.050 Slovakia 6,1% 4.198 69.104 Czech Republic 5,6% 11.656 206.630 Austria 5,3% 44.965 854.229 Germany 5,0% 384.414 7.665.206 France 4,0% 323.072 8.150.044 Italy 3,3% 130.535 3.919.502 Ireland 3,0% 32.305 1.086.843 Hungary 2,7% 3.022 112.408 Netherlands 2,5% 61.101 2.430.643 Belgium 1,6% 16.905 1.073.501 United Kingdom 1,3% 121.268 9.355.722 Greece 1,3% 4.961 386.025 Luxembourg 1,0% 10.166 1.002.760 Cyprus 0,7% 650 91.020 Poland 0,3% 1.266 394.333 Bulgaria 0,0% 0 48.585 Estonia 0,0% 0 23.240 Croatia 0,0% 0 57.879 Latvia 0,0% 0 31.932 Lithuania 0,0% 0 24.783 Malta 0,0% 0 47.397 Romania 0,0% 0 92.288 Slovenia 0,0% 0 41.603 EU 4,4% 2.105.421 43.306.519 Source: Commission Services estimates. Another way to look at the uneven development of covered bond markets in relative terms is to consider the ratio between covered bonds outstanding and residential mortgages in different countries. While the EU average is 30%, there is a lot of variability across countries with Denmark at 100% and Poland at 1.4%. The reasons why covered bonds developed in some Member States and not in others is partly due to history. The instrument was created decades ago (in some cases even centuries ago, as in Denmark and Germany it is around 200 years old) and has grown gradually over time. There are several factors which underpin the development of covered bond markets. Some of them are of a macroeconomic and structural nature. There are, however, important regulatory factors that play a crucial role in the development of covered bond markets. They include: I.the existence of an enabling regulatory framework that commands confidence among investors; and II.broader regulatory elements related to the insolvency framework and the enforceability of collateral, including foreclosure processes and legal aspects of asset transfer. The lack of a legal framework in Member States characterised by underdeveloped covered bond markets in principle confirm the importance of regulatory factors. However, the cases of countries with legal frameworks in place, but no active covered bonds market (see table 1) could also suggest that other factors play a significant role. As outlined above, a legislative framework for covered bond is indeed in place in six of the nine Member States that do not have covered bond markets. As also outlined, the framework is in most instances outdated and not able to support a properly functioning market. Some economic factors might help explain the lack of urgency in dealing with regulation. For example, countries with non-existent or very small covered bond markets are usually characterized by a lack of diversification in banks' funding sources. In many Central and Eastern European countries, banks mainly rely on deposits for their funding. The abundance and availability of bank deposits makes the need to find alternative funding sources less compelling. However, there are several reasons why this situation is not sustainable in the longer term. First, banks with a broad and diversified range of funding tools are more resilient, as recognised by the IMF (2013) and the BIS (2013). In times of crisis, covered bonds allow banks to continue access funding markets, as was evident during the financial crisis, especially in some peripheral European countries. For many banks most notably from Spain, Italy, Greece, Ireland and Portugal, this instrument became the main source of long-term wholesale funding, as their access to unsecured markets was partially or fully closed (Van Rixtel and Gasperini, 2013). Secondly, in normal times, in order to finance growth in banks' balance sheets, banks need other sources of funding than deposits. Deposits indeed can grow only up to a certain limit and, at the same time, they need to be financed through more capital, while covered bonds have lower capital and liquidity requirements. Finally, from the investing bank's point of view, covered bonds can be used as liquid assets to meet liquidity requirements (for example in the LCR). Nevertheless, covered bonds also present some risks. One of the main risks resulting from a significant growth in covered bond markets is asset encumbrance i.e. assets specifically pledged to pay for certain liabilities. However, according to the EBA (2017), the level of asset encumbrance in Member States where covered bond markets do not exist or are underdeveloped is low at the moment (ranging between 0% and 10%). Undertaking a process of updating the existing legislation requires, however, specific expertise and collaboration between different institutional actors including the ministry of finance and the supervisors. This, along with the non-urgency of the bank funding diversification in some Member States, explains why some of them did not embark in the process. Other Member States are doing it with the help of the EBRD (EE, HR, LT, LV, PL, RO, SK). In Poland, for example, where the ratio of deposit to loans was 94% at the end of 2016, the planned total asset growth for 2017 is 15% (EBA, 2017) and the planned deposit growth 18%. However, planned deposit growth rates are not always met and even a small negative deviation from the planned target could hit lending and economic growth significantly. For similar reasons, in Slovakia CB legislation has been recently amended. The EBRD itself and most Member States consider having a framework at EU level in place an important blueprint on which modelling their legislation. According to the EBA, three Members States (AT, ES, IE) have informed that they intend to wait for the Commission's conclusions before taking any action. In another 9 jurisdictions no changes to national frameworks have been introduced (BE, CY, DK, FI, IT, LU, PT, SI, UK). Also in those cases, the expectation of EU action has played a role in postponing any adjustment. There is also another dimension of the uneven development of covered bond markets which relates to economies of scale and the size of issuers. Covered bonds are mainly issued by large banks, as setting up programs entails high upfront costs. Moreover, liquidity is important in covered bond markets and the latter is largely determined by a certain minimum volume of bonds outstanding. Smaller transactions are possible although they typically require a higher coupon to reflect the lack of liquidity. This explains why issuing covered bond is currently a business mainly for large banks, as illustrated by the large size of covered bond issuers across the EU (on average above EUR200 bn). As a consequence, the benefits of covered bonds are currently often beyond the reach of smaller banks. Undiversified investor base

