- Regulated Covered Bonds
- Dutchified UCITS requirements
- CRD-compliance as an option
- Loan-to-value ratio
- Ongoing administration and reporting obligations
The Dutch regulation for the issuance of covered bonds (the 'Regulation') aims to:
- provide Dutch issuing banks with a level playing field with other issuers of covered bonds within the European Union;
- facilitate a market in safe instruments in accordance with the applicable European directives; and
- impose solid conditions to protect covered bondholder interests.
The Regulation prescribes a so-called ‘segregated’ structure, being a structure where the cover assets are segregated from the issuer and owned by an independent, special purpose covered bond company (the 'CBC'). Under the Regulation, asset segregation takes place on the basis of the Dutch Civil Code and the Dutch Bankruptcy Code. As the applicable statutory provisions are relatively creditor-friendly they did not need to be amended when the Regulation was adopted.
The Regulation is not a separate instrument. It is a collection of rules forming part of two layers of secondary regulation implementing the Dutch Financial Supervision Act (Wet op het financieel toezicht). These are:
- the Decree on Prudential Rules Regulation (Besluit prudentieel toezicht Wft); and
- the Implementing Regulation (Uitvoeringsregeling Wft).
The Regulation only relates to the issuance of covered bonds by Dutch banks. Dutch rules pertaining to investment in covered bonds by Dutch regulated entities are contained in regulations other than the Regulation.
Covered bonds which meet the requirements set out in the Regulation ('Regulated Covered Bonds') are eligible for receiving special favourable treatment under the UCITS Directive (85/11/EEC; 'UCITS'), the Capital Requirements Directive (2006/48/EC; 'CRD') and the monetary policy operations of the European Central Bank. Dutch covered bonds qualify as Regulated Covered Bonds if they have been recognised as such by the Dutch Central Bank ('De Nederlandsche Bank' (DNB)).
The register is available online and can be found at www.toezicht.dnb.nl/en/2/2/51-202602.jsp. If an issuing bank wishes its covered bonds to be recognised as Regulated Covered Bonds it will need to demonstrate to DNB that the following requirements are met:
- the requirements set out in paragraphs 3 (Dutchified UCITS requirements) and 6 (Ongoing administration and reporting obligations) below are met;
- the covered bonds have a credit rating of at least AA- (Fitch or S&P) or Aa3 (Moody’s);
a healthy ratio exists between on the one hand the programme/issuance amount and on the other hand
(i) the value of the cover assets;
(ii) the value of the remaining assets of the issuing bank eligible and freely available for addition to the cover assets; and
(iii) the consolidated balance sheet of the issuing bank (the latter to protect other stakeholders); and
- the issuing bank has solid and effective strategies and procedures for verifying and procuring the sufficiency of the cover assets, taking into account the composition of the cover assets, the over-collateralisation and the applicable risks and stress tests.
The Regulation defines a Regulated Covered Bond basically by prescribing six general requirements that follow from section 52(4) UCITS as interpreted and implemented by the Dutch Ministry of Finance:
- it is issued by a bank having its registered office in the Netherlands. That excludes banks operating in the Netherlands on a cross-border basis or through a branch office. Subsidiary companies of a Dutch licenced bank are not eligible to act as issuing bank, even if their obligations are guaranteed by their parent bank and they are included in the consolidated supervision on that parent bank. The issuing bank must be licenced and subject to full ongoing supervision by DNB;
it is covered by cover assets which will be used with priority towards payment of principal and interest on the covered bonds if the issuing bank defaults. The Regulation acknowledges that certain costs need to be made so as to ensure that the covered bondholders are fully and timely paid. The Regulation therefore allows certain proceeds of the cover assets to be applied towards certain higher ranking payment obligations of the CBC such as those relating to:
(i) the management and administration of the cover assets; and
(ii) derivative contracts;
- the cover assets have been safeguarded for the benefit of the covered bondholders by way of a transfer to a CBC and a pledge to a trustee. The transfer may occur on a universal legal basis (algemene titel; such as a demerger (afsplitsing)) or a special legal basis (bijzondere titel; such as a transfer (overdracht) pursuant to a guarantee support agreement) and the transfer may be governed by foreign law. Instead of a right of pledge (pandrecht) a comparable foreign law security right may be created. Alternative ways of safeguarding the cover assets for the covered bondholders are also permitted, as long as they are approved by a ministerial regulation;
- the cover assets provide sufficient cover for the payment of principal and interest on the covered bonds and the cost of managing and administering the cover assets;
- the cover assets are governed by the law of a Member State, the United States of America, Canada, Japan, the Republic of Korea, Hong Kong, Singapore, Australia, New Zealand or Switzerland; and
- the issuing bank does not own or control the CBC or the trustee. The CBC and the trustee must be remote special purpose vehicles and may be foreign legal entities.
