Covered bonds were introduced in the Italian legal system in 2005,
but the implementing regulations were enacted only in 2007, completing
the legal framework necessary for the issuance of covered bonds in the
country. Italian legislators introduced article 7-bis and 7-ter in the
framework of Law no 130 of April 30 1999 (the Securitisation Law), for
the purpose of allowing segregation techniques envisaged by this law to
be used in the context of covered bonds issuances.
The legal framework applicable to Italian covered bonds (obbligazioni bancarie garantite)
is now set out in the Securitisation Law, as implemented by decree of
the Ministry of Economy and Finance No 310 of December 14 2006 (the MEF
Decree) and regulations of the Bank of Italy (Circular No 263 of
December 27 2006, eighth amendment dated 18 November 18 2011).
Under Article 7-bis of the Securitisation Law, banks may issue
covered bonds which benefit from a guarantee granted by a special
purpose vehicle (SPV) incorporated under the Law, and backed by
high-quality assets: mortgage loans with a specific loan-to-value,
public sector exposures, or asset-backed securities meeting certain
eligibility criteria (the cover pool).
The structure envisaged by the law resembles, with certain
differences, the structure of the statutory covered bonds issued in the
UK market. In an Italian covered bond transaction, one or more banks
transfer a portfolio of eligible assets to an SPV, by a true sale
transfer, and the SPV will become the owner of the cover pool. The SPV
will fund the purchase of the cover pool by means of a subordinated loan
received by the seller bank, and a bank (which can be different from
the originator of the eligible assets, but usually from the same banking
group) will issue covered bonds.
The covered bonds are guaranteed by the SPV, with a first demand
guarantee issued in favour of the holders of the covered bonds (the
covered bondholders) and the other costs of the transaction, and backed
by the cover pool.
During the life of the transaction, while the covered bonds are
outstanding, the issuing bank will pay interest and principal on the
covered bonds. In case of an event of default by the issuer, the SPV
will continue making payments on the bonds, at the same scheduled
payment dates, with limited recourse to the available funds of the SPV.
Differences and similarities
As mentioned above, the issuance of covered bonds has been
implemented within the context of the Securitisation Law. Unlike
securitisation SPVs, however, which have as their sole corporate purpose
the purchase of assets and the issuance of asset-backed securities,
covered bond SPVs incorporated under article 7-bis acquire eligible
assets and grant a guarantee, secured by the assets, to assist the issue
of notes by an Italian bank.
The same provisions that apply to securitisation transactions with
respect to formalities for perfection and enforceability of the transfer
also apply to covered bond transactions. Therefore, the transfer of the
assets is perfected by way of publication of a notice of transfer in
the Official Gazette and registration in the Companies' Register where
the SPV is registered.
The segregation principle applies to covered bond transactions as
well as to securitisations. Therefore, once the transfer of assets to
the SPV and perfection formalities have been completed, the assets will
be segregated by operation of law, from the assets of the seller and the
issuer (if different from the seller) of the covered bonds, and
exclusively destined to satisfy the rights of the covered bondholders,
the rights of the counterparties to the SPV under the derivative
agreements for the hedging of the risk connected to the cover assets and
the other ancillary agreements relating to the transaction, and the
payment of the other transaction costs. As a result, the cover pool is
not available to the general creditors of the issuer, seller or the SPV.
Features and obligations
The characteristics of the guarantee that will be granted by the SPV
are defined in the 2006 MEF Decree. The covered bond guarantee granted
by the SPV in favour of the covered bondholders is an irrevocable, first
demand, unconditional guarantee, autonomous from the obligations of the
issuer, and with limited recourse to the SPV's available funds related
to the cover pool, irrespective of any invalidity, irregularity or
unenforceability of any of the guaranteed obligations of the issuer.
The MEF Decree also sets out certain principles which are aimed at
ensuring that the payment obligations of the SPV are isolated from those
of the issuer. In case of default of the issuer, on its obligations
towards the covered bondholders (as defined in the terms and conditions
of the covered bonds), or if the issuing bank is subjected to
liquidation proceedings, the MEF Decree provides that the SPV must carry
out the obligations of the issuer within the limits of the cover pool
in accordance with the terms and conditions originally set out for
the covered bonds.
The acceleration of the issuer's obligations (decadenza dal beneficio del termine),
provided for in article 1186 of the Italian Civil Code, will not affect
the payment obligations of the SPV under the covered bond guarantee,
which will continue to make payments to the covered bondholders, at the
scheduled payment dates and at the same conditions originally agreed
upon in the terms and conditions of the covered bonds.
