SEC approval for RBC to issue covered bonds in a public offering in the US has been seen by some, including a Senator, as positive, but the arrangement has also triggered uncertainty about whether tougher asset disclosure standards under Reg AB II could be required in future, potentially impeding the development of a domestic issuer base.

David Power, vice president, corporate treasury at RBC, told The Covered Bond Report that the move to seek full SEC registration of a covered bond programme is in line with the bank’s practice to issue in a registered format wherever possible in foreign markets.

“The move is independent of the covered bond legislation initiative in Canada, but it is complementary to it,” he added. “We are reaching the end of our ability to evolve our programme in the context of the US and hopefully we have got closer to the best practice model that we will be using going forward.”

Ben Colice, head of covered bonds origination at RBC Capital Markets, said that full SEC registration of a covered bond represents a positive step for the market, with any such deal expected to be eligible for a range of bond indices.

“One way or another investors will have to take a view on SEC registered covered bonds,” he said, “and that is nothing but positive for the product because it will continue to bring it to the forefront of investors’ minds here in the US.

“Eligibility for broad indices would mean that the product qualifies for more internal investment policies and becomes acceptable to more investors.”

In addition, a fully SEC registered covered bond should be eligible for the TRACE bond reporting system, added Colice, increasing pricing transparency and improving secondary market liquidity.

RBC’s success in obtaining the Securities & Exchange Commission’s approval for issuance of its covered bonds into the public market may also spur momentum on US covered bond legislation, with one of the Senators who sponsored covered bond legislation in November responding to the SEC registration of RBC’s programme by calling for “swift” action on a US legal framework.

“The growing acceptance of covered bonds among US regulators is a positive development, said Democrat Kay Hagan in a statement released on Monday. “Unfortunately, until a legislative framework for covered bonds is in place in the US, our economy, US lenders and their customers will be unable to benefit from the low cost funding that covered bonds provide.

“This is all the more reason for the Congress to act swiftly to pass legislation to authorize this mainstream capital markets product.”

Mike Durrer, partner at Sidley Austin, said that the SEC-RBC move is a positive step in respect of its potential implications for US covered bond legislation.

“It can only be helpful in terms of building momentum,” he said, “and focussing people’s minds to get something on the table once distractions associated with an election year are out of the way.”

In addition, he said, to the extent that the possibility of SEC registration of covered bonds increases issuance by Canadian and other non-US issuers, this would enhance the argument about foreign institutions soaking up US investment dollars that should also benefit the home market.

Regarding the topic of asset disclosure, he said that the no action letter serves as a useful template for covered bond structures following the UK model, such as the programmes recently established in Australia, although non-US issuers using a similar issuance structure to RBC’s would need to fulfil other basic standards of corporate and financial disclosure in addition to providing cover pool information if they do not already issue SEC registered securities.

“They would need to consider whether they already issue SEC-registered debt and take into account that there are other hurdles to clear,” he said.

RBC’s move is also a useful forerunner for US covered bonds, said Durrer, even though the no-action letter would not be fully applicable to US issuers based on Congressman Garrett’s legislative proposal in the House of Representatives.

“It helps set the stage by providing a template for the type of disclosure, in particular asset disclosure, that will likely be applicable to US covered bonds,” he said. “It’s useful to have this preview of the disclosure the US issuers may eventually need to provide in terms of asset and bank disclosure.”

Reg AB “consistency” sparks concerns

However, the terms on which the SEC’s approval of RBC’s filing are based have also caught the attention of market participants given the reference in the no action letter to disclosure being “consistent” with Regulation AB, a rule codifying requirements for the registration, disclosure and reporting for all publicly registered asset-backed securities, and the prospect of reporting standards such as loan level data being required under a revised version of the regulation that is under development, Reg AB II.

Lewis Cohen, partner at Clifford Chance, said that the no action letter implies important questions about what happens when Reg AB II comes into effect, with the letter suggesting that reporting standards set out by the updated regulation could need to be taken into account.

While this is something of “the elephant in the room”, Cohen said that the SEC’s willingness to weigh in with a relatively market-friendly approach given political sensitivity around covered bonds and reform of the housing finance system in general and at a time of regulatory flux is a positive signal that the SEC is looking to find ways to support capital market initiatives.

But others have concerns that the precedent set by RBC may be prejudicial to the development of a domestic US covered bond market, with the reporting standards that form the basis of the SEC’s no action release for RBC key to this outlook.

“The deal they cut is a curious one, in that they offered to comply with Reg AB,” said Ralph Daloisio, managing director, Natixis, and chairman of the American Securitization Forum. “That in itself isn’t a problem since that level of disclosure is probably appropriate for covered bonds, but the issue is that Reg AB II is really in play now and that aims for loan level disclosure.

