However, the document also raises some general questions and concerns, as explained in the following.

Transcription

1 Commissioner Jonathan Hill European Commission Rue de la Loi / Wetstraat Brussels Belgium cab-hill-contact@ec.europa.eu Dear Commissioner, As representatives of all Danish issuers of covered bonds we would like to thank the Commission for its initiative in this important area. We support the Commission s ambition to further strengthen covered bonds as a core European funding tool for the real economy. The consultation is an important occasion for a Europe-wide debate on covered bonds and the Capital Market Union in general. As the Commission notes, a reform agenda pushing for more convergence at an EU level would have to tread carefully to avoid disrupting existing covered bond markets, in particular those which exhibited a stronger performance. The Danish specialised covered bond system has proven to be one of the well-functioning covered bonds markets throughout the crisis. We have endeavoured to respond to the consultation in some detail and we hope our description of the basic elements in a specialised banking model will help the Commission find a way forward to a system which ensures high quality and is flexible enough to accommodate the existing diversity. 17. december 2015 Finanssektorens Hus Amaliegade København K Realkreditforeningen Telefon Fax mail@realkreditforeningen.dk Finansrådet Telefon Fax mail@finansraadet.dk Realkreditrådet Telefon Fax rkr@rkr.dk However, the document also raises some general questions and concerns, as explained in the following. The consultation document suggests that harmonisation is needed if the EU is to achieve further capital market integration and efficient covered bond markets either by voluntary means or through the adoption of legal acts. To some degree this may be true, but it may not achieve the desired goals and there are important risks that must be taken into account. As one of the main reasons for the differences in performance of covered bond markets across the EU, the Commission cites country factors, including some elements that are not easily harmonised. We believe this is true.

2 It suggests that even with the same covered bond legislation for all Member States, the importance of country factors is likely to persist; dependent as they are on a broad range of features specific to each Member State. Caution must therefore be exercised in the harmonisation effort, even for example when establishing a single common definition of covered bonds. If the requirements are made too stringent, some issuers may get stuck in a dilemma. Either they must change business models or they will lose any preferential treatment. The effect is likely to be disruptive either way. Side 2 This type of difficulty is particularly likely to arise when the existing framework is significantly different from what appears to be the starting point in the consultation document. This may be the case with the specialised banking model used in some Member States, including Denmark. This is explained in the accompanying document. An EU reform effort in this area whether it is made using recommendations or regulation should aim for high quality rather than uniformity. Where high quality has already been achieved, uniformity provides little benefit. Where it has not yet been achieved, the situation can be improved while still allowing for different business models and issuer types. We hope that the Commission shares this view and look forward to a continuous discussion of these important matters. Yours sincerely, Karsten Beltoft Managing Director Danish Mortgage Banks Federation Ulrik Nødgaard CEO The Danish Bankers Association Ane Arnth Jensen Managing Director Association of Danish Mortgage Banks

3 Side 3 Annex: Differences between covered bond issuers models Covered bond issuer models defined by the European Banking Authority In the report of the European Banking Authority on EU covered bond frameworks and capital treatment, three covered bond issuer models are identified: The universal credit institution issuer model has been adopted by sixteen EU Member States. Under this model, covered bonds are issued by universal credit institutions, which are diversified in terms of activities and sources of funding. Consequently, covered bond issued and cover pool assets only account for a fraction of the balance sheet of the issuer. Covered bond investors have a first claim on the issuer and the cover assets which are listed in a cover pool registry to ensure segregation. The specialised credit institution issuer model has been adopted by eleven EU Member States. Under this model, covered bonds are issued by specialised credit institutions which are focused on mortgage lending or public sector lending funded by the issuance of covered bonds primarily. Consequently, cover pool assets and covered bonds issued account for a large part of the balance sheet. Covered bond investors have a first claim on the issuer and the cover assets on the balance sheet of the issuer. Asset segregation is thereby ensured by the very balance sheet structure of the issuer. The special purpose vehicle issuer model has been adopted by three Member States. Special purpose vehicles are established by credit institutions to enhance the extent of segregation of cover assets from other assets of the credit institutions. Covered bond issuance through special purpose vehicles is specific to jurisdictions where the asset segregation provided by law is deemed inadequate to effectively protect the covered bond investors in

4 the bankruptcy scenario. Covered bond issuance through special purpose vehicles will not be considered further. The covered bond issuer models have developed in reflection of the regulatory, institutional and economic landscape of each Member State. Each covered bond issuer model is therefore deeply rooted. Abandoning one covered bond issuer model in favour of another is likely to be a very costly, difficult and protracted process. Side 4 An over-ambitious harmonisation agenda - if it is not duly calibrated - for covered bond issuer models across EU Member States may, therefore, entail cost that exceed the envisaged benefits. Instead, care should be taken to accommodate the different models and their difference, as explained below. Balance sheet structure The balance sheet structures of universal credit institutions and specialised credit institutions are different. The balance sheet of a universal credit institution reflects the diversification of business activities. Assets may include unsecured loans, loans secured by mortgages, loans otherwise secured and securities holdings whereas liabilities may include deposits, unsecured debt, covered bonds, other secured debt, and equity. Cover pool assets may include only a subset of assets eligible as collateral for covered bond issuance. The issuer is therefore able to replace assets in the cover pool with assets from outside the cover pool or to add additional assets as over collateralisation in support of the covered bond issued. However, this may give rise to asset encumbrance concerns. The balance sheet of a specialised credit institution is less diversified but more transparent. Assets of a specialised credit institution include loans secured by a mortgage and securities holdings, whereas liabilities include covered bonds, other debt, and equity only. Stylised versions of these balance sheet structures are shown in the chart.

