Winds of Change from Europe: A New Perspective and Role for Covered Bonds in a Changing Global Financial Landscape

Abstract

Although efforts to enact a comprehensive legislative framework for covered bonds in the U.S. have heretofore been unsuccessful, covered bonds are a key component of European capital markets, with the asset class playing an important role as a robust long-term financing instrument contributing to the efficient allocation of capital and, ultimately, economic development and prosperity. With their key safety features, such as strict legal and supervisory frameworks, asset segregation, or a cover pool actively managed in order to maintain the quality of the collateral, covered bonds play an essential role in ensuring the flow of capital in financing long-term growth and the real economy. The European Covered Bond Council (ECBC) advocates the inclusion of covered bonds in Level 1 assets under the Basel III liquidity coverage ratio (LCR). The author believes that the inclusion of covered bonds in Level 1 would mitigate overreliance on sovereign debt by the European banking sector and facilitate the objective of delinking the sovereign from the banking sector, which is one of the key principles behind the Bank Recovery and Resolution Directive. Indeed, if the numerator of the LCR were constituted only of sovereign or central bank securities, it would be an obstacle to the financing of the real economy by banks, whereas covered bonds have all of the required features to be eligible as Level 1 assets.