Under our covered bond programme we adhere to requirements to maintain a minimum level of overcollateralisation (regulatory, contractual and what is required by the rating agencies to maintain the rating of the covered bonds). We also maintain an additional level of surplus assets above and beyond these required overcollateralisation amounts (“Surplus Assets”). These Surplus Assets are economically available to the issuer at all times and can either be  withdrawn from the cover pool (subject to an operational process alone, described below) or used to support a future issuance of covered bonds.

The cover-assets monitor for the programme monitors compliance by the issuer with minimum regulatory and contractual over-collateralisation amounts. The cover-assets monitor is required under national law and the programme documentation to give its prior consent before underlying assets can be withdrawn from the cover pool, including in the case of Surplus Assets. Where the relevant underlying assets are not required in order to meet any minimum regulatory or contractual over-collateralisation requirements (or any other legal requirements monitored by the cover-assets monitor under national law and the programme documentation in the context of the cover pool for the programme), then the consent of the cover-assets monitor can be considered an operational process alone because there is no basis for the cover-assets monitor to refuse consent where the assets have met the relevant tests.

The issuer monitors over-collateralisation levels in the context of rating agency requirements that are communicated to it by the relevant rating agencies on a periodic basis. Underlying assets are only considered Surplus Assets in the context of rating agency requirements where they meet the test that their withdrawal from the cover pool would not impact the rating of the covered bonds in any way. This test is an operational process alone as whether underlying assets meet it is a factual matter.

In accordance with the general instructions in section 1.7 (Definition of encumbrance) of Annex XVII (Instruction for reporting on asset encumbrance) of the IT Solutions for Section 8 (Annex XVI) (Reporting on asset encumbrance) of Annex I to Commission Implementing Regulation (EU) 2024/3117, 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”.

In Q&A 2015_1817, the EBA responded to a question that asked whether assets in cover pools that are not necessary to fulfil regulatory requirements should be deemed to be encumbered for the purposes of the (then applicable) reporting templates. In its response, the EBA referred to the (then applicable) definition of encumbrance and stated 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” but also clarified that “assets which are not subject to such regulatory and contractual restrictions and that are subject to an operational process alone for release, may be considered unencumbered”.

In Q&A 2022_6522, the EBA responded to a question that asked whether surplus collateral in a covered bond programme (beyond contractual and rating agency requirements) should be considered encumbered if its release requires a signature from an external party (for example, the trustee for the covered bond programme) based on the programme documentation. In its response, the EBA referred to the (then applicable) definition of encumbrance and repeated what it had said in response to Q&A 2015_1817 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”. However, no reference was made to assets that are subject to an operational process alone for release and whether the position had changed so that those assets should be considered encumbered instead of unencumbered.

There is a note to Q&A 2015/1817 dated 26 March 2021 that says that the Q&A has been reviewed in light of changes to CRR and it continues to be relevant. The definition of encumbrance and the instructions in terms of asset have remained substantively the same since those changes to CRR were made.

In our view, the requirement to seek prior approval of the cover-assets monitor before Surplus Assets can be withdrawn from the cover pool is an operational process alone, as there is no basis for the cover-assets monitor to refuse consent where regulatory and contractual over-collateralisation thresholds (and any other requirements monitored by the cover-assets monitor) will still be met following the withdrawal of the relevant assets. The requirement for the issuer to check whether withdrawal of the relevant assets would impact the rating for the covered bonds before Surplus Assets can be withdrawn from a cover pool is also an operational process alone, as whether the test is met is a question of fact.

Furthermore, if Surplus Assets are reported as encumbered on the basis they are included in a cover pool until they are withdrawn (as is the right of the issuer) or used to support a future issuance of covered bonds the asset encumbrance ratio will increase immediately.  This may mask any evolution of an increase in dependence on the assets where they are actually used for funding in future, as the ratio will be reflecting potential rather than actual funding usage. From a contingent liquidity perspective, financial institutions may leave Surplus Assets in the cover pool without issuing or retaining covered bonds.  This approach provides flexibility to mobilise liquidity if the need arises while avoiding any unnecessary costs associated with issuing and retaining covered bonds when there is no immediate funding requirement.