EU Bank Authority Sparks Danish Outrage in Liquidity Battle

Denmark is urging the European Commission to ignore a recommendation by its banking authority that the Nordic nation says would hobble the world’s largest mortgage finance system per capita.

The European Banking Authority’s decision not to give mortgage-backed covered bonds the highest liquidity status ignores more than 200 years of “reality,” according to Economy Minister Margrethe Vestager. Her government will fight to ensure the EBA is sidestepped, she said. Denmark’s financial watchdog said banks should disregard the EBA for now, while central bank Governor Lars Rohde predicted the European Commission will pay greater attention to liquidity studies than to the EBA’s recommendation.

“We have been in constant contact with the EU Commission at all levels,” Vestager said in an e-mailed reply to questions today. “This is about ensuring that the rules are formed in such a way so that highly liquid Danish mortgage bonds are recognized for what they are.”

Denmark’s $530 billion mortgage industry has been in crisis talks since it emerged last month that the EBA might give covered bonds a lower liquidity status than sovereign debt. The EBA’s official recommendation today ignores its own findings in an October technical report, which showed covered bonds are as liquid as government debt.

Sovereigns, Banks

“The EBA’s final decision doesn’t seem to be aligned with the key principle of delinking the sovereign from the banking sector,” Luca Bertalot, head of the European Covered Bond Council, said in an e-mailed response to questions. Europe needs to acknowledge the “crucial role” covered bonds played during the crisis “by ensuring access to capital markets for mortgage lenders and lending capacity to the real economy,” he said.

The EBA said all sovereign bonds issued by EU countries, including Greece and Spain, must be treated as equally liquid because to do otherwise would “reinforce the fragmentation of the single market and the sovereigns-banks loop.”

“Despite the excellent liquidity features showed by some covered bonds, doubts remain as to whether these findings are sufficient to justify a deviation from the international standards and their inclusion” in the top category of liquid assets, the EBA, set up in 2011 to harmonize banking rules across the 28-nation bloc, said in a statement.

Understanding EBA

“It’s hard to understand why the EBA” decided to recommend that “illiquid, low-rated government bonds should be given a higher liquidity status than more liquid, highly rated mortgage bonds,” Rohde said in an e-mailed reply to questions.

Draft technical standards for covered bonds are set to be completed by March and the EU Commission is due to decide in June. Denmark’s Financial Supervisory Authority said today it won’t tell banks to follow the EBA’s proposal unless the EU Commission approves it, an outcome the regulator in Copenhagen doesn’t expect.

“We therefore see no need to change the guidance we have previously given to our institutions on their reporting of the Liquidity Coverage Ratio,” Kristian Vie Madsen, deputy director at the FSA, said in an e-mailed response to questions. If the commission backs the EBA, Denmark will comply, though the FSA would then seek “exemption-possibilities in place for countries with constraints on liquid assets,” he said.

Following Basel

The EBA’s proposal follows standards set by the Basel Committee on Banking Supervision in 2010, which require banks to limit holdings of covered bonds to 40 percent, and to book the securities at only 85 percent of their market value.

Karsten Beltoft, director of the Danish Mortgage Bankers’ Federation, said the potential sell-off of bonds if the EU Commission follows the EBA would be “considerable.”

“Around 70 percent to 75 percent of banks’ liquidity buffers are in covered bonds,” he said by phone. “If they can only be up to 40 percent, it’s a considerable amount for which we have to find new buyers.”

Anders Jensen, the chief executive officer of Nordea Bank AB’s Danish operations, said capping banks’ use of covered bonds is a “systemic issue” as the fallout felt in the mortgage market would feed through to the rest of the economy.

“It also could negatively impact the credit capacity in the system because we can’t get enough liquid assets to carry alongside our lending book,” he said in a phone interview.

Sovereign Gap

In Denmark, a stable AAA-rated nation with a public debt load that’s less than half the euro-zone average, banks have relied on the mortgage bond market -- which is more than three times the size of the government debt market -- to build liquidity buffers.

Banks hold about 34 percent of Denmark’s mortgage-backed covered bonds and the industry warns the EBA’s proposal would trigger a sell-off.

“It would be ironic if you end up punishing Denmark,” Jesper Berg, head of regulatory affairs and senior vice president at Nykredit Realkredit A/S in Copenhagen, said in an e-mailed response to questions. “Danish covered bonds have far outperformed most government bonds during the crisis and Danish fiscal policies have been sufficiently disciplined for Denmark to create a shortage of government bonds.”

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