The Regulation permits, but does not require, Regulated Covered Bonds to also comply with the requirements set out in Annex VI, Part 1, points 68, 69 and 70 of the CRD. The Regulation therefore allows issuing banks of (and thus investors in) Regulated Covered Bonds the flexibility to choose whether they wish to issue (or invest in) covered bonds which are either compliant with just UCITS or compliant with both UCITS and the CRD. For each programme under which Regulated Covered Bonds are issued, DNB indicates in its above-mentioned register whether the relevant covered bonds are compliant with both UCITS and the CRD.
The CRD prescribes that covered bonds may be backed by residential mortgage loans only up to the lesser of
(a) the principal amount of the relevant mortgage right; and
(b) 80% of the value of the underlying mortgaged property.
However, relevant Dutch residential mortgage loans may in practice have a loan-to-value ('LTV') ratio of up to 125%. To date all Dutch covered bond programmes take a two-step approach towards LTV ratio’s of Dutch residential mortgage loans, as follows:
- subject to some exceptions in some programmes, a loan is only eligible to be transferred to the CBC if the LTV-ratio did not exceed 125% ( the 'Eligibility Percentage') of at origination; and
once a loan forms part of the cover assets of the CBC, the maximum value attributed to it in the asset cover test is a certain percentage (the 'LTV Cut-Off Percentage') of the value of the underlying mortgaged property at such time. For example, if:
(i) the relevant LTV Cut-Off Percentage is 80%; and
(ii) a residential mortgage loan has a principal amount of 110 and is backed by mortgaged property with a value of 100, then such loan would be valued at no more than 80 in the asset cover test. The 30 excess value of the loan would serve as extra credit enhancement. Currently the LTV Cut-Off Percentage applied to Dutch residential mortgage loans is:
- (i) 80% for all Regulated Covered Bonds, which is in line with the maximum LTV ratio prescribed by the CRD;
- (ii) 125% for covered bonds that are not Regulated Covered Bonds; and
- (iii) in some covered bond programmes, notwithstanding the percentages mentioned in the previous two paragraphs, 100% or a different percentage for residential mortgage loans that have the benefit of a Dutch National Mortgage Guarantee (Nationale Hypotheek Garantie).
Like the CRD, the Regulation does not prescribe whether the foreclosure value or the market value of the underlying mortgaged property should be taken into account when calculating the LTV ratio. To date under the Dutch covered bond programmes:
(a) the Eligibility Percentage is applied to the foreclosure value at origination; and
(b) the LTV Cut-Off Percentage is applied to the market value of the mortgaged property at the relevant time. The way in which the market value is determined differs per programme.
Once a Dutch covered bond programme is registered by DNB, the issuing bank will have ongoing administration and reporting obligations towards DNB:
- it must keep a record of all covered bonds issued and of all assets serving as cover assets;
- it must demonstrate at least quarterly that the covered bonds continue to meet the criteria summarised in paragraph 2 (Regulated Covered Bonds) above, by granting DNB access to the records referred to in (a) above and for instance audit reports, credit rating reports and reports regarding the cover assets. This is without prejudice to the general authority of DNB to request information from the issuing bank on the basis of its regular banking supervision powers;
- it must demonstrate at least annually to DNB that it complies with the requirement set out in paragraph 2 (Regulated Covered Bonds) under (d) above;
- annually, within six months of the close of its financial year, it must submit to DNB the annual financial statements and the annual report of the CBC;
it must immediately notify DNB if, for as long as any covered bond is outstanding
(i) changes occur in respect of the data, transaction documents or other submitted documents, as a result of which the outstanding covered bonds are or will no longer be compliant with the requirements for registration; or
(ii) significant changes are made in the covered bond programme or the conditions of the covered bonds; and
before it issues any further covered bonds,
(i) it must ascertain that the requirements for registration are complied with (there is no need to have the further covered bonds assessed by DNB); and
(ii) if the ratio between the total nominal value of the covered bonds and the consolidated balance sheet total of the issuing bank increases beyond what DNB had determined to be a healthy ratio, the issuing bank must demonstrate to DNB that the new ratio can be considered healthy.
If Regulated Covered Bonds no longer meet the requirements set by the Regulation or if the issuing bank no longer complies with its ongoing administration and reporting obligations towards DNB, there are likely to be short communication lines between the issuer and DNB. If it comes to sanctions, it may be that an issuance-stop is imposed on the issuing bank, which may be disclosed by DNB in its register. DNB is entitled to strike the registration of a covered bond. In practice it is not very likely that DNB would ever exercise its deregistration authority. Apart from verbal assurance this is confirmed by explanatory notes pertaining to the Regulation, which in short state:
that deregistration will only occur
(i) after due consideration of the interests of the issuing bank and the covered bondholders; and
(ii) in the exceptional circumstance that DNB’s supervision is no longer in the interest of the issuing bank and no longer grants protection to covered bondholders; and
- that the interests of the issuer and the covered bondholders include that the registration and supervision be maintained.
In the event of de-registration of Regulated Covered Bonds by DNB, DNB will notify the Commission of the European Communities without delay and publish the same on its website immediately.
DACB is Rezah Stegeman and Kees Westermann very grateful for their contribution to the text above.