Tuesday, May 03, 2011

House Marks Up Bi-Partisan US Covered Bond Legislation

The House Capital Markets Subcommittee marked up legislation creating a covered bond market for the US. This is bi-partisan legislation with a good chance of passing Congress this year. The U.S. Covered Bond Act of 2011 was introduced by Rep. Scott Garrett (R-NJ), Chairman of the Financial Services Subcommittee on Capital Markets and Rep. Carolyn Maloney (D-NY), Ranking Member of the Financial Services Subcommittee on Financial Institutions and Consumer Credit. H.R. 940 will help facilitate a robust covered bond market in the U.S. to add liquidity and certainty to the capital markets. The legislation was passed out of the subcommittee by voice vote and will now be considered by the full Financial Services Committee and is expected to garner wide bipartisan support.

The legislation will not only generate increased liquidity but will also level the playing field so that U.S. financial institutions are no longer at competitive disadvantage to their foreign counterparts. Covered bonds have been used in Europe for centuries to help provide additional funding options for the issuing institutions and are a major source of liquidity for many European nations mortgage markets. The purpose of the U.S. Covered Bond Act is to create a legislative framework for the development of a covered bond market in the U.S. This framework will enable credit to flow more readily from the capital markets to households, small businesses, and state and local governments in a way that enhances stability of the broader financial system. The core elements of the legislative framework are legal certainty for covered bond programs and public supervision by federal regulators.

According to recent testimony from the US Covered Bond Council, the public supervision of covered-bond programs by a federal regulator, whose mission is the protection of covered bondholders, is central to any legislative framework. In the European Union, this feature is enshrined in the Directive on Undertakings for Collective Investment in Transferable Securities (the UCITS Directive), compliance with which is what has given covered bonds their unique status in Europe, including privileged risk weighting under the Capital Requirements Directive and preferential treatment by the European Central Bank in Eurosystem credit operations. Issuances by regulated financial institutions is another fundamental element of covered bonds that is also recognized in the UCITS Directive. One other indispensable feature of covered bonds is a cover pool that contains performing assets and that is replenished and kept sufficient at all times to fully secure the claims of covered bondholders. This too receives specific mention in the UCITS Directive.

With covered-bond programs subject to rigorous public supervision, investors will be well protected. As a result, an
expansion of existing securities-law exemptions may be appropriate. Regardless, because legal certainty for covered bonds is paramount, the Council supports a framework that includes at least the following: Existing exemptions for securities issued or
guaranteed by a bank would apply equally to covered bonds issued or guaranteed by a bank. Each estate would be exempt from all securities laws but would succeed to any requirement of the issuer to file applicable periodic reports. Each residual interest would be exempt from all securities laws.