A summary in Edition 12 of this SCM Briefing provided initial details of the European Central Bank's (ECB) plans to make outright purchases of covered bonds (under the "CBPP3") and asset-backed securities (under the "ABSPP"), with purchases under CBPP3 already having begun in

mid-October, and further details of (and eligibility criteria for) the ABSPP set to be released by the ECB at a later date. The ECB has now released further details of the eligibility criteria for both the ABSPP and CBPP3, in two Decisions (Decision ECB/2014/45 and Decision ECB/2014/40), which may be summarised as follows:

Decision ECB/2014/45 on ABSPP

To be read in conjunction with Technical Annex 1 (on the ABSPP), which was released along with the ECB's initial announcement in early October, Decision ECB/2014/45 makes clear that, after an "initial phase" during which the purchases will be made by the ECB in a "uniform and centralised" manner, after this period (although it is not clear at what stage), the EU's national central banks will take over the purchases such that ABSPP is run in a "decentralised" manner. The four "executing asset managers" appointed by the ECB at end-October 2014 (Amundi and Amundi Intermédiation, Deutsche Asset & Wealth Management International, ING Investment Management and State Street Global Advisors) will be instructed by the ECB to purchase eligible ABS from "eligible counterparties" (see below). The specific eligibility criteria for ABS set out in Article 2 of the Decision may be summarised as follows:

  • The ABS must have a rating of at least Credit Quality Step 3 (i.e. are rated 'BBB+' to 'BBB-' or higher), expressed in the form of at least two public credit ratings provided by any two External Credit Assessment Institutions (ECAIs, i.e. rating agencies).

  • Other than as per the above bullet, the ABS must meet all of the ECB's eligibility criteria for ABS as set out in the General Documentation.

  • If the ABS are not rated at least Credit Quality Step 2 (i.e. are rated A+ to A-), then they must meet the slightly lower requirements for ABS set out in Article 3 of Guideline ECB/2014/31 (i.e. the underlying assets must belong to certain asset classes, contain no mix of asset classes, not be non-performing, or at any time structured, syndicated or leveraged).

  • No less than 90% of the obligors of the underlying assets are classed as private sector non-financial corporations or natural persons (measured by reference to the outstanding principal amount of the assets attributable to such obligors).

    • No less than 95% of:

      the outstanding principal amount of the assets is denominated in Euro;

      any properties securing the assets in an RMBS or CMBS are located in the Euro area (measured by reference to the outstanding principal amount of the assets attributable to such properties); and

      the obligors (other than for RMBS and CMBS) are incorporated or resident in the Euro area (measured by reference to the outstanding principal amount of the assets attributable to such obligors).

  • The issuer of the ABS must be established in the Euro area.

  • A tranche of ABS previously retained by the Originator (or an entity with which it has "close links") will be eligible only if an external investor with no "close links" to the Originator also purchases part of that tranche of ABS.

  • Specifically for ABS backed by obligors located in Greece and Cyprus, the minimum rating level set out in the first bullet point above does not apply to them, but they must satisfy all the other ABSPP eligibility criteria and all of the following:

    the Eurosystem's minimum credit threshold does not apply;

    the ABS must have two public credit ratings at the maximum achievable rating level for ABS issues in the relevant Member State;

    the ABS structure incorporates credit enhancement equal to a minimum of 25% of the current principal amount outstanding of all tranches of the issue;

    investor reports are available and the ABS can be modelled using standard third party ABS cash-flow modelling tools, as assessed by the ECB;

    the best available rating of the following service providers must comply with a minimum of Credit Quality Step 3 (i.e. are rated 'BBB+' to 'BBB-' or higher), expressed in the form of at least one public credit rating: the issuer account bank; any issuer account bank guarantor; any liquidity facility provider; any hedge counterparty the principal paying agent; and any guaranteed investment contract provider; and

    a back-up servicer for the ABS issue has been appointed.

    The ECB will purchase up to 70% of each eligible ABS (but there is a lower, 30% limit for deals backed by Greek and Cypriot assets). The ECB also notes that prior to any purchases, it will conduct a credit risk assessment and undertake due diligence.

