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Comments on the draft Insolvency and Bankruptcy (Registration of Insolvency Professionals) Regulations, 2016
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/in /by adminCovered Bonds Legislations
2011 Developments in covered bonds legislation
Vinod Kothari
27 July 2011
Whether the popularity of covered bonds as the alternative form of on-balance sheet securitisation is based on the merits of covered bonds, or the lately-discovered demerits of securitisation, remains to be affirmed. However, of late, several countries have taken steps to put in place either legislation or enabling regulatory statements on covered bonds. The first half of 2011 has been like the covered bonds legislation season.
US legislation on covered bonds:
In early March 2011, the Covered Bond Act [HR 940 – see here] was presented before the Congress. The House Committee gave a report on the Bill in June 2011.
The 6-sections tiny bill deals basically with regulatory oversight in case of covered bonds, and treatment in the case of default of the issuer.
Unlike in several European countries, the US covered bonds program is not to be limited to residential mortgage loans. In fact, the ambit of “eligible asset” in the Bill includes the whole ambit of asset classes that have been commonly securitized, including home equity, commercial mortgages, auto loans, student loans, small business loans, credit or charge cards, and nay, there is a residual class which allows the Secretary of Department of Treasury, in consultation with covered bonds regulators, to notify. Likewise, “eligible issuers” include both banks, bank holding companies and non-bank financial companies as defined in Dodd-Frank Act.
The Act envisages a Covered Bond Regulatory Oversight program. The Oversight Program involves covered bonds regulators for each of the asset classes that the Bill covers. Each covered bonds program that hits the market has to be pre-approved by the concerned regulator. Note that the approval is not for each issue, but a program – that is, a program may cover various issues upto a limit of maximum amount of bonds outstanding.
Unlike several European laws, the law leaves the over-collateralisation requirements in case of covered bonds to be fixed by the relevant regulator. For every covered bond program, there will be a “independent asset monitor” whose primary task would be to monitor and report whether covered pool is being maintained as required, including the minimum over-collateralisation requirements. Among the tests for eligibility of assets to form part of covered pool, a loan which is overdue for more than 60 consecutive days would cease to be eligible. That is to say, the issuer has to replace such loan with a good loan.
The most important part of the law is the bankruptcy proofing provisions. On happening of an event of default before a covered bonds issuer enters conservatorship, receivership, liquidation, or bankruptcy, an estate shall be immediately and automatically created by operation of law. This is the most notable provision – creating a separate estate by operation of law. The law further goes to say that there shall be a separate estate for each covered bond program. That is, the separation of estate backing the covered bonds is both from the rest of the property of the issuer, as also each of the running covered bonds programs. The residual of the cover pool after discharging the obligations of the affected covered bonds program shall flow back to the issuer. And as for the deficit, the covered bonds investors shall have a claim against the rest of the bankruptcy estate of the issuer.
UK legislation:
In early April 2011, the Financial Services Authority UK, jointly with Her Majesty’s Treasury issued a consultation paper for review of the existing regulations for “regulated covered bonds”. The expression “regulated covered bonds” refers to covered bonds that are issued under the March 2008 regulations of the FSA. The FSA now proposes to revamp the existing regulatory scheme and replace the same with new regulations. The existing rule book is here. The comment date on the consultative paper ended on 1st July 2011.
Korea:
On June 29, 2011, Korea brought covered bonds guidelines. These guidelines pertain only to residential mortgage loans or RMBS. The mortgage loans must be prime loans, with LTV of 70% or less, and overdues of not more than 60 days. The guidelines impose a minimum 5% over-collateralisation requirement.
South Africa:
In a season of regulatory measures to promote covered bonds across the world, the Reserve Bank of South Africa decided to go alone, and issued a guidance, on 23rd May 2011 (Guidance note no G3/ 2011 – see here) which said that covered bonds subordinate general depositors and creditors of banks, and therefore, covered bonds are inconsistent with the policy objectives of the regulator. The SA regulator went on to say that banks in South Africa will not be allowed to issue any instrument, synthetic or otherwise, which in substance amounts to covered bonds. Humbly, the South African regulator thoroughly misunderstood the purport and impact of covered bonds. If a bank transfers assets to securitisation vehicles, that also amounts to, in a way, subordinating the interest of depositors as those assets move away from the bankruptcy domain that serves the unsecured creditors. Extending that logic, every time a bank issues a conventional secured bond as well, it is doing so against the interest of unsecured depositors. By this logic, every secured bond issuance by a South African bank should also be inconsistent with the policy objective. However, the classification of mutual rights of different claimants in corporate finance has been understood over the centuries. It has the impact of reducing the overall cost of borrowings or cost of capital for any corporation, and therefore, it serves every one’s interest. The interest of the depositors, or any creditors for that matter, is no different from that of the corporation itself – so, it something makes economic sense for the issuing corporation in general, it makes sense to the creditors and other claimants too.
