REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL on Article 503 of Regulation (EU) No 575/2013 Capital requirement for covered bonds
Date: 2015-10-20
Institutions: Directorate-General for Financial Stability, Financial Services and Capital Markets Union, European Commission
Subjects: claim, credit, credit institution, debt, financial requirements, issue of securities, securities

EN 

   EN 

   EUROPEAN COMMISSION  Brussels, 20.10.2015  COM(2015) 509 final   REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL on Article 503 of Regulation (EU) No 575/2013  Capital requirement for covered bonds  
 
 
REPORT on Article 503 of Regulation (EU) No 575/2013 

CAPITAL REQUIREMENTS FOR COVERED BONDS 

BACKGROUND 

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  a  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  comprises  high  quality  assets,  typically,  but  not  exclusively, 
mortgage loans and public sector debt. The issuer is normally under the 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 
relevant eligibility criteria.  

The features described above contribute to make covered bond low-risk debt instruments, thus 
providing a rationale for the beneficial regulatory capital requirements set out in Article 129 
of  Regulation  575/2013  (the  "CRR").  Credit  institutions  investing  in  covered  bonds 
qualifying under Article 129 are allowed to hold lower levels of regulatory capital in relation 
to those instruments than would otherwise apply to senior unsecured bank debt (eg 10% risk 
weight for a "credit quality step 1" covered bond compared to 20% for another type of direct 
exposure  to  a  credit  institution  of  the  same  step).  These  comparative  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", 
that  is,  those  backed  by  the  high  quality  assets  laid  down  in  that  Article  129  of  the  CRR. 
Cover pools may, inter alia, include qualifying senior units issued by French Fonds Communs 
de Creances ("FCCs") or equivalent securitisation instruments up to a maximum of 10% of 
the covered bonds' outstanding issue amount, and that limit may be derogated by competent 
authorities in accordance with Article 496 of the CRR until 31 December 2017.     

Article 503 of the CRR mandates the Commission to report to the Co-legislators on a number 
of items related to the regulatory capital treatment of covered bonds under the CRR, having 
regard to the recommendations made by the European Banking Authority ("EBA") on each of 
the  matters  set  out  in  Section  10  of  EBA's  "Report  on  EU  Covered  Bond  Frameworks  and 
Capital Treatment" (the "EBA Report"). 

ITEM  NO.  1:  ARE  PREFERENTIAL  RISK  WEIGHTS  APPROPRIATE  FOR 
COVERED BONDS? 

Paragraph  1  of  Article  503  of  the  CRR  mandates  the  Commission  to  report  on  whether  the 
preferential risk weights laid down in Article 129 and the own funds requirements for specific 
risk in Article 336(3) of the CRR are adequate for qualifying covered bonds having regard to 
the various types  of cover assets, level of transparency on the cover pool  and the impact of 
covered bond issuance on the issuer's unsecured creditors (asset encumbrance). 

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On  the  general  question  concerning  the  appropriateness  of  the  preferential  risk  weights,  the 
EBA opined that "due to the good historical default/loss performance of covered bonds in the 
EU, the dual recourse principle embedded in covered bond frameworks [..], the special public 
supervision [..] and  the  existence of qualifying criteria in  Article  129 of the CRR, the EBA 
considers the preferential risk weight treatment laid down in Article 129 of the CRR to 
be, in principle, an appropriate prudential treatment"1.  

Having  regard  to  the  above,  the  Commission  submits  the  following  in  accordance  with 
paragraph 1 of Article 503 of the CRR: 

  while  the  decision  of  Member  States'  governments  to  support  or  even  bail-out  certain 
covered bond issuers could have contributed to the complete absence of formal defaults, 
the  Commission  acknowledges  that  the  overall  credit  performance  of  European  covered 
bonds was very robust throughout recent periods of market stress between 2008 and 2012, 
in particular compared with other financial instruments (namely asset-backed securities). 
The three Eurosystem Covered Bond Purchase Programmes also played an important role 
in ensuring liquidity in European covered bond markets;  

 

the EBA Report shows that the double recourse principle is effectively embedded in the 
covered bond laws of Member States  consistent with  the requirements set out in  Article 
52(4)  of  Directive  2009/65/EC  and  those  laws  largely  follow  the  credit  quality, 
underwriting and transparency standards set out in Article 129 of the CRR. Although the 
degree of harmonisation of covered bond laws brought about by these provisions has only 
been  indirect  and  high  level,  the  Commission  recognises  that  it  has  nevertheless 
contributed  to  enhancing  financial  stability  for  the  overall  market  and  creating  a 
benchmark of quality that investors seek to rely on.  