5 Balance sheet structure of universal and specialised credit institution Side 5 Universal credit institution Specialised credit institution Unsecured loans Secured loans Mortgages outside cover pool Deposits Mortgages Covered bonds Mortgages inside cover pool (a) Other debt Covered bonds Securities Securities (b) Equity Other debt Equity A L A L In some jurisdictions, e.g. France and Denmark, the bankruptcy privilege of covered bond investors includes all assets on the balance sheet of specialised credit institutions. Consequently, securities holdings, whether funded by debt ranking junior to covered bonds issued or equity form part of the cover pool and are recognised as over collateralisation in support of the covered bonds issued. As credit institutions, specialised institutions must comply with the capital and liquidity coverage requirements of the Capital Requirement Regulation. With the balance sheet structure of a specialised bank, this means that any increase in risk on cover assets entails an increase in over collateralisation in support of the covered bond issued. Capital and liquidity coverage requirements work as a transmission mechanism. This is done without asset encumbrance concerns. It is the common understanding - due to the simple balance sheet structure and high transparency- of all creditors of a specialised institution that they rank junior to the covered bonds investors. Poor fit for specialised credit institutions The Consultation Document considers proposals which would be part of the reform agenda and work in the direction of harmonisation of covered bonds across the EU. Some of these proposals appear to have been con-

6 ceived with the universal credit institution issuer model in mind and would be a poor fit for the specialised credit institution issuer model. Non-performing mortgages The Consultation Document considers a proposal to exclude nonperforming mortgages from the cover pool. Side 6 A universal credit institution with the balance sheet structure shown in the chart would be able to replace non-performing mortgages inside the cover pool with performing mortgages from outside the cover pool marked by the arrow (a) in the chart. This does not imply extra costs, but it increases asset encumbrance as non-performing assets are replaced by performing assets from outside the cover pool. A specialised credit institution with the balance sheet structure shown in the chart would not be able to replace non-performing mortgages with performing mortgages from outside the cover pool, since no such mortgages exists. The specialised credit institution covers the economic risk from the nonperforming mortgages by its loan impairment charges which reduce its capital marked by the arrow (b) and, consequently, the amount of securities serving as over collateralisation. Consequently, the economic risk from non-performing mortgages is fully covered within the scope of the specialised credit institution covered bond issuer model. To restore over collateralisation, the specialised credit institution would need to restore its capital or issue other debt for the funding of over collateralisation. If non-performing mortgages were to be excluded completely from the cover pool the specialised mortgage credit institution would need to restore the outstanding balance of the mortgage either by capital or by debt which would be disproportionate. Mortgages in breach of loan-to-value limits The Consultation Document considers whether loan-to-value requirements should be applied for the entire duration of the covered bond issued and whether loan-to-value ratios should be updated frequently. To some extent these questions are addressed by article 208 in the Capital Requirements Regulation. In general, loan-to-value limits should be observed at inception of the mortgage in the cover pool. For a special credit institution, this would correspond to time of disbursement of the mortgage. Following the inception of the mortgage into the cover pool, loan-to-value limits might be breached on an indexed basis by house price deflation. In this scenario, there is a basis for distinctions between universal credit institutions and specialised credit institutions.

7 A universal credit institution with a balance sheet structure, as shown in the chart, is able to replace high loan-to-value mortgages inside the cover pool with low loan-to-value mortgages from outside the cover pool in response to requirements such as those considered in the Consultation Document. Side 7 A specialised credit institution, on the other hand, would be unable to do so, as no such mortgages exist. Instead, the specialised credit institution needs to issue debt instruments specifically to fund replacement assets needed as extra collateral. But the economic risk from holding high loan-to-value mortgages are already covered by increased capital requirements insofar as the high loanto-value ratios imply higher expected losses. Any rule that disqualifies cover assets because of high loan-to-value in part or full is therefore more onerous in the context of a specialised institution. Over collateralisation and liquidity buffers The Consultation Document considers proposals on minimum requirements for collateral and liquidity buffers. A specialised credit institution funds over collateralisation and liquidity buffers by capital or by debt instruments ranking junior to covered bonds. Rules on capital and liquidity set forth in the Capital Requirement Regulation impose minimum requirements on over collateralisation and liquidity buffers. Therefore in the context of a specialised institution - cover pool specific minimum requirements on over collateralisation and liquidity would duplicate requirements already in place. Cover pool monitor and supervision The Consultation Document considers the proposal to require the issuer or competent authority to appoint an independent third party cover pool monitor. Specialised credit institutions are generally subject to specialised supervision on mortgage lending activities and covered bond issuance by competent authorities. An independent third party cover pool monitor would, at best, be duplicating the work of the competent authority. Cut-off mechanism in the issuer insolvency or resolution process The Consultation Document considers introducing a cut-off mechanism to release the insolvency estate or successor credit institutions from possible residual claims on covered bonds.

