The Reserve Bank of New Zealand published proposals for covered bond legislation today (Friday), saying that existing issuance should be able to be brought under the framework easily and that the plans will clarify treatment of cover pool assets in the event of a bank failure.

“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,” said Reserve Bank deputy governor Grant Spencer. “Legislative frameworks exist in most other countries with covered bond markets.”

The proposals follow a consultation launched in October 2010 on a framework for covered bond issuance by New Zealand banks.

“Industry responses to the consultation indicated widespread support for a legislative framework,” said the Reserve Bank in the new consultation.

“The regime proposed in this document provides a simple and low cost approach to regulating covered bonds,” it added.

The Reserve Bank highlighted what it said are key elements of the proposals:

• covered bond issues must be registered with the Reserve Bank;
• the cover pool assets must be held by a special purpose vehicle;
• an asset pool monitor must also be appointed to monitor the cover pool; and
• legislative amendment to provide that the SPV cannot be included in the statutory management of the issuing bank and that certain “moratorium provisions” of the statutory management and liquidation regimes will not prevent the SPV gaining full legal control of cover pool assets.

“The Reserve Bank considers that there are unnecessary costs involved in establishing current structures in order to provide priority for covered bond holders to cover pool assets,” said the Reserve Bank in the consultation paper. “Further, some market participants appear to be uncertain as to the potential application of the statutory management regime to cover pool assets.

“The Reserve Bank considers that a statutory framework aimed at clarifying the treatment of cover pool assets in the event an issuing bank fails would be beneficial. The proposal involves two main elements: a requirement that covered bond issues are registered and a ‘carve-out’ of registered issues from specific parts of the statutory management and liquidation regimes.”

The changes, said the Reserve Bank, will require amendments to the Reserve Bank Act 1989, The Corporations (Investigation and Management) Act 1989, and sections 248 and 271 of the Companies Act 1993.

In April the Reserve Bank introduced a rule whereby banks must not encumber more than 10% of their total assets through covered bond issuance and this condition is not being revisited in the consultation.

The Reserve Bank said that some responses to its previous consultation said that the framework should provide that covered bond issues are repo-eligible with the Reserve Bank.

“We do not consider that it would be appropriate, or necessary, to provide for repo-eligibility in legislation as this would create inflexibility,” it said. “Hence we do not discuss repo-eligibility further in this paper.”

The consultation is open until 16 March 2012.