The Finance & Expenditure Committee of New Zealand’s House of Representatives has recommended that covered bond legislation going through parliament be passed with few amendments and with a 10% cap in place, but did not take up key suggestions from market participants.

In a report on the Reserve Bank of New Zealand (Covered Bonds) Amendment Bill, the MPs said that their amendments are generally for clarification purposes.

New Zealand parliament buildings, Wellington

However, they discussed the key issue of risks to unsecured creditors and a related 10% cap on the proportion of a bank’s assets that may be encumbered in favour of covered bonds, saying that they had given careful consideration to how covered bonds may affect ordinary depositors.

“We have sought to weigh up this increased risk for unsecured creditors against the benefits offered by issuing covered bonds,” they said. “The main benefit is the reduced likelihood that a bank will default in times of financial market stress, because the ability to issue covered bonds improves banks’ access to longer term, relatively secure funding. Another potential benefit is that the reduced funding costs for banks from issuing covered bonds may be passed on to unsecured creditors if banks can pay higher deposit rates.

“On balance, we consider that the risks to unsecured creditors are justified provided their application is limited to a conservative proportion of a bank’s assets.”

The MPs agreed that a prevailing Reserve Bank 10% cap on issuance in place since 2011 was appropriate. They noted that Australia has a lower, 8% cap, but said that this works differently and is indeed in practice comparable to New Zealand’s cap, and said that a lower cap, such as the 4% applied in Canada, would restrict issuance to New Zealand’s largest banks.

“It is of interest that ratings agencies have assessed the issuance of covered bonds by New Zealand banks with a 10% limit as ‘ratings positive’ for unsecured debt; that is, that the benefits outweigh any risks to unsecured creditors,” added the MPs. “After considering all these factors, we have concluded that a 10% issuance limit as currently imposed is appropriate.”

They also discussed the possibility of the cap being determined by the government and legislation rather than by the Reserve Bank, but a majority of the MPs preferred that the central bank retain the power to change the limit to enable it to respond flexibly and rapidly in times of crisis.

Other amendments proposed by the MPs were mainly technical in nature and substantive changes that were recommended in submissions to the committee were not taken up. Westpac NZ, for example, had called in a submission for legislation to include a minimum overcollateralisation level.

Fitch had earlier noted that the draft bill also left open what types of assets are eligible for cover pools and did not specify limits on loan-to-value ratios for mortgage loans.

The report can be found here.