Key features of the upcoming legislation
Belgian authorities have prepared draft legislation for a dedicated legal framework to govern covered bonds issued by Belgian credit institutions (the “BCB Act”). In this newsletter, we summarize the main features of this new framework. The BCB Act and ancillary legislation which deals with certain asset related legal issues (the “Mobilization Act”), when passed by Parliament, will achieve a particularly robust framework for covered bonds as well as very important enhancements for the liquidity of Belgian loan assets more generally. This description is based on the draft legislation as it stands today and may therefore still be subject to change in the final approval process.
- On balance sheet structure, using ringfenced cover assets
The BCB Act follows the approach of certain other continental European countries (such as Germany and France) as it envisages a fully on-balance-sheet structure without the use of an SPV-issuing vehicle.
The Belgian covered bonds, officially labeled Belgische covered bonds or covered bonds belge (“BCB”), are thus issued directly by a Belgian credit institution (the “Issuer”) and the cover assets will be ringfenced on the balance sheet by using an innovative on-balance-sheet ringfencing technique that will be made available by the new legislation.
Effective ringfencing is achieved by legally splitting the overall assets and liabilities of the Issuer into a “general estate” (algemeen vermogen/patrimoine général) and one or more “special estates” (bijzonder vermogen/patrimoine spécial). Each special estate will consist of, as far as assets are concerned, the cover assets allocated to a particular issuance of BCB or a BCB program and, as far as liabilities are concerned, consist of the liabilities under the BCB and related liabilities (hedging, fees for service providers). Only the holders of BCB issued in respect of a special estate and parties related to these BCB (as referred to in the issuing documentation) will have recourse to the assets of the special estate. The general estate will consist of all assets not allocated to a special estate, and all creditors of the bank (including BCB holders and parties related to the BCB) will have recourse to the assets included in the general estate.
The BCB Act makes it clear that the creation of a special estate involves the restructuring by operation of law of the asset and liability structure of the Issuer in a way that is best comparable to the concepts of legally segregated “compartments” (a feature of many UCITS) or protected cell companies. This is especially important in order to avoid any risk of triggering “negative pledge” clauses the Issuer may have entered into previously. For banks that would prefer not to restructure their entire asset and liability structure in this way, the BCB Act recognizes and protects the transfer of cover assets to another Belgian credit institution (typically a subsidiary of the same group) that will then act as Issuer using the same ringfencing technique. The licencing requirements that are imposed by the BCB Act recognize such approach, but it will involve the issuing-subsidiary having a full banking licence, even though it would typically not have any other activity than acquiring the cover assets and issuing the BCB with the support of the parent bank (including operational support and a guarantee).
If the Issuer becomes the subject of insolvency proceedings, the BCB will not be accelerated and the special estate will remain fully ringfenced from the rest of the Issuer’s assets. The insolvency proceedings applicable to the Issuer will be limited in all respects to the general estate. Any proceeds arising from the assets contained in the special estate (even though collected by the Issuer) are automatically excluded from the assets which will be used to repay the creditors of the general estate. Thus the framework will allow the special estate(s) to continue to be managed and operated notwithstanding the insolvency of the Issuer. In such circumstance the competent regulator (see below) will appoint an independent portfolio manager. The liquidator or curator/curateur of the Issuer is required by law to cooperate with the view of the continuity of the operations of the special estate(s).
It is important to highlight that although general creditors have no recourse to the special estate, BCB holders and specified creditors will retain their general recourse on the general estate. They therefore enjoy a dual recourse (on both their allocated special estate and the general estate). Only after all BCB have been redeemed in full will any amounts left in the special estate be returned to the insolvent general estate.
- Conditions required for the issue of BCB
Only Belgian credit institutions will be allowed, under the new legal framework, to issue BCB. A general authorization by the National Bank of Belgium (“NBB”) will be required in order for a credit institution to become an issuer of BCB. In order to obtain such authorization, the credit institution will have to provide the NBB with a file in which several aspects of the credit institution’s organizational structure, risk management, and long term strategy must be described in order to demonstrate that the Issuer’s organization and strategy are suitable and ready to issue BCB and comply with the legal requirements. The NBB keeps a list of all authorized issuers of BCB on its website.
