Report from the Commission to the European Parliament and the Council on Article 503 of Regulation (EU) No 575/2013 – Capital requirement for covered bonds

Covered bonds are debt obligations issued by credit institutions and secured on the back of a ring-fenced pool of assets (the "cover pool" or "cover assets") which bondholders have direct recourse to as preferred creditors. Bondholders remain at the same time entitled to a claim against the issuing entity or an affiliated entity of the issuer as ordinary creditors for any residual amounts not fully settled with the liquidation of the cover assets.

This double claim against the cover pool and the issuer is denominated the "dual recourse" mechanism. Furthermore, the cover pool comprises high quality assets, typically, but not exclusively, mortgage loans and public sector debt. The issuer is normally under the obligation to ensure that the value of the assets in the cover pool at least matches at all times the value of the covered bonds and to replace assets that become non-performing or, otherwise, do not meet relevant eligibility criteria.

The features described above contribute to make covered bond low-risk debt instruments, thus providing a rationale for the beneficial regulatory capital requirements set out in Article 129 of Regulation 575/2013 (the "CRR"). Credit institutions investing in covered bonds qualifying under Article 129 are allowed to hold lower levels of regulatory capital in relation to those instruments than would otherwise apply to senior unsecured bank debt. These comparative lower capital requirements are referred to by the CRR as "preferential risk weights".

These preferential risk weights are, however, only available for "qualifying covered bonds", that is, those backed by the high quality assets laid down in that Article 129 of the CRR. Cover pools may, inter alia, include qualifying senior units issued by French Fonds Communs de Creances ("FCCs") or equivalent securitisation instruments up to a maximum of 10% of the covered bonds' outstanding issue amount, and that limit may be derogated by competent authorities in accordance with Article 496 of the CRR until 31 December 2017.

Article 503 of the CRR mandates the Commission to report to the Co-legislators on a number of items related to the regulatory capital treatment of covered bonds under the CRR, having regard to the recommendations made by the European Banking Authority ("EBA") on each of the matters set out in Section 10 of EBA's "Report on EU Covered Bond Frameworks and Capital Treatment" (the "EBA Report").

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