The Estonian parliament passed a new covered bond law on Wednesday, paving the way for potential issuance later this year and a planned pan-Baltic market, while Moody’s deemed the move a credit positive for the country’s banks.

Draft legislation was published in April 2018 and the Covered Bond Bill (760 SE) was adopted by a plenary session of the parliament on Wednesday. According to Moody’s, the law will enter into force on 1 March and allow banks to issue covered bonds from 1 October once they have regulatory approval.

The rating agency said today (Monday) that covered bonds will allow Estonian banks to diversify their funding sources and extend debt maturities, thereby improving asset-liability mismatching – a credit positive.

Estonia’s law provides key safeguards to investors, according to Moody’s, including dual recourse, close regulatory supervision of programmes and leverage limits. However, the rating agency said there is ambiguity around events that would trigger a separation of the cover pool from the issuer.

“The uncertainty is around the timing and effect of separating a covered bond programme from the issuer because the new law considers the cover pool separated if a resolution procedure is initiated for the issuer, which would likely be credit negative if the issuer was resolved as a going concern (or its assets transferred to one) but the cover pool and covered bonds were separated and no longer benefited from key issuer support,” it said. “According to available information, after a separation triggered by resolution, the covered bond programme would remain managed by the issuer and would benefit from a senior unsecured claim against the issuer but in a resolution, the cover pool would be managed and disposed of in accordance with provisions of the resolution law.”

Estonia, Lithuania and Lativa signed a memorandum of understanding in November 2017, agreeing to work together on harmonising capital markets regulations and dismantling investment barriers, with the creation of a pan-Baltic legal framework for covered bonds as one of the first projects.

Moody’s said the Estonian initiative is a potential first step towards this goal.

“A pan-Baltic market would allow banks to gain the critical mass that enables benchmark-size bond issuance (typically from EUR500m) to create a liquid market and attract foreign investors,” it said.

Luminor Bank has already said it is targeting covered bond issuance this year.

Photo: Toompea Castle, home of the Estonian parliament; Credit: Kaupo Kalda/Riigikogu