In addition to obtaining the authorization to become an issuer of covered bonds, the issuing credit institution must also obtain a specific authorization from the NBB in respect of each issuance (or issuance program) of BCB. For these purposes, the NBB will require that specific information relating to the covered bonds be provided. This must cover in particular a description of the assets contained in the cover pool and the potential mismatch between the maturity of the assets and the maturity of the bonds (or mismatch between interest payment dates). The NBB keeps a list of all approved BCB issues or issuance programs on its website.
- Cover assets
The BCB Act allows for the following categories of assets to be included into the cover pool: (a) residential mortgage loans; (b) commercial mortgage loans; (c) public sector loans with debtors from OECD member-states (or debts guaranteed by those public authorities, their central banks, or international development banks and organizations); (d) senior securities issued by securitization SPVs provided that the securitized assets are mainly of a type described in (a) to (c) and meet other certain conditions; (e) claims against other credit institutions; and (f) claims arising from hedging transactions. It is to be expected that initially only BCB—the cover assets of which comply in all respects with the asset requirements of the CRD Directive—will be authorized. BCB that are thus CRD-compliant may be referred to as Belgische pandbrief or lettre de gage belge.
For each issue of BCB or each BCB program, the cover assets (up to at least 85% of the nominal amount of the BCB) must consist of assets of one of the first three categories (so either residential mortgage loans, commercial mortgage loans, or public sector loans).
Assets will be included in the special estate by way of registration in a dedicated cover assets register. By operation of law (i.e., without separate registration) the special estate will also include (a) all cash and financial instruments received as collateral for hedging transactions; (b) all security interests, guarantees, insurance, etc. linked to the cover assets; and (c) any amounts held by the Issuer as a consequence of the recovery of the cover assets or that are otherwise held for the account of the special estate.
- Asset and liability management
The pool must, at all times during the life of the BCB, offer full coverage of the financial obligations (in principal and interests) arising from the BCB from the other creditors specified in the terms and conditions and from the administration of the pool.
The BCB Act and the draft implementing decrees provide for several asset cover tests. First, the value of the cover assets must exceed at all times the nominal amount of the BCB, (overcollateralization), a minimum level of 5% being envisaged. Second, the value of cover assets that belongs to the first three categories described above (i.e. (a) to (c) inclusive) must be at least 85% of the nominal amount of the BCB.
The Issuer will also need to comply with a liquidity test. The BCB will need to have the benefit of liquid cover assets to provide sufficient liquidity for a period of 180 days. Implementing regulations will specify what type of cover assets can be used. A liquidity facility provided by a credit institution is allowed only if the facility provider is not part of the same group as the Issuer.
For each BCB program, the Issuer will need to manage its interest and currency risk exposure.
- Special supervision and the different actors
In its capacity as a Belgian credit institution licensed to issue BCB, the Issuer will be subject to special supervision by the NBB. Based on the reporting by the Issuer and the cover pool monitor (see below) and based on audits it may directly undertake, the NBB will be able to assess the continued compliance of the Issuer with the requirements imposed to maintain the BCB license, including the requirement that the total financial position of the Issuer must provide sufficient comfort also to other creditors than the holders of covered bonds. In case of insufficient compliance, the NBB may suspend the further issuance of BCB or revoke the Issuer’s license as a BCB issuer. The withdrawal of the license as Issuer of covered bonds and the removal from the list of BCB issuers will, however, not adversely impact on the rights of holders of previously issued BCB.
Cover pool monitor
Each Issuer must appoint a cover pool monitor for each issue of BCB or for each program. Only persons or entities included in the official list of certified/statutory auditors established by the NBB for credit institutions may be charged with this role. Moreover, the specific choice must be approved in advance by the NBB. The general auditor of the Issuer may not be appointed as cover pool monitor.
The main tasks of a cover pool monitor consist of (a) ensuring compliance with legal and regulatory requirements and (b) performing reporting obligations towards the NBB on several aspects (such as the level of overcollateralization and results of the different tests that have to be performed).