In accordance with the MEF Decree, in case of liquidation (liquidazione coatta amministrativa)
of the issuer, only the SPV will be entitled to enforce the rights of
the covered bondholders against the issuer in the insolvency proceedings
and any amount recovered by the SPV as a result of the exercise of such
rights will be part of the cover pool. The Bank of Italy supervises
compliance with these provisions.
As the cover pool must be only composed of high-quality assets, only
three main types of assets can be transferred to the SPV (with the
exception of integration assets described below).
The first type is residential and commercial mortgage loans, provided
that the outstanding amount of the loans does not exceed 80% (with
respect to the residential mortgage loans) and 60% (with respect to the
commercial loans) of the value of the property.
Second is exposure to public sector entities (public assets). In
particular, the cover pool may comprise receivables owed (or guaranteed
with a guarantee that is valid for purposes of the credit risk
mitigation). It may also consist of securities issued (or guaranteed) by
the following: public entities of EEA Member States and the Swiss
Confederation with a risk weighting (standardised method) not higher
than 20%; public entities of other states, to which a 0% risk weighting
would apply; and, local public entities of other states, with a risk
weighting not higher than 20% (within the limit of 10% of the cover
The third type of asset which can be transferred to the SPV is
asset-back securities with a risk weighting not higher than 20%, and
provided that at least 95% of the underlying assets consist of the
eligible assets indicated above.
Exposures to credit institutions are not eligible to be included in
the asset pool originally assigned to the SPV. However, for the purpose
of ensuring compliance with the mandatory tests on the cover pool which
will be described below, in addition to the eligible assets listed
above, two other types of assets may be used for the purpose of the
integration of the cover pool. The first of these is the creation of
deposits with banks incorporated in EEA Member States, the Swiss
Confederation or in a state which attracts a risk weight factor equal to
0%. The second is the assignment of securities issued by the banks
referred to above, having a residual maturity not exceeding one year.
Integration through these two types of assets is only allowed within the
limits of 15% of the cover pool.
The legislator has also set out a number of specific provisions aimed
at protecting the investors in covered bond instruments issued by
Italian banks. At the same time, the regulations have established
certain restrictions and minimum requirements for Italian banks who want
to access the covered bond market. These are intended to avoid banks
wanting to access the covered bond market excessively depleting their
portfolio of assets, at the detriment of the other creditors of the
Tests set out under the MEF Decree
Pursuant to the MEF Decree, the issuer and the seller (to the extent
different from the issuer), will have to ensure that, in the context of
the covered bond transaction, three mandatory tests are satisfied on an
First, the net present value (valore attuale netto) of the
assets included in the cover pool, net of the transaction costs to be
borne by the SPV, including the expected costs and the costs of any
hedging entered into in relation to the transaction, must be greater
than or equal to the net present value of the outstanding covered bonds.
Second, the outstanding aggregate nominal amount (valore nominale complessivo) of the assets comprised in the cover pool must be greater than or equal to the aggregate nominal value (valore nominale) of the outstanding covered bonds.
Finally, the interests and proceeds deriving from the asset pool, net
of any cost and expenses to be paid by the SPV, must be sufficient to
cover the interests to be paid under the bonds and the other costs and
expenses to be borne by the issuer in relation to the transaction (also
taking into account the relevant hedging agreements).
There is no mandatory over-collateralisation required under the law.
However, contractually, covered bonds programmes established in Italy,
especially if the relevant bonds are assigned a rating, usually provide
for a minimum level of over-collateralisation, agreed upon with the
rating agencies, and therefore for an asset coverage test which will
take into account such over-collateralisation. Furthermore, the
transaction documents will provide for an amortisation test (which, like
the asset coverage test, will usually be agreed with the rating
agencies) to be performed after the occurrence of an issuer event of
Controls over the transaction
The Bank of Italy Regulations set out a system of rules on controls
to be carried out by the issuer in order to ensure the regularity of
covered bond transactions.
The management body of the issuer must ensure that the internal
structures delegated to the risk management verify certain elements for
each transaction on a regular basis. Among other things, this inlcudes:
the quality and integrity of the assets sold to the SPV guaranteeing the
payment obligations of the issuer; compliance with the maximum ratio
between covered bonds issued and the portfolio sold to the SPV for
purposes of backing the issue, in accordance with the MEF Decree;
compliance with the limits to the assignment and the limits to
integration set out by the Bank of Italy Regulations; and, effectiveness
and adequacy of the coverage of risks provided under derivative
agreements entered into in connection with the transaction.
