The recently published covered bond graduated valuation haircut schedule from the European Central Bank (ECB) did not take the market by surprise, according to Bank of America Merrill Lynch analysts.

The ECB announced on April 8 that it would introduce the schedule in July saying that the revised version will not imply an undue decrease in the collateral available to counterparties.

The market still reassesses the liquidity of covered bonds, and sometimes liquidity is associated with a security’s eligibility as collateral for central bank operations and valuation haircuts apply to it, according to BofA Merrill analysts. With the latest revisions to the risk control measures in its collateral framework, the ECB has placed a “liquidity stamp of approval” on some covered bond products, they said.

The ECB has reviewed the risk control measures in its collateral framework and has reclassified several of its covered bond products.

As of Jan. 1, 2011, covered bonds will be classed as structured covered bonds, Jumbo covered bonds, traditional covered bank bonds, and multi-issuer covered bonds. They will be included in either liquidity category II or III.

The ECB further specified that Spanish Jumbo covered bank bonds will move to liquidity category II from category III; Canadian, Dutch, French, and U.K. (Jumbo) general-law-based covered bonds will move to liquidity category III from category IV; and (Jumbo) Greek covered bonds will move from liquidity category III from category V.

Effective next year, the valuation haircuts for the eligible debt instruments included in liquidity categories I through IV will differ according to credit quality, residual term and coupon structure.

Lower valuation haircuts will apply to covered bonds that will move to liquidity category III from category IV or V, or to category II from category III. Higher valuation haircuts will apply to traditional covered bank bonds of credit quality step 1 or 2 with a residual term of three years or more, and covered bonds that are given a theoretical value will be subject to an additional valuation markdown of 5%, the ECB said.

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