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Fitch: EU Bank Funding Rules Would Help Covered Bonds' Liquidity
February 8, 2017 / 11:20 AM / 9 months ago

Fitch: EU Bank Funding Rules Would Help Covered Bonds' Liquidity

(The following statement was released by the rating agency) BARCELONA/LONDON, February 08 (Fitch) The net stable funding ratio (NSFR) requirement proposed for EU banks would boost secondary market liquidity for covered bonds (CVBs), Fitch Ratings says. We believe the rules would encourage banks to buy back CVBs as the securities' maturity profile declines to one year and issue longer-dated CVBs to preserve their NSFR. Activity like this could significantly improve secondary market liquidity. Lack of secondary market liquidity was highlighted as a top-three challenge for the CVB market by 49% of respondees in Fitch's end-2016 CVB investor survey. Active management of maturity profiles is already common practice is Sweden, where issuers use it to reduce refinancing risk. The NSFR will require banks to maintain a stable funding profile in relation to their assets and off-balance-sheet activities. The EU NSFR proposals include preferential treatment for pass-through CVB programmes that are fully match-funded from the moment of issuance. There is no NSFR requirement if assets and liabilities are match-funded and the institution acts solely as a pass-through unit to channel the funding from the liability into the corresponding interdependent asset. This pass-through structure is a feature of traditional Danish mortgage CVBs, but is rare elsewhere in the EU, where the majority of CVB programmes have significant maturity mismatches between assets and liabilities. The zero NSFR requirement is consistent with our view of the lack of refinancing risk in pass-through CVB programmes that are fully match-funded from issuance. There are still uncertainties on the relative treatment of other CVBs and, in particular, conditional pass-through CVBs. We believe that policymakers do not intend to extend preferential treatment to programmes that are not match-funded on a going-concern basis, such as conditional pass-through models. This is because these programmes have maturity mismatches at the outset and only convert to a match-funded profile upon a trigger event, that is, on a gone-concern basis. The treatment of overcollateralisation (OC) has also been a topic of debate. Unlike the treatment of match-funded assets, OC is treated as encumbered assets and therefore subject to a 100% required stable funding requirement. This may motivate issuers to manage OC more tightly, closer to the break-even OC for a target rating level, given the more onerous requirements for encumbered assets. Senior unsecured debt investors stand to benefit as a consequence of lower encumbrance. However, issuers tend to manage the level of OC in the context of overall asset encumbrance levels and may be satisfied with maintaining OC for the protection of CVB investors irrespective of the cost of related NSFR requirements. Overall, the NSFR proposals are ratings neutral for EU CVB programmes rated by Fitch, as our ratings approach already takes into account exposure to liquidity and refinancing risk. The NSFR proposals were put forward by the European Commission in November 2016 based on Basel III global liquidity standards issued by the Basel Committee, with certain EU-specific adjustments to avoid hindering the broader economy. The Basel Committee proposals aim to prevent banks' overreliance on short-term wholesale funding and to ensure that banks can meet their funding needs during a one-year period under both normal and stressed conditions. The proposals are subject to discussions with the European Parliament and Council and may not be finalised until 2018. They would take effect on 1 January 2019. Carmen Munoz Senior Director +34 93 323 8408 Fitch Ratings Espana, S.A.U. Avenida Diagonal, 601, Second Floor 08028 Barcelona Monsur Hussain Senior Director Financial Institutions +44 20 3530 1793 David Prowse Senior Analyst Fitch Wire +44 20 3530 1250 The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at All opinions expressed are those of Fitch Ratings. Related Research Russian Banking Sector in 2016: Limited Growth, Liquidity Surplus Emerges here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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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