The main investors in covered bonds are banks and central banks (see section 2.1.1). The limited uptake from other financial institutions (e.g. insurance/pension/asset managers) is problematic from a CMU perspective, as it limits these firms from channelling funds to banks and through them to the real economy. The situation was different in the recent past. As figure 4 above shows, before 2013 the combined share of investors other than banks was significantly higher. It has since declined, largely due to lower yields resulting from ECB purchasing programs. These have reduced the incentives of asset managers, pension funds and insurance companies to invest in covered bonds. This effect has been reinforced by the limited size of the market in some Member States and by fragmentation across the euro area. The lack of diversification also leads to prudential concerns, in terms of increased concentration of risks. If covered bonds end up being mostly acquired by other banks, this does not bring additional liquidity to the sector and concentrates credit risks within the sector itself, creating interconnectedness. It is therefore important to diversify the investor base in light of the temporary nature of the ECB's involvement, future financing needs of banks and to address prudential concerns. Untapped potential for investments across the Single Market There is an untapped potential for further development of cross-border investments across the EU single market. While cross-border investment in covered bond markets across the EU currently represents 60% of total covered bond investments, this figure needs to be better qualified. Not only it overstates the cross border activity in the EU, but also the bulk of such investments come from countries with a strong covered bond tradition (e.g. Germany and Nordic countries). Germany is particularly dominant, accounting on average for 37% of all cross-border investments of which most go to Nordic countries. Finally, the most part of cross-border investments takes place across countries with similar covered bond and mortgage legislations (for example Nordic countries typically invest in other Nordic countries). All this leaves an untapped potential in terms of cross-border investments. Fulfilling this potential through a broader harmonized market would be important for issuers aiming at expanding the markets for selling their covered bonds both within and outside the Union. It would also be important for investors wanting to geographically diversify their portfolios.. In the context of the public consultation conducted by the European Commission between 2015 and 2016, many respondents confirmed that cross-border investment in covered bonds is “already taking place”, but many (insurers, investors, public authorities including the ECB) underlined that it faces significant legal or practical obstacles. Among them, a commonly highlighted issue referred to differences in legal frameworks which require prospective buyers to invest more in credit analysis and legal research. This may partly explain why the investor base remains home-biased and concentrated in markets with similar regulatory frameworks. Certain respondents suggested that harmonisation could encourage and facilitate additional cross-border investment. The ECB, in responding to the public consultation on the CMU MTR, manifested concern for the low comparability of covered bonds across Member States and fragmentation in the markets, showing support towards an EU covered bond harmonized framework and the EBA's recommendations to that effect. Another aspect of the cross-border dimension is the existence of cross-border cover pools which could help lending across countries. Cross border cover pools allow lowering country risk concentration. This could help countries that do not currently have developed covered bond markets and where the small scale of mortgage operations may necessitate cross-border cover pools to achieve critical mass . Nonetheless, cross-border cover pools remain very limited. Of 125 programmes rated by Fitch, only 21 included assets from jurisdictions other than the one in which the issuer was based. This minority represents EUR 70.3 billion, or 3.2 per cent of the outstanding European covered bond market. Most were concentrated in four Member States (DK, FR, DE, and LU). Many respondents to the Open Public Consultation highlighted that there are significant legal or practical barriers to cross-border cover pools. For example, only a few jurisdictions have developed rules catering for this situation, e.g. specifying valuation methodologies for loans in other countries. Limited third-country investments The lack of a European covered bond regulatory framework might also hamper investment from third countries, as investors from outside the bloc do not have a comprehensive basis for comparison with the covered bond framework of their home jurisdiction. Currently, investments from outside the EU represent a small share of the market as only 11% of EU issued covered bonds are held outside the EU (ICF, 2017) compared to 16.5% of total debt securities (Commission estimates). This illustrates that covered bonds are underrepresented among investments from outside the EU. This issue will become more important in the medium term when the ECB support programmes will eventually come to an end. More third-country investments would help maintain good funding conditions for European banks. However, it is unlikely that those kinds of investors will invest time and resources to perform due diligence of the different characteristics of more than 25 non-harmonised national regimes. Moreover, in absence of an EU harmonized framework it is also difficult to establish equivalence between jurisdictions and therefore allow for reciprocal recognition of preferential treatment. This could hamper foreign investors' interest in EU covered bonds and limit EU investors' range of interesting investment choices. 