Reserve Bank proposes law to protect covered bonds

Grant Spencer. Photo / Supplied

The Reserve Bank has proposed that new legislation be put in place to protect investors in covered bonds in the event of a bank being placed in statutory management.

Covered bonds are debt securities issued by banks, where the bond holder is both an unsecured creditor of the bank and holds a secured interest in a pool of assets, called the cover pool.

In the event of a bank failure, holders of covered bonds rank higher than bank depositors when it comes to getting their money back.

New Zealand banks have dipped their toes into the covered bond market over the last year or so, with the Bank of New Zealand being the first to tap into this market.

Reserve Bank deputy governor Grant Spencer said yesterday that covered bonds can provide banks with access to a stable funding source, which helps support stability during times of severe disruption in international markets.

"The proposed legislative framework aims to provide investors with legal certainty as to the treatment of cover pool assets in the unlikely event that the issuing bank becomes insolvent," he said.

The Reserve Bank has proposed that covered bond issues are registered with the bank, the cover pool assets are held by a special purpose vehicle (SPV), and that an asset pool monitor is appointed.

The central bank said a change in the law would be required to provide that the SPV can not be included in the statutory management of the issuing bank and that certain moratorium provisions of the statutory management and liquidation regimes would not prevent the SPV gaining full legal control over the cover pool assets.

PwC financial services partner Sam Shuttleworth said regulation would clarify the legal position of covered bonds and ultimately increase investor confidence in them.

"Therefore this gives the banks another secure source of funding, which is good in these times of volatility in the financial markets."

Following a previous consultation in October 2010, the Reserve Bank imposed an upper limit on the volume of covered bonds that can be issued by locally incorporated banks to a maximum of 10 per cent of the total assets of the issuing bank.

Covered bond issuance in Europe has been heavy in the wake of the European sovereign debt crisis because it has been one of the few reliable sources of funds at a time when other funding avenues have dried up.

The Australian government has only just made covered bonds legal and Australian banks have made moves to follow their New Zealand offshoots by raising funds in this market.

Massey University Centre for Banking Studies senior lecturer David Tripe said covered bonds had some advantages for the banks because they allowed them to lock in some long-term funding.

"The potential risk is that the assets available to [covered bond owners] may not be available to other creditors in the case of a liquidation," Tripe said. "Those are the pluses and minuses, and then there is the mechanics of how they work it all out."

Submissions on the Reserve Bank's proposals close on March 16, 2012.