Accordingly,  the  Commission  agrees  with  the  EBA's  recommendation  that  the  preferential 
risk  weights  currently  laid  down  in  Article  129  and  the  own  fund  requirements  for  specific 
risk in Article 336(3) of the CRR remain an adequate prudential treatment for qualifying 
covered bonds.  

Without  prejudice  to  the  above,  the  EBA  Report  shows  that  Member  States'  covered  bond 
laws differ quite significantly in some key technical aspects, in particular those relating to the 
safety and transparency of these instruments. In order to justify the on-going existence of the 
preferential prudential treatment, the EBA recommends more convergence between Member 
States'  covered  bond  laws  on  the  basis  of  the  best  practice  principles  set  out  in  the  Report. 
Such  convergence  could  not  be  achieved  only  through  changes  to  the  qualifying  criteria  set 
out in Article 129 of the CRR as the scope of such article is limited to the prudential treatment 
of  a  subset  of  these  instruments.  The  Commission,  therefore,  intends  to  seek  stakeholder 
feedback on the convenience and shape of an integrated EU covered bond framework through 
a  dedicated  Consultation  Paper  on  covered  bonds  ("CP"), as  it  was  announced  in  the  CMU 
Green Paper on 18 February.  

In  relation  to  the  specific  matters  set  out  in  paragraph  2  of  Article  503  of  the  CRR,  the 
Commission submits the following: 

  preferential risk weights should continue to be applied uniformly to all qualifying covered 
bonds,  without  distinction  between  asset  classes  or  Member  State  of  origination.  The 

1 Recommendation EU COM 1 (see page 148 of EBA Report) 

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Commission,  however,  would  like  to  discuss  with  stakeholders  whether  it  would  be 
appropriate: (i) to replace the high level conditions set out in Article 129 of the CRR with 
a set of more comprehensive qualifying criteria and (ii) to recognise secured instruments 
using covered bond-like structures  backed by loans  that  fund non-financial activities  for 
the  purposes  of  a  hypothetical  European  legal/regulatory  framework  (see  Item  No.  2  of 
this Report); 

 

the  disclosure  requirements  towards  investors  forming  part  of  the  eligibility  criteria  in 
Article 129 of the CRR should not be changed at this juncture. However, the Commission 
intends  to  seek  feedback  from  stakeholders  on  the  convenience  and  manner  of  applying 
detailed and consistent disclosure requirements on issuers in relation to the credit, market 
and liquidity risks of European covered bonds and their underlying cover assets; 

  at this juncture, there should be no changes to Article 129 of the CRR taking into account 
the  risk  to  which  other  creditors  of  the  issuer  institution  are  exposed.  Although  asset 
encumbrance in favour of covered bondholders has an impact on the risk borne by other 
creditors of the issuer, this issue has been addressed through the minimum requirement for 
own funds and eligible liabilities (MREL) laid down in Directive 2014/59 (the "BRRD"), 
and continues to be monitored by supervisors and macroprudential authorities. 

ITEM NO. 2: ARE PREFERENTIAL RWs APPROPRIATE FOR AIRCRAFT LOANS  

Paragraph  3  first  part  of  Article  503  of  the  CRR  mandates  the  Commission  to  report  on 
whether  covered  bonds  secured  by  aircraft  loans  (aircraft  liens)  should,  under  certain 
conditions, be considered as  eligible asset in  accordance with  Article 129 of the CRR. This 
type of covered bonds is not included among those currently eligible in accordance with this 
Article.   

In relation to this, the EBA concluded that "based on the qualitative and quantitative evidence 
included within this report the EBA considers that it would not be appropriate to include 
loans  secured  by  aircraft  liens  among  the  underlying  asset  classes  eligible  for  the  risk 
weight preferential treatment provided for in Article 129 of the CRR"2.  