2.2.2.Prudential concerns There are also prudential concerns associated with the preferred treatment enjoyed by covered bonds, given that EU law does not comprehensively define what covered bonds are and much is left to national legislation. As a result, the preferential treatment may be accorded to very different products depending on the Member State in question. Furthermore, where EU law exists it may not fully address potential risks related to covered bonds (CRR) or may not have stood the test of time in terms of financial innovation or regulatory developments, e.g. as regards state aid and resolution. This section further outlines those concerns. At the same time, it is commonly recognized that covered bonds performed well during the financial crisis. This should not give ground to complacency, also taking into account the exceptional state support granted to the banking sector during the crisis. In forming a view on how the existing prudential rules perform, the Commission services have drawn on a variety of sources, including the two reports issued by the EBA in 2014 and 2016 as well as views expressed during the public consultation. Diversity in national covered bond frameworks and risk of misalignment with preferential prudential treatment As seen in section 2.1.2, the only piece of EU legislation that defines a covered bond is art. 52 UCITS. However, this provision was not conceived for this broader purpose in mind, but was rather focused on extending the limit on investment concentration in some product offerings (including those that contain covered bonds) that were considered of higher quality. The UCITS definition in Article 52(4) has therefore never been intended to serve as the general definition of covered bonds as a financial instrument, but to ensure an appropriate level of protection to investors investing in UCITS compliant funds. From this perspective, the UCITS definition contains only a few provisions for a debt instrument to be considered covered bond namely: i) the nature of the issuer; ii) the dual recourse principle; and iii) the special public supervision. It does not develop detailed provisions to define other structural features of covered bonds and is therefore not suitable to be considered a proper definition for an instrument having such a significant size and importance for the EU banking sector. Over time, covered bond instruments have further developed and contain elements that go beyond the narrow definition in UCITS. For instance, some covered bonds have extendible maturity structures such as the soft-bullet and conditional pass through, while others contain specific provisions on liquidity buffers or composition of the cover pool. These aspects are not captured by the existing provisions in UCITS. Instead, the structural characteristics of covered bonds are mainly defined in national legislations. This leads to a large diversity of covered bonds instruments across the EU. The EBA documents the current diversity in the national covered bond frameworks in legal, regulatory and supervisory terms. While there are similarities (e.g. related to dual recourse and the coverage principle), there are variations in the frameworks in the area of special public supervision as well as in relation to the disclosure of data, liquidity buffers, composition of the cover pool, and stress testing. In light of these differences, action at EU level may be necessary in order to ensure that the favourable treatment extended to covered bonds in EU legislation rests on solid ground. For example, in relation to public supervision, the EBA finds differences across the EU in the content and level of detail regarding the rules on special public supervision, scope of duties and the powers of supervisory authorities regarding ongoing supervision of covered bond issuers and programmes, as well as the rules on approval and licensing of covered bond programmes. Furthermore, the EBA notes that the divergences extend beyond regulatory frameworks and are also observed in actual supervisory practices of individual competent authorities in the execution of special public supervision. The elements of the regulatory framework related to the supervisory model have indeed potential credit impact as confirmed by rating agencies. The EBA 2016 Report also shows that, since the publication of the EBA Best Practices on Covered Bonds in 2014, more than half of the responding jurisdictions (12 out of 22) have either not implemented any changes to their covered bond frameworks or action is on hold pending the results of the Commission’s review of the EU covered bond framework. Convergence has therefore not taken place in the recent years during which the process has been monitored. The diversity of national frameworks means that covered bonds with diverse characteristics benefit from the same preferential treatment. This may give rise to prudential concerns. Preferential capital treatment not adequate (art 129 CRR) When adopting the CRR in 2013, the legislators called on the Commission and the EBA to review whether the preferential capital treatment for covered bonds is adequate in light of the prudential risks. On the basis of a first report in 2014, the EBA concluded that art 129 CRR does not need modifications in terms of inclusion/exclusion of specific cover assets, but is less specific on equally relevant aspects of prudential treatment. In a second report in 2016, the EBA recommended that the CRR be strengthened in relation to (i) disclosure requirements for the issuer; (ii) rules on substitution assets; (iii) Loan-To-Value limits for cover assets collateralised on physical property (i.e. for mortgage cover pools); and, (iv) minimum over-collateralisation. The EBA also notes that existing provisions on the eligibility of cover assets for the capital preferential treatment should be reassessed. The Commission services share this assessment and believe that the treatment provided for in article 129 of the CRR is not adequate and that the conditions for accessing this treatment needs to be strengthened. Not addressing new risks resulting from financial innovation The combination of EU and national frameworks is inadequately equipped to deal with new risks presented by financial innovation. Financial innovation has, for example, prompted the increasing use of new structures, so-called Soft-bullet and Conditional Pass Through (CPT) programmes. These aim to mitigate liquidity risk through the introduction of long-term maturity extensions regarding repayments to bondholders. These kinds of extendible structures may involve a higher level of complexity, incorporate non-uniform features and introduce changes to the structural characteristics of the product, as the EBA recognizes. The new structures may pose new risks to investors in terms of liquidity. These risks may not be in line with the current preferential treatment.

