The European Commission could expand the European Banking Authority’s mandates for follow-up work on the EU covered bond directive to include recommendations on green covered bonds, which were a key topic for the European Central Bank at a recent Helsinki European Covered Bond Council plenary.
Various follow-up initiatives were included in the EU covered bond directive, with three to be completed by July 2024 – the development of a third country equivalence regime, a report on European Secured Notes (ESNs), and a study on extendible maturity structures – while a report on the overall implementation of the directive was anticipated by July 2025. The European Banking Authority (EBA) is expected to provide input to the Commission in each area.
Luca Bertalot, secretary general of the European Mortgage Federation-European Covered Bond Council (EMF-ECBC), told Sustainabonds that he expects the EBA to receive an expanded mandate from the Commission, but with the deadline for the bulk of its work potentially pushed back from next year.
“My understanding is that the EBA will receive a cumulative mandate covering all the pending issues in the directive – ESNs, a study of the covered bond market, and global third party equivalence,” he said. “On top of this, they will be asked to undertake an analysis of the potential of the green covered bond market – although there has been no official word on any of this.
“They will probably be given a bit longer than what is written in the directive,” added Bertalot, “probably until 2025 rather than 2024.”
EBA has already, in November 2022, received a call for advice from the Commission on the definition and possible supporting tools for green loans and mortgages to retail and SME borrowers, as part of work on the EU sustainable finance framework, which also includes the EU Taxonomy Regulation and EU Green Bond Standards. This work includes a green loan definition based on the taxonomy, measures to encourage and facilitate the uptake of green loans, and the green loan origination process.
An EBA mandate on green covered bonds could complement this work and the ECBC has been such anticipating developments under its Covered Bond Label and Energy Efficient Mortgages Initiative (EEMI) work.
From next month, it will be mandatory for Labelled issuers self-certifying their covered bonds as ESG issuance (via a green leaf symbol) to complete a tab (F1) for green data in their harmonised transparency templates (HTTs) that has thus far been voluntary, following a decision in November 2022.
“So now you cannot have a green leaf without having full disclosure on the ESG section of the HTT,” said Bertalot.
“Since September, when this decision was proposed, we have moved from €50bn to €125bn of issuance having the green leaf,” he added, “which is a big jump for the market.”
At the September ECBC plenary in Vienna, Torsti “Toto” Silvonen, Deputy Director General Market Operations, at the European Central Bank, had called for greater disclosure around covered bonds, and at the latest plenary in Helsinki on 19 April he said he was encouraged by the latest step, calling it “great news” on a way towards increased transparency.
Silvonen noted that the ECB has begun tilting reinvestments under the corporate sector purchase programme component CSPP of its asset purchase programme (APP) and said it started with corporate bonds partly because it has more comprehensive climate-related data available.
“But this is not enough,” he said, “as we need to consider our entire operational framework, which includes also other purchase programmes and various types of collateral we accept in our lending operations. And as a matter of fact, corporate bonds make up a very small share of mobilised collateral, only 2%-3%, whereas covered bonds and ABS each make up much more, and together almost 40% of mobilised collateral.
“Therefore, we need more data also on their climate-related risks.”
In March the European Supervisory Authorities (ESAs – EBA, EIOPA and ESMA) and the ECB published a joint statement on climate disclosures for structured finance products, saying that “consistent and harmonised” requirements are across securitisations and similar funding instruments, such as covered bonds, to ensure a level playing field. Proponents of covered bonds have already argued that pool level disclosures would be more appropriate for the instrument than securitisations’ loan level reporting.
“Our initial view is that having granular loan level reporting for covered bonds may not necessarily be the first and foremost important issue, given the revolving nature of covered bond loan pools versus instruments without revolving assets in the underlying pool, such as ABSs,” said Silvonen. “At this stage, issuers might benefit more from spending their time and resources on getting actual data on energy performance and understanding the risks of the mortgage pools, rather than setting up very granular reporting infrastructure.”
He said the Energy Performance of Buildings Directive (EPBD) should help banks source data, even if the ECB has issues with elements of the directive.
“The lack of actual data on the energy efficiency of buildings still constitutes the main obstacle for properly assessing climate related risks,” noted Silvonen, “as well as steering financing towards more energy efficient real estate. Closing these gaps is of the highest importance, because any type of disclosure is only as good as the underlying data.”
Banks should therefore seek comprehensive climate-related information when originating new loans, with the option of using proxies for the existing mortgage portfolio.
Silvonen highlighted another issue facing the market: whether disclosures should focus on the use of proceeds, or the climate risk profile of the underlying pool.
“In our view, these are complementary perspectives that are both important,” he said. “Identifying and labelling the green use of proceeds is important for steering funds towards green purposes and energy efficient buildings. And on the other hand, the climate risk profile of the underlying cover pools is important for risk management purposes, and extends not only to energy efficiency – which is relevant to transition risks – but also physical risk and mitigation. In contrast to the use of proceeds, this type of information is already required from banks in the scope of Pillar 3 ESG risk disclosures”
Silvonen concluded by repeating a call to arms.
“Climate change constitutes a unique opportunity for the covered bond industry to become a pioneer in financing the green transition and boosting the transparency of climate related risks,” he said, “and this will only grow in importance.”