Basel’s Liquidity Rules Ignored as EU Sides With Denmark

The European Commission is ready to side with Denmark in agreeing to more lenient rules in the treatment of covered bonds than recommended under Basel III.

A document obtained by Bloomberg News shows that an expert group inside the commission will base talks next week on a set of figures first published by Denmark in May. That means banks will be free to use 75 percent more in covered bonds to fill liquidity buffers than allowed under Basel III rules.

“There has been a great effort from many sides in Denmark, and it seems to have been a success,” Karsten Beltoft, head of the Danish Mortgage Bankers’ Federation in Copenhagen, said by phone.

The document shows that Denmark, whose $550 billion covered bond market is the world’s largest per capita, is moving closer to ensuring Basel’s liquidity rules aren’t implemented in Europe. The success follows 3 1/2 years of intense lobbying by the nation’s mortgage bank industry and government officials.

Economy Minister Margrethe Vestager, who has led Denmark’s campaign against Basel III liquidity rules, said today she hopes the commission’s latest draft on how to treat covered bonds is “final.”

Asset Encumbrance

“There may be some changes before it’s finished, but the main point is that it should follow the main lines of what the commission drafted,” she said in an interview on the island of Bornholm. “The various alternative scenarios that had been drawn up were considerably worse than what we’re facing now.”

Basel says excessive covered bond use can lead to so-called asset encumbrance, as banks set aside less collateral to cover other creditors. The committee has also warned of the risk of interconnectedness that arises when banks hold securities issued by other lenders.

Denmark, which doesn’t hold a seat on the 27-member Basel Committee on Banking Supervision, has railed against the global regulator’s preferential treatment of government bonds in liquidity buffers, a position the government in Copenhagen says ignores the experiences of Europe’s crisis. Basel rules allow banks to hold limitless stores of state debt at market value.

Denmark, a AAA-rated nation with a public debt load that’s less than half the average in the European Union, says it doesn’t have enough government bonds to fill banks’ liquidity buffers under Basel rules.

Level Split

While Basel had assigned all covered bonds a so-called Level 2 status, limiting their use in banks’ liquidity buffers to 40 percent, the Brussels-based commission is set to split the securities into two classes. Banks will be free to use Level 1 covered bonds to fill 70 percent of their liquidity buffers, booked at 93 percent of their market value.

To qualify as Level 1, bonds will need to be issued in sizes of at least 500 million euros ($677 million), carry high credit ratings and be over-collateralized, the commission document showed.

Banks will also be required to sell a “representative sample” of their Level 1 covered bonds and Level 2 assets on “at least” a yearly basis to demonstrate liquidity and to “minimize the risk of sending a negative signal to the market as a result of the credit institution’s monetizing its assets during periods of stress,” according to the document. Institutions won’t be allowed to hold their own covered bonds in liquidity buffers, it said.

Defeating Basel

Though the commission’s draft represents a victory over Basel, Denmark’s mortgage industry says it will still lobby for more concessions.

“We are still hoping” for a higher cap on banks’ covered bond holdings than 70 percent and that banks will be free to book the securities at more than 93 percent of their market value, “but we are closing in on something that will work,” Beltoft said. His group represents the mortgage arm of Danske Bank A/S, Denmark’s largest lender.

The latest signals from the commission mean “that we will be able to continue more or less as we do today,” he said. “The majority of the bonds that are within the scope of the liquidity buffer will qualify.”

At the Association of Danish Mortgage Banks, which represents Europe’s biggest issuer of mortgage-backed covered bonds, Nykredit Realkredit A/S, the view is that Denmark still has a lot to fight for.

The more lenient proposals first published by the Danish government in May are “out of line with the facts,” Ane Arnth Jensen, head of the association, said by phone. “It’s worse than what we have today and it’s worse than what we have aimed for. So there is nothing to celebrate.”

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