Evidence suggests that covered bonds containing these new features so far represent a relative limited share of the overall market for outstanding covered bonds. However, their market share is increasing. The fact that these features have increased structural diversity in the covered bond market is also the result of how they have typically been introduced – by contractual terms – rather than by regulation. While, within any given country, soft bullet structures seem relatively homogenous, there are differences across jurisdictions.



Figure 6.Problem tree Drivers Problems Consequences Unevenly developed covered bond national markets Untapped CMU Potential: Restricted financing and investment options, leading to reduced capacity of the banking sector to finance the wider economy Differences in national legal frameworks on covered bonds and lack of frameworks in some MS -> legal uncertainty and informational problems for investors Low diversification of investor base Untapped potential for EU cross-border investment Low level of investment in covered bonds from outside the EU

Prudential concerns: Financial risks, market integrity and investor protection Prudential requirements not aligned with structural characteristics of the product: financial risks National frameworks defining different structural characteristics for covered bonds Preferential capital treatment not adequate: prudential concerns Requirements for capital preferential treatment not adequate Out-of-scope drivers: - ECB covered bonds programme - investor and issuer preferences - market conditions - macroeconomic developments - etc. Increased risks due to financial innovation Financial innovation (soft bullets/CPT)

2.3.The EU's right to act and justification The Treaty on the Functioning of the European Union confers to the European institutions the competence to lay down appropriate provisions that have as their objective the establishment and functioning of the internal market (Article 114 TFEU). The previous section demonstrated that covered bonds are unevenly developed across the Single Market and that there is an untapped CMU potential. It also highlighted that covered bonds are only partially addressed in EU law, which may give rise to prudential concerns. To address these two concerns, action at EU level is warranted. First, concerning the CMU potential, the EU level is the most effective to address significant differences in national regulatory frameworks, diverging practices in the market and at regulatory level by Member States, fragmentation in the Single Market and lack of harmonization that hamper cross-border investments. These problems can best be tackled at EU level. Second, as regards prudential concerns, these stem from the fact that what constitutes a covered bond is not comprehensively addressed in EU law. The only definition of covered bonds at EU level is in the UCITS directive. That definition was, however, not drafted with this broader purpose in mind but had a more limited scope and is not considered to sufficiently ensure convergence of the structural characteristics of the product across the EU with the level of risk implied by the favourable EU treatment. As a result, covered bond structural characteristics are mainly defined at national level and these regimes vary significantly. Harmonising national frameworks would ensure that the structural characteristics of the product are the same across the Single Market. EU action appears the most effective way to achieve that objective. Also in this second area, problems can therefore best be tackled at EU level. The Public consultation, the 2016 EBA Report, the resolution of the European Parliament and subsequent discussions with Member States in e.g. the Financial Services Committee of the Council and the European Commission Expert Group on Banking, Payments and Insurance show that stakeholders in general welcome a further harmonisation in form of a directive building on well-functioning national systems. A directive represents, indeed, the best means to achieve the stated objectives while respecting the principle of subsidiarity. A number of Member States have also put on hold changes to national covered bond-legislations, which also show that they expect further harmonisation at EU level. 3.Objectives In light of the concerns outlined in the previous chapter, two general objectives will be pursued, which in turn can be articulated into specific objectives: ·Enhance CMU potential, leveraging banking capacity to support the wider economy: a harmonised EU framework for covered bonds would enhance their use as a stable and cheaper source of funding for credit institutions, especially where markets are less developed, in order to help financing the real economy in line with the objectives of the CMU. This would translate into the following specific objectives:

–Contribute to the development of covered bonds markets in EU countries where they do not exist or are less developed. Expanding the scope of covered bond markets, is not only to be intended from the geographical perspective, but also in terms of issuers size; –Diversify covered bonds' investor base; –Tap the potential for more cross border investments; and –Attract investors from third countries. This will be particularly important when the ECB ends its covered bond purchase programme and the monetary stance eventually becomes less accommodative. Credit institutions will then be more in need of cheap and long-term sources of funding to finance the real economy; ·Address prudential concerns and ensure the coherence of preferential prudential treatment: national frameworks need to be strengthened and harmonised in order to ensure that the preferential treatment provided for under EU legislation is aligned with the level of risk implied by the structural characteristics of the instrument. This would translate into the following specific objectives: –Define the structural features of covered bonds in EU law in order to align the structural characteristics of covered bonds across the EU with the risk features underlying the EU preferential treatment; –Strengthen the requirements for benefitting from preferential capital treatment under the CRR; and –Define a framework for newly developed liquidity structures (Soft-bullets and Conditional Pass-Through (CPT) programmes). Table 3 – Intervention logic diagram Problems and consequences Objective Consequence 1 Untapped CMU potential – Restricted financing and investment options, leading to reduced capacity of banking sector to finance the wider economy. General Objective 1 Enhance CMU potential - Leveraging banking capacity to support the wider economy. ·Problem 1: Unevenly developed national markets ·Specific objective 1: contribute to develop covered bond markets in all EU countries ·Problem 2: undiversified investor base ·Specific objective 2: diversify investor base ·Problem 3: Obstacles to cross border investments ·Specific objective 3: tap the potential for more cross border investments ·Problem 4: Low levels of investments from outside the EU ·Specific objective 4: attract investors from outside the EU Consequence 2 Prudential concerns – Financial risks, market integrity and investor protection General Objective 2 Ensure the coherence of EU prudential regulation with the structural characteristics of covered bonds ·Problem 1: diversity in national covered bond frameworks and risk of misalignment between EU preferential treatment and risk characteristics of covered bonds ·Specific objective 1: Define the structural features of covered bonds in EU law in order to align the structural characteristics of covered bonds across the EU with the risk features underlying the EU preferential treatment ·Problem 2: requirements for capital preferential treatment not adequate ·Specific objective 2: strengthen the requirements for benefitting from preferential capital treatment in CRR (art 129) ·Problem 4: increased risks due to financial innovation (soft bullets and CPTs) ·Specific objective 4: define a framework for new liquidity structures 4.Options This section will examine the policy options available to achieve the above objectives. The baseline scenario consists of the current status quo (i.e. no action). There will then be a range of options that differ in terms of intensity of harmonisation, spanning from a non-regulatory option to options involving full harmonisation. More specifically: ·Baseline: do nothing; ·Option 1: Non-regulatory option; ·Option 2: Minimum harmonisation based on national regimes; ·Option 3: Full harmonisation replacing national regimes; or ·Option 4: 29th regime operating in parallel to national regimes. The four options listed above will all be assessed in the following. In addition, the final part of this section outlines an option (adjusting the preferential prudential treatment) that has been discarded as it would significantly disrupt existing markets and lacks any stakeholders' support.

