The instructions/guidance from Annex XVII can appear inconsistent and we therefore seek further clarification.
In section 1.7 it is stated that: 'For the purpose of this Annex and Annex XVI, an asset shall be treated as encumbered if it has been pledged or if it us subject to any form of arrangement to secure, collateralise or credit enhance any transaction from which it cannot be freely withdrawn.' And in the following paragraph, it says: '… assets pledged that are subject to any restrictions in withdrawal, such as for instance assets that require prior approval before withdrawal…, shall be considered encumbered.'
This can be understood in a way, that, if a signature is required, for example from the appointed Trustee for a covered bond programme, any assets pledged should be considered encumbered. The same Annex XVII, section 2.1.1., specifically the instruction for covered bonds, however instructs: 'In case of retention of part of the issuance and in order to avoid double counting, the proposed treatment below shall apply:
(i) where the own covered bonds are not pledged, the amount of the cover pool that is backing those securities retained and not yet pledged shall be reported in the AE-ASS templates as non-encumbered assets. Additional information about the retained covered bonds not yet pledged (underlying assets, fair value and eligibility of those available for encumbrance and nominal of those non-available for encumbrance) shall be reported in the AE-NPL template;
(ii) where the own covered bonds are pledged, then the amount of the cover pool that is backing those securities retained and pledged shall be included in the AE-ASS template as encumbered assets.'
Because the assets are pledged to a Covered Bond Programme (as part of the Programme, subsequently, Covered Bonds can/will then be issued) in our setup, which we believe is common, it would seem counterintuitive to have to consider any amount pledged to the Programme as being encumbered (based on requiring a signature before release/re-assignment), where however it would no longer be considered encumbered, if subsequently a Covered Bond is issued under the programme and is fully retained (and that own covered bond is not pledged). The counterintuitive part being that in such a situation issuing a covered bond would actually decrease encumbrance.
In our view therefore the assets pledged to a Covered Bond Programme should in first instance (before issuance of covered bonds under the programme) be considered as fully retained and therefore not encumbered. The amount to be classified as encumbered would then be based on the required overcollateralization for the programme based on programme documentation or (if higher) the amount of overcollateralization required by the rating agencies to prevent drops in ECAI ratings for the Covered Bonds issued under the programme (this in reference to Q&A 1817).
We believe it is common for covered bonds/covered bond programmes to require signatures from the various stakeholders for release or re-assignment of security pledged. In practice, with surplus collateral above the overcollateralization rates, such a check would only be a formal one, where collateral would be available to the issuer. It is not clear whether such an interpretation could be applied in such a case, or whether a literal reading (with respect to “requiring prior approval”) should be taken.
As regards the first question, in accordance with the general instructions in section 1.7 (Definition of Encumbrance) of Annex XVII of the ITS No 451/2021 on asset encumbrance reporting under Article 430 of Regulation (EU) No 575/2013, it is outlined that an asset shall be treated as encumbered if it has been pledged or if it is subject to any form of arrangement to secure, collateralise or credit enhance any transaction from which it cannot be freely withdrawn. It is noted that assets pledged that are subject to any contractual or regulatory restrictions, or which impact on ratings of bonds in any way in withdrawal, such as for instance assets that by virtue of legal, regulatory or contractual provisions require prior approval before withdrawal or replacement by other assets, should be considered encumbered. In line with this provision, when the release of the asset pledged depends on the prior approval from external parties, the asset should be considered encumbered, in spite of the fact that is an additional collateral on top of collateralization of the covered bond program.
In the section 2.1.1 of Annex XVII of the ITS No 451/2021 related to the specific instructions for retained covered bond, it is stated that in case of retention of part of the issuance, the proposed treatment below shall apply:
(i) where the own covered bonds are not pledged, the amount of the cover pool that is backing those securities retained and not yet pledged shall be reported in the AE-ASS templates as non-encumbered asset;
(ii) where the own covered bonds are pledged, then the amount of the cover pool that is backing those securities retained and pledged shall be included in the AE-ASS template as encumbered assets.
The key point is that the instructions above apply only when the full or in part retention of the covered bond has already taken place, in order to avoid double counting. At the same time, it is not possible to know before the issuance of the covered bond if they will be retained by the bank.
Furthermore, the assets at issue are pledged in a cover pool for a future issuance of covered bonds. Therefore, in spite of the difference in time between the pledge on assets and the issuance of the covered bonds, they still have to be considered encumbered.