COVERED BONDS IN THE EUROPEAN UNION

Transcription

1 06/01/2016 Joint response from the Banque de France and the Autorité de Contrôle Prudentiel et de Résolution to the Consultation Paper of the European Commission COVERED BONDS IN THE EUROPEAN UNION 1 / 47

2 Summary GENERAL REMARKS... 3 PART I COVERED BOND MARKETS: ECONOMIC ANALYSIS... 4 PART II EXPLORING THE CASE FOR A MORE INTEGRATED FRAMEWORK PART III ELEMENTS FOR AN INTEGRATED COVERED BOND FRAMEWORK COVERED BOND DEFINITION COVERED BOND ISSUERS AND SYSTEM OF PUBLIC SUPERVISION Issuer models and licensing requirements. Role of SPVs On-going supervision and cover pool monitoring (pre-insolvency) Covered bonds and the SSM DUAL RECOURSE AND INSOLVENCY/RESOLUTION REGIME Definition of dual recourse principle Segregation of the cover assets Administration of the cover pool post insolvency/resolution of the issuer Interaction between cover pool and issuer in insolvency/resolution THE COVER POOL Eligible assets: qualifying criteria and requirements Coverage requirement and overcollateralization Cover assets/liabilities risk mitigation: market and liquidity risks TRANSPARENCY REQUIREMENTS ADDITIONAL INFORMATION / 47

3 General remarks We welcome the initiative of the European Commission to thoughtfully assess Member States covered bonds markets and frameworks in regards to the Capital Markets Union project ("CMU"). After the global financial crisis and the European sovereign debt crisis, financial investors have turned to safe and sound instruments. This trend has benefited covered bonds, which are considered as robust and safe assets, and receive as such a favourable regulatory treatment. Against this background, we agree with the development of sound principles and best market practices harmonised at the European level for covered bond markets in order to further protect the interest of investors and facilitate the funding of credit institutions. In this regard, we believe that the general orientations given by the European Banking Authority (EBA), with a special focus on common safety, soundness and risk weight principles should be followed. However, we consider that a single harmonised European legislation on covered bonds is not desirable, as national covered bond markets are based on a wide set of rules and laws private law, which governs private and commercial transactions, along with insolvency law that are embedded in very different national law frameworks. As mentioned by the EBA Report 1, the national nature of covered bond markets and of covered bond legal/regulatory frameworks is grounded in solid historical and structural factors. In addition, the few existing European rules, which already apply to covered bonds, allow sufficient flexibility for national legislations to shape a balanced system which protects bondholders, especially in case of insolvency (of the parent bank as well as of the issuing subsidiary). Therefore, we would favor a combination of (i) targeted harmonisation limited to the aspects of covered bonds applicable to risk control measures and (ii) adoption of best practices regarding structural features that are deeply embedded in national legal frameworks. Risk control measures could include public supervision, liquidity management, transparency inclusive of investors protection, loan-to-value and overcollateralization requirements, as well as cover pool quality. Structural features would concern, among others, issuing structures, segregation mechanisms, licensing requirements, dual recourse regime and cover pool composition. Finally, Member States should remain free to set higher standards. 1 EBA, Report on EU covered bond frameworks and capital treatment, 3 / 47

4 PART I Covered bond markets: economic analysis 1 In your opinion, did pricing conditions in European covered bond markets converge and diverge before and after 2007, respectively? 1.1 If so, what where the key drivers of this convergence/divergence? We largely agree with the analysis provided by the Commission on pricing evolution before and after the start of the global financial crisis, but we would like to highlight some recent specific trends explaining, in our view, the normalization which happened after 2011 and reveals new drivers for covered bond pricing. Foremost, European covered bond markets benefited from the global bond rally which started in 2011 onwards, but were also driven by some specific market dynamics: - First, the three covered bond purchase programmes launched by the Eurosystem have revitalised the market and improved funding conditions for issuers. For instance, the latest asset purchase programme launched in 2014 (CBPP3) includes 24% of primary market operations. It has a significant quantitative impact on net supply and is also impacting liquidity according to some dealers, with widely diverging effects between eligible covered bonds and non-eligible covered bonds. - Second, covered bond ratings have experienced some decorrelation with sovereign bond ratings. After an episode of strong widening of risk premia versus sovereign bonds during the real estate crisis in 2008, some recorrelation occurred during the sovereign crisis due to the link between SIFIs and their own sovereign. Since 2011 however, some decorrelation has occurred again reflecting in part methodological changes brought by rating agencies especially for covered bonds issued in peripheral countries but due also to the credit quality of covered bonds and their recognition by investors as a resilient asset class. - Third, the eligibility of most covered bonds for inclusion in the LCR fostered a strong demand by bank treasurers which has helped to push yields lower, particularly on the short end of the yield curve. All in all, it seems that this new environment for covered bonds markets weighs on investors risk perception across countries and issuers. More precisely, investors seem to rely less than before on fundamentals (credit signature, pool quality, soft or hard bullet, etc.) to assess the credit quality of covered bonds (cf. for instance the fact that Spanish cedulas traded below UK covered bonds during the month of September 2015). Please provide evidence to support your view on the possible convergence and divergence of pricing conditions in European covered bond markets before and after 2007 respectively: 4 / 47

