Although the United States still lacks a statute that would permit US
depository institutions to issue covered bonds, foreign banks have
found that US investors are interested in covered bonds. Foreign banks
have met investor demand by issuing covered bonds into the US relying on
their domestic covered bond frameworks. The cover pools supporting
these foreign-issued covered bonds have been comprised exclusively of
assets located outside the US.
When issuing covered bonds into the US, foreign issuers must comply
with US securities laws, including the Securities Act. This law requires
that all securities issued and sold in the US be either registered or
exempt from registration. To date, offerings of covered bonds by foreign
banks have been structured as exempt offerings, although, as discussed
below, recent developments may lead to a new approach.
Registration exemption
One approach for offering debt securities to US persons without
pursuing a registered public offering is to rely on the exemption from
registration provided by Rule 144A. Upon issuance, the covered bonds of
foreign issuers are first offered in a private placement to the initial
purchasers (the investment banks that distribute the securities) in
reliance on Section 4(2) of the Securities Act. The initial purchasers
will immediately re-sell the covered bonds to institutional investors
that are qualified institutional buyers in reliance on the Rule 144A
safe harbour. At the same time, the covered bonds also may be offered
outside of the United States to non-US persons in reliance on Regulation
S of the Securities Act.
If a foreign bank has a branch or agency in the US, it may be able to
rely on the exemption from registration provided by Section 3(a)(2) of
the Securities Act for issuances of securities by banks. To qualify for a
Section 3(a)(2) offering, the covered bonds must be either issued or
guaranteed by the US branch or agency. The US Securities and Exchange
Commission (SEC) treats the US branch or agency of a foreign bank as a
US branch or agency for purposes of Section 3(a)(2) if the foreign bank
is a 'national bank' or a 'banking institution organized under the laws
of any state' if the nature and extent of regulation and supervision of
such foreign bank is 'substantially equivalent to that of applicable
federal or state chartered domestic banks doing business in the same
jurisdiction'. Additionally, if the covered bonds are guaranteed by such
a branch or agency, the guaranty or assurance must cover the entire
obligation. The guarantee or assurance cannot be for a partial repayment
of the covered bonds.
Relying on the Section 3(a)(2) exemption has certain advantages
compared to a Rule 144A offering. An offering made in reliance on
Section 3(a)(2) is generally not subject to the prohibition against
general solicitation and advertising that applies to a Rule 144A
offering. (The prohibition against general solicitation and advertising
has been relaxed by recently enacted legislation in the US; however,
rulemaking is required to effectuate this change. It is not clear
whether the relaxation of the prohibition will permit the use of general
solicitation and advertising in combined Rule 144A/Regulation S
offerings. Securities sold in reliance on Section 3(a)(2) are not
classed as restricted securities, while securities sold in a private
placement and resold in reliance on the Rule 144A safe harbour are. Many
institutional investors are subject to limitations on the amount of
restricted securities that they may purchase. Resales of Rule 144A
securities may only be made to qualified institutional buyers, whereas
3(a)(2) securities may be sold to a broader universe of investors.
Finally, restricted securities are not eligible to be included in bond
indices and are therefore viewed as less liquid.
Documentation
A European covered bond issuer with a current prospectus (prepared in
accordance with UKLA or Luxembourg Stock Exchange standards) can access
the US market relatively easily. The prospectus can be supplemented
with a few additional sections for the US market. The additional
sections to be added generally include: disclosure regarding US tax
implications and Erisa (Employee Retirement Income Security Act)
implications; settlement information for clearance of the covered bonds
through the Depository Trust Company (DTC); the identity of the US
paying agent, information regarding any selling restrictions and
transfer restrictions in the case of a Rule 144A offering; and
information regarding the role of any US branch of a foreign bank in
offerings as well as financial data regarding such branch in the case of
a Section 3(a)(2) offering.
It is relatively simple to amend an existing European covered bond
programme to accommodate an offering in the United States. There is no
requirement that the programme agreement be governed by US law, so the
existing agreement remains largely unchanged. A few changes are
necessary, however. First, a co-issuing agent must be appointed in the
US under the existing agency agreement (or other agreement providing for
the issuance of securities) to provide for issuance of, and payment on,
the bonds. This change is often accomplished by notice, without
amending the agency agreement. Second, as required by the DTC, the
global bonds must be issued in the name of the DTC's nominee, Cede &
Co, and physically held by the US issuing agent. This may require
amending the agency agreement. The programme agreement (or other
agreement governing the offering and distribution of the covered bonds)
must be amended to include representations, warranties and covenants
typical for an offering to US investors, selling restrictions, US-style
indemnification provisions for false or misleading statements or
omissions contained in the offering document, typical market-out
provisions, and a requirement that the issuer's accountants deliver a
comfort letter and perform certain agreed upon procedures.