This section explores the main advantages and disadvantages of the options listed above. For ease of reference, the following policy-option matrix (table 4) summarises each of the available options (rows) along with the related policy areas to be addressed (columns). Each cell specifies the level at which each area will be settled. The first column is about the structural characteristics that a covered bond must have (for example dual recourse, segregation of cover assets and bankruptcy remoteness of the cover pool). The second column is about what assets should be allowed in the cover pool (especially in terms of traditional vs non-traditional assets). The third column is about how covered bonds should be supervised. Such "special public supervision" is another fundamental characteristic of covered bonds. The fourth column is about whether or not EU covered bonds should be granted a label. The fifth column is related to the preferential treatment that covered bond investors enjoy under EU law (cfr section 2.1.2). The sixth column is related to transparency requirements. Finally, the last column concerns all the other technical aspects spanning from overcollateralization levels to cover pool derivatives and liquidity risk mitigation tools. Each of the four options considered will cover all the policy areas in the columns with a different degree of harmonisation. Table 4 – Policy-option matrix Structural features

a) Cover pool

b) Supervision



c) Label



d) Preferential treatment

e) Transparency



f) Technical aspects

g) Baseline Mainly national National National Market EU Market National Option 1 Mainly national National National Market EU Market National Option 2 EU National and EU National + basic EU rules EU EU revised/ strengthened EU Principles at EU level + details at national level Option 3 EU only EU National/SSM + detailed EU rules EU EU revised/ strengthened EU Principles + details at EU level Option 4 EU (national for parallel regimes) EU (national for parallel regimes) National/SSM + detailed EU rules EU EU revised/ strengthened EU Principles + details at EU level (national for parallel regimes) In designing these options, the Commission services have taken due account of the views expressed by various stakeholders and in particular the 2016 advice of the EBA and the 2017 report of the European Parliament. The EBA advice In their 2016 Report, the EBA suggests a ‘three-step approach’ to the harmonisation of covered bond frameworks in the EU: (1)Step I: develop a principle-based covered bond framework, which would aim to provide a definition of the covered bond product as an instrument recognised by the EU financial regulation (implementation via directive is recommended). This would be the central point of reference for prudential regulation purposes; (2)Step II: targeted amendments to the CRR provisions on covered bonds, which would aim to enhance conditions for the access to preferential risk weight treatment of covered bonds; (3)Step III: use of non-binding instruments with a view of stimulating voluntary convergence between national frameworks in specific areas considered less critical in terms of alignment with preferential prudential treatment, and, at the same time, also the most controversial among Member States. Overall, the EBA approach is advocating for minimum harmonisation. The EBA approach intends to be principle based and to build on the strengths of the existing national frameworks, while, at the same time, ensuring more consistency in terms of definition and regulatory treatment of covered bonds in the EU. It should however be noted that some stakeholders, including Member States, have expressed the view that the 2016 EBA report, in some instances, goes beyond the advocated principle-based approach and gets into a high level of details on some issues (e.g. liquidity requirements). The EP Report Overall, the EP Report shares the EBA approach to covered bond harmonization, except for some elements. For example, the EP report proposes a common definition of covered bonds based on two labels: some covered bonds would become Premium Covered Bonds (PCBs) and others would remain Ordinary Covered Bonds (OCBs). In addition, the Parliament also proposes to create a new category of covered bonds to be named European Secured Notes (ESNs) based on SMEs loans or non-government-backed infrastructure loans. 4.1.Baseline: do nothing The baseline scenario implies no action at EU level. The structural features of covered bonds would therefore continue to be regulated mainly at national level with the exception of the few elements imposed by the UCITS Directive (Art. 52). The current preferential treatment would remain in place. The Best Practices published in 2014 by the EBA would continue to serve as a reference point for the coordination of Member States regulations, but they would remain voluntary. The industry could continue or intensify its ongoing initiatives of voluntary standardization. While the definition of an industry-led EU covered bond label is already in place in relation to transparency requirements (see work of European Covered Bond Council), in the future the industry could provide standardisation also in the field of defining market standards for new maturity structures. Another market push in the direction of harmonisation could come from credit rating agencies' requirements as issuers tend to comply with them to get better ratings. Under this scenario: a)Structural features: The structural features of covered bonds would remain regulated at national level; b)Cover pool: The cover pool would remain regulated at national level. However, for covered bonds eligible for capital preferential treatment, assets are explicitly listed in art 129 CRR; c)Supervision: The characteristics of the supervision model would remain regulated at national level;