5 2.1 Was pricing divergence an evidence of fragmentation between covered bonds from different Member States? 2.2 Do you agree with the reasons for market fragmentation described in section 2.1 of Part I 2.3 Were there any other reasons? Please explain your answers to question 2: Looking backward, the Consultation Paper insists on three main elements to describe market fragmentation in the European market: the credit quality of cover pools during the global financial crisis, the rise in sovereign risk from 2011 onwards and some stigmatization of several national markets legislations mostly those of peripheral countries. We largely agree with the description provided. But from a market perspective, however, we would advocate that a yield and price differentiation across issuers is not necessarily a sign of market fragmentation, as it also reflects rational, structural, and different risk assessments. We furthermore consider that current market valuations are healthier than pre-crisis levels when there was no yield differentiation across European issuers. In a period of spread normalization after the crisis-widening, we therefore consider that some differentiation is a sign of a better functioning of the market. 3. In your view, is there any evidence of pricing differentiation/fragmentation between covered bond issuers on the basis of size and systemic importance, as well as their geographical location? - Don t know / no opinion / not relevant Please explain your answers to question 3: 5 / 47

6 The three factors listed in the question (i.e. size, systemic importance and geographical location) do contribute to pricing differentiation, albeit on different scales. The most important one is indeed the geographical location of the cover pool: as observed for primary market transactions, stressed countries (mainly peripheral countries and Austria) offer indeed higher new issue premium (cf. chart 1 from Crédit Agricole in our additional document) than non-stressed countries (mainly core countries). It illustrates the greater importance of the geographical location for the pricing of covered bonds in Europe. Chart 1: New issue premium (bp) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Source : CACIB Average Core Average Periphery Average Non-EZ With no surprise, other dynamics are worth mentioning to explain this pricing differentiation across banking groups: in addition to their size, already mentioned in the Consultation Paper, the issuers rating and the quality of their pool. Peripheral countries are the most impacted by this aspect that exacerbates the country premium (as shown in chart 3 in our additional document). From this perspective, some ongoing trends are also to be mentioned, especially the implementation of BRRD and the restructuring (or not) of real estate markets that weigh on peripheral markets. All in all, our understanding is that pricing differentiation is mainly caused by the geographical location of the covered pool, while idiosyncratic aspects play a role on pricing, albeit to a lesser extent. 6 / 47

7 Chart2 French sovereign and covered bond issuers yield curves (%, Nov-2015) Chart3 Spanish sovereign and covered bond issuers yield curves (%, Nov-2015) Source: Bloomberg 7 / 47

8 4. Is there an appropriate alignment in the regulatory treatment between covered bonds and other collateralised instruments? 4.1 If there is a misalignment, could you illustrate what differences in regulatory treatment you deem as inappropriate and why? Please explain your answers to question 4: Important regulatory rules include: - BRRD which exempts covered bonds from bail-in; - the LCR which categorizes covered bonds as highly liquid assets; - the CRR which assignes low risk weights to covered bonds; - Solvency II which grants low spread risk factors to covered bonds. We believe that the preferential regulatory treatments given to covered bonds are appropriate, given the low risk nature of covered bonds (lower than securitisation products that have no dual recourse). 5.1 Are operational costs for covered bond issuance lower than for other collateralised instruments? 5.2 Can you quantify the respective costs, even if only approximately? Please explain your answers to question 5: With respect to the operational costs of a covered bond, it is important to remember that covered bond issues are set up as programmes, the costs of which arise at the inception of the programme mostly. During the life of the covered bond, each new issuance benefits from the existing structure of the covered bond programme and bears only a fraction of the costs. 6.1 Are there significant legal or practical obstacles to cross-border investment in covered bond markets within the Union and in third countries? 8 / 47

9 Please provide evidence to support your view on possible obstacles to cross-border investment in covered bond markets within the Union and in third countries: Cross-border investment is already effective on covered bonds markets, but could be improved. Harmonisation of data and information reporting would lead to additional transparency and facilitate the comparison and the understanding of key differences between covered bonds issued in different countries. Nevertheless, in our view, a loan-by-loan disclosure would not be particularly useful, as the cover pool may change several times in the covered bond issuer s life. Furthermore, any decision on adding more requirements about transparency should take into account the additional costs for covered bonds issuers. 6.2 Are there significant legal or practical obstacles to issuance of covered bonds on the back of multijurisdictional cover pools? Please provide evidence to support your view on possible obstacles to issuance of covered bonds on the back of multi-jurisdictional cover pools: In any jurisdiction, covered bonds are designed to be in compliance with specific national features (i.e. bankruptcy law, private law which is governing private and commercial transactions, etc.). National covered bonds legal frameworks can sometimes define and/or restrain the type of eligible assets in the cover pool, such as in France with the Sociétés de Financement de l Habitat («SFH») that can only purchase residential loans. There is no specific limit on the purchase of foreign assets under the two French covered bond legal frameworks. However, more restrictive eligibility criteria can be set at the covered bond structure level and, in practice, we have observed that foreign assets would be included only in a Société de Crédit Foncier («SCF») structure. The two French covered bond legal frameworks provide for the responsibility of an administrator in case of the issuer s default. The situation would lead to the liquidation of the pool which could be problematic if the underlying assets are located in different countries. 9 / 47

