CRD draft raises false LCR hopes for ABS

* Positive interpretation for ABS on liquidity buffers misplaced

* Covered bonds the likely target of draft text on LCR

By Jean-Marc Poilpre

Jan 23 (IFR) - Structured finance bankers hopes securitised products might be included in banks' liquidity buffers under CRD4, and give a regulatory boost to the struggling European market, may have been falsely raised by the form of words used in the draft text prepared by the Danish presidency.

The technical wording may just be aimed at making room for covered bonds in this new buffer that banks have to build.

JP Morgan structured finance analysts this morning dismissed reports that the draft provided scope for the beneficial treatment of ABS under the liquidity coverage requirement (LCR). In fact it more explicitly closes the door on the inclusion of securitised products in the liquidity buffer, the analysts said.

In their view, weekend reports that gave a positive interpretation of the revised text were misplaced.

The LCR, which is loosely defined as high-quality liquid assets divided by net cash outflows, serves to demonstrate whether a bank has a stable funding structure and sufficient liquidity. It is a key component of Basel III, which will dictate a 100% LCR for firms.

"While we would sorely like to provide a more positive spin on the proposed rules, unfortunately, Denmark did not bring home the bacon for the ABS market," JPM analysts said.

One investor suggested that some of the confusion comes from the fact that the draft makes a distinction between ABS issued directly by banks (eligible) and ABS issued by special vehicles (ineligible).

The second option is of course typical in structured finance as it makes possible the true de-linkage of the pool sold to investors from the credit risk of originator, thus ensuring the bonds are bankruptcy-remote.

The same investor thought it possible that the door is now open for the inclusion of ABS in banks' liquidity buffers: otherwise why would ABS be mentioned at all?

One lawyer said it was confusing but ABS issued through a SPV seems to be ineligible therefore: "I guess they are saying that covered bonds are eligible," he added.

Market participants fear that the exclusion of ABS from the liquidity buffer will make the product less appealing and reduce bank investors' appetite.

JP Morgan analyst Gareth Davies believes that the clause of the draft, which mentions "asset-backed instruments of high liquid and credit quality" is "designed to capture covered bond-type instruments which currently fail to meet the prescriptive definition of a covered bond outlined in Article 124 (3) and (4) (and coincidently include a significant amount of traditional Danish covered bonds)".

Moreover, he thinks that the Danes have gone one stage further by explicitly excluding ABS with the insertion in the draft of a clause which includes, among the assets that should not be considered liquid, a securitisation special purpose entity and assets otherwise constituting securitisation positions.

RBC Capital Markets analysts recalled today that the Basel committee recommends that a minimum standard for the LCR is introduced on January 1, 2015. However, the CRD IV proposal states that by the end of 2016 the EC shall, if appropriate, submit a legislative proposal to European Parliament and Council.

In Sweden, the regulator has recommended that banks are compliant with the LCR by January 1, 2013 with disclosure to be shown from the second quarter of 2012, RBC added. (Reporting by Jean-Marc Poilpre,; editing Alex Chambers)