d)Label: The labelling process would be market-driven; e)Preferential treatment: Preferential treatment would remain regulated at EU level in different pieces of EU law (see section 2.1.2); f)Transparency: Transparency requirements would remain mainly market driven. However, for covered bonds eligible for capital preferential treatment under article 129 CRR, transparency requirements would remain explicitly listed in the same article; and g)Technical aspects: Other technical aspects would remain regulated at national level. Under the baseline scenario, covered bonds issuance is expected to increase in the short term. According to a survey by the EBA, EU banks indeed plan to increase covered bond issuance in 2018 and 2019 after below average supply in 2017. However, this only affects the largest and established EU covered bond markets. Substantial increases compared to 2017 of the order of 50% are expected in Sweden, Germany, Denmark, France, Italy and Spain. The main driver is the expectation of increase in overall debt issuance in the banking sector for the next couple of years. The latter is due to the winding down of central bank funding and to improved economic conditions. According to Credit Agricole analysis, spreads are expected to widen by around 20-30bp on the back of tapering. In relation to the main problems identified in section 2.2, under the baseline we would expect: ·CMU potential – Problem 1: a few countries with no legislation in place would undertake legislation in line with EBA best practices. It is unlikely that all countries would comply with EBA best practices, as empirical evidence has already shown. Even if issuance in the largest and well-established market is expected to increase compared to 2017 (see above), no uptick in issuance is expected in less developed markets. ·CMU potential – Problem 2: the increase in yields of around 20-30bp on the back of tapering (see above) would likely have the effect of attracting investors other than banks such as insurers and asset managers. The latter have partly retreated because of the ECB purchasing programmes and should find it easier to recover their demand should the CBPP3 step back and the yields widen thus proving more attractive for them. ·CMU potential – Problem 3: no significant changes are expected in this respect and the cross-border activity is expected to remain the same and taking place mainly between countries with similar jurisdictions (see section 2.2). ·CMU potential – Problem 4: no significant changes are expected in this respect. In the absence of any EU regulatory framework for covered bonds, it would be difficult to assess equivalence with third country regimes. This would hamper investments by third countries. It would also restrict the choice for investors based in the EU. Moreover, the increased issuance coupled with the likely reduction or ending of the ECB CBPP3 could cause difficulties for issuers in placing their issuance on the market. ·Prudential concerns – Problem 1: the process of harmonisation would not necessarily take place or would take place only slowly, mainly driven by market forces. In some areas, a process of divergence could be envisaged for example in relation to market innovations. This could increase prudential concerns associated with the preferential treatment, the conditions of which would remain unchanged. This could undermine the international credibility of EU covered bonds. An eventual reduction of preferential treatment would imply costs to the market (see section 4.6). ·Prudential concerns – Problem 2: the inadequacy of requirements for capital preferential treatment under art 129 CRR could undermine the international credibility of EU covered bonds. An eventual reduction of preferential treatment would imply costs to the market (see section 4.6). ·Prudential concerns – Problem 3: the proliferation of market innovations might lead to increased divergence across Member States. For example, the increase in the issuance of soft bullet and CPT could replace the whole market in some countries and not in others (in Germany all issuance is hard bullet whereas other jurisdictions such as Italy currently only issue soft bullets). This would widen differences across Member States in terms of the structural characteristics of the product and make the rationale for preferential treatment still more difficult to defend. 4.1.1.Advantages The baseline would imply no disruption of the status quo and no costs of adaptation and transition. Member States would retain their own models and related specificities. This would help preserving the functioning of at least those markets already working well. In the absence of EU action, market bodies might try to regulate the market themselves (e.g. by developing further standardisation practices). In addition, in the absence of EU action, Member States might also change their laws to conform to EBA best practices. At the same time, credit rating agencies could induce issuers to comply with international standards (e.g. EBA best practices) independently of national rules. 4.1.2.Disadvantages Voluntary convergence is no guarantee of effective and coherent harmonization. Moreover, market-based voluntary arrangements aimed at harmonising certain market practices in the form of self-regulation are unlikely to constitute a sufficiently robust basis for maintaining over time the preferential prudential treatment currently conferred on covered bonds. Moreover, as any convergence would be voluntary, there is no certainty that actors in the market would comply. In addition, there is no guarantee that market standardisation goes in a prudentially sound direction: the content of market standards would indeed be beyond the control of regulators and could deviate from EBA best practices. Finally, there would be no covered bond label at EU level in regulatory terms, but only national labels. All the above elements hamper both the achievement of further stimulating market development (objective 1) and addressing prudential concerns (objective 2). 4.2.Option 1: Non-regulatory action Under this option, harmonisation would be encouraged on a voluntary basis through the use of soft tools such as the issuance of recommendations by the Commission. This would accompany and support what has already been done by the EBA and the ECBC (see baseline scenario). The backing by the Commission would provide further encouragement for Member States and issuers to align with the recommended best practices. No legislative initiative would be undertaken under this scenario. This option is not in line with the EBA advice and with the EP Report as both ask the Commission to legislate. This option only partly overlaps with the third step of the EBA approach where compliance is left to voluntary convergence. However, for the EBA, this step should only concern minor areas considered less critical in terms of alignment with preferential prudential treatment.