10 PART II Exploring the case for a more integrated framework 1.1 Would a more integrated EU covered bond framework based on sound principles and best market practices be able to deliver the benefits suggested in section 2 of Part II? 1.2 Are there any advantages or disadvantages to this initiative other than those described in section 2 of Part II? Please explain your answers to question 1: We agree with further convergence at the EU level in order, amongst others, to further protect the interest of the investors and facilitate the funding of credit institutions. In this regard, we believe that the general orientations given by the EBA with a special focus on common safety, soundness and risk weight principles should be followed. However, we are not convinced by the necessity and the benefits of developing a unique regime whereby national legislations would fully converge. As mentioned in the EBA Report, the national nature of covered bond markets and of covered bond legal/regulatory frameworks is grounded in solid historical and structural factors. For instance, in France, covered bond issuers must be credit institutions and the French regulator has ensured that the holders of covered bonds are protected by a dedicated issuing structure whereby covered bond holders benefit from a legal privilege (please refer to our answers under part III section 3 with respect to the solvency/resolution regime applicable to French covered bonds). This framework has allowed French covered bonds to maintain their level of performance despite the crisis and, more specifically, to accurately satisfy the financing of the real economy, while providing for a high level of protection to investors. 2.1 In your view, are market-led initiatives such as the Covered Bond Label sufficient to better integrate covered bond markets? 2.2 Should they be complemented with legislative measures at Union or Member State level? 10 / 47

11 Please explain your answers to question 2: We think that such market-led initiatives are a very useful step but should be complemented by legislative action focusing on the definition of common risk control measures. 3. Should the Commission pursue a policy of further legal/regulatory convergence in relation to covered bonds as a means to enhance standards and promote market integration? 3.1 If so, which of the options suggested in section 3 of Part II should the Commission follow to that end and why? - Option 1: Subsidiarity and indirect harmonisation - Option 2: EU product regulation elements and shape of an integrated framework Please explain why you think the Commission should follow the option you selected in order to enhance standards and promote market integration: We actually favour a combination of the two options (please refer to our answer under item 8). Please explain your answers to question 3: Please refer to our answer under item Specifically, if the Commission were to issue a recommendation to Member States as suggested in section 3 of Part II, would you consider that sufficient or should it be complemented by other measures (both legislative and non-legislative)? (see question 8 below), I consider that sufficient, I think it should be complemented by other measures (both legislative and non-legislative) Please explain your answer to question 4: See our answer under item 8 below. 5.1 Is the suggested list of high level elements for an EU covered bond framework sufficiently comprehensive? 11 / 47

12 , it is sufficiently comprehensive, it should include other items Please explain which other items should be included in the list of high level elements for an EU covered bond framework: 5.2 Should the Commission seek to develop all the elements of the suggested list of high level elements for an EU covered bond framework, or a subset of them? - All the elements contained in the suggested list - Only a subset of the elements contained in the suggested list If the Commission seek to develop only a subset of the elements of the suggested list, should the Commission give priority to the target areas identified by the EBA Report (i.e. (i) special public supervision of cover pools and issuers; (ii) characteristics of the cover pool; and (iii) transparency)? Please explain your answers to question 5: In case the EU sets a unified covered bonds framework, we agree that the target areas identified by the EBA report should be a priority for the Commission with one exception: the content of the cover pool which should take account of national specificities. 6.1 What are your views on the merits described under section 3 of Part II of using different legal instruments to develop an EU covered bond framework? In particular, would it be desirable to harmonize through a directive some of the legal features of covered bonds and requirements applicable to them under Member States laws? Please describe your views on the merits described under section 3 of Part II of using different legal instruments to develop an EU covered bond framework: Please refer to our answer under question / 47

