CHAPTER xx I EUROMONEY HANDBOOKS 1 A helicopter view of Dutch covered bonds by Daniëlle Boerendans of ABN AMRO Bank N.V., Rezah Stegeman of Clifford Chance LLP and Kees Westermann of Linklaters LLP Regulated versus Contractual Covered Bonds In most European countries, covered bond issuance is regulated by specific regulation implementing the relevant provisions of the Undertakings for Collective Investment in Transferable Securities Directive (UCITS) and the Capital Requirements Directives (CRD) 1 . In the Netherlands, covered bond regulation was implemented in 2008, which in comparison to the rest of Europe, was relatively late. In this respect a distinction needs to be made between covered bonds which are issued pursuant to such specific covered bond regulation (Regulated Covered Bonds) and covered bonds which are issued outside the scope of such specific covered bond regulation (Contractual Covered Bonds). Until about eight years ago the jumbo covered bond market consisted exclusively of Regulated Covered Bonds. 2 Exhibit 1 demonstrates the basic elements of a Dutch covered bond structure. Essentially, a Dutch bank issues covered bonds to the covered bondholders and transfers cover assets to a special purpose vehicle called a covered bond company (the CBC). The covered bonds are unsecured bonds which are guaranteed by the CBC, meaning that if the issuing bank defaults, the CBC will, instead of the issuing bank, make payments of scheduled principal and interest to the covered bondholders, thus creating dual recourse for the covered bondholders. The above structure is called a ‘segregated’ structure because the cover assets are segregated from the issuing bank. The segregated structure needs to be distinguished from an ‘integrated’ structure, where the cover assets continue to be owned by the bank and no CBC is involved. The basic elements of a Dutch covered bond structure Exhibit 1 Issuing bank CBC Covered bondholders Covered bonds Guarantee Transfer of assets ABM AMRO_DEBT_2010 13/9/10 16:12 Page 1
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CHAPTER xx I EUROMONEY HANDBOOKS
1
A helicopter view of Dutch covered bondsby Daniëlle Boerendans of ABN AMRO Bank N.V., Rezah Stegeman of Clifford Chance LLP and Kees Westermann of Linklaters LLP
Regulated versus ContractualCovered Bonds
In most European countries, covered bond issuance is
regulated by specific regulation implementing the relevant
provisions of the Undertakings for Collective Investment in
Transferable Securities Directive (UCITS) and the Capital
Requirements Directives (CRD)1. In the Netherlands, covered
bond regulation was implemented in 2008, which in
comparison to the rest of Europe, was relatively late. In this
respect a distinction needs to be made between covered
bonds which are issued pursuant to such specific covered
bond regulation (Regulated Covered Bonds) and covered
bonds which are issued outside the scope of such specific
covered bond regulation (Contractual Covered Bonds).
Until about eight years ago the jumbo covered bond
market consisted exclusively of Regulated Covered Bonds.2
Exhibit 1 demonstrates the basic elements of a Dutch covered bond structure.Essentially, a Dutch bank issues covered bonds to the covered bondholdersand transfers cover assets to a special purpose vehicle called a covered bondcompany (the CBC). The covered bonds are unsecured bonds which areguaranteed by the CBC, meaning that if the issuing bank defaults, the CBCwill, instead of the issuing bank, make payments of scheduled principal andinterest to the covered bondholders, thus creating dual recourse for thecovered bondholders. The above structure is called a ‘segregated’ structurebecause the cover assets are segregated from the issuing bank. Thesegregated structure needs to be distinguished from an ‘integrated’structure, where the cover assets continue to be owned by the bank and noCBC is involved.
The basic elements of a Dutchcovered bond structure Exhibit 1
Issuing bank
CBCCovered
bondholders
Covered bonds
Guarantee
Transfer ofassets
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CHAPTER xx I EUROMONEY HANDBOOKS
This changed in 2003, when the first jumbo Contractual
Covered Bonds were issued, out of the UK. The UK example
was soon followed by banks from other countries such as
Canada, France, Germany, Italy, Switzerland, the US and
the Netherlands (starting with ABN AMRO in 2005). Like
the UK, the Netherlands did not have specific covered bond
regulation when the first jumbo Contractual Covered Bonds
were issued.
