According to Article 86(5) of the Directive 2013/36/EU (CRD) competent authorities shall ensure that institutions distinguish between pledged and unencumbered assets that are available at all times, in particular during emergency situations.
According to Article 86(7) of the Directive 2013/36/EU (CRD) institutions have to maintain adequate level of liquidity buffer in order to be able to withstand a range of different stress events.
The EBA Guidelines for common procedures and methodologies for the supervisory review and evaluation process (SREP) refer to the Guidelines on disclosure of encumbered and unencumbered assets for a definition of encumbrance. According to these (Title 1, paragraph 5) “an asset should 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collateralise or credit-enhance any on-balance-sheet or off-balance-sheet transaction from which it cannot be freely withdrawn (for instance, to be pledged for funding purposes)”.
In this context, credit claims which are pledged to the cover pool for a covered bonds programme, could – under certain circumstances – also be considered as part of the counterbalancing capacity if they are not necessary to fulfil the minimum cover requirements set by legislators and do not challenge the bank’s targeted rating. Otherwise the over-collateralisation could result encumbered since a monetisation of the over-collateralisation could conflict with existing business or risk management strategies oriented to maintain those assets as a form of arrangement to credit-enhance the cover pool in order to heavily contribute to a minimum credit assessment of the covered bonds issued or to be issued and subsequently to their stable presence in the funding structure of the institution.
Hence, these assets should be considered as encumbered and cannot be included in the liquidity buffer. Furthermore their eligibility to be pledged directly with the central bank or as collateral for further issuance of covered bonds has to be unquestionable and the credit institution has to provide evidence to the satisfaction of the competent authority that the claims can be removed immediately from the cover pool at the sole discretion of the liquidity management function and be pledged with the central bank in an appropriate time horizon to meet the requirements of the particular stress event.
This answer should be understood in the context Article 86(5) CRD and the internal liquidity risk management of the institution and does not affect the definition of the LCR.