The U.K. Treasury has announced its plans to introduce new regulations for the U.K. covered bond market. The new rules are broadly aimed at enhancing the creditworthiness of covered bonds and making U.K. banks more cost efficient.
The Treasury said that the legislation will comply with the Undertakings for Collective Investment and Transferable Securities (UCITS) directive that allows for authorized investors in European Union (EU) member states to risk weight U.K. covered bonds at 10%, as opposed to the 20% these bonds are currently weighted at.
Last February, the U.K.'s Financial Services Authority (FSA) said in a letter that it planned to have new rules for covered bonds in place by January 2007. The secondary legislation introduced by the Treasury will involve consultations with the U.K. parliament and is likely to be introduced later in 2007. "They have said that the directive will be implemented by the end of 2007, we were hoping that would mean sooner rather than later," said Mauricio Noe, head of covered bonds at ABN Amro. "It's not ideal that it's delayed and I think the market will find that once it's passed, we will be in a better position than we were in the first place."
The directive would generally help continental European investors to better understand the functions of covered bonds under a common law jurisdiction - having a distinct law would give these players something tangible to understand, Noe explained. Currently, there is no recognized covered bond regime in the U.K.
Although U.K. covered bonds are based on existing European legislation, they are not currently recognized under these laws by the FSA, thus the U.K. authorized banks currently issuing structured covered bonds do not benefit from the lower risk-weighting for covered bonds under an EU recognized regime. In order to have an EU recognized covered bond regime, a country must implement the requirements found in Article 22(4) of the UCITS Directive. This directive, originally published in 1985, imposes protection for covered bonds holders. The FSA has not yet implemented the requirements in Article 22(4) so the U.K. does not have, at present, an EU recognized covered bond regime.
The implementation of Article 22(4) was initially presented in consultation paper (CP) 135 and feedback was given to this CP in policy statement (PS) 135. While CP135 said that the FSA believed that there would be no demand for this type of instrument; a number of respondents thought the provisions should be implemented to ensure maximum future flexibility. The FSA response in February stated that implementing these articles - which have been provided for in the directive since 1988 - would give the market additional duties, over and above those of merely making provision for such investments in the current rules. As there was no demand to invest in these bonds at the time, the FSA did not permit it. The policy statement did, however, state that the FSA would reconsider this issue if there were enough demand in the future.
ABN's Noe said that these upcoming changes to U.K. covered bonds currently being discussed have not caused any market movement.
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