13 6.2 If it were proposed, how could a 29th Regime on covered bonds be designed to provide an attractive alternative to existing national laws? We do not believe that a 29 th Regime should be implemented. Please explain your answers to question 6: We are not convinced by the necessity and the benefits of developing a single regime whereby national legislations would fully converge. As mentioned in the EBA Report: the national nature of covered bond markets and of covered bond legal/regulatory frameworks is grounded in solid historical and structural factors. Thus, we fear that an attempt for a total harmonisation of covered bonds legal regimes into a single EU regime would require so many exceptions due to national specificities that eventually, the result would remain fragmented. 7 How should an EU covered bond framework deal with legacy transactions? All legacy transactions should be captured and grandfathering periods should be established. The simplest option would be to refer to the treatment at the time of issuance. 8 Would you view a combination of recommendations to Member States (Option 1) and targeted harmonisation of certain minimum standards (Option 2) as desirable and sufficiently flexible? 8.1 If you would view a combination of recommendations to Member States (Option 1) and targeted harmonisation of certain minimum standards (Option 2) as desirable and sufficiently flexible, what should be the subject of each option? We would favor a combination of (i) adoption of best practices and recommendations regarding structural features that are deeply embedded in national legal frameworks and (ii) targeted harmonisation possibly through the mean of a directive - limited to the aspects of covered bonds applicable to risk control measures. Please explain your answers to question 8: We believe that a consensus on risk control measures can be reached with regards to public supervision, liquidity management, transparency inclusive of investors protection, loan-to-value and overcollateralisation requirements, as well as cover pool quality. By contrast, rules related to the structure of covered bonds strongly depend of historical and jurisdiction specific features e.g. issuing structures, segregation mechanisms, licensing requirements, dual recourse regime and cover pool composition. 13 / 47

14 PART III Elements for an integrated covered bond framework 1. Covered bond definition 1. What are your views on the proposals set out in section 1 of Part III for a "new legal definition" of covered bonds to replace Article 52(4) of the UCITS Directive? We agree with this new legal definition, including the distinction between regulated covered bonds and other covered bonds, as well as the protection of covered bonds denominations. However, we are not in favor of widening the location criteria to equivalent third countries for issuers with their registered office in a non EEA country. Indeed, national insolvency regimes and enforcement procedures available to secured creditors (i.e. efficient foreclosure following default) may differ substantially. 2. Covered bond issuers and system of public supervision 2.1 Issuer models and licensing requirements. Role of SPVs 1.1 Should the current licensing system be simplified to require a "one-off" authorisation only for all covered bond issuers based on common high level standards? 1.2 What specific prudential requirements (that is, in addition to those in CRR and CRD) could be applied as a condition for granting a covered bond issuer license? Covered bond issuers should be, in our view, regulated institutions submitted to specific requirements such as dedicated prudential reporting and on-going special public supervision from the competent authority. Please explain your answers to question 1: If all covered bond issuers were subject to an authorization as specialised credit institution to issue covered bonds, they would not need to be granted a specific authorization for each issuance. In the current French legal framework, for instance, the authorization to issue obligations foncières (OF) and obligations de financement à l habitat (OH) is only granted to specialised credit institutions (Sociétés de Crédit Foncier (SCF) and Sociétés de Financement de l Habitat (SFH)) whose activity is strictly defined by law. Any new programme, even if not notified to the competent authority, is then easily followed on regulatory figures sent by the SCF or the SFH. In other words, according to the reporting requirements applicable to credit institutions, information on any covered bond programme is available to the French regulator Autorité de Contrôle Prudentiel et de Résolution (ACPR). 14 / 47

15 Moreover, before any issuance above 500 M, a control has to be made by the contrôleur spécifique (cover pool monitor), checking for instance that the cover pool is sufficient compared to covered bonds issuances. This control can, if something unusual is detected, lead the contrôleur spécifique to report to the ACPR as he is required to according to French law. Approving of a credit institution as an SCF or SFH includes then authorizing it «one-off» to issue covered bonds. As the Commission pointed out, issuer structures are very different from one Member State to another i.e universal credit institution to specialised credit institution such as in France. France shares the Commission s preoccupation to fit all different national frameworks whatever the option chosen for integration in covered bond markets. Any EU framework should not prevent a Member State from requiring more stringent requirements, if required by the national legal framework, for the issuance of covered bonds within its territory. 2.1 If the covered bond issuer is subject to a one-off covered bond-specific licence, what would be the additional benefits of requiring that each covered bond programme be subject to prior authorisation as well? There is no particular benefit and relevance of requiring a prior authorization for each covered bond programme, if the covered bond issuer is a regulated institution submitted to specific requirements, such as dedicated prudential reporting and on-going special public supervision from the competent authority. 2.2 Alternatively, would pre or post notification to the competent authority of the programme and of each issue within or amendment to the programme suffice? 2.3 How should "covered bond programme" be defined for these purposes? Pre or post notification of the programme to the competent authority could prove an interesting requirement. Post notification would be, according to us, the most useful tool as it could include the final issuance amount of the covered bond programme. Covered bond programme should then be defined as the issuance of covered bonds responding to the Commission s proposed definition above a certain amount (500M for example). Please explain your answers to question 2: 3.1 Should the Framework explicitly allow the use of SPVs to ring-fence cover pools of assets backing issues of covered bonds? 15 / 47

