ESNs revived as post-pandemic recovery tool
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ESNs revived as post-pandemic recovery tool


The European Commission has reached out to the European Covered Bond Council (ECBC) to make the case for reinvigorating the market for European Secured Notes. ESNs could improve access to crucial funding for Europe’s small and medium-sized enterprises (SMEs), which are struggling to recover following lockdowns imposed to contain the spread of Covid-19.

The Commission is keen to promote ESNs and, in late July, wrote to the ECBC suggesting it could help with a more thorough assessment of the potential market for them.

“In light of the Covid pandemic, the [Commission] is looking at ways to support the European recovery and it believes the ESN structure could provide a new driver for supporting the real economy — and in particular SME funding under the Capital Markets Union,” said Luca Bertalot, secretary-general of the European Mortgage Federation-European Covered Bond Council (EMF-ECBC) on Tuesday. 

ESNs are dual-recourse instruments structured like a covered bond but secured on alternative assets, such as SME loans, green loans or infrastructure loans. The concept was pioneered by Commerzbank in February 2013 with a €500m deal secured on SME loans.

Even though this deal proved a one-off, the idea gained traction, particularly in southern Europe and especially in Italy. In 2014 the Italian parliament introduced the Obbligazioni Bancarie Collateralizzate (OBC) legal framework that was designed to fund SME loans.

Although no bank has issued an OBC or ESN since the Commerzbank deal, the EC recognised the instrument could be a useful additional source of funding for financial institutions that do not have access to the securitization market and have difficulty issuing unsecured long-term debt.

In July 2018, the European Banking Authority published a report on ESNs that set out the case for establishing a pan-European legal framework that would sit alongside the covered bond directive. 

Richard Kemmish Consulting followed up that November with a feasibility study undertaken on behalf of the Commission, stating confidence that there would be considerable investor appetite for the product.

And when the covered bond directive was published in the Official Journal of the EU in December 2019, the Commission re-stated its intention to take an ESN legislative proposal to the European Parliament and Council by July 8 2024.  

More lately, in a letter sent to the ECBC in July this year, the Commission further underscored its belief that ESNs could help unlock more financing for Europe’s SMEs by contributing to economic growth and helping to solidify the Capital Markets Union (CMU) — especially in the wake of economic lockdowns that have followed the spread of Covid-19.

In response to an offer of help from the ECBC, the Commission asked for assistance in accomplishing its task of trying to establish whether ESNs could benefit from preferential regulatory treatment and whether the instrument has the potential to support sustainable development and to be used for financing green loans.

Ucits, but not CRR

Depending on the structure and the eligibility criteria of underlying assets, ESNs could benefit from a degree of preferential regulatory treatment, said Bertalot.

For example, they could comply with the undertakings for collective instruments in transferable securities (Ucits) and potentially be eligible for inclusion in a subordinate category of the liquidity coverage ratio (LCR).

That would stand in contrast to mainstream covered bond products that are secured on defined pools of eligible mortgages and public sector assets. Such bonds, which comply with the capital requirement regulation (CRR), attract a low capital charge for regulated investors and are eligible for the best LCR treatment.

The ECBC quickly reacted to the Commission’s plea for help by reactivating its ESN taskforce. It is led by Intesa San Paolo’s head of European regulatory policy, Stefano Patruno.  

Patruno took over from Boudewijn Dierick in April, after Dierick, who is head of ABS and covered bond structuring at BNP Paribas, was promoted to chairman of the ECBC in January 2020. He had held the deputy chairman post since June 2018. 

The taskforce has split up into several different work streams “that are brainstorming ideas and assessing pros and cons to consider the possible shape of the [ESN] market”, Bertalot told GlobalCapital.

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