For a Section 3(a)(2) offering, steps must be taken to effect the
issuance of the bonds through the US branch or agency of a foreign bank
or for such branch or agency to guarantee the obligations evidenced by
the covered bonds. In the case of an issuance of the covered bonds by
the US branch or agency of a non-US bank, the final terms and
subscription agreement or other documents to be executed for the
issuance of a new series of bonds must be executed by the bank "acting
through the branch [agency]" and the global bonds issued to the DTC
should show the bank "acting through the branch [agency]" as the
obligor. In the case of a guarantee by the branch, the bank "acting
through the branch [agency]" would execute the final terms and the
subscription agreement as guarantor. While it may initially appear
strange that a branch office of a non-US bank would guarantee the
obligations of the non-US bank, the structure is significant. The US
branch or agency of a non-US bank is regulated by a US regulator and
such branch or agency must often maintain separate capital in its local
jurisdiction. In the case of the branch or agency's failure, the US
banking regulator will marshal the assets of the branch or agency in the
jurisdiction and apply those assets to repayment of claims against the
branch or agency before releasing assets to the home office of the
branch or agency or to insolvency proceedings in the home jurisdiction
of the bank.
Due diligence
Several liability and diligence-related documents are commonly
delivered at closing in connection with the issuance of debt securities
into US markets. These documents include an auditor comfort letter, a
pool audit letter (agreed upon procedures letter), and a 10b-5 letter.
In a Rule 144A offering or a Section 3(a)(2) offering, an initial
purchaser or dealer is subject to securities law liability in respect of
losses if there are material misstatements or omissions contained in
disclosure documents for the offering. The initial purchaser or dealer
may, however, limit its liability if it can establish that it did not
know and, in the exercise of reasonable care, could not have known of
such misstatement or omission. This is often referred to as the due
diligence defence. The diligence process will entail discussions with
the issuer's management, review of certain documents, including the
issuer's board minutes and material contracts and other similar
agreements and a review of the issuer's mortgage business policies and
procedures.
Some non-US issuers may find this inquiry intrusive, but the
diligence process can be handled with due consideration for the
confidentiality of sensitive information. Furthermore, the review
relating to a debt offering by a regulated financial institution with
publicly available financial data should not be a lengthy process. For a
regulated financial institution, a great deal of information about the
institution is publicly available. As part of the diligence process,
there also will be various business and regulatory diligence conference
calls and discussions with the issuer's accountants, counsel and other
advisors. Naturally, conducting diligence for the very first offering
will be more time-consuming than for subsequent offerings. Subsequent
offerings require only a review of new agreements and new board minutes.
It should also be noted that diligence conducted, for example, for a
covered bond programme can also serve as the basis for diligence for
other securities offerings by the same issuer, such as offerings
pursuant to a medium-term note programme or a 3(a)(2) banknote
programme. Accordingly, once initial diligence is completed, the issuer
may achieve future efficiencies if the issuer and the dealers work with
the same counsel on other offerings. The initial purchaser/dealer also
will request that the issuer's counsel and its own counsel deliver Rule
10b-5 or negative assurance letters at closing.
Registered covered bonds
A foreign issuer also may want to consider registering an issuance of
covered bonds with the SEC, so that the issuer can offer the bonds in a
public offering. Registering covered bonds entails different
considerations for each jurisdiction and in some cases for each issuer
within a jurisdiction. There are different issuance structures for
covered bonds in different jurisdictions and sometimes more than one
structure in the same jurisdictions. Moreover, individual issuers may
have existing relationships with the SEC, may be subject to special
accounting requirements, be subject to certain prohibitions on
disclosure or otherwise present unique facts.
Foreign issuers would register securities with the SEC on Form F-1
for a one-time offering or on Form F-3 for a shelf offering. A shelf
offering is usually desirable because it permits the issuer to register
an amount of securities to be sold over three years and to come to
market multiple times over the three-year period at times of the
issuer's choosing. In order to qualify for use of Form F-3 for a
registration statement, however, the issuing entity must have been
reporting to the SEC for at least one year. If the issuer does not
qualify for Form F-3, it must register its covered bonds on Form F-1.
The disclosure required in the prospectus for an issuing bank will
include full financial statements, presented in standard IFRS or
reconciled to US GAAP. Disclosure regarding the bank should be drafted
in accordance with SEC Industry Guide 3, which is the disclosure guide
applicable to banks. Periodic reporting will include annual filings on
Form 20-F, interim reporting on Form 6-K and material event reporting on
Form 8-K.
