As anticipated for the past several weeks, the European Central Bank (ECB) was due to release full details of its plan to make outright purchases of asset-backed securities (ABS) and covered bonds, and had released some initial information to the market about these plans during September and October 2014. Mario Draghi, ECB Governor, provided further, full details of the ECB's ABS purchase plan (ABSPP) and covered bond purchase plan (CBPP3), in an expected announcement made following the ECB's Governing Council Meeting on 2 October 2014. Both programmes will last for at least two years, with purchases to begin in the fourth quarter of 2014, starting with covered bond purchases which began in the second half of October. The details have been set out in two very brief Technical Annexes to the announcement, which may be summarised as follows:
Technical Annex 1 (on the ABSPP)
Annex 1 confirms that the "guiding principles" of the ABSPP will be the collateral eligibility criteria for ABS set out in the ECB's General Documentation, as amended, with some amendments to reflect the nature of the outright purchases. Senior and guaranteed mezzanine tranches of ABS will be purchased in both primary and secondary markets (with separate eligibility criteria for mezzanine tranches to be communicated at a later stage, as this will require some EU-wide agreement on the possible provision of government guarantees). The ABS must be denominated in Euro and the issuer must be resident in the Euro area. The ABS must be secured by claims against non-financial private sector entities resident in the Euro area (either legacy or newly originated), with a minimum of 95% of the claims to be Euro-denominated and a minimum of 95% of the entities to be resident in the Euro area. The ABS must have a "second-best" (i.e. their lowest) rating of at least Credit Quality Step 3 (equivalent to BBB-/Baa3/BBBl), although ABS with underlying claims against entities in Greece and Cyprus which cannot achieve the second-best rating may still be accepted provided they meet further requirements (including minimum credit enhancement levels, the provision of investor reports etc). Up to 70% of each tranche will be purchased by the ECB, except for Greek and Cypriot deals which will be purchased only up to 30%. The ECB will apply appropriate credit risk and due diligence procedures to its purchases. Finally, the ECB will purchase fully retained ABS, but notes that these purchases "would be subject to some participation by other market investors", suggesting the ECB may seek to on-sell the purchased securities. The ECB has still not confirmed the precise amount of ABSPP purchases it will make.
Technical Annex 2 (on CBPP3)
Annex 2 confirms that Euro-denominated covered bonds will be "progressively" purchased across the Euro area and that those purchases will be conducted in both primary and secondary markets. Eligible counterparties are those eligible for Eurosystem operations. Covered bonds must be eligible as collateral for the ECB's repo facility in accordance with Section 184.108.40.206. (para 5(b)) of the General Documentation. They must be issued by Euro area credit institutions (or in the case of multi-cedulas, by SPVs incorporated in the Euro area). They must be denominated in Euro and held and settled in the Euro area. The underlying assets must include exposures to private and/or public entities. The covered bonds must have a "first-best" (i.e. their highest) credit rating of Credit Quality Step 3 (BBB- or equivalent) (but, as with ABS, any Greek and Cypriot covered bonds do not have to meet the rating threshold but must meet other requirements, including 25% minimum over-collateralisation, minimum rating requirements for hedge counterparties, and the claims must be against Euro area-domiciled debtors). The ECB will purchase up to 70% of each issue of covered bonds (again, this is limited to 30% for Greek and Cypriot covered bonds), and will conduct appropriate credit risk and due diligence procedures on the "purchasable universe" of covered bonds on an ongoing basis. Fully retained issues of covered bonds will be eligible for purchase, and the ECB makes clear that the purchased covered bonds portfolio will be made available for lending via securities lending facilities. Again, the ECB has not confirmed the exact level of covered bond purchases it will make.
Industry reaction to the announcement has been mixed, partly given the lack of commitment to precise purchase volumes. The ECB has simply hinted that there is around €1 trillion of ABS and covered bonds available for it to purchase. However, the market may have preferred a specific commitment to a certain minimum volume of purchases. In addition, the Association for Financial Markets in Europe (AFME, the key industry body for the securitisation market) notes that, while the ABSPP programme is welcome, it will not, in isolation, be sufficient to restore the European securitisation market. Public sector investment in mezzanine tranches will not be required if sufficient private sector demand can be generated - and this depends heavily on gaining regulatory support for, and a possible reduction in regulatory capital requirements for, "High Quality Securitisations" (HQS). Regulators are currently working on developing a definition of (and the possible separate regulatory treatment of) HQS - see the EBA's initial proposals for criteria defining "simple, standard and transparent" securitisations, as summarised in this Edition of the SCM Briefing. We also outline some recent updates to the ECB's eligibility criteria for ABS, as set out in a series of amendments to the General Documentation, in this Edition of the SCM Briefing.
ECB Press Release