“That could have a chilling effect on the development of the issuer side for covered bonds in the US, if they start to look less attractive to issue than asset-backeds, for example. From an investor perspective, it might put covered bonds in the camp of collateral focused buyers rather than senior unsecured credit investors.”

Daloisio also said that, with a lack of legislative progress in Washington, foreign issuers are setting precedents that may or may not be appropriate for the US.

“Because we are not moving forward quickly enough in setting the standards for a domestic dollar market, the Yankee issuers are having more and more influence over how this market shapes up,” he said. “It’s not Americans who are deciding what the American market is starting to look like, and at the end of the day that might not be the right road to go down because I think the American market should be deciding more for itself what this market should look like if it ever happens here.”

Sidley Austin’s Durrer said that the logic of the no action letter in its reference to Reg AB suggests that registered covered bonds would also be subject to Reg AB II and any additional disclosure standards set out in this regulation.

“The Reg AB effect is partly known and partly unknown,” he said. “The current Reg AB sets higher disclosure standards than are currently in use in 144A covered bond offerings, but what the new version will entail is a bit of an unknown and we do not expect to see it until next year.”

Gareth Old, partner at Clifford Chance, noted that while the no action letter states that the SEC does not consider the guarantor in RBC’s structure to be an issuer of ABS, further insight into the SEC’s thinking in their response letter would have been helpful to better gauge the potential future applicability of Reg AB II.

“It would have been nice to know whether the SEC agreed to issue a no action letter because it considers as a matter of principle or long term policy that a covered bond guarantor is not an issuer of an ABS,” he said, “or whether it concluded that as a practical matter since the guarantor was providing equivalent disclosure to an ABS issuer that whether it constitutes an ABS issuer or not was irrelevant to its determination.”

Disclosure package strikes a balance

Morrison & Foerster (MoFo) advised RBC on the filing of its registration statement with the SEC and Jerry Marlatt, senior of counsel at the law firm, said that the SEC’s position is that covered bonds are not ABS and therefore not subject to Reg AB, but that the no action letter sets out that disclosure should be “consistent” with Reg AB.

“But they won’t commit to limit their future rulemaking authority,” he said. “In the future they could decide to expand Reg AB to cover the type of hybrid securities represented by covered bonds, i.e. part corporate debt obligation and part ABS obligation.”

And even if the SEC does not bring covered bonds within the definition of securities that are subject to Reg AB, added Marlatt, the Commission may request additional disclosure for covered bonds in their review of registration statements that are filed.

Colice at RBC Capital Markets said that the disclosure requirements strike “a nice balance” between what information is possible for issuers to provide and what investors will find valuable to help them make investment decisions.

“They are more fulsome than what has been seen in the US covered bond market in the past, and we believe this will be beneficial for the product more generally,” he said.

MoFo’s Marlatt said that the disclosure requirements come closest to those for UK master trust RMBS programmes, for example in that loan-by-loan data is not asked for.

“In a way the requirements are tailor-made,” he said. “It’s a compromise from the staff’s point of view between senior bank debt and an ABS security because it does not fit neatly into either from the SEC’s point of view.”

“From an ABS perspective the disclosure is by analogy more like that at master trust level for a credit card programme,” he said, “and because multiple series are issued off such programmes and because the assets are pretty granular the SEC does not in its proposal to amend Reg AB propose to require loan by loan disclosure for credit cards. We will have to wait and see where the commission will come to a year or two from now on covered bonds.”

However, given moves by the ECB and Bank of England to require loan level disclosure the prospect of such reporting being required in the US is not much of a concern to issuers such as those in the UK, he said.

Marlatt also noted that market participants are following an SEC proposal to apply the same ABS disclosure requirements to 144A programmes that they do to registered programmes, which could have enormous implications for the existing market.

“The fact that they’ve deemed covered bonds not to be ABS doesn’t directly address that proposal but it suggests that they might not see covered bonds as ABS for those purposes.”

Away from the question of cover pool disclosure standards and any future applicability of Reg AB II, market participants also picked up on other aspects and effects of RBC’s move.

Durrer, for example, raised the possibility of the precedent of SEC covered bond registration reducing overseas interest in issuing under the 3(a)(2) format given that the former offers similar and more advantages, while Old at Clifford Chance drew attention to RBC’s approach in registering the programme without doing so in a manner that is compliant with the Prospectus Directive, as a result of which it could not issue the same series of notes to US investors and European investors requiring a listing.

“Some of the old master trust ABS structures were set up to be SEC-registered and listed, which was quite cumbersome, so you can understand why RBC did not take this approach,” he said. “However, it means that they would have to have a separate prospectus for listed European offerings and shows that they are making decisions about which investors they would market any particular series to.”