8 If a specialised credit institution were to enter into bankruptcy or resolution, covered bond holders would have a first claim on all assets of the insolvency estate i.e. both mortgages and securities holdings. Side 8 The proposed cut-off mechanism applicable upon issuer insolvency seems to be conceived with a universal banking model in mind. In the absence of a date of expiry on residual covered bond claims against the insolvency estate, the presence of covered bonds with long maturities would hold up the final settlement for many years, thus creating uncertainty. In the context of a specialised institution, however, virtually all creditors are covered bond holders who would not benefit from such a rule. They themselves hold direct claims on the same type of collateral and cannot expect a final settlement of those claims any sooner than other covered bond holders. Investors holding debt instruments junior to the covered bonds are aware of the bankruptcy order and do not expect the insolvency estate to be resolved before covered bonds have been discharged in full. A cut-off mechanism would therefore disrupt the bankruptcy order and would not achieve its purpose. On the contrary, a cut-off mechanism would weaken the position of bonds issued from cover pools that eventually turn out to be insolvent, leaving them with no claim to any possible excess coverage present in other cover pools of the institution. Conclusion Covered bond issuers across the EU are not uniform. The balance sheet structures of universal credit institutions are fundamentally different from those specialised credit institutions. The balance sheet structure of universal credit institutions implies a segregation of the cover pool and covered bonds issued from the securities holdings and capital of the issuer. Consequently, higher capital requirements in reflection of higher risks do not translate into higher over collateralisation in support of the covered bonds issued per se. Over collateralisation requirements and requirements to replace non-performing mortgages in the cover pool may therefore add value. The issuer may respond to these requirements by replacing mortgage assets inside cover pools by mortgage assets outside cover pools. The balance sheet structure of specialised credit institutions in e.g. France and Denmark implies a full integration of mortgage assets and covered bonds issued with the securities holdings and capital of the issuer. Consequently, higher risks on mortgage assets will be accounted for by higher capital requirements to be met by the issuer and over collateralisation re-

9 quirements and requirements to replace non-performing mortgages are not needed. Initiatives to harmonise covered bond frameworks across the EU should build on the different covered bond issuer models and not favour one over the other, unless merited by performance. Distinctions should, therefore, be made between universal credit institutions and specialised credit institutions with respect to requirements to replace non-performing mortgages in cover pools, eligibility of mortgages in breach of current loan-to-value limits in cover pools and over collateralisation and liquidity requirements on cover pools. Furthermore, a cut off mechanism should not be applied on the insolvency estate of a failed specialist credit institution. Side 9

10 Side 10 Background information on the Danish Mortgage market In terms of covered bonds funding mortgage loans, the Danish covered bond market is the largest in the world both in absolute size and as a share of GDP. By year end 2014, the outstanding amount of covered bonds funding mortgage lending was about EUR 370 billion, which is roughly the 140% of GDP. The importance of this market can also be caught in the fact that the Danish market represents 18% market share between all markets covered by the European Covered Bond Council (ECBC). Covered Bonds Outstanding - backed by Mortgage, EUR million, year end 2014 Source: European Covered Bond Council, Covered Bond Fact Book 2015 In the Consultation paper, in Figure IV, the column with Nordic CB s does not contain a breakdown of investors in covered bonds issued by Danish specialised mortgage banks. Furthermore, the statistics in Figure IV is only based on primary market data, i.e. the investor break down at the time of issuance of new benchmark issues, whereas changes in the investor break down due to secondary market activity afterwards is not displayed.

11 Due to the match funding business model, Danish specialised credit institutions do not build up traditional European benchmark issues, but they are in the market every day tap issuing in accordance with the actual mortgage lending activity. As a consequence, primary and secondary markets are more considered mixed in the market for Danish covered bonds. Side 11 The relative distribution of domestic and foreign investors in the current holdings of covered bonds issued by Danish specialised mortgage banks is shown in the figures below. In line with the Commission s analysis, the market for Danish covered bonds is also predominantly a domestic market with a well-diversified investor base. Domestic credit institutions account only for approximately one-third of the total market. However, one-fifth of the market is hold by foreign investors. There is no statistics showing the distribution of foreign investors country-by-country, but it is known that foreign holdings are mainly German and Nordic investors. Figure: Break down of investors (domestic vs. foreign) in covered bonds issued by Danish specialised mortgage banks holdings as of end-august % Domestic investors Foreign investors 78% 22% 2% 22% Public sector Insurance & pension 6% MFIs Investment funds Private 17% 31% Foreign Source: The Danish Central Bank s MFI statistics, 2015