16 3.2 What specific requirements should apply to these SPVs? - Don t know / no opinion /not relevant Please explain your answers to question 3: In our view, SPV or pooled covered bond structures, if allowed, should be regulated institutions submitted for instance to specific requirements, such as dedicated prudential reporting and on-going special public supervision from competent authority. 4.1 Would it be desirable for an EU covered Bond Framework to allow the use of pooled covered bonds structures and SPVs? 4.2 Please explain why you think it would be or wouldn't be desirable: If we refer to the definition of pooled covered bonds structures and SPVs provided in the Commission consultative document (p22), those structures are unregulated entities, and we consider that it would weaken the security of covered bonds. 4.3 What legal structures are used in your jurisdiction to pool assets from different lenders or issuers? French law requires every covered bond issuer to be a licensed credit institution (Société de Financement de l Habitat («SFH») or Société de Crédit Foncier («SCF»)). The latter is a dedicated entity, subsidiary of the parent bank, whose sole purpose is to issue covered bonds. The credit institution is regulated, which allows for a sound and safe regime as regards the ring-fencing of the cover pool of covered bonds. French SCF and SFH ought to comply with specific supervisory requirements on liquidity, maturity mismatch and overcollateralization, in addition to requirements that apply to any dedicated credit institution. 4.4 Which approach would be the most suitable for pooling assets across borders? 16 / 47

17 4.5 Where the issuer of pooled covered bonds is an SPV, should this issuer be regulated as: - A credit institution - Some other form of legal entity Under which form of legal entity should this issuer be regulated? In our view, SPV or pooled covered bond structures, if allowed, should be regulated institutions submitted for instance to specific requirements such as dedicated prudential reporting and on-going special public supervision from competent authority. Please explain your answers to question 4: 2.2 On-going supervision and cover pool monitoring (pre-insolvency) 1.1 In your view, would it be desirable for an EU covered bond Framework to set common duties and powers on competent authorities for the supervision of covered bond programmes and issuers? 1.2 What specific duties and powers should be included in the Framework and/or EBA or ESMA Guidelines? Minimum specific reporting requirements could for instance include reports on overcollateralization, maturity mismatch, interest rate mismatch and liquidity. Moreover, the cover pool monitor should be required to immediately report to the competent authority any event, decision or fact that has come to his knowledge and that is likely to affect and or jeopardize operating conditions of the issuer or compliance to regulations. In the French framework, among his duties, the cover pool monitor, called the contrôleur spécifique, along with his staff and experts, is bound by professional secrecy with regard to the facts, acts and information he has knowledge of on account of his duties. He is nevertheless released from professional secrecy with regard to the Autorité de Contrôle Prudentiel et de Résolution (ACPR), to which he is required to immediately report any fact or decision he has become aware of in the performance of his duties which could affect the situation or the continuing operation of the Société de Financement de l Habitat («SFH») or the Société de Crédit Foncier («SCF») (see articles L and L of the French Monetary and Financial Code). The contrôleur spécifique also sends an annual report on his mission to the Autorité de Contrôle Prudentiel et de Résolution. We consider that a similar requirement would be beneficial to the 17 / 47

18 European Framework. Please explain your answers to question 1: The special public supervision of covered bond issuers is a central pillar of the system and a fundamental guarantee for bondholders. Nevertheless, due to a large diversity of frameworks within the Member States, it is sometimes difficult for covered bonds investors to assess and fully understand how these special public supervisions are conducted. Regarding on-going supervision and cover pool monitoring, we therefore believe that legislative coordination measures could be useful to define a common European framework on the basis delivered by the EBA on this matter. 2. What are your views on the proposals set out in subsection 2.2 of Part III on the appointment of and legal regime for cover pool monitors? We agree with the proposals set out in subsection 2.2 and would like to further clarify some of them. Appointing an independent third party to monitor the cover pool could be a relevant requirement. Its appointment should, in our view, be subject to the approval of the competent authority. In order to be appointed, the cover pool monitor should have very high qualifications. The French system includes for instance the obligation for covered bond issuers to appoint a contrôleur spécifique selected from the list of statutory auditors. They are appointed for a term of four years by the company's senior management, subject to a positive opinion from the Autorité de Contrôle Prudentiel et de Résolution (articles L et seq. of the French Monetary and Financial Code). In order to preserve his independence, the statutory auditor of the Société de Financement de l Habitat («SFH») or the Société de Crédit Foncier («SCF»), the statutory auditor of any company controlling the SFH or SCF or the statutory auditor of a company directly or indirectly monitored by a company controlling the SFH or SCF should not be appointed as contrôleur spécifique or contrôleur spécifique adjoint. Please explain your answer to question 2: 2.3 Covered bonds and the SSM 1. Should the ECB have specific supervisory powers? 1.1 If so which ones, in relation to covered bond issuance of credit institutions falling within the scope of the SSM? 18 / 47

