Co-published Covered bonds guide: UK
Changes and challenges
Clifford Chance’s Peter Voisey and Will Sutton outline the regulatory changes affecting the UK covered bond market, but remain optimistic that clarity and certainty will emerge
T
he first half of 2013 has undoubtedly been slow in the UK covered bond market. Issuance levels are well down from their
equivalent in 2012 and 2011. Nevertheless, the regulatory and macro-economic landscape that impacts the UK covered bond market has not stood still, indeed far from it. It remains to be seen how the UK covered bond market will develop in the face of these changes. This article will analyse some of the challenges that the UK market faces, and will also consider what the future holds.
Recent developments ECBC covered bond label The ECBC covered bond label was established with the aim of improving the standards and transparency of the European covered bond market, and one of its stated goals has been positioning the covered bond asset class with respect to “upcoming regulatory challenges”. The regulations and challenges are numerous, and the ECBC has not been silent in the face of them. Each European issuer of regulated covered
bonds may apply for the covered bond label and will go through a self-certification process. Each issuer is required to pay a registration fee and then supply ongoing information to the ECBC website regarding their programme and the issuances under it. The label also recommends detailed transparency items to be included at a national level on the relevant issuer’s website. To date, the number of applications for the label by
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UK issuers has been relatively low compared with some other jurisdictions.
Amendments to RCB Regulations A recent development in the UK market was the amendments to the UK RCB Regulations, which came in force at the beginning of this year. Although their market impact may be limited, it is worth considering them here briefly, not only because of their practical impact but also because of the wider question of what the amendments demonstrate about the regulation of the UK covered bond market. The individual amendments can hardly be described as ground-breaking: a fixed minimum overcollateralisation and interest coverage requirement; the supply of loan level data; the requirement to appoint an asset pool monitor to provide an annual report to the FCA; and the single- or multi-asset class election. None of these requirements will have alarmed any UK issuers. The reporting requirements in particular
can be seen as part of a general push for greater transparency in the covered bond market, something that the covered bond label initiative seeks to promote on a European level. The amendments can also be seen as a demonstration that the FCA remains a robust and hands-on regulator of the UK covered bond market.
Funding for Lending There can be little doubt about the detrimental effect that the Bank of England’s
Funding for Lending Scheme (FLS), with the access to low-cost funding that it provides, has had on issuance levels in the UK covered bond and RMBS market. Clearly, drawing a direct correlation between the FLS and the declining levels of UK covered bond issuance is difficult: in an environment where banks are deleveraging and with the significant market concern over the impact of forthcoming regulations (discussed below), linking the issuance decline directly to a single government scheme is questionable. Nevertheless, the Bank of England has
recently noted a significant drop in covered bond issuance by both UK and European lenders. Although the Bank did not link this directly to the FLS, it did comment that the relatively low level of issuance over the review period was due to a number of factors, and expressly mentioned the FLS. In the short- term at least, the impact of the FLS will continue to be felt by the UK covered bond market given the April announcement by the Bank of England that the FLS would be extended to allow drawdown until January 30 2015.
Forthcoming European regulations On a European level, there is still a focus on the vast array of regulations affecting financial institutions and insurance companies that are being proposed, debated and consulted on. These include, among others, the forthcoming CRDIV proposals (in particular the Liquidity Coverage Ratio, LCR), the bail- in proposals, a financial transaction tax, a regulation on asset encumbrance, Solvency II and EMIR. Many of these have the potential to boost
the covered bond market, but at the moment, uncertainty reigns to its detriment. In addition to the uncertainty, some of the regulations seem to be in active conflict with others, in particular regarding their impact on the covered bond market. As such, the impending regulations represent a major challenge to the market and some of the key concerns are discussed below.
There can be little doubt about the detrimental effect of the Bank of England’s Funding for Lending Scheme
The main challenges ahead Basel III and the LCR The LCR is to be introduced as part of the suite of regulatory proposals from the Basel committee (to be implemented by member states in the European Union through CRD IV). Basel III proposes that covered bonds with credit ratings of at least AA- are to be treated as Level 2A high quality liquid assets (HQLA), thereby attracting a 40% holding limit and a 15% haircut. This is not yet settled, however. The
European Banking Association (the EBA) has launched a consultation process on the
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