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The Covered Bonds Decree is expected to take effect on 1 July 2008.
Covered bonds are bonds issued by banks on the capital market that are insured (‘covered’) by mortgage claims that those banks have against their clients.
The idea behind drafting rules for covered bonds is to encourage a level playing field in Europe, as a result of which Dutch institutions may also reap the benefits offered by a statutory framework.
Investing in covered bonds issued by Dutch banks is becoming more attractive for Dutch and foreign undertakings for collective investments in transferable securities (UCITS).
The costs involved in attracting capital are lowered, which is of great importance to Dutch banks.
The lack of a statutory arrangement means that they are still at a competitive disadvantage with respect to banks in Member States that do have such an arrangement.
Covered bonds are an important financing instrument for mortgage banks in particular.
The idea is not new, as covered bonds are standard financing instruments in many countries, e.g. the familiar German Pfandbriefe.
The market for covered bonds has grown sharply in the past few years, which explains the increased interest.
What makes issuing covered bonds attractive is the interest owed, which is lower than that owed on regular bonds issued by the undertakings in question.
Investors are prepared to accept a lower interest as they have, in principle, seniority when recovering mortgage claims and therefore run no risks with regard to other business activities.
To acquire that seniority for investors in the case of covered bonds, many countries (but not the Netherlands) have legislation that ensures that the mortgage claims for insuring
the covered bonds are more or less separate from the banks’ capital.
There are certain facilities for investors in covered bonds.
The Council Directive on the coordination of laws, regulations and administrative provisions relating to UCITS (85/611/EC) stipulates that Member States may raise the limit for UCITS to invest their capital in securities from a maximum of 5% to 25% if investments are made in covered bonds.
The revised Directive relating to credit institutions (2006/48/EC) stipulates that investments by banks in covered bonds, in the context of the solvability supervision, may be eligible for an exemption to the large positions restriction.
If the standard approach is adopted, a lower risk weight is granted.
If the internal rating method is chosen, a lower LGD (loss given default) value is granted.
The consultation version of the Decree stipulates that bonds issued by a bank may be considered covered bonds if the issuing bank transfers the mortgage claims to a special purpose vehicle that guarantees the covered bonds unconditionally and creates a right of pledge on the transferred mortgage claims for the benefit of investors.
This arrangement follows current practice for covered bonds issued by Dutch banks.
These are what are referred to as structured covered bonds and are line with the British model.
Under the proposed arrangement, the issuing bank may request the Dutch central bank [DNB] to include the bonds in a public register, after which they are covered bonds.
The consultation version of the Decree contains further detailed provisions for UCITS (in accordance with the UCITS Directive) and for banks (in accordance with the revised Directive relating to credit institutions) which invest in covered bonds.
Certain provisions have also been introduced for life insurance and damage insurance companies in the sense that the 5% limit for technical provisions is increased to 40% if investments are made in covered bonds.
For more information, please contact Roel Botter,
Financial Institutions Market Group.
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