Having  regard  to  the  EBA's  analysis  and  recommendation  on  this  matter,  the  Commission 
does not intend to make any proposals at this juncture to amend Article 129 of the CRR 
in order to include aircraft loans as eligible assets. The Commission, however, intends to seek 
feedback  from  stakeholders  on  the  appropriate  treatment  for  securities  backed  by  loans  that 
fund  non-financial  activities  (which  would  include  not  only  aircraft  but  also  ship  and  SME 
loans).  The  Commission  is  very  keen  on  striking  the  right  balance  between  an  adequate 
prudential treatment for covered bonds and other forms of secured lending and the potential 
benefit in terms of economic growth that may result from encouraging sound lending to the 
real economy on the back of covered bond-like technology using these assets as collateral.  

ITEM  NO.  3:  ARE  PREFERENTIAL  RWs  APPROPRIATE  FOR  GUARANTEED 
RESIDENTIAL LOANS 

Paragraph 3, second part of Article 503 of the  CRR  mandates the Commission  to  report on 
whether  covered  bonds  guaranteed  by  residential  loans  should,  under  certain  conditions,  be 
considered  as  eligible  assets  in  accordance  with  Article  129  of  the  CRR.  Guaranteed 

2 Recommendation EU COM 2-A (see page 111 of EBA Report) 

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residential loans are currently subject to the eligibility requirements set out in paragraph 1(e) 
of this Article.  

In relation to this, the EBA concluded that "Based on the qualitative and quantitative evidence 
included  within  this  report  the  EBA  considers  it  appropriate  to  maintain  residential  loans 
secured  by  a  guarantee  within  the  scope  of  preferential  risk  weight  treatment.  However  the 
EBA deems appropriate that, in addition to the qualifying criteria currently included in Article 
129(1)(e) of the CRR, the following additional criteria be considered for inclusion:  

 

 

the national legal/regulatory covered bond framework should not allow borrowers to place 
mortgage liens on the loans included in the cover pool;  

the  national  legal/regulatory  covered  bond  framework  should  be  such  that  no  legal 
impediments exist for the administrator of the covered bond programme to place mortgage 
liens on the loans included in the cover pool, in a scenario where the covered bond issuer 
has  entered  default  or  resolution  and  where  the  guarantee,  for  any  reasons,  ceases  to 
exist".3  

The  Commission  is  of  the  view  that  it  is  appropriate  to  continue  treating  qualifying 
guaranteed  residential  loans  as  eligible  assets.  In  relation  to  the  additional  criteria 
recommended by the EBA, the first one is already included in the eligibility requirements in 
Article 129 of the CRR. The Commission intends to seek stakeholder feedback on the second 
additional criterion. 

ITEM NO. 4: REVIEW OF THE ARTICLE 496 DEROGATION 

Sub-item no. 4.1: Derogation for covered bonds backed by securitisation instruments 

Paragraph  4  of  Article  503  of  the  CRR  mandates  the  Commission  to  review  whether  the 
derogation  set  out  in  Article  496  of  the  CRR  is  appropriate  and  should  be  applied  to  other 
types of covered bonds. Specifically, reference is made to the derogation from the 10% limit 
for senior units issued by French FCCs or equivalent securitisation instruments laid down in 
points  (d)  and  (f)  of  Article  129(1)  of  the  CRR  which  competent  authorities  may  grant  to 
credit  institutions  until  31  December  2017.  For  the  avoidance  of  doubt,  references  to 
"securitisation instruments" in this Report must be understood as including senior units issued 
by FCCs.   

The EBA expresses overarching prudential concerns on the use of securitisation instruments  
as  cover  assets  in  excess  of  the  above-referred  10%  threshold  mainly  due  to:  (i)  the  added 
legal  and  operational  complexity  resulting  from  the  double  layer  structure  provided  by  the 
covered bonds and the tranche of securitisation instruments backing those;  (ii) the potential 
for conflicts of interest that may arise as a result of the provision in the derogation in Article 
496  requiring  a  member  of  the  covered  bond  issuer's  group  to  retain  the  whole  first  loss 
securitisation tranche backing the senior securitisation tranches in the event of issuer's default; 
and  (iii)  potential  conflicting  requirements  on  transparency  and  due  diligence  between  the 
covered  bond  programme  and  the  underlying  securitisation  instruments.  In  light  of  these 
concerns,  the  EBA  "considers  it  appropriate  that  the  derogation  to  the  10%  limit  for 

3 Recommendation EU COM 2-B (see page 123 EBA Report) 

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senior  securitisation  units  currently  foreseen  in  Article  496  of  the  CRR,  be  removed 
after 31 December 2017"4.       