In any case, most countries limit the extent to which banks can issue covered bonds as a percent of their total deposit or debt liabilities.
New Zealand:
In March 2011, the Reserve Bank of New Zealand issued a summary of the regulatory proposals for covered bonds. Earlier this year, the Kiwis’ central bank had issued regulatory proposal to limit covered bonds upto 10% of total liabilities of the issuing bank. There is no separate law for covered bonds in New Zealand – hence, issuers in this country also use the structured covered format.
Our articles on Covered Bonds
- Introduction to Covered Bonds by Vinod Kothari
- Article on Covered Bonds in Asia
- The name is Bond. Covered Bonds – article by Vinod Kothari
Our Workshops on Covered Bonds
- To know about the latest workshops on Covered Bonds, see our page on latest workshops here
Useful links on Covered Bonds:
- European Covered Bonds Council
- UK Regulated Covered Bonds Council
- Financial Services Authority, UK, on Regulated Covered Bonds
- Fitch Ratings Covered Bonds Rating Methodology
- S&P's Covered Bonds Rating Methodology: Clarification of Liquidity Need Calculation, March, 2009
- Deutsche Bank, Global Markets Research, Overview of Covered Bonds, Feb 2009
- Covered Bonds in Asia, Asian Bond Market Forum
- Handbook on Covered Bonds
- Fitch Rating: Reports on Covered Bond
Country Pages
Covered Bonds Legislation
Covered Bonds in Canada
/in /by adminThe Raipur Bench of ITAT upholds the thread of distinction between mandatory CSR and voluntary CSR
/0 Comments/in Companies Act 2013 /by adminCovered Bonds to increase Banks’ risk-Norway Financial Regulators argue
/in /by admin3rd November, 2012: While the world is going gung-ho on promoting Covered Bonds as an alternative to securitisation and regulators are making necessary regulatory amendments to accommodate/ promote covered bonds; Norway's financial regulators have presented the flip side of the coin by proposing to curb covered bond financing arguing that increase in such funds fuels balance sheet risks.
The Financial Supervisory Authority of Norway in the Summary of the report Financial Trends 2012[1] and in its press release on the financial industry outlook[2] stated that after the substantial growth of the instrument, need for putting limits to covered bonds financing was felt. It is felt that extensive use of covered bonds can increase the vulnerability of financing structure of banks. The several reasons posed by the financial regulators are as below:
a. Mortgage loans are used to secure covered bonds, less quality assets remain with banks for availing other types of financing – hence banks' unsecured creditors may perceive an increased credit risk and banks may find it difficult to obtain unsecured funding. With increasing usage of covered bonds banks will experience problems in obtaining funding other than by way of covered bonds which in turn will reduce banks ability to finance loans;
b. The risk associated with investments in covered bonds is lower than the risk associated with investments in bank bonds. Hence, low funding costs of covered bonds are drawing away funding from other areas;
c. The fact that home loans can be funded at significantly lower interest rates through covered bonds than is the case with loans to business and industry may, detrimentally, draw bank lending away from businesses towards households;
Relatively favourable funding of home loans has spurred growth in mortgage lending and intensified price pressures in the housing market in various countries.
The financial crisis had exposed the need for robust alternate modes of funding, which was answered by Covered Bonds providing banks with better access to funds in turbulent markets. The Covered Bond market in Norway has seen rapid growth and the instrument makes up 20% of the banks' funding. Covered Bonds have helped banks mitigate liquidity risk and have helped banks through financial crisis but like they say excess of everything may be bad is the message from the financial authority.
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[1] Summary of the Report Financial Trends 2012 http://www.finanstilsynet.no/en/Document-repository/Reports/2012/Summary-of-the-report-Financial-trends-2012/
[2] Norwegian financial industry well positioned to meet international turbulence
[Reported by: Nidhi Bothra]
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