Covered bonds: elements outside the issuance regulations The ICMA - - PowerPoint PPT Presentation

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9 June 2016 | Frankfurt

Covered bonds: elements outside the issuance regulations

The ICMA CBIC & The Covered Bond Report Conference 2016

Rodrigo Buenaventura, Head of Markets Department, ESMA

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Issuance and outstanding volumes of securitised products

=> Since 2008, the issuance of securitised products in Europe has fallen by 88%. Outstanding amounts have declined accordingly Issuance of securitised products in the EU – placed and retained (Mio €) Outstanding volume of securitised products in the EU (bln €)

9 June 2016 | Frankfurt

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Covered bond: German market

Covered bond issuance in EUR Mio Covered bond outstanding in EUR Mio

Source: European Covered Bond Council

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Covered bonds’ annual issuance volumes (worldwide)

Source: European Covered Bond Council

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Covered bond markets (outstanding volumes)

Source: European Covered Bond Council Public Sector Mortgage Ships Others Mixed A ssets TOTA L Germany 206,535 189,936 4,811 1,006

• 402,288

Denmark

• 369,978

5,013

• 374,991

France 67,696 188,925

• 68,896

325,517 Spain 25,495 282,568

• 308,063

Sweden

• 209,842
• 209,842

United Kingdom 6,152 130,797

• 136,949

Italy 8,700 122,464

• 131,164

Norway 1,820 102,704

• 104,524

Switzerland

• 100,436
• 100,436

Canada

• 64,836
• 64,836

A ustralia

• 61,326
• 61,326

The Netherlands

• 58,850
• 58,850

A ustria 19,279 22,450

• 41,729

Ireland 20,258 18,473

• 38,731

Portugal 400 33,711

• 34,111

Finland

• 32,031
• 32,031

Luxembourg 16,002

• 16,002

Greece

• 14,546
• 14,546

Belgium 1,750 10,575

• 12,325

Czech Republic

• 11,106
• 11,106

New Zealand

• 9,464
• 9,464

United States

• 4,000
• 4,000

Slovak Republic

• 3,939
• 3,939

Hungary

• 3,272
• 3,272

South Korea

• 1,349
• 1,349

Cyprus

• 1,000
• 1,000

Poland 82 882

• 964

Iceland

• 927
• 927

Panama

• 247
• 247

Latvia

• Total

374,169 2,050,633 9,824 1,006 68,896 2,504,527 COVERED BONDS OUTSTA NDING 2014 in EUR million

9 June 2016 | Frankfurt

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Covered bond markets (issuance volumes)

Source: European Covered Bond Council Public Sector Mortgage Ships Others Mixed A ssets TOTA L Denmark

• 154,310

399

• 154,709

Sweden

• 48,424
• 48,424

Germany 15,334 29,145 920 500

• 45,899

Italy 1,000 39,475

• 40,475

France 5,318 14,483

• 6,149

25,950 Spain 1,853 23,038

• 24,891

Canada

• 19,275
• 19,275

Switzerland

• 19,193
• 19,193

Norway 664 14,474

• 15,138

A ustralia

• 12,716
• 12,716

United Kingdom

• 12,529
• 12,529

A ustria 5,146 7,111

• 12,257

Finland

• 6,469
• 6,469

Belgium 1,750 2,387

• 4,137

The Netherlands

• 3,910
• 3,910

Portugal

• 3,825
• 3,825

Ireland

• 2,535
• 2,535

Czech Republic

• 2,188
• 2,188

Greece

• 750
• 750

New Zealand

• 750
• 750

Slovak Republic

• 654
• 654

Luxembourg 398

• 398

Poland

• 269
• 269

Iceland

• 91
• 91

Hungary

• 91
• 91

Cyprus

• Latvia
• Panama
• South Korea
• United States
• Total

31,463 418,094 1,319 500 6,149 457,524 COVERED BONDS ISSUA NCE 2014 in EUR million

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Key elements of regulatory treatment of covered bonds

• Covered bonds are benefitting from favourable regulatory environment:

– At national level: several countries have set in place (or updated) ad-hoc covered bond legislations which “waive” the general applicable insolvency law and provide for a specific regime “setting in stone” the preferential claim of covered bond holders over the asset contained in the cover pool. – At European level:

• Bank Recovery and Resolution Directive (BRRD): exempts covered bonds from

bail-in,

• Capital Requirement Regulation (CRD IV / CRR): covered bonds are (i)

categorised as High Quality Liquid Asset for the purposes of the Liquidity Coverage Ratio or LCR (certain types of covered bonds receive same treatment as sovereign which goes beyond the Recommendations of the Basel Committee) (ii) assigned low risk weights to covered bonds

• Solvency II: grants low spread risk factors to covered bonds
• EMIR (exemption for clearing obligation and bilateral collateral posting) and

MiFID II (pre-trade SSTI)

