Changes to the Czech covered bond framework have been delayed until next year due to tweaks to the proposals and political hold-ups, putting back upgrades of inaugural international issues launched in the past year that had been expected on the back of the amendments.

Raiffeisenbank a.s. launched the first benchmark-style euro covered bond from the Czech Republic in October 2014, a Eu500m five year deal, half of which was retained. This was followed by a Eu250m public debut in euros from UniCredit Bank Czech Republic & Slovakia.

Ahead of this mortgage-backed issuance, the Czech Banking Association had in 2014 begun discussions with the Czech National Bank, the regulator for covered bond issuance, and the Ministry of Finance about amending legislation – the Bond Act and Insolvency Act – to improve its treatment by Moody’s. The rating agency had, for example, applied a Timely Payment Indicator (TPI) of “very improbable” to Czech programmes.

After receiving positive feedback from the authorities, draft amendments were sent to the Ministry of Finance and market participants had said that they expected legislation to be changed this year.

However, amendments to the framework may not now come into effect until January 2017, according to Petr Vybiral, senior associate at Allen & Overy, which has been working on the process on behalf of the Czech Banking Association and has also been involved in the Raiffeisenbank and UniCredit issuance.

“There were some political moves in the country and changes to key personnel at the Ministry of Finance,” he said, “and they were busy with all the EU regulatory reforms. The topic of covered bonds was not something that was considered a priority.

“But early this year they returned to us and said that they had reviewed the draft and were ready to proceed. The Czech National Bank has said that it is happy with the latest draft and the Ministry is now making some technical amendments.”

Input from the Ministry of Justice, which has primary competence regarding the Insolvency Act, and other authorities will also be needed, according to Vybiral.

He said that the framework could now be updated in parallel with Czech MiFID 2 legislation, which is set to be implemented in January 2017 at the latest.

“That sounds realistic to me,” he said. “The current draft should be sent to the government in the fall, and to parliament early next year.”

Raiffeisenbank’s covered bonds were rated A2 at launch and cut to A3 in January because of Moody’s downgrades affecting its parent, Austrian banking group Raiffeisen Banking Group. They were then upgraded to A1 in June on the back of Moody’s implementing an update to its general methodology to incorporate Counterparty Risk assessments, which has typically resulted in higher anchor points for covered bond programmes. UniCredit Czech & Slovakia covered bonds were also upgraded, from A3 to Aa3 two weeks ago, on 5 August, as part of this update to Moody’s methodology.

But when upgrading the UniCredit issuance, Moody’s noted that the programme’s TPI of “very improbable” only restricts the rating to Aa1 and that the Aa3 rating reflects legal uncertainty regarding whether overcollateralisation (OC) will remain in the cover pool and available to bondholders after an issuer insolvency, while Raiffeisenbank’s upgraded covered bond rating was likewise below a TPI constraint, of Aa3.

According to Stepan Nyvlt, head of debt origination/structuring and bond sales at UniCredit in Prague, this is one of the key issues that the planned amendments will address. Upgrades are hence expected to follow their implementation – subject to other factors, such as the sovereign ceiling, for example, not preventing them.

Another issue that the amendments seek to address is the possible acceleration of covered bonds in the event of issuer insolvency, according to Vybiral at Allen & Overy.

“The current law does not have a caveat explicitly excluding covered bonds from the debt that would accelerate upon declaration of a bank insolvency,” he said. “So there has been a real risk that there would be an automatic acceleration of the covered bonds.

“This would be dealt with in the amendments by taking the mortgage estate out of the general insolvency regime.”

The amendments would also provide for a cover pool administrator post-insolvency, he added.

Vybiral said he expects other issuers to join Raffeisenbank and UniCredit in the covered bond market. The biggest three mortgage lenders in the Czech market are: Hypotecni banka, a subsidiary of KBC-owned CSOB; Ceska sporitelna, owned by Erste; and Komercni banka, part of the Société Générale group.

Photo: Czech Ministry of Finance; Source: SJu/Wikimedia Commons