The evolution of Swiss structured covered bonds
Daniel Haeberli and Stefan Kramer of Homburger consider why the first bond issued by a Swiss car leasing company is the next logical step in the evolution of Swiss structured covered bonds
At the end of 2021, a new Swiss capital market instrument was successfully launched: a bond issued by a Swiss car leasing company backed by a pool of lease receivables and leased cars. This transaction was a primer in Switzerland and Europe, but also a logical next step in the evolution of Swiss structured covered bonds.
Switzerland does not have a legislative framework for the issuance of structured covered bonds. As such, Swiss covered bonds do not necessarily correspond to the common definition of covered bonds set out in the legislative framework of the EU for the issuance of covered bonds but may, depending on its features, be classified of secured notes in the European terminology.
Swiss structured covered bonds have been in existence for a while and are based on contract law and designed to replicate international market standards. The first Swiss structured covered bonds were issued more than 10 years ago by the UK branch (or another non-Swiss branch) of the two Swiss GSIBs into the international market.
To a considerable extent, such Swiss structured international covered bonds were built on features developed in the context of covered bonds structured under English law (including a UK trustee concept), but the resulting structure was tailored to reflect specific Swiss legal, regulatory, tax and insolvency law aspects.
Starting in 2017, Swiss banks developed purely Swiss law governed covered bond structures for the Swiss market with a listing on the Swiss securities exchange SIX Swiss Exchange. Swiss banks replicate traditional English law elements of covered bonds under Swiss law, enabling the covered bonds to be assigned a triple-A rating. Until recently, Swiss structured covered bonds were exclusively issued by Swiss banks with a portfolio of mortgage assets as cover pool. This changed at the end of 2021.
On November 10 2021, the first Swiss structured covered bond was launched where the issuer is not a Swiss bank and the cover pool does not comprise of mortgages.
AMAG, Swiss largest mobility group, has developed a new structure for the issuance of covered bonds that are indirectly backed by a portfolio of lease assets. AMAG’s auto-covered bond programme is employing traditional techniques of the contractual structured covered bond format used by Swiss banks but uses a different kind of asset pool to back the bonds.
The issuer under the programme is AMAG Leasing, the leading car leasing company in Switzerland with a portfolio currently comprising of approximately 180,000 car lease contracts valued at more than CHF 4 billion. These lease contracts and the respective lease receivables and leased cars are used to fund the cover pool for the bonds.
The case for corporate covered bonds
Regardless of the terminology, corporate covered bond programmes present the following advantages over traditional senior coporate bonds and ABS transactions:
Dual recourse structure backed by a segregated cover pool;
In the present case, funding costs were significantly lower compared to a senior bond and an ABS (driven by a larger appetite from investors who do normally not invest in an ABS issuances due to internal or regulatory constraints);
The programme allows the issuer to approach the market within a short timeframe;
The issuance volume can be chosen freely based on investor demand, which allows the issuer to adjust the offering size to market appetit;
Low additional costs for follow-on transactions make smaller issuance volumes economically attractive;
One cover pool serves all outstanding auto covered bonds; and
Long-term maintenance costs are lower compared to ABS.
The ALAG auto covered bond programme
AMAG Leasing’s auto covered bond programme is documented on the basis of a Swiss based prospectus. The base prospectus is approved by the SIX Exchange Regulation as Reviewing Body under the Swiss Financial Services Act and is valid for 12 months for Swiss public offerings and listings and trading admission on SIX Swiss Exchange.
The programme allows AMAG Leasing to issue an auto-covered bond with a very short time to market. This provides greater flexibility for AMAG Leasing’s financing needs allowing AMAG Leasing to access the market at any time very quickly.
Key structural elements of the auto covered bond programme
The key elements of auto covered bonds issued by AMAG Leasing can be summarised as follows:
The company issues covered bonds as direct, unconditional and unsubordinated obligations of the company.
The obligations of the issuer under the covered bonds are guaranteed in favour of the bondholders by a subsidiary of the issuer, which issues the guarantee under a guarantee mandate agreement with the issuer. Such subsidiary guarantor is incorporated as a special purpose vehicle. The only purpose of the subsidiary guarantor is to guarantee bonds issued by its parents and to receive certain lease assets as security in connection with the issue of the bonds it guarantees. In order to enhance the bankruptcy remoteness of the guarantor, recourse under the guarantee will be limited to the available funds of the guarantor from time to time, subject to the applicable priority of payments, the ability of the guarantor to make payments under the guarantee will ultimately depend on the transferred lease assets and the substitute assets assigned and transferred to the guarantor for security purposes.
Under the guarantee mandate agreement, all liabilities, costs and expenses incurred by the subsidiary guarantor under or in connection with the guarantee will have to be reimbursed (or pre-funded accordingly) by the issuer.
As security for the relevant reimbursement and pre-funding claims of the subsidiary guarantor against the issuer, a cover pool is created by the issuer transferring lease assets to the guarantor. Such transfer is for security purposes only and the ‘risk and rewards’ in respect of the transferred lease assets remain with the issuer as security provider.
Conditional pass-through: Failure to redeem a particular series of covered bonds when due does not trigger default of the issuer as long as the relevant tests (in particular, the amortisation test) are still met. Instead, the affected covered bonds would go into pass-through mode, thereby avoiding a situation where the guarantor would have to liquidate the cover pool assets under significant time constraints.
Based on the traditional covered bond concept of dual recourse, bondholders will look to the issuer for payment under the auto covered bonds. If the issuer fails to pay, the guarantee can be drawn and bondholders can make a payment claim against the guarantor.
