As investors shun asset-backed securitisation, banks are using unwanted mortgages as security for covered bonds. And thanks to a new regime introduced in the UK last week, banks could find these instruments attract even more investors.
The new legislation, which became law on March 6, brings UK covered bonds under the European Ucits (Undertaking for Collective Investment in Transferable Securities) Directive, widening the potential investor-base and making covered bonds an attractive instrument for mortgage-laden banks.
"A similar sort of portfolio backs securitisations and covered bonds," said Angela Clist, a partner at Allen & Overy who was consulted on the new regime. "An issuer would typically have both financing options and issue both types of product, but if one product couldn't be issued then it could divert portfolios into the other product."
Covered bonds use a mortgage portfolio to give investors greater security. Bondholders have recourse to the issuer and to assets in a special purpose vehicle. The SPV manages a portfolio of assets – mortgages, for example – providing security, or cover, for investors if the issuer fails.
To become a regulated issuer under the new regime, institutions must provide the Financial Services Authority with information about the quality and quantity of the assets in the SPV. The regulator must be notified if the pool changes and the issuer must confirm the state of the assets annually.
For the banks, covered bonds mean paying investors less interest (than on standard bonds, for example) and access to a wide investor base. And investors currently want low risk products, such as covered bonds.
"We now have a legal regime that reflects the contractual arrangements of existing deals," said Clist. "UK covered bonds should now be Ucits eligible and accordingly issuers will be on an even playing field with our European counterparts. It should also enable issuers to target new types of investors."