Based on the recent no action letter granted to Royal Bank of Canada
(available May 18 2012), it is likely that SEC staff will expect
disclosure about the cover pool assets consistent with the requirements
of Regulation AB that are applicable to master trust structures, such as
credit card master trusts or UK mortgage master trust for residential
mortgage-backed security issuance. Prospectus disclosure will include
static pool disclosure and statistical disclosure of the expected cover
pool at the time of issuance, including delinquency and loss
information. Static pool information is stratified disclosure of
mortgage loans in the cover pool based on the year of origination of the
loans. Periodic reporting of cover pool assets will include an annual
filing on Form 10-K consistent with what an asset-backed security issuer
would report (including an annual statement of the servicer of the
mortgage loans regarding compliance with applicable servicing criteria,
an attestation by an accounting firm on the servicer's statement, a
statement from an authorised officer of the servicer regarding his
review of the servicer's activities and its performance under the
servicing agreement during the period and that based on such review and
to the best of his knowledge the servicer has fulfilled all of its
obligations under the servicing agreement; for a covered bond issuer
using a single-tier issuance structure, such as a Pfandbrief
issuer, the SEC may request different statements and disclosure),
interim reporting on Form 10-D within 15 days of a distribution date of
distribution amounts, application of collections on the assets and
performance of the cover pool and material event reporting on Form 8-K.
As noted above, if a foreign issuer of covered bonds does not qualify
for use of Form F-3 because it has not been reporting to the SEC for at
least one year, the issuer must use Form F-1, which requires the filing
of a registration statement for each offering. However, only one
offering is required to begin the reporting process. If the issuer
wishes to come to market frequently during the year and finds the filing
and approval process for Form F-1 interferes with market timing for an
offering, the issuer may wish to consider using a Rule 144A private
placement or a Section 3(a)(2) offering to enable quick market entry
during the year when it is building its reporting history. It is also
possible to offer Rule 144A securities with registration rights to be
followed by the filing of a Form F-1 to register those securities. At
the end of the one-year reporting period, a Form F-3 can be filed.
Of course, the decision to register a covered bond offering will be
easier for a foreign issuer that is already a US reporting entity. There
are a number of significant advantages associated with SEC-registered
covered bonds. An issuer would be able to offer securities to a broader
array of investors, and the securities would be freely transferable, not
restricted securities. The covered bonds would therefore be eligible
for inclusion in bond indices. As a result, the offering may attract
interest from funds that track bond indices. Although registered covered
bonds are a relatively new alternative available to foreign issuers,
foreign issuers should consider carefully their various issuance options
when accessing the US market and in weighing the various benefits of
each approach take into account all of their funding needs. As we note
above, documentation and diligence for one issuance programme may well
be leveraged and used in connection with other issuance platforms and
result in significant efficiencies for the issuer.
| Anna Pinedo |
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Morrison & Foerster
Anna Pinedo has concentrated her practice on securities and derivatives. She represents issuers, investment banks/financial intermediaries, and investors in financing transactions, including public offerings and private placements of equity and debt securities, as well as structured notes and other structured products. She works closely with financial institutions to create and structure innovative financing techniques, including new securities distribution methodologies and financial products, and has particular financing expertise in certain industries, including working with technology-based companies, telecommunications companies, healthcare companies, financial institutions, Reits and consumer finance companies.
In the derivatives area, Pinedo counsels a number of large financial institutions acting as dealers and participants in the commodities and derivatives markets. She advises on structuring issues, as well as on regulatory issues, monetisation, and hedging techniques. Her work focuses on foreign exchanges, equity and credit derivatives products, and structured derivatives transactions. She also has advised derivatives dealers regarding their Internet sites and other Internet and electronic signature/delivery issues.
Pinedo regularly speaks at conferences and participates in panel discussions addressing securities law issues, as well as the securities issues arising in connection with derivatives and other financial products.
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| Jerry Marlatt |
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Morrison & Foerster
Jerry Marlatt specialises in corporate finance with a focus on structured capital markets. He represents issuers, underwriters and placement agents in covered bonds, surplus notes, structuring investment and specialised operating vehicles, insolvency restructuring of such vehicles, securities repackagings and public offerings and private placements of asset-backed securities in domestic and foreign capital markets. His representative transactions involve the first covered bond by a US financial institution, the first covered bond programme for a Canadian bank, surplus notes and common stock for a US monoline insurance company, eurobond offerings by US issuers and a variety of structured vehicles, including CBOs, SIVs, CDOs, derivative product companies, ABCP conduits and credit-linked investments. He is co-author of ‘Considerations for Foreign Banks Financing’ (IFLR, 2012), a contributor to Covered Bonds Handbook (Practising Law Institute, 2010), and a charter member of the United States Covered Bonds Council.
Marlatt was educated at the University of Southern California (BA, 1967) and Southwestern University School of Law (JD, 1977). He is recommended as a leading lawyer by Chambers Global 2012, Chambers USA 2012 and Legal 500 US 2012.
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