On July 23, the UK Treasury and the Financial Services Authority (FSA) announced a consultation on proposals that will allow UK issued covered bonds, a class of corporate bond where interest and repayment of the principal is “guaranteed” by ring-fenced assets, to benefit from options on EU Directives.

The lack of a covered bond regime in the UK has been cited as a prime reason why the development of long-term fixed rate mortgage lending has been restricted.

The proposed framework is designed to provide the necessary underpinning for compliance with the EU’s Undertakings for Collective Investment in Transferable Securities (UCITS) Directive. For example, covered bonds that comply with the UCITS Directive benefit from higher prudential investment limits. UCITS can invest up to 25 % (rather than 5%) of their assets in the compliant covered bonds of one issuer.

In summary, the proposals would require: (i) the issuer must be a credit institution with a UK registered office, (ii) UK recognized covered bonds will be regulated by the FSA, (iii) bonds will be supported by an asset pool, (iv) the asset pool must have sufficient collateral to cover bondholder claims throughout the whole term of the bond, and (v) bondholders must have a priority claim on the asset pool in the event of insolvency.

The consultation period ends on October 15.

http://www.fsa.gov.uk/pubs/cp/cp_bonds_hmt.pdf