FDIC Says US Covered Bond Legislation Falls Short on Key Principles

Legislation creating a US covered bond market is gaining momentum in Congress and may well pass before the 111th Congress adjourns sometime in December after an almost certain lame duck session concludes. Recent hearings before the Senate Banking Committee revealed that Chairman Chris Dodd wants to explore alternatives to securitization, which covered bonds offer. Senator Dodd supported a provision in the Dodd-Frank draft in conference creating a US covered bond market, but the provision did not make it into the final legislation.

In testimony before the Committee, FDIC officials said that, while the FDIC generally supports legislation, but conditions its support on the covered bonds legislation having three key principles. First, it should clarify the right and duties of investors, issuers and regulator, Second, it should ensure that investment risks are not be transferred to the public sector or to the deposit insurance fund, Third, it should remain consistent with long-standing U.S. law and policy for secured creditors Unfortunately, H.R. 5823, the current legislative vehicle for creating a US covered bond market would, in the FDIC's view, muddy the relationship between investors and regulators, transfer some of the investment risks to the public sector and the deposit insurance fund, and provide covered bond investors with rights that no other creditors have in a bank receivership. As a result, cautioned the FDIC, this legislation could lead to increased losses in failed banks that have issued covered bonds.