News on Covered Bonds: Australia joins the league: APS 121 and Response Paper on Covered bond & Securitisation released by APRA

Australia joins the league: APS 121 and Response Paper on Covered bond & Securitisation released by APRA

 

25th July, 2012: The year 2012 witnesses yet another State in the league to have issued formal rules for Covered Bonds issuance. This time it's Australia. The Australian Prudential Regulation Authority ("APRA") has issued a Response Paper on Covered Bonds and Securitisation matters dated 12th July, 2012 along with the Prudential Standard APS 121 Covered Bonds for issue of covered bonds by authorised deposit taking institutions ("ADI"). The response paper observes the comments and responses received from various industry participants to the discussion paper that APRA had issued last year in November and sets out its responses/views to the issues raised during these consultations with various industry participants. Whereas the Prudential Standard APS 121 (the Standard) outlines the practices to be observed by ADIs in the course of issuing covered bonds. The Standard also underlines the principles to be followed by ADIs to manage risk associated with exposure to a covered bond special purpose vehicle ("SPV").

Background     

The APRA released a discussion paper – "Covered Bonds and Securitisation matters" and draft prudential standard – "Prudential Standard APS 121 Covered Bonds (APS 121)", on 8th November, 2011.  

These documents set out APRA's proposal to ensure that ADIs adopt prudent practices while issuing covered bonds. The discussion paper outlined the then proposed changes to APRA's prudential standards and was open for written public submissions pending 9th December, 2011. Further, pursuant to the amendment made in the Banking Act, 1959 to give effect to the Covered Bonds Act so to allow ADIs to issue covered bonds, APRA had amended the Prudential Standard APS 120 Securitisation ("APS 120") to remove the prohibition on ADIs issuing covered bonds. Hence the draft stated APRA's proposals to introduce a new prudential standard and make amendments to existing prudential standards in relation to requirements for ADIs that issue covered bonds. This change in APS 120 was related to the capital treatment of subordinated tranches of securitisations issued by another entity.

 

Response Paper issued – APRA's response on holdings of subordinated tranches of non-originated securitisations

Subordinate tranches: The discussion paper issued by APRA in November 2011 defines subordinate tranches as "any tranche of a securitisation that is exposed to the bottom 10 per cent of the initial capital structure, unless that tranche is also the most senior"

On several submissions and arguments received to the discussion paper regarding the definition of subordinate tranches APRA ("Regulatory Authority") states that over-reliance on assessments by credit rating agencies in relation to risks associated with securitisation structures always has a risk as already demonstrated during the global financial crisis. The Regulatory Authority therefore is keen on adopting the crystal clear and simple definition proposed in the discussion paper. As far as straddling tranches are concerned, it intends that any tranche that is exposed to the bottom 10 per cent of a securitisation's initial capital structure should be deducted unless it is the most senior.

APRA proposes amendments to APS 120 to require ADIs to deduct holdings of subordinated tranches of non-originated securitisations from their regulatory capital. It intends to amend APS 120 so that these changes can take effect from 1st January, 2013.

Prudential Standard APS 121 – Covered bonds

APRA has finally released new Prudential Standard – APS 121 ("Standard") for issuance of covered bond by ADIs.  APS 121 is made under section 11AF of the Banking Act 1959 (Banking Act) and applies to all ADIs, other than foreign ADI.

The Standard 121 explicitly states that a covered bond is not securitisation for the purposes of APS 120 and that APS 120 does not apply to covered bonds.

Requirements with regard to SPV- The standard mandates proper legal documented terms between the issuing ADI, covered bond SPV and covered bond holders setting out crystal clear rights and obligations amongst all the parties to the transaction.

Assets in the cover pool – While determining whether an asset is a part of the cover pool, an issuing ADI must have regard to the priority of claims and the following shall be duly considered by the issuing ADI:

  1. Deduct the aggregate amount of assets in the cover pool that do not qualify for treatment as assets of the ADI from the Common Equity Tier 1 Capital.

  2. Assets in cover pool that qualify for treatment as assets of the issuing ADI shall be treated as if they were held directly by the ADI.

APS 121 is exhaustive and states detailed provisions with regard to assets outside the cover pool and liabilities between the ADI and covered bond SPV. It would go a long way in ensuring that the ADIs adopt consistent policies and procedures to hedge risks relating to issuance of covered bonds and apply an appropriate capital treatment exposure associated with covered bond issuance. This might spurge some issuances in the recent future and the Australian market is all set for revival with covered bond issuance as the most sought after funding tool.

[Reported by Abhijit Nagee]