Under this option: a)Structural features: The structural features of covered bonds would continue to be regulated mainly at national level; b)Cover pool: The cover pool would continue to be regulated at national level. For covered bonds eligible for capital preferential treatment, assets would remain explicitly listed in article 129 CRR; c)Supervision: The characteristics of the supervision model would continue to be regulated at national level; d)Label: The labelling process would be market-driven; e)Preferential treatment: The preferential treatment would continue to be regulated at EU level; f)Transparency: The transparency requirements would continue to be market driven. For covered bonds eligible for capital preferential treatment under article 129 CRR, transparency requirements would continue to be explicitly listed in the same article; g)Technical aspects: Other technical aspects would continue to be regulated at national level. The main difference with the baseline would be the active role the Commission would take alongside the EBA in issuing recommendations and best practices. In addition, market standards would continue to play an important role and could be further strengthened by the Commission backing. 4.2.1.Advantages The main advantage of this approach is that it would minimise any potential disruption on the functioning of the current regimes and the related costs compared to all other options. From the regulatory side, Member States would have more scope to retain their own models compared to other options. This would help preserve the functioning of at least those markets already working well. EU recommendations could provide backing both to the EBA Best Practices and to market-led self-regulation initiatives. This could encourage Member States drafting sensible covered bond frameworks and align them with EU recommended best practices. This in turn would help achieving objectives 1 and 2. 4.2.2.Disadvantages The disadvantages of this option are very similar to those of the baseline. As illustrated above, the use of non-binding tools and self-regulation has limits. That undermines the willingness and ability of operators in less developed covered bond markets to conform to an EU recommended framework. This, along with the lack of an EU label, would in turn hamper further market development (objective 1) and in particular the potential to develop not existent or very small markets. It would also not help enhance cross-border investments and attract more investments from third countries. At the same time, those jurisdictions where covered bond features are not coherent with the risk level implied by the EU-wide preferential treatment would be allowed to leave their frameworks as they are. The prudential concerns would therefore not be addressed (objective 2). Moreover, this option has been discarded by a large majority of institutional stakeholders, among them notably the EBA, the European Parliament and the ECB as an ineffective way of achieving harmonisation. The majority of other stakeholders have underlined that market-led initiatives are valuable but insufficient. At the beginning of the consultation process, a majority of market stakeholders (in particular issuers) was in favour of this option. However, after the EBA published its advice, clarifying the contours of a possible EU legislative initiative, industry views have evolved, as testified by the ECBC position. Accordingly, only a minority of market stakeholders remain in favour of non-legislative action. 4.3.Option 2: Minimum harmonization based on national regimes Under this option, a harmonised legal framework for covered bonds would be established at EU level. This EU framework would aim at a minimum level of legislative harmonization across the EU, building on the characteristics of existing national jurisdictions and seeking to avoid disrupting well-functioning markets. Under this option, the structural features that covered bonds must respect in order to be labelled as such would be harmonised to ensure that a minimum set of common basic structural rules become applicable across the Single Market. The specificities of well-functioning national markets would be taken into account and accommodated as far as possible. Where possible, harmonisation would remain principle-based, minimising detailed provisions to the strict minimum. Member States would therefore retain some room of manoeuvre to devise their own laws on how to reach the goals set out in the directive. This would allow national specificities to remain in place, provided they are compatible with the principles defined in the EU framework. Under this option, Article 52 of UCITS would be replaced by a new Directive defining the structural elements of covered bonds. This would become the new point of reference for other pieces of EU legislation and would be the only EU definition of what is a covered bond. Among those pieces of law, Article 129 CRR would also be adjusted in order to strengthen the conditions for accessing the preferential capital treatment. This option is in line with the EBA advice and with the EP Report as both ask the Commission to legislate and to define (through a directive) the structural features of covered bonds at EU level, remaining principle based and respecting the characteristics of national markets. Concerning the overall approach and most of the specific recommendations for each policy area, option 2 comes close to the EBA advice. In particular, this option follows the three-step approach defined by the EBA. However, there are differences between option 2 and the EBA Report, notably as regards the level of detail and prescription as option 2 would not go as far as sometimes suggested by the EBA. Regarding the EP Report, option 2 is in line with the EP position concerning the approach (principle based) and the legislative means (directive). However, also in this case, in some areas the level of details of the proposal by the EP is too high for a principle-based approach. Moreover, the EP Report defines three labels: PCBs, OCBs and ESNs sharing common basic features and being part of the same legislative initiative. This is not endorsed by the Commission that has already decided that while the ESN is promising, given the particular risk characteristics of SME loans, it requires a dedicated impact assessment separate from that of covered bonds. Under this option, a)Structural features: The structural features of covered bonds would be regulated at EU level through a dedicated directive. The very high level principles contained in art 52 UCITS would be replaced by a new self-standing directive that would define the structural elements a covered bond must comply with. This directive would also serve as a point of reference for the several pieces of EU law that grant preferential treatment to investments in covered bonds. It would regulate key elements like for example the dual recourse mechanism, the need to segregate cover assets and ensure the bankruptcy remoteness of the cover pool.