19 Please explain your answers to question 1: As mentioned in the Consultation Paper, covered bonds have significant implications for the prudential soundness of credit institutions, which already fall within the scope of the SSM supervisory powers. However, special public supervision of covered bond issuers should remain of national competence for two reasons : - Specific public supervision of covered bond issuers based on national regulations is not strictly related to prudential supervision, as the main purpose of these legislations is the protection of investors. For instance, under French law, specific requirements concerning overcollateralization or specific liquidity rules aim at ensuring that covered bond holders will be fully paid back, even if the issuer s parent bank has any kind of financial difficulties. However, these missions do not fall within the scope of ECB s missions as defined by article 4 of Council Regulation (EU) n 1024/2013 which explicitly links SSM s competence to prudential supervisory purposes. - National covered bonds laws are enshrined in a larger national legal framework with very specific and technical regulations, which significantly vary from one Member State to another, such as bankruptcy law or mortgage/housing loans regulations. On the other hand, we consider current interest of the ECB on covered bonds, while exercising its competence to prudential supervisory purposes, as it is carried out today and described in the Commission s Consultation, to be sound, natural and desirable. 3. Dual recourse and insolvency/resolution regime 3.1 Definition of dual recourse principle 1. Do you agree with the proposed formulation for "dual recourse"? Please explain your answer to question 1: We understand that the dual recourse principle is a recourse limited to the issuer and to the assets of the cover pool without extension to the parent bank and/or to other members of the banking group where different from the issuer. 3.2 Segregation of the cover assets 1.1 Are there any advantages to using an SPV as an additional segregation mechanism at issuance? 19 / 47

20 1.2 Are cover assets typically transferred to the SPV at issuance via legal or equitable assignment? Please explain your answers to question 1: The use of an SPV limits the risks of insolvency of the issuer and ensures an optimal segregation of the cover pool, but to the extent that the SPV is a regulated entity. 2.1 In your jurisdiction, what legal and practical steps are required in order to segregate effectively the cover assets from the issuer s insolvent estate or in resolution? Cover assets of French regulated covered bonds are always transferred at issuance via legal assignment (specified in articles L and L of the French Monetary and Financial Code). The transfer of assets (which gives right to the issuance of covered bonds) to a specialised credit institution is made by the remittance/delivery of a form. Such transfer is effective amongst the parties and enforceable towards third parties as of the date of the form whatever the record, term or due date of the claim. No other formality is needed and the transfer of any and all accessories linked to the claim is also made simultaneously. The form needs to contain the following information: the denomination transfer of claims form ( acte de cession de créance ), references to the relevant articles of the French Monetary and Financial Code (esp. article L ), the social denomination of the financial institution benefiting from the transfer and the individualisation/registration of the transferred assets. Articles L and subsequent of the French Monetary and Financial Code (applicable to both categories of French regulated covered bonds) provide bondholders with a legal privilege to be paid in priority to any other creditor of the issuing structure. The privilege is extended to all subsequent costs and transactions effected in the interest of the issuing structure. Thereafter, it can be stated that, as of transfer, the assets are protected from any subsequent insolvency (esp. article L ) and resolution (esp. article L ) proceeding. 2.2 Would it be necessary to serve a notification to each borrower of the issuer? 2.3 Until notification is served, what is the legal status of any proceeds of the cover assets which may be paid directly into the insolvent estate or to the issuer in resolution? 20 / 47

21 As already mentioned, the assets are protected from any subsequent insolvency (esp. article L of the French Monetary and Financial Code) and resolution (esp. article L ) proceeding as of transfer. Please explain your answers to question 2: No notification to the borrower is necessary. In case of a change of servicer, a simple notice sent to the borrower indicating the change in the bank servicing is needed (see art L of the French Monetary and Financial Code). 3.3 Administration of the cover pool post insolvency/resolution of the issuer Legal form and supervision of the cover pool 1. Should the cover pool be incorporated as a regulated entity? 1.1 As what type of regulated entity should the cover pool be incorporated? As suggested in the Consultation Paper, the cover pool should be incorporated as a credit institution, in order to place it under public supervision. Please explain your answers to question 1: 2. Who should be the supervisory authority for these purposes, the competent authority or the resolution authority? If the cover pool is incorporated in a properly regulated entity, this entity should survive insolvency/resolution of its parent bank. The competent authority would then stay the authority in charge of monitoring these entities as mentioned above. If the cover pool entity enters itself into ordinary resolution procedures, resolution authority would then be in charge of supervising this entity. Sociétés de Financement de l Habitat («SFH») or Sociétés de Crédit Foncier («SCF») are compliant with this scheme Special administrator of the cover pool 21 / 47