To ensure that the SPV can perform in an orderly and timely manner
the obligations arising under the covered bond guarantee, the issuer
must also put in place asset and liability management techniques for
purposes of ensuring that the payment dates of the cash-flows generated
by the portfolio substantially match the payments dates with respect to
payments due by the issuing bank under the covered bonds issued and the
other transaction costs.
Finally, in relation to the information flows, the parties to the
covered bonds transactions shall assume contractual undertakings
allowing the issuer (and the seller, if different) also acting as
servicer (and any third party servicer, if appointed) to hold the
information on the portfolio which are necessary to carry out the
controls described in the Bank of Italy Regulations and for the
compliance with the supervisory reporting obligations, including the
obligations arising in connection with the participation to the central
credit register (Centrale dei Rischi).
The asset monitor
Pursuant to the Bank of Italy Regulations the issuer must also
appoint a third party (known as the asset monitor) to carry out controls
over the regularity of the transaction and the integrity of the covered
bond guarantee in favour of the covered bondholders.
The asset monitor must be an auditing firm with adequate professional
experience in relation to the tasks entrusted to it, and independent
from the bank that has appointed it and from the other entities that
take part in the transaction; in particular, the asset monitor must not
be the same auditing firm that is entrusted with the auditing of the
issuer, the seller and the SPV.
The asset monitor must prepare annual reports on controls and
assessments on the performance of transactions, to be addressed, among
others, to the body having the control function within the issuer.
The Bank of Italy Regulations make reference to the provisions of the
Banking Law which impose on persons who are responsible for control
functions within the banks specific obligations to report to the Bank of
Italy. Such reference appears to be aimed at ensuring the reporting of
any irregularities found
The Bank of Italy does not exercise a specific supervisory activity
over covered bond transactions. Pursuant to the Italian Banking Act,
however, it will supervise banks in all of their activities, which
includes covered bonds transactions.
Requirements and limits
As mentioned above, the Italian authorities wanted to ensure
protection of the other creditors of the bank, in particular depositors,
in order to avoid the bank depriving itself of its high quality assets.
The Bank of Italy Regulations therefore set specific limits that banks
issuing covered bonds are required to meet, at the issue date:
regulatory capital (patrimonio di vigilanza) on a consolidated basis of at least 500 million ($625 million); and an overall capital ratio (coefficiente patrimoniale complessivo) on a consolidated basis not lower than 9%.
The Bank of Italy Regulations also set out certain provisions which
limit the amount of assets that can be sold by a bank to the SPV for
purposes of a covered bond programme. The limits are based on the level
of the consolidated (or individual, as the case may be) solvency ratio
and the tier 1 ratio.
So far, so good
The framework provided by the Italian legislator provides
principles-based legislation, where the legislator has set forth the
main principles and provisions and guidelines with which all covered
bond transactions must comply, and has left the determination of the
details and other transaction specifics to the contractual arrangements
between the parties.
Over the past few years, all or most of the Italian banks who have
met the relevant eligibility criteria have established covered bonds
programmes. In some cases banks have established more than one
programme. Covered bonds have proved to be, especially in times of
liquidity crisis, a strong source of funding for Italian banks, who used
these financial products for funding with the capital markets, at
first, and then as collateral for financing transactions with the
European Central Bank.
The legal framework provided by the Italian legislator has imposed
restrictions on banks and mandatory controls over transactions. In
conjunction with contractual arrangements, which have integrated the law
drawing on other European experiences and have now become quite
homogenous for all players in the market, this has contributed to
providing Italian banks with an instrument for accessing liquidity which
has so far proved effective and adequate for both banks and
||Allen & Overy|
Annalisa Dentoni-Litta has wide experience in structured finance, securitisations and covered bond transactions, with a focus on public finance and Italian local entities. Her structured finance experience includes advice to arrangers, issuers and originators in relation to a number of public and private securitisations, both domestic and cross-border, as well as receivables purchase transactions, involving various types of receivables including RMBS, consumer loans, healthcare receivables, tax, and trade receivables. She has assisted, and continues to assist, on several covered bond programmes established by Italian banks.
Dentoni-Litta holds a law degree from the University of Rome, La Sapienza, and an LLM from New York University School of Law. She is admitted to the Italian and New York Bars and has also practised law in New York, where she gained significant experience in debt and equity offerings, securitisations and other structured finance and private equity transactions.