b)Cover pool: The cover pool would be regulated both at EU and national level, with principles set at EU level and implementing measures at national level. As is the case today, the new instrument would not list what types of assets can be used in the cover pool in the context of the directive, nor explicitly exclude any of them (status quo compared to Art. 52 UCITS). It would nevertheless define principles that guarantee the high quality level of the assets in the cover pool, allowing for some flexibility for the Member States to decide on their preferred assets. At the same time, as it happens today, assets are strictly listed in art 129 CRR in order to identify the subgroup of covered bonds which are granted preferential capital treatment. Under option 2, the situation concerning article 129 CRR would stay the same as in the baseline with the possibility to reassess some kinds of assets currently listed in art 129 such as ships. Assets, such as SMEs and infrastructure loans, which most likely would not fit the principle of asset eligibility set out in the defining directive, could be considered part of the ESN initiative targeted at creating a new instrument (see section 1). In terms of cover assets, the new directive would also extend the possibility to use pooled covered bond structures i.e. covered bonds using as cover assets other covered bonds or pooled assets in order to let small issuers enjoy economies of scale. Finally, under this option, the new directive would envisage the removal of all legal obstacles to cross-border cover pools; c)Supervision: General principles of special public supervision would be defined at EU level specifying the areas that the special public supervision should cover while leaving the choice to the Member States to decide on how such supervision should actually take place. Supervision principles also imply the definition of eligibility criteria for issuers. Supervisors will have to apply those principles when authorizing covered bond programs. Under this option, supervision would stay with national competent authorities. d)Label: Under this option, "European covered bonds" (EU CB) would become an EU label. Issuers would be able to (voluntarily) use this label when marketing their bonds, provided that the product complies with the requirements set out in the directive. Monitoring of compliance with the conditions under which such label could be legally used would form part of the special public supervision of the covered bond framework. An ex-ante control of the use of the label would not be necessary, but supervisors should be able to withdraw its use when the conditions are not/or longer met (with possible sanctions). National denominations and labels would be able to stay in place and could be used simultaneously or alternatively, at the discretion of the issuer. Supervisors should periodically compile a list of EU CBs. This approach would differ from the one recommended by the EP report where two different labels would be granted to covered bonds: Ordinary CBs (OCBs) when compliant with the directive and Premium CBs (PCBs) when compliant with both the directive and article 129 CRR. Such double label does not appear necessary to promote the EU legislation among investors and would risk creating confusion as to the actual nature and quality of the different instruments. e)Preferential treatment: Preferential treatment would only be granted to covered bonds compliant with the requirements set out in the directive. In some cases (for example for the CRR art 129 capital preferential treatment) additional conditions would need to be met to become eligible for preferential treatment. In particular, the conditions of eligibility for preferential treatment in the CRR for investors in the banking sector would be strengthened, following advice by the EBA, by introducing additional rules on substitution assets, minimum overcollateralization and by revising rules concerning eligible cover assets and LTV limits. f)Transparency: transparency requirements in the form of increased disclosure, frequency and granularity would be set in the directive; g)Technical aspects: other technical aspects would be considered mostly in the form of principle based provisions leaving leeway to Member States to translate those principles into more detailed requirements. For example, principles would be defined in the directive to establish liquidity requirements or specific conditions for maturity extensions. 4.3.1.Advantages This approach would respect the national characteristics of those markets already working well as advocated by all stakeholders (especially Member States). This option would be in line with what is envisaged by the EBA and the European Parliament. In general, all stakeholders in the public consultation advocated a principle-based approach building on the characteristics of existing national frameworks already working well. A minimum level of harmonization would help developing markets and stimulate cross-border investments, in line with objective 1. At the same time, it would make the framework more robust from the credit point of view and this would better underpin the preferential treatment envisaged in EU legislation, so meeting objective 2. This option carries a lower disruption potential compared to options 3 and 4, as recognized by Member States and stakeholders and would lower transition costs as compared with options 3 and 4. Overall it is more in line with subsidiarity. Finally, the strengthening of the eligibility conditions for the preferential prudential framework for banks investing in covered bonds would also strengthen the international credibility of the preferential treatment accorded to covered bonds. 4.3.2.Disadvantages Being too principle-based could imply the risk of not providing an effective harmonisation, if national rules do not properly reflect the principles. This would not help develop markets and cross-border investments as per objective 1. At the same time, leaving Member States too much flexibility might present the risk of them making more hazardous choices, for example in terms of assets to be allowed in the cover pool. This would hamper achieving the objective of addressing prudential concerns (objective 2). The main challenge with this option would therefore lie in how to achieve a proper balance between a principles-based approach and more detail where necessary. In addition, this option also entails adaptation costs compared with the baseline and with option1 (see section 5). 4.4.Option 3: Full harmonisation This option would involve the design of a new fully harmonised regime for covered bonds at EU level. In contrast to option 2 (minimum harmonisation), this option would establish a fully harmonised EU framework for covered bonds that would replace existing national regimes. It would define every detail of a sound covered bonds regulatory framework. It would also be different from option 4 to the extent that it would replace national regimes instead of flanking them. The legislative instrument envisaged to implement this option would be a regulation. This option differs both from the EBA advice and from the Parliament Report as both ask the Commission to define (through a directive) the structural features of covered bonds at EU level, remaining principle based and respecting the characteristics of national markets. A full harmonization instead would be very detailed, leaving no space to Member States for adaptation and would risk disrupting markets that are currently working well. Option 3 also departs from the EBA three steps approach. In spite of all the differences, there are, however, some similarities between option 3 and the EBA Report. The very detailed provisions envisaged in certain areas would fit with this option better than with option 2. Overall, however, option 3 foresees a much more detailed harmonisation of rules compared to the ones advised by the EBA and proposed by the Parliament. Under this option, a)Structural features: the structural features of covered bonds would be defined at EU level. A comprehensive definition would focus on the structural features a covered bond must have in order to seek regulatory recognition (for example in terms of dual recourse mechanism, segregation of cover assets and bankruptcy remoteness of the cover pool) and would replace the covered bond-related provisions in UCITS Directive. This would be similar to option 2, except for the fact that all rules would need to be very detailed, not just enouncing principles, but also accompanying them with operational details as this framework would replace all the existing national ones. b)Cover pool: in terms of cover assets allowed in the cover pool, they would need to be explicitly listed, thus significantly limiting Member States leeway in this area. It would be necessary to make specific choices on the kind of traditional or not traditional assets allowed in the cover pool. In case only traditional assets are allowed, the need to launch a parallel and separate instrument based on SMEs and infrastructure loans (ESN, see section 2.1) would become urgent. Coverage requirements would need to be defined in details. A similar provision allowing pooling structures for cover pools (as in option 2), would be introduced in order to let small issuers enjoy economies of scale. Finally, similarly to option 2, also under this option the regulation would envisage the removal of all legal obstacles to cross-border cover pools. c)Supervision: supervision would remain with national competent authorities for the less significant institutions and for banks outside the euro area, while it would go to the SSM/ECB for the largest banks in the euro area. This would be the consequence of pursuing full harmonization. Related level 2 legislation would be required to ensure consistent application of the legal framework. In that respect, the duties of the supervisors would need to be spelled-out in detail for instance in terms of the way covered bonds programmes would need to be authorised. d)Label: a labelling process would be put in place similarly to option 2. In this case, however, the EU label would replace all the existing national labels. e)Preferential treatment: same changes of the provisions governing the preferential treatment as in option 2. f)Transparency: transparency requirements would change as in option 2.

g)Technical aspects: other technical aspects would have to be included in the EU framework with a sufficient degree of detail to make them operational. Differently from option 2, there would be no leeway in how Member States implement those detailed requi