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Public sector covered bonds

The legal framework for the mortgage covered bonds and public sector covered bonds set forth in Decree-Law 59/2006 of March 20 2006 (DL 59/2006) came into force on March 27 2006 but it was not until June 2008 that the first Public Sector Covered Bonds (PSCBs) programme was established in Portugal, with other programmes of the same nature expected to follow in the near future.

Only credit institutions with no less than €7.5 million ($10.2 million) own funds, the corporate purpose of which includes the granting of credits secured by mortgages over real estate and credits granted to, or guaranteed by, public sector entities may issue PSCBs.

Only credits granted to central public administrations, regional or local authorities of any EU member state, as well as credits guaranteed by an express and legally binding guarantee issued by a central public administration, regional or local authority of any EU member state may be allocated as collateral to the performance of PSCBs.

PSCB underlying assets benefit from the special nature, reputation and solvability usually connected with the public nature of the respective debtors or guarantors, a feature that contributes much to the AAA potential that PSCBs entail.

In addition to the public sector credits, other assets may also be allocated as collateral to the performance of PSCBs. Such assets comprise deposits with the Bank of Portugal (BoP) in cash or in securities eligible for credit transactions in the Eurosystem, current or term account deposits with credit institutions (which are not in a control or group relationship with the issuer) having a rating equal to, or higher than, the minimum rating required at any time by the rating agencies, providing such minimum rating is at least "A-" or equivalent, as well as other assets meeting both the low risk and high liquidity requirements as determined by the BoP.

The issue of PSCBs may be made either on a continuous basis or in series and a PSCB's maturity can be neither shorter than two years nor longer than 50 years.

Special creditor's privilege and segregation rules

Another essential feature of PSCBs is that holders benefit from a special creditor's privilege over the underlying assets included in the cover pool allocated to the PSCB as an autonomous and segregated pool of assets (património autónomo), which is not available to meet any other debts or liabilities of the issuer until all payments due to the holders of PSCBs have been made in full. This means that holders are entitled to be paid out of capital and interest related to the PSCBs with preference over the generality of the other issuer's creditors.

Also, in the event of the issuer's dissolution or winding-up, the assets allocated to the PSCBs and included in the cover pool, as well as all payments of interest and principal thereunder, are segregated from the issuer's estate until all payments due to the holders of PSCBs have been made in full.

The register of all assets comprised in the cover pool will be made in segregated accounts of the issuer, ensuring segregation between the assets allocated to the PSCBs and the assets allocated to other issuer's liabilities (such as those assets allocated to other covered bonds issued by the issuer) at all times.

Prudential limits

The issue of PSCBs is subject to tight prudential limits including the prohibition of: (i) the global nominal amount of outstanding PSCBs exceeding the global amount of the assets comprised in the cover pool; (ii) the average maturity of the outstanding PSCBs exceeding the average maturity of the assets comprised in the cover pool; and (iii) the global amount of interest to be paid to the holders of PSCBs exceeding the amount of interest to be received under the assets pertaining to the cover pool.

The compliance with these prudential requirements is assessed and monitored on a regular basis by an independent cover pool monitor and, in the case of breach of those limits, the issuer is obliged to allocate new assets to the cover pool or to acquire outstanding PSCBs in the secondary market.

Offers and trading of PSCBs

The relevant provisions of the Portuguese Securities Code (including the Prospectus Directive as implemented) apply, necessary changes having been made, to the offers of PSCBs, irrespective of their public or private nature, and PSCBs can be admitted to trading on regulated markets.

ECB eligibility

The PSCBs, which are held through central securities depositaries (CSD) such as Interbolsa-Sociedade Gestora de Sistemas de Liquidação e de Sistemas Centralisados de Valores Mobiliários, SA, Euroclear Bank SA/NV and Clearstream SA are eligible collateral for Eurosystem operations, providing the additional requirements of the European Central Bank are fully met.

Tax regime

PSCBs benefit from the attractive tax treatment enacted through Decree-Law 193/2005. Under said regime, investment income paid to non-resident beneficial owners of PSCBs, as well as capital gains arising from the sale or other disposal of such PSCBs integrated in the centralised system for securities recognised under the terms of the Portuguese Securities Code and complementary legislation will be exempt from Portuguese income tax provided that certain non-resident requirements are met.

Also, the fact that the issue of PSCBs and the interest payments paid in connection thereto are not subject to stamp tax in Portugal increases their attractiveness.

In a sensitive global financial context where the more regulated a product is the bigger are the chances of its success, PSCBs appear as alternative investment products to be borne in mind by market participants, now made available for the Portuguese banking community to use in their qualified access to liquidity in an environment requiring increased security and protection for investors.

Ana Rita Almeida Campos and Lara Reis

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