Proposed New Zealand covered bond legislation should be amended to include elements such as a minimum OC level and maximum loan-to-value ratios, Westpac NZ has argued in a submission to a parliamentary committee reviewing the draft law, with one out of another five filed calling for covered bonds to be prohibited.

The Finance & Expenditure Committee received six submissions on the Reserve Bank of New Zealand (Covered Bonds) Amendment Bill, which would create a legal framework governing covered bond issuance in the country. The deadline for submissions was 3 July, with the committee due to report by 22 November.

Submissions came from two law firms, PricewaterhouseCoopers, a senior associate at the Institute of Policy Studies at the Victoria University of Wellington, and Westpac New Zealand, while New Zealand’s existing four covered bond issuers plus Kiwibank submitted comments as a group.

PricewaterhouseCoopers’ submission restricted itself to provisions concerning the role of the cover pool monitor, noting at the beginning of its comments that the nature of the monitor’s involvement with a covered bond issue and related statutory functions is unclear, while the group of existing and prospective covered bond issuers focussed on making technical drafting suggestions, albeit noting that the bill “will significantly enhance their ability to access the domestic and international covered bond markets in a more competitive manner than is currently possible”.

Law firm Russell McVeagh said that it supports the introduction of the covered bond bill, and that it endorses the recommendations made in the submission by the group of issuers, who they assisted, with the law firm Chapman Tripp making the same endorsement.

Of the six submissions, only those of Westpac NZ and the senior associate, Ivo Geoffrey Bertram addressed the broader substance of the proposed legislation.

Westpac was party to the submission made by the group of New Zealand covered bond issuers, but also filed standalone comments to propose amendments that it said should be made “so as to ensure that the maximum benefit can be derived from it and that it does not result in any unintended consequences”.

The suggested amendments include: that the transition period for existing covered bond programmes to be registered with the Reserve Bank of New Zealand (RBNZ) should be extended from six to 12 months; that a statutory minimum overcollateralisation (OC) level of 105% be included; and that RBNZ should designate eligibility criteria for cover pool assets.

Fitch previously noted that the proposed New Zealand legal framework is not prescriptive compared with other covered bond issuing countries, for example leaving open what types of assets are eligible for cover pools, and not specifying limits on loan-to-value (LTV) ratios for mortgage loans or a minimum OC level. (See here for previous coverage of the proposed legislation.)

With respect to a minimum OC levels, Westpac said that there should be a statutory minimum level of 105%, noting that contractual minimum OC for New Zealand covered bond programmes is typically between 103%-111%, with around 120% required by rating agencies for a triple-A rating, and that the Australian covered bond legislation provides for a 103% minimum OC level.

“Investors are likely to gain additional comfort from having this requirement entrenched in legislation and not just in contract,” said the bank. “The impact on issuers will be relatively low given the existing programme documentation specifies higher contractual minimum overcollateralisation levels.”

The value attributed to the loans secured by residential mortgages for the purposes of determining the statutory minimum OC, it added, should be limited to loans with a maximum LTV of 80%. Loans with higher LTVs should be allowed to be included in the cover pool, but with a haircut for the purposes of that test, said Westpac, as is the case in legislation in several overseas jurisdictions, including in the European Union and Australia.

In addition, the RBNZ should avail itself of the right granted to it by the bill to specify on its register different classes of cover pool assets that covered bond programmes would be designated as, said Westpac, such as residential mortgage covered bonds or commercial property loan covered bonds.

“It is important that the Reserve Bank designate at least a residential mortgage class and specify the eligibility criteria for that class promptly after the legislation is passed,” said the issuer. “Investors will have additional comfort knowing that there are regulatory eligibility criteria as a ‘back-stop’ for the contractual criteria and that the regulatory eligibility criteria are similar to the criteria used in overseas jurisdictions (for example, the EU and Australia).”

Assets eligible for a residential mortgage class of covered bonds should include, according to Westpac, home loans secured by New Zealand residential mortgages, at call bank deposits, registered certificates of deposit issued by New Zealand registered banks (other than the covered bond issuer or an associated person thereof) up to a limit of 15% of the face value of the covered bonds issued, New Zealand government bonds, and contractual rights relating to the assets in the cover pool.

“If the Reserve Bank were to designate a class with eligibility criteria as per the above,” said Westpac, “it is likely that only very minor changes (if any) would need to be made to existing covered bond programmes.”

The submission from Bertram, a senior associate at the Institute of Policy Studies at the Victoria University of Wellington, was the only one registering opposition to the proposed framework.

“My central submission therefore is that covered bonds ought to be prohibited explicitly by legislation,” he wrote, “and I ask the Select Committee to recommend accordingly.

“If the Select Committee feels unable to face down the banking lobby and ban these bonds,” he added, “I submit that it should demand far stronger safeguards and restrictions than the Reserve Bank is proposing.”

The structural subordination of unsecured creditors as a result of covered bond issuance is central to his argument, with Bertram noting that covered bonds are “a device to put a favoured group of investors ahead of other (unsecured) creditors in the queue to recover their money in the event of a bank failure” and that they are “corrosive of the incentives that governments the world over acknowledge are needed to reduce the risk of future banking crises”.

Although retail deposit insurance or guarantees can protect depositors the cost of such schemes is borne by taxpayers, most of whom are bank depositors, he said.

His submission made several criticisms of a Regulatory Impact Statement (RIS) accompanying the draft covered bond legislation, such as it not addressing currency mismatches as a result of offshore issuance or not explaining why a 10% limit on issuance as a proportion of a bank’s total assets was chosen rather than a tighter limit.