In order for the guarantor to be able to make payments under the guarantee, it makes a respective payment claim for pre-funding against the issuer under the guarantee mandate agreement.
If the issuer fails to make payment to the guarantor under the guarantee mandate agreement, the guarantor has the right to enforce its security interest in the lease assets comprised in the cover pool and use the enforcement proceeds to satisfy its payment obligations under the guarantee. In case the proceeds from an enforcement of the cover pool were not sufficient to fully satisfy the bondholders claim under the auto covered bond, bondholders would be left with a claim against the bankruptcy estate of the issuer of the covered bond.
The dual recourse is also a key difference to an ABS (asset-backed securities) transaction where the investors just have a claim against the special purpose vehicle issuing the ABS. Another important difference is the fact that under the covered bond programme, the cover pool assets are transferred from the issuer to the issuer by way of security as opposed to a ‘true sale’.
The cover pool
While we have seen ABS transactions in Switzerland using a cover pool consisting of car lease assets, the dual recourse structure of a covered bond has so far only been used by Swiss banks using a cover pool of mortgages. AMAG’s auto covered bond is the first Swiss dual recourse structure using a cover pool consisting of car lease assets. The cover pool used by AMAG consists of the same type of assets AMAG has been using for its ABS transactions.
The key elements of the cover pool is that it consists of assets that meet certain eligibility criteria and are continuously originated and that these assets are segregated from the issuer also in an insolvency of the issuer. The main assets of the auto covered bond cover pool are the monthly lease receivables payable by the lessees and the cars being leased to the lessees by AMAG Leasing as owner thereof.
The monthly lease receivables arising under the lease agreements are silently assigned for security purposes by the originator to the guarantor. Such assignment is not disclosed to lessees and the cash flows related to the transferred lease receivables will continue to be received and collected by AMAG Leasing.
“With the new auto covered bond programme, AMAG Leasing has created a debt instrument that is investable to a larger universe of investors.”
Only upon the occurrence of an issuer event of default under the auto covered bonds will the lessees be notified of the assignment and instructed to make payment directly to the guarantor. Payments made to AMAG Leasing at a time when AMAG Leasing is insolvent will fall into the bankruptcy estate and no longer be part of the cover pool and be protected by the security granted by AMAG Leasing, unless the lessees have been given notice prior to making a payment. Therefore, it is important that notice to lessees is timely made by the guarantor in order to avoid that payments are made to AMAG Leasing.
The transfer of the leased cars from AMAG Leasing to the guarantors is structured as a transfer of legal title for security purposes under Swiss law. In order to perfect such transfer of legal title it is necessary that the lessees are informed that they are holding the leased car for the benefit of the guarantor rather than AMAG Leasing.
Any such information to lessees may be critical for the ongoing business of the originator of the assets being transferred to a cover pool. Therefore, any communication to lessees of leased cars being transferred to the cover pool needs to be carefully designed to avoid any disruption of the originator’s business.
In order to create comprehensive package not only the lease receivables and leased car are transferred to the cover pool but also the respective lease agreements and dealer agreements related to the leased vehicles as well as all claims and receivables under or in connection therewith (including claims arising from such lease and dealer agreements and any other related claims).
The transfer of the relevant lease agreements and dealer agreements from the originator to the guarantor result in a change of party. The guarantor replaces AMAG Leasing as a party to the agreements and becomes the lessor under the relevant transferred lease agreements and the purchaser under the relevant transferred dealer agreements.
Consequently, to the extent the lessees would have a claim against the lessor under the transferred lease agreements or transferred dealer agreements, the guarantor would be liable for such claim. Therefore, when structuring the auto covered bond it was important to ensure that lessees do not have any claims that may arise over the course of the term of the lease.
Last but not least, it is essential that the standard lease agreement and dealer agreement explicitly allow for a unilateral transfer of the lease agreement and the dealer agreement and any receivables / claims thereunder.
The future of Swiss corporate covered bonds
AMAG Leasing was able to price the 3.25 years inaugural auto covered bond with a negative yield of -0.2%. Despite the lack of a positive yield, the maximum possible issue size was two times oversubscribed.
With the new auto covered bond programme, AMAG Leasing has created a debt instrument that is investable to a larger universe of investors. The first auto covered bond received a lot of attention in and outside of Switzerland and it is seen by many as the door opener for other corporate covered bonds.
T: +41 43 222 16 33
Daniel Haeberli is a partner at Homburger.
Daniel is in the banking and finance as well as in the capital markets team. His areas of expertise include derivatives, structured products and bonds as well as syndicated debt financing and financial restructurings. Daniel is also the co-head of Homburger’s TechGroup and regularly advises clients on blockchain related projects.
Daniel has a master’s degree in law from the University of Zurich and a LLM in corporate law from the New York University School of Law. He is mandated by the Swiss Structured Products Association SSPA as Director of Legal & Regulation and a member of the Appeals Board of the Swiss exchange BX Swiss.
T: +41 43 222 16 35
Stefan Kramer is a partner in Homburger’s banking and finance team as well as in the firm’s tech group.
Stefan regularly advises on asset-based financings (covered bonds and securitisations), banking regulation (including regulatory capital transactions) and derivatives markets regulations. Other areas of work include DLT-based and crypto-linked issuance structures and financial markets infrastructures.
Stefan is a graduate of, and holds a PhD from, the University of Zurich and has completed a LLM at Harvard Law School.