The new EU Covered Bond Directive (which came into force, together with an EU Regulation, in January 2020 and needs to be implemented in member states by July 2022) contains a discretionary initiative that can, but is not required to be, introduced by individual EU member states. If individual member states do introduce the provision by way of national implementing regulations, it will contribute to optimising the financing tools available for banking groups that operate in more than one member state.
Prior to the introduction of the Directive, the cover pool (e.g., mortgage portfolios) of each of the subsidiaries in a banking group could only be used to issue local covered bonds. That was not ideal, as issuances would inevitably be smaller and the strength of a member of the group could not be used in larger covered bond issuances as they would always be limited by the size of the cover pool of that particular member. In other words, the covered bond as a funding tool was compartmentalised for each credit institution in a banking group.
However, the Directive allows member states to set out rules regarding the use of covered bonds issued by one credit institution in a group as collateral for the external issue of covered bonds by a different credit institution within the same group (either located in the same jurisdiction or in another member state).
It is important to note, however, that this innovative funding tool contains certain limitations:
1. it does not cover self-retained covered bond structures (the externally issued covered bonds need to be placed among third party investors).
2. although the wording of the Directive is unclear, and national implementing regulations should clarify this, it looks like the cover pool of the externally issued covered bonds may contain, in addition to the internally issued covered bonds, other assets that are eligible under the national legislation applicable to the external issuer. However, it seems clear that not more than one group credit institution can contribute internally issued covered bonds.
3. the minimum rating requirement for both the internal covered bonds and the external covered bonds may limit the use of this tool in countries or group entities with lower ratings where it may be most useful.
It remains to be seen if and how this provision will be implemented and operate in practice and what EU and national regulations are brought in to aid, and provide guidance on, that operation. It will also be interesting to monitor whether, and how, the tool is used and relied on by banking groups, particularly given it will take effect in the aftermath of COVID-19 when such groups may well have significant funding requirements.
It remains to be seen if and how this provision will be implemented and operate in practice and what EU and national regulations are brought in to aid, and provide guidance on, that operation.