• Favourable haircuts for ECB repo operations

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Regulatory concepts of liquidity and transparency

Concepts of liquidity and transparency are serving different purposes under “securities market regulation” (e.g. MiFID II) or “banking regulation” (e.g. CRD IV) and, thus, are interpreted differently depending on the context:

• Liquidity:

– CRD IV: whether an instrument in a portfolio can be sold during financial turmoil. Definition of liquidity under Article 509(4) of the CRR focusses rather on the credit quality of the instrument and includes criteria such as “proven record of price stability” whereas… – MiFID II it is about the trading frequency and (daily) volume traded (Article 2(1)(17) of MiFIR) in order to be suitable for the transparency regime

• Transparency:
• CRD IV package, and especially when it comes to covered bonds or securitisation,

transparency refers to the information available on the cover assets and the intrinsic credit quality of the product whereas…

• MiFID II transparency refers to pre- and post-trade transparency (publication of

prices before the transaction and details of the transaction afterward).

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MiFID II / MiFIR – Transaction reporting & transparency

• Transaction reporting: MiFID II / MiFIR extends the scope of the transaction

reporting obligation and enhances the scope of the reports:

– From “admitted to trading on a regulated market”, to all financial instruments “admitted to trading or traded on a trading venue” (i.e. include bonds traded only on MTF or OTF). As a consequence, if a bond is traded on at least a TV in the EU (either a RM, an MTF or an OTF), all transactions (including OTC transactions) have to be reported. – New information specification to be included in transaction reports (+ ESMA Guidelines)

• Transparency: The existing pre- and post-trade transparency regime which

applies under MIFID I only to shares admitted to trading on a regulated market is extended to all type of financial instruments and asset classes (i.e. including covered bonds and SFP):

– Pre-trade transparency (Article 8, MiFIR): current bid and offer prices and depth of trading interests at those prices. Information to be available to the public on a continuous basis during normal trading hours. Calibration depending on the trading system or protocol. – Post-trade transparency (Article 10, MiFIR): Shall make public, in real time (i.e. within 15 during the first three years and 5 minutes thereafter), price, volume and time of the transactions executed.

• MiFID II / MiFIR provides here the general applicable framework and ESMA has

delivered in September 2015 to the EC a package of RTS and ITS (ESMA/2015/1464) specifying further the applicable requirements

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MiFID II / MiFIR – Pre-trade transparency for bonds and derivatives

9 June 2016 | Frankfurt

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MiFID II / MiFIR – Post-trade transparency for bonds and derivatives

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MiFID II / MiFIR – Amendments to draft RTS 2 proposed by the Commission

• EC said in April it wanted to introduce 2 changes to the RTS 2 on non-equity

transparency :

– Definition of what constitutes a liquid market for bonds – in particular the liquidity criterion ‘average daily number

• f trades’;

– The trade percentile for determining the pre-trade size specific to the instruments (SSTI) for certain non-equity classes

• ESMA issued an opinion (2 May 2016), supporting the idea of a phased-in

implementation of the new transparency regime but recommending an automatic phase-in.

• Main amendments to be introduced:

– Increased ‘average daily number of trades’ in the definition of liquid bonds (from 2, as initially proposed by ESMA, to 15 trades per day); – Increased issuance thresholds to be used to determine whether newly issued corporate bonds and covered bonds have a liquid market (from EUR 500 million to EUR 1 billion); – Reduced thresholds to determine the applicable pre-trade SSTI (reduced to the 30st percentile) and introduction of threshold floors for bonds; – Annual report to be published by ESMA to assess the impact of those metrics on bond market liquidity and on the activity of liquidity providers.

9 June 2016 | Frankfurt

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MiFID II / MiFIR - Definitions

• ESMA’s proposal for transparency uses, for covered bonds,

the 6-point definition provided by Article 52(4) of UCITS Directive which requires:

1. The covered bond issuer must be a credit institution. 2. Covered bond issuance has to be governed by a special legal framework. 3. Issuing institutions must be subject to special prudential public supervision. 4. The set of eligible cover assets must be defined by law. 5. The cover asset pool must provide sufficient collateral to cover bondholder claims throughout the whole term of the covered bond. 6. Bondholders must have priority claim on the cover asset pool in case of default of the issuer.