  • Eligible counterparties are: counterparties participating in Eurosystem monetary policy operations as defined in Section 2.1 of the General Documentation; counterparties used by Eurosystem central banks for the investment of their euro-denominated investment portfolios; and entities deemed to be eligible counterparties for ABSPP transactions by the ECB's Governing Council on the basis of a counterparty risk assessment by the ECB.

We note that there is no mention in the Decision of the eligibility of mezzanine tranches of ABS and the possibility of Government-guarantees for mezzanine tranches, as initially suggested by the ECB, and referencing compliance with the existing eligibility criteria in the General Documentation would appear to restrict the ECB's purchases to senior tranches only. However, comments made subsequently to publication of the Decision by Mario Draghi, ECB Governor, in a Letter to the European Parliament, clarify that, in relation to the possible purchase of mezzanine tranches, the decision to initiate a guarantee scheme for ABS, or to participate as a guarantor, lies exclusively with the potential guarantors (thereby precluding the idea that the ECB will issue further guidance or eligibility criteria for mezzanine tranches). The treatment of mezzanine tranches is important, as (meaningful) capital relief is likely only to be available to banks selling mezzanine notes along with senior notes, and the lack of clarity may hamper further issuance (at least of ABS intended to be eligible for ABSPP).

With the Decision taking effect on the day after it is published on the ECB website (i.e. taking effect on 20 November 2014), the ECB is able to begin making ABS purchases from as early as 21 November 2014. As of the 5 December 2014 reference date, the ECB has reported that it has purchased £601 million of ABS.

Decision ECB/2014/40 on CBPP3

To be read alongside Technical Annex 2 (on CBPP3) which was also released along with the ECB's initial announcement in early October, Decision ECB/2014/40 makes clear that eligible covered bonds may be purchased by Eurosystem central banks (hence the programme is "decentralised" as the ABSPP will become) in both primary and secondary markets, subject to detailed eligibility criteria which may be summarised as follows:

  • The covered bonds (or multi-cédulas issued by SPVs) must be eligible for monetary policy operations in line with Section 6.2.1. of the ECB's "General Documentation", and must specifically meet the requirements of Section 6.2.3.2. (fifth paragraph).

  • The covered bonds must be assigned a minimum first-best (i.e. their highest) credit rating of Credit Quality Step 3 (i.e. they are rated 'BBB+' to 'BBB-' or higher), awarded by at least one ECAI.

  • A 70% issue share limit to the joint holdings under the first and second covered bond purchase programmes (which were established in 2009 and 2011 respectively), CBPP3 and to other holdings of central banks will apply (in other words, the ECB will only purchase up to 70% of any one issue, whether that issue has been eligible for the earlier purchase programmes or not). This purchase limit is restricted to 30% for Greek and Cypriot covered bonds, as with ASBPP.

  • The covered bonds must be denominated in Euro and held and settled in the Euro area.

  • Covered bonds issued by entities suspended from Eurosystem credit operations shall be excluded from purchases under CBPP3 for the duration of their suspension (for obvious reasons).

  • As with the ABSPP, Greek and Cypriot covered bonds do not have to meet the minimum rating threshold, but must meet other requirements, including: monthly reporting of the pool characteristics to the national central bank where the issuer is domiciled; 25% minimum over-collateralisation; minimum rating requirements for hedge counterparties (or alternatively that 95% of the assets are denominated in Euro); and the claims must be against Euro area-domiciled debtors. 

  • Covered bonds that have previously been retained by the issuer are eligible, provided they meet all of the criteria set out above.

  • Eligible counterparties are: domestic counterparties participating in Eurosystem monetary policy operations as defined in Section 2.1 of the General Documentation; and any other counterparties that are used by Eurosystem central banks for the investment of their Euro-denominated investment portfolios, including non-Euro area counterparties active in covered bonds.

The Decision entered into force on the day after publication on the ECB's website (i.e. 23 November 2014), with the ECB already having begun purchases in mid-October 2014, with some €20.9 billion of covered bonds purchased under CBPP3, reported as at the 5 December 2014 reference date.

Useful links: European Central Bank Decision ECB/2014/45 (ABSPP) and Technical Annex 1

European Central Bank, Decision ECB/2014/40 (CBPP3) and Technical Annex 2