The guidelines elaborate on CEBS position on the appropriate size and composition of liquidity buffers to enable banks to withstand a liquidity stress for a period of at least one month without changing their business models, the committee said in a statement.
Covered bonds are the only asset class apart from government bonds that CEBS named as instruments that can be held as part of the very short term buffer banks must hold to generate liquidity within a week a broader range of assets may contribute to the part of the buffer that can provide liquidity over up to a month.
"Firms should hold a core of assets that are both central bank eligible and highly liquid in private markets (such as high quality unencumbered government bonds, covered bonds, etc; qualifying assets vary according to specific jurisdictional circumstances) to guard against severe, but short term (at least one week) periods of liquidity stress where market liquidity is under strain and the institution needs to be able to generate liquidity immediately and at predictable values without adding to the market strain," read the guidelines.
CEBS said that it expects its members to make sure that institutions will apply the guidelines by June 30, 2010, at the latest.
Richard Kemmish, head of covered bond origination at Credit Suisse in London, said that the move should underpin strongly the covered bond market in 2010 and beyond. "This is a massive vote of confidence in the market," he said. "The amount of liquidity that banks have to put on because of these proposals will be substantial and the ability to do this in covered bonds rather than just govvies is vital for bank profitability from a pure cost of carry point of view."
UniCredit analysts described CEBS move as a confirmation of everything that covered bonds stand for. "Our favourite sentence on covered bonds currently is that covered bonds are considered to be part of the solution and not part of the problem," they said. "However, if anybody still asked for a confirmation of this statement, well, voilà! The direct effect of this regulation might just be that banks will be sustainable and important buyers of covered bonds (which they have been through the ages).
"However, the various secondary effects range from enhanced systemic importance and therefore implicit government support, higher and sustainable absorption capacity for primary market deals thanks to an increase in investor awareness also outside the bank investor group, to a gain in reputation."
CEBS inclusion of covered bonds contrasts with the approach of the UK Financial Services Authority, which in October did not include covered bonds in its liquidity regime, but restricted banks to holding high quality government bonds, central bank reserves and some supranational bonds.
RCB review in early 2010
Itwas announced in the Pre-Budget Report (PBR) on Wednesday that the UK government will hold a consultation in early 2010 on potential supplementary rules for Regulated Covered Bonds.
The PBR said that the government will "consult on and promote" the UK regulated covered bond market.
"Covered bonds play a significant role in Europe, and the government wishes to facilitate a robust Regulated Covered Bond market in the UK," said the report. "In March 2008, the government established a new legislative framework for covered bonds, supervised by the FSA. The government and the FSA have consulted with market participants, and believe the current regulatory regime for covered bonds supports high quality products. They also recognise investors desire for clarity and transparency about how the regulatory framework works.
"The government will consult in early 2010 on supplementary rules where greater clarity may be warranted on issues such as asset quality and asset capability standards for regulated covered bonds. Regulated covered bond issuers, the government and the FSA will work together to promote familiarity with the UKs regulatory regime."The PBR also said that the government will explore ways of encouraging more sustainable, transparent and standardised mortgage-backed securities.