22 1. What are your views on the proposals set out in subsection 3.3 of Part III on the appointment and legal regime for a cover pool special administrator? Strictly speaking, as the liquidator is legally obliged to respect the ranking of cover pool liabilities, and as the bondholders benefit from a priority claim on the assets included in the cover pool (Article 52 (4) of the UCITS Directive), the appointment of a cover pool special administrator is not justified. Nevertheless, according to article 35 of the BRRD, resolution authorities may decide to appoint a special manager to replace the management body of the institution under resolution. In the case where the parent company and the covered bond issuer were in resolution, only one special manager would be appointed for the group and he would not have the specific duty to protect the cover pool. In this case, the appointment of a cover pool special administrator would be justified. This cover pool special administrator could be appointed by the Court upon recommendation by the resolution authority of the issuer to protect the bondholders and should administer the cover pool consistently with the resolution plan regarding the issuer. In post issuer s resolution, if the tools available in the BRRD, such as the transfer of both the cover pool of assets and the liabilities to another covered bond issuer/specialized credit institution or to a bridge bank could not be successfully completed, as a result of the resolution process or following insolvency of the issuer, then a cover pool administrator could be appointed to ensure that the cover pool is administered and serviced in the best interest of the bondholders. 2.1 Should the special administrator be obliged to report regularly to the relevant supervisory authority? 2.2 Should the content and regulatory of such reporting be the same as for the issuer? Please explain your answers to question 2: Ranking of cover pool liabilities 1.1 Do you agree with the suggested ranking for cover pool liabilities? 22 / 47

23 1.2 Is the wording proposed in subsection 3.3 of Part III sufficient to define clearly the claims that may arise, avoid confusion between claims and prevent claims in an unreasonable amount from arising? Please explain your answers to question 1: As pointed by the Commission, «the bondholders should continue to benefit from a priority claim on the proceeds of the cover pool, both during the on-going operation of the cover pool as an independent entity and at the time it is wound up». While we agree with the suggested ranking, we would prefer amending the wording of it to read as follows: instead of persons providing services to the cover pool, we would propose: persons providing services in relation to the cover pool/to the issuance of covered bonds. In some models such as in the French one, the cover pool is an independent entity, a separate credit institution. What is referred to as the cover pool in the Consultation Paper would then refer to a fully licensed credit institution. This cover pool term could thus be confusing if applied to the French system. 2. Is it possible to define hedging activity better? 2.1 How is it possible to define hedging activity better? 3.4 Interaction between cover pool and issuer in insolvency/resolution 1.1 Are current provisions in EU law sufficient to deliver effective protection for bondholders in a resolution scenario involving covered bonds? 1.2 In particular, is it sufficiently clear: Yes No Don t know / 23 / 47

24 no opinion / not relevant how the cover pool would be segregated under each possible resolution or recovery scenario of the issuer? how the full recourse against the issuer would take effect if the issuer is in resolution and is not placed subsequently into liquidation? what procedural steps should be followed in resolution and by whom in order to make effective the dual recourse mechanism? x x x Please explain your answers to question 1: The BRRD provisions can fully apply to the resolution of the parent bank of the dedicated credit institution issuing covered bonds. Resolution tools could also apply to the dedicated credit institution except for the bail-in tool which excludes covered bonds from its scope (article 44 2.b of the BRRD). In addition, article 45 of the BRRD provides that the resolution of the dedicated credit institution issuing covered bonds will be wound-up through national insolvency procedures or other types of procedure implemented in accordance with article 38, 40 or 42 of the BRRD. a) How the cover pool would be segregated under each possible resolution or recovery scenario of the issuer? Two possibilities can be considered: (1) In case the covered bond issuer is a dedicated, licensed credit institution: French law provides a segregation of the cover pool for these dedicated institutions issuing covered bonds as the Sociétés de Financement de l Habitat («SFH») or Sociétés de Crédit Foncier («SCF»). They are regulated entities which are legally restricted in the range of business activities they can exercise. They can lend or acquire certain qualifying assets and fund those activities mostly or exclusively through the issuance of covered bonds backed by those assets. They issue covered bonds backed on assets originated by their parent bank with which they form the same banking group. The segregation of their cover pool is enshrined in the law. The specificity of this kind of structure allows: - To disconnect the dedicated credit institution from the parent bank and, as a result, to clearly identify the pool of loans that covers the issuance of the bonds and implement a strong specific supervision; - Bankruptcy remoteness should the parent bank defaults. The efficiency of the bondholders protection is enshrined in the legal framework which provides that: - The bondholder benefits from a legal privilege (article L of the French Monetary and Financial Code). In the event of the default of the issuer, bondholders benefit from the protection provided by the Sociétés de Financement de l Habitat («SFH») and the Sociétés de Crédit Foncier («SCF») legal frameworks, in so far as any debt under the legal privilege should be repaid before any other debts (article L of the French Monetary and Financial Code). Until the holders of privileged debts have been fully paid off, no other creditor of the SCF may claim any right against the property and rights they have on the defaulting dedicated 24 / 47