Representative of the covered bondholders
The terms and conditions of the BCB will typically provide for the appointment of one or more representatives of the covered bondholders. The BCB Act requires the portfolio manager (see below), the Issuer, and the NBB to consult with such representatives when certain important decisions are being considered (e.g., in the event of early liquidation of the cover pool).
In some circumstances, a “portfolio manager” may be appointed by the NBB to manage the special estate. Those circumstances are basically when the NBB considers that the situation is such that the interest of the BCB holders is endangered (including insolvency proceedings) or where the authorization of the issuing credit institution to act as BCB issuer is withdrawn by the NBB. The portfolio manager (appointed by the NBB) will have full competence and authority to manage the special estate, without restriction, in order to ensure that all obligations due to the BCB holders (and potentially the specified creditors) continue to be respected in full. Actions by the portfolio manager could include the (partial) sale of the underlying cover assets, taking out a loan, issuance of new bonds to use for ECB purposes, or any other action that might be required to fulfill the obligations owed to the BCB holders. Any act by the credit institution in respect of the special estate which has not been ratified by the portfolio manager would automatically be null.
Acceleration of the BCB would only be possible (a) in the circumstances clearly provided for in the terms and conditions of the BCB, (b) in other circumstances where the bondholders would approve, or (c) if it is clear that further deterioration of the cover assets would lead to a situation whereby it is impossible to satisfy the obligations under the BCB.
- A particularly robust legal framework
In structuring the BCB framework, as summarized above, the Belgian authorities have successfully taken into account the experience to date in other comparable jurisdictions and markets, including applicable rating criteria. In addition, innovative solutions have been developed, including for issues that have a particular importance in the Belgian market.
Taking into account the experience with asset-based financings and in other jurisdictions, the ringfencing technique stipulated in the BCB Act includes rules that would protect the covered bond holders against the commingling of collections if the Issuer, having acted as collection agent and custodian for the account of the special estate, were to become insolvent. Thus, collections received by the Issuer after the commencement of the insolvency proceeding will be viewed as segregated from all other cash held by the Issuer and must be handed over by the Issuer’s liquidator to the portfolio manager. Also, sums already held by the Issuer prior to the commencement of the insolvency proceedings can be reclaimed by the portfolio manager, either in kind or by way of substitution with other available assets.
Asset related enhancements
Whereas the BCB Act organizes the regulatory framework for the licensing of the Issuer, the special supervision by the NBB, and the legal mechanics for ringfencing the cover assets, the Mobilization Act deals with insolvency claw-back rules and important issues relating to the suitability of Belgian loan assets to be used as cover assets. Many of these issues are particular to the Belgian market for these types of loan assets and include assignment restrictions under public procurement laws, set-off and defenses following assignment and/or inclusion in a cover pool, springing mortgages (hypothecaire volmachten/mandats hypothécaires), etc.
Restructuring of the Issuer
The BCB Act expressly addresses situations where the Government or the NBB would be forced to restructure the Issuer because of financial distress. It provides that in implementing such restructuring, the rights and interests of the special estate and the BCB holders must be safeguarded.
- Enhanced asset liquidity more generally
By giving access to the deep and more stable investors’ market for covered bonds, the BCB Act and the Mobilization Act offer Belgian credit institutions an important additional instrument to use their loan assets to attract stable funding against the best available market pricing. However, the solutions developed for the structuring of BCB will also (directly or indirectly) favor other types of asset-based funding and the liquidity of loan portfolios generally. First of all, as envisaged already in 2011 when the financial collateral legislation was extended to include banking loans as collateral type, the new legislation completes the Belgian financial collateral legislation to the extent that it applies to banking loans, so that underlying asset restrictions are also removed for the effective use of loans as collateral. Second, the removal of such restrictions will also have a positive impact on existing and new securitization and repackaging transactions, in particular those intended to allow originating banks to have access to collateralized funding provided by the Eurosystem. Finally, these changes will be directly beneficial for sales of loan portfolios or for further consolidation (at asset level) of the (Belgian) banking sector.