With ideas about how to perfect covered bond laws and structures ricocheting around Europe, the EU is taking an interest. "Given the EU's desire to harmonize everything, this is an obvious area where it can practise its hobby," is one credit analyst's deadpan observation. European intervention could, though, clear up doubts about which bonds qualify for 10% risk weighting - a particular concern for banks given the impending implementation of the Basle II capital adequacy rules.
In April 2003, the European Commission published a working paper on the treatment of covered bonds. It outlined the EC's current thinking on capital requirements for covered bonds and invited comments.
More certainty needed
Article 22 (4) of the UCITS (undertakings for collective investment in transferable securities) directive defines the bonds to which EU member states can assign 10% risk weightings. In practice, these are bonds backed by mortgages subject to "prudent" loan-to-value (LTV) ratios, and by public-sector loans.
The paper makes the point that these bonds have the characteristics of secured loans and so share the general approach for setting capital requirements that applies to secured lending. It goes on: "The Commission Services favour more harmonization with respect to eligibility criteria for covered bonds ...