25 credit institution; - Both the SFH and the SCF have to regularly update a register which specifies the loans they have granted or bought, the nature and the value of the securities which are backed by these loans and the nature and the amount of the preferred debts (articles R and R of the French Monetary and Financial Code); - Safeguard procedure, judicial reorganisation or liquidation proceedings (procédures de sauvegarde, redressement ou liquidation judiciaires) of a company holding shares of the SCF cannot be extended to the SCF (article L of the French Monetary and Financial Code); - The insolvency of a SCF or a SFH does not result in the acceleration in the payment of the bonds and other privileged debts (article L of the French Monetary and Financial Code); - Specific compliance requirements are to be met (see below on the cover pool monitor). These provisions clearly demonstrate that, under French law, the cover pool is owned by a separate licensed credit institution. Hence, the segregation of the cover pool is already in place. (2) in the case of a universal credit institution issuer frameworks or in structures with universal credit institution issuers establishing unregulated special purpose vehicles, segregation intervenes during early intervention phase or resolution. In that case, segregation should be managed by the National Resolution Authority. To this end, BRRD already takes into account the covered bond processing (art. 44(2) b). In this scenario, French law together with EU provisions is sufficient to determine how the cover pool would be segregated. b) How the full recourse against the issuer would take effect if the issuer is in resolution and is not placed subsequently into liquidation? c) What procedural steps should be followed in resolution and by whom in order to make effective the dual recourse mechanism? Under the French system, the insolvency and/or bankruptcy of the parent bank is remote from the dedicated credit institution issuing covered bonds. Besides, the issuer structure benefits from many protection tools: - A registered auditor named contrôleur spécifique (see answer on on-going supervision ), appointed by the issuing company s senior managers and subject to a positive opinion from the Autorité de Contrôle Prudentiel et de Résolution (ACPR), monitors the cover pool and ensures its quality; - A legal framework that has even been reinforced by two regulations adopted by the French government in May 2014: o Décret n du 23 mai 2014 relatif au régime prudentiel des sociétés de crédit foncier et des sociétés de financement de l'habitat; o Arrêté du 26 mai 2014 relatif au régime prudentiel des sociétés de crédit foncier et des sociétés de financement de l'habitat. 2 These regulations have: o reinforced limitations of intra-group exposures; 25 / 47

26 o introduced a servicing contingency plan in order to facilitate transition to a new servicer upon servicer default; o increased reporting frequency. - In addition, the French legal framework for covered bonds provides that, in case of insolvency, bondholders benefit from a priority in right of payments over all the assets and revenues of the SCF or SFH and other privileged debts (article L of the French Monetary and Financial Code). In other words, the protection offered to bondholders under French Law, especially in case of issuer s insolvency, is fully efficient. Such high standards of prudential measures are making a resolution scenario highly unlikely. Should it nevertheless happen, the existing legal protection makes the dual recourse principle fully effective and does not request any further developments. 2.1 Should the Framework provide for a cut-off mechanism as suggested in subsection 3.4 of Part III? 2.2 In particular, should such a cut-off mechanism: Yes No Don t know / no opinion / not relevant preclude the closure of insolvency or resolution before possible residual claims from the covered bondholders against the issuer or the insolvent estate have been identified and quantified? set out clear and objective requirements on the valuation of the cover pool and the timing for such valuation? extinguish the residual claim on the estate or the successor credit institutions after sufficient assets have been segregated for the benefit of covered bondholders at the outset of the resolution or insolvency proceedings? give specific powers and duties to the resolution authority and, if so, what should those consist in? x x x x Please explain your answers to question 2: The idea of a cut-off mechanism seems contrary to the objective of the planned reform of covered bonds which aims to enhance investor confidence. Such a process would deprive covered bonds of their main appeal for investors (i.e. providing certainty 26 / 47

27 over payment whatever situation arises) and may create a situation where bondholders turn away from this kind of investment. 4. The cover pool 4.1 Eligible assets: qualifying criteria and requirements Residential and commercial loans 1.1 Do you agree with the proposed definitions for "residential" and "commercial loans" as cover assets? 1.2 Should certain riskier residential or commercial loans (i.e buy-to-let mortgages; second home loans; loans to real estate developers; etc.) be excluded from the cover pool or permitted subject to stricter criteria? Please explain your answers to question 1: As the features of the cover pool affect the performance of covered bonds and, ultimately, the risk that both interest and principal payment obligations may not be honoured for investors, the cover pool should comprise high quality assets - plain vanilla. Residential loans and commercial loans should be two separate types of cover assets. Residential loans would include, as referred to within the suggested definition, two subcategories of assets (mortgage loans and/or French guaranteed residential loans). Commercial loans would include, as referred to within the suggested definition, one category of assets (mortgage loans). As the risks pertaining to residential and commercial loans are widely different, they should not be considered as the same asset class, and therefore should be governed by a different set of rules. Given the higher level of risk attached to commercial loans, a lower maximum LTV ratio should be enforced (60% versus 80% for residential loans) and their inclusion in a cover pool could be limited by the setting of a cap. We would allow the inclusion of residential loans to individuals (such as buy-to-let mortgages and second home loans) in the cover pool. However, concerning riskier commercial loans (such as loans to real estate developers), we are somewhat more reserved on their inclusion, as we consider their level of risk higher. If they were to be excluded from the cover pools, a grandfathering period should be established. 27 / 47