Although  a  double-layer  feature  involving  securitisation  instruments  may  make  these 
structures  relatively  less  transparent  and  more  complex  to  manage  from  a  risk  mitigation 
perspective  than  one  layer  structures,  it  may  be  possible  to  address  some  of  the  concerns 
expressed  by  EBA  through  the  use  of  simple  and  transparent  structures.  The  Commission 
would  like  to  discuss  with  stakeholders  the  broader  issue  of  the  eligibility  of  securitisation 
instruments  as  cover  assets,  the  criteria  and  limits  that  should  apply  to  them  and  the 
interaction  with 
initiative  on  Simple,  Transparent  and  Standard 
securitisations in the context of the Capital Markets Union project.  

the  Commission's 

Sub-item no. 4.2: Derogation for covered bonds backed by other covered bonds 

The EBA notes that in at least one Member State, the derogation in Article 496 of the CRR 
has  been  granted  to  intra-group  covered  bond  structures:  in  these,  covered  bonds  issued  by 
members of the same group are pooled together in a separate legal entity which issues covered 
bonds  to  final  investors.  In  relation  to  these  structures,  EBA  "recommends  that  the 
Commission  should  further  consider  whether  a  specific  provision  could  be  introduced  in 
Article  129  of  the  CRR  making  it  possible  to  allow  specific  intra-group  transfers  of  CRR-
compliant  covered  bonds  as  eligible  collateral.  From  a  prudential  perspective,  no  additional 
risk  appears  to  be  introduced  by  such  provision,  provided  that  the  entity  is  sufficiently 
integrated within the group"5. 

The  Commission  acknowledges  that  structures  involving  covered  bonds  backing  other 
covered bonds do not raise the same complexity issues described for transactions backed by 
securitisation instruments, insofar as there may be a better alignment between the features of 
the covered bonds in both layers of the transaction. In addition, there may be specific merits 
to allowing the pooling of covered bonds from different issuers as cover assets generally, not 
only  for  intra-group  funding  purposes.  For  instance,  these  types  of  structures  have  been 
commonly used by smaller covered bond issuers in various Member States as a means to gain 
issuance volume through the larger combined size of their cover pools and, thus, be able to 
access  capital  markets  in  better  economic  terms  than  might  be  otherwise  available  to  each 
individual issuer.   

Accordingly, the Commission intends to consult further with stakeholders on the appropriate 
legal and regulatory treatment of covered bond structures pooling cover assets originated or 
issued  by  other  issuers.  Structures  involving  covered  bonds  issued  for  intra-group  funding 
purposes as currently used should be considered as part of this debate.  

CONCLUSIONS 

Items no. 1 to 3 

The Commission does not propose amending Article 129 of the CRR at this stage in relation 
to the matters referred to by items no. 1 to 3.  There would be little merit in engaging in such 
an  amendment  before  stakeholders  have  had  the  opportunity  to  comment  on  the  relative 
merits of each of the relevant policy options presented in the CP. 

4 Recommendation EU COM2 –C (page 128 of EBA Report) 
5 See footnote in page 128 of EBA Report 

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Following the review of feedback received, the Commission may submit legislative proposals 
which may consist in targeted amendments to Article 129 of the CRR or its repeal if replaced 
by a covered bond framework. 

Item no. 4 

The  Commission  will  wait  to  review  stakeholder  feedback  to  the  CP  to  decide  whether  it 
would be appropriate to let Article 496 derogation lapse, make it permanent or replace it with 
a covered bond framework that may include provisions on covered bond structures backed by 
securitisation instruments. 

The same applies to the matter of applying Article 496 derogation to other forms of covered 
bonds, specifically the pooled covered bond structures referred to in sub-item No. 4.2.  

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