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MiFID II / MiFIR – Transparency thresholds for covered bonds (Article 52(4) of the UCITS directive)

Asset class - Bonds (all bond types except ETCs and ETNs) Bond Type Transactions to be considered for the calculation of the thresholds per bond type Percentiles to be applied for the calculation of the pre-trade and post- trade SSTI and LIS thresholds for each bond type SSTI pre-trade LIS pre-trade SSTI post- trade LIS post- trade Trade - percentile threshold floor Trade - percentile threshold floor Trade - percentile Trade - percentile Sovereign Bond transactions executed on Sovereign Bonds following the exclusion of transactions as specified in Article 13(10) S1 S2 S3 S4 EUR 300,000 70 EUR 300,000 80 90 30 40 50 60 Other Public Bond transactions executed on Other Public Bonds following the exclusion of transactions as specified in Article 13(10) S1 S2 S3 S4 EUR 300,000 70 EUR 300,000 80 90 30 40 50 60 Convertible Bond transactions executed on Convertible Bonds following the exclusion of transactions as specified in Article 13(10) S1 S2 S3 S4 EUR 200,000 70 EUR 200,000 80 90 30 40 50 60 Covered Bond transactions executed on Covered Bonds following the exclusion of transactions as specified in Article 13(10) S1 S2 S3 S4 EUR 300,000 70 EUR 300,000 80 90 30 40 40 40 Corporate Bond transactions executed on Corporate Bonds following the exclusion of transactions as specified in Article 13(10) S1 S2 S3 S4 EUR 200,000 70 EUR 200,000 80 90 30 40 50 60 Other Bonds transactions executed on Other Bonds following the exclusion of transactions as specified in Article 13(10) S1 S2 S3 S4 EUR 200,000 70 EUR 200,000 80 90 30 40 50 60

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Market Abuse Regulation (MAR)

• The new MAR framework, extends beyond financial instruments admitted to

trading on a regulated market (MAD I) to include also financial instruments traded on an MTF or OTF and financial instruments which price depends on (or has an effect on) the price or value of a financial instrument trade on a RM, an MTF or an OTF.

• Main consequences for the issuers:

– Obligation to disclose inside information – Prohibition of insider dealing and unlawful disclosure – Prohibition of market manipulation

• Main consequences for trading venues and investment firms:

– Obligation to report suspicious transactions : Suspicious transaction and order reports (STORs)

• ESMA submitted draft technical standards to the Commission further specifying

the Level 1 rules in September 2015 (ESMA/2015/1455)

• MAR will enter into application as of 3 July 2016 (except for some new

provisions linked to MiFID II / MiFIR, like OTFs)

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EMIR –Risk mitigation requirements

• Risk mitigation requirements apply to all non-centrally cleared OTC

derivative transactions: ESMA has just submitted to the Commission for endorsement the requirements on non-centrally cleared OTC derivative contracts, including swaps associated to covered bonds for hedging purposes. Main elements include:

– No obligation to post initial or variation margins. However, obligation to return cash previously collected as variation margin – Exposures arising from either OTC derivative contracts or to counterparties that are exempted or partially exempted from margins should nevertheless be included in the calculation of the aggregated gross notional amount

9 June 2016 | Frankfurt

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EMIR – Clearing obligation

• Clearing obligation: contracts concluded with covered bond issuers or with

covered pools for covered bonds are excluded from the clearing obligation.

• Reasons:

– difficulty for CCPs to differentiate between the derivatives of the cover pool and those of the issuer (the covered bond derivatives need to continue to hedge the cover pool after the issuer’s default) – bespoke characteristics of the covered bonds derivatives (e.g. non-standard reference rate, dynamic feature of the notional amounts). – eligible collateral: the cover pool may not hold CCP-accepted collateral. Collateral would in this case need to be posted by the issuer, which would prove problematic in case the issuer becomes insolvent. – counterparties entering covered bond derivatives: Depending on the structure of the covered bonds and on the national legislation, the counterparty that is entering into OTC derivative contracts for the purpose of hedging the interest rate or currency mismatches of the cover pool will either be the issuer itself, a Special Purpose Vehicle (SPV) in the case of bonds issued through an SPV. There might cases where the SPV would qualify as non-financial counterparty using the derivatives for hedging purposes only and would de facto be excluded from the clearing obligation. Therefore, existing differences in national legal frameworks for covered bonds may lead to unequal treatments within the EU.

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EMIR –Bilateral margins

Risk mitigation requirements apply to all non-centrally cleared OTC derivative

• transactions. ESMA has proposed no obligation to post initial or variation margins
• n derivatives by covered pools.
• Two main reasons:

– No eligible collateral in the cover pool (mainly mortgages, public assets, etc…) – The derivative counterparty has already preferential claims on the cover assets within the cover pool (mitigating to a certain extent the credit risk associated with the derivative). For covered bond derivatives, the posting of collateral is indeed unilateral. This means that only the hedging counterparty posts margins to the covered bond issuer while the latter does not. To compensate this, the counterparty has a claim on the cover pool ranking pari passu with the covered bond holder to mitigate the counterparty credit risk it is exposed to.

• In the draft RTS, ESMA has introduced certain safeguards: (i) OTC derivative contracts

should only be used for hedging purposes, (ii) the covered bonds should meet the requirement of Article 129 of CRR (imposing conditions regarding the composition of the cover pool) and (iii) the cover pool should be over-collateralized (102%).

9 June 2016 | Frankfurt

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Thank you. Questions?