Liquidity lowdown: Covered bond potential rule change reversed – market impact

July 2025 brought an end to a regulatory shake-up for the covered bond market in the UK. The UK Prudential Regulation Authority (PRA) officially withdrew its proposed modification to the treatment of non-UK covered bonds under the Liquidity Coverage Ratio (LCR) framework.

So what actually happened? In April 2025, the PRA floated a proposal (a ‘modification by consent’), that would have changed how third-country (non-UK) covered bonds are treated in banks’ liquidity buffers. Specifically, it aimed to tighten eligibility for these bonds to qualify as Level 2A High Quality Liquid Assets (HQLA)—a key component of the LCR. Level 2A asset can comprise up to 40% of the overall buffer, and can be made up of assets like covered bonds and corporate debt securities. The PRA proposed recognising these bonds on a ‘limited and declining basis’ only, which in reality, meant that once existing third-country covered bonds matured, they could not be replaced in the calculation. The initial announcement came on 8 April 2025. 

Banks must hold enough HQLA to cover net outflows over a 30-day stress period, with Global Systemically Important Banks (G-SIBs) required to hold even more. The modification would have had major implications for not only buyers of sterling dominated non-UK covered bonds but also issuers of those bonds. A change of this magnitude would likely have reduced the incentive for non-UK issuers to bring covered bond deals to the UK market, because a smaller investor base ultimately means lower demand. Banks are the main buyers of UK covered bonds, which account for roughly 7% of all covered bonds issued, with euro-denominated assets making up the majority of the market. With a weakened demand for non-UK covered bonds, this may have pushed up demand for other sterling assets and government debt, concentrating the risks face by investors and putting potential price pressures in other markets.

A change of this magnitude would likely have reduced the incentive for non-UK issuers to bring covered bond deals to the UK market

Following the initial PRA announcement on 8 April 2025, the outlook for non-UK covered bond issuance in the UK looked uncertain, and this was reflected in their price. Heighted concerns around lack of future supply and market liquidity resulted in an increasing number of bonds being offered at elevated levels, which inevitably spiked the supply of secondary covered bonds in the market. A potential buying opportunity for those keen to buy at more attractive levels, but a reflection of the market’s unease at such a potential significant change to the treatment of these bonds as HQLA. Just 10 days later, the PRA paused the modification following ‘technical comments and requests for clarification’, reversing much of the price movement seen earlier in the month. Fast forward to July 2025, and the PRA has now decided not to proceed with any modifications to the rules – and the market appears to have moved on entirely.

For professional investors only. This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change. Forward looking statements are subject to certain risks and uncertainties, Actual outcomes may be materially different from those expressed or implied.