Fitch Ratings-Sydney-May 21: Fitch Ratings believes that the main non-European covered bond markets of Australia, Canada, New Zealand, South Korea and Singapore could receive third-country recognition under the EU's covered bond directive, in conjunction with the changes proposed to the capital requirement regulation in the long term.
The features of the frameworks in these non-European countries compare well with those of their European counterparts. We thus expect the covered bonds from these countries to tick all the boxes for recognition. However, the directive leaves the question of recognition open and there is a long lead time before a decision will be made, which extends the inequity in risk-weight treatment between markets.
Fitch-rated covered bonds from all these jurisdictions enjoy 'AAA' ratings and have substantial buffers against the downgrade of the issuing bank's Issuer Default Rating (IDR). Issuers and regulators in these markets took aspects from European legislative regimes, including high-quality assets, liquidity protection, independent monitoring and regulatory oversight and incorporated it into their own. This was due in part to ensure comparability to the European market and reflected what investors expected. Notably, issuance templates involving a special purpose company holding the cover assets and acting as guarantor of the covered bonds, had previously been adopted successfully in the Netherlands and in Italy.
Liquidity protection via maturity extension or pre-maturity test, as well as liquidity reserve is standard in many countries, with a few exceptions, such as in Spain. These same aspects are taken into account in our credit analysis when considering factors that support a rating uplift above the bank's IDR. The strong liquidity protection allows us to assign a six-notch payment continuity uplift for most programmes, whereas a traditional covered bond in countries like Spain cannot achieve such high uplift and ratings. The directive opens up the possibility of regulatory recognition by leaving open a decision on "third countries".
After the directive is transposed into national law, which is expected by 2020, the European Commission and the European Banking Authority will have a three-year period to formulate recommendations for an equivalence regime and report to the European Parliament. The length of time afforded under the directive to confirm the regulatory equivalence of these third countries is long. While historically the non-European covered bonds have not benefited from specific risk-weights among EU investing banks, regulated covered bonds from 28 different OECD jurisdictions around the globe are set to benefit from the proposed Basel III risk-weight provisions due to be implemented in 2022 - for so long as they meet an overcollateralisation (OC) of at least 10%. In some cases, we believe issuers looking to comply will need to amend their programme documentation or publish contractual commitments to fulfil this provision. Increased minimum OC levels in programmes in our view would strengthen programmes against adverse credit risk events. However, the proposed changes to the EU capital requirements maintain the favourable treatment for EU covered bonds, provided mandatory OC is at least 2% or 5%. This potentially gives the European programmes an advantage over their non-European counterparts not only in regulatory risk-weights, but in pricing as well. Europe-based investors are incentivised, under the current regulatory regime, to hold European covered bonds. Nevertheless, this should give impetus for investors considering pricing versus rating differentials between the traditional EU covered bonds and those issued in the rest of world. As is the case currently, investors will find value in covered bonds outside of the EU with equivalent ratings, regimes and credit risk profiles. Contact: Claire Heaton Senior Director +61 2 8256 0361 Fitch Australia Pty Ltd Level 15, 77 King Street Sydney NSW 2000 Susan Hosterman Director +1 212 908 0670 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com; Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com. Additional information is available on www.fitchratings.com ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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