Saturday, December 10, 2011

As US Considers Covered Bond Market, Transparency Is Enhanced in UK Covered Bond Market

With pending legislation in Congress to create a US covered bond market, UK authorities enhanced the transparency and clarity of the UK covered bond market through amended regulations. The Financial Services Authority supervises the UK covered bond market. Covered bonds are a category of secured bonds issued by financial institutions backed by mortgages or public sector loans. Covered bonds can provide long-term, stable funding from a diverse investor base and have demonstrated their resilience even in distressed market conditions.

An important feature of covered bonds, which clearly distinguishes them from securitizations, is that investors have dual recourse, both to the issuer and to the underlying pool of assets. In order to enhance this clarity, the regulations excluded securitizations as eligible collateral for covered bonds. This change will further allay investor concerns around the risk of blurring the distinctions between covered bonds and securitizations. In addition, the designation of asset pools as composed of a single class of eligible assets or a mixture of eligible asset classes should not be changeable over time.

The regulations formalize the existing practice of audits of covered bond programs by introducing an independent Asset Pool Monitor to inspect issuer compliance with the regulations. The inspection by the Asset Pool Monitor will be conducted based on agreed upon procedures using a random selection of loans statistically significant at a 99 percent confidence level. This level has been selected to standardize the most rigorous level observed in current practice. The Asset Pool Monitor will submit an annual report to the FSA alongside the annual confirmation of compliance.

The FSA believes that consistent standards of investor reporting: will increase transparency for investors and highlight the quality of underlying assets in the covered bond program and also make it easier for investors to compare different programs. Thus, the regulations will require issuers to provide loan level information on assets in the covered pool.

The reporting requirements when issuers apply to register with the FSA and on an ongoing basis were also enhanced. Prospective issuers must complete an application form with details of the proposed covered bond programs, supporting assets, and governance structure. This form must be signed by a director or senior manager. Issuers must also provide an Annual Confirmation of Compliance of the regulated covered bond program. This confirmation must be completed and signed by a director or senior manager.

Each issuer must also submit an Asset Pool Notification Form each month and publish it on a secure, password-protected website. In addition, if an issuer proposes to add or remove assets in the covered bond asset pool in a way that will change the level of over collateralization by 5 percent or more, it must notify the FSA using the Asset Pool Notification Form at least five business days prior to the proposed transfer, giving details of the size and composition of the transfer.

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