Specific Dutch covered bond regulation (the Regulation)
was introduced in the Netherlands in 2008. The Regulation
aims to:
• provide Dutch issuers with a level playing field with
other issuers of covered bonds within the European
Union;
• facilitate a market in safe instruments in accordance
with the applicable European directives; and
• impose solid conditions to protect covered bondholder
interests.
The Regulation does not recognise an integrated structure
but embraces the segregated structure referred to above.
Under the Regulation, asset segregation takes place on the
basis of the Dutch Civil and Bankruptcy Codes. The
applicable statutory provisions are relatively creditor-
friendly and have enabled the Dutch legislator to take a
time-efficient and principles-based approach without
having to amend the Dutch Civil or Bankruptcy Code.
Five Dutch covered bond programmes are active to date.
One out of those five programmes enables issuance of
Contractual Covered Bonds only and is not yet registered
under the Regulation. The other four programmes are
registered under the Regulation and enable the issuance of
Regulated Covered Bonds.3
Cover pool
To date, all Dutch covered bond programmes are backed by
residential mortgage loans. In addition they allow for
inclusion of substitution assets, meaning euro-denominated:
• cash; or
• subject to minimum rating and maximum percentage
requirements (this differs per programme), other assets
eligible under the CRD to collateralise covered bonds.
All programmes allow for inclusion of non-Dutch
residential mortgage loans, subject to certain restrictions.
In practice all cover pools consist of Dutch residential
mortgage loans and, in one programme, German
residential mortgage loans.
The Regulation regards CRD-compliance as an option, and
not as a requirement. It allows issuers of (and thus
investors in) Dutch covered bonds the flexibility to choose
whether they wish to issue (or invest in) covered bonds
which are either:
• UCITS-compliant; or
• both UCITS and CRD-compliant.
All four Dutch programmes registered under the Regulation
are designed to be both UCITS and CRD-compliant. The
above feature of CRD-compliance as an option should be
seen against the background that the CRD prescribes that
covered bonds may be backed by residential mortgage
loans only up to the lesser of: (a) the principal amount of
the relevant mortgage right; and (b) 80% of the value of
the underlying mortgaged property.
However, relevant Dutch residential mortgage loans may in
practice have a loan-to-value (LTV) ratio of up to 125%. To
date all Dutch covered bond programmes take a two-step
approach towards LTV ratios of Dutch residential mortgage
loans, as follows:
• the loan is only eligible as a cover asset if its principal
amount did not exceed 125% (subject to some
exceptions in some programmes; the Eligibility
Percentage) of the value of the mortgaged property at
origination; and
• once a loan forms part of the cover assets, the
maximum value attributed to it in valuing the cover
assets is a certain percentage (the LTV Cut-Off
Percentage – this differs per programme) of the value
of the underlying mortgaged property at such time.
2
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CHAPTER xx I EUROMONEY HANDBOOKS
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For example, if: (a) the relevant LTV Cut-Off Percentage is
80%; and (b) a residential mortgage loan has a principal
amount of 110 and is backed by mortgaged property with
a value of 100, then such loan would be valued at no
more than 80 in the asset cover test determining the
value of the cover assets. The 30 excess value of the loan
would serve as extra credit enhancement in Dutch
covered bond programmes. That would not be the case in
integrated covered bond structures used in other
countries applying prescriptive (i.e., rule-based rather
than principles-based) regulations.
The LTV Cut-Off Percentage applied to Dutch residential
mortgage loans is:
• 80% in Dutch covered bond programmes which are
designed to be backed by CRD-compliant cover assets
(i.e. ABN AMRO, ING, NIBC and SNS);
• 125% in Dutch covered bond programmes which are
not designed to be backed by CRD-compliant cover
assets (i.e., Achmea); and
• notwithstanding the percentages mentioned in the
previous two paragraphs, 100% or a different
percentage for residential mortgage loans that have
the benefit of a Dutch National Mortgage Guarantee
(Nationale Hypotheek Garantie).
Asset and liability management
Under all current Dutch covered bond programmes a total
return swap is entered into at the inception of the
programme in relation to the cover assets. The total return
swap essentially swaps the different types of interest to be
received on the cover assets to one month’s EURIBOR. In
addition, an interest rate swap or structured swap is
entered into each time a series of covered bonds is issued.
The interest rate/structured swap essentially swaps one
month’s EURIBOR/euros to the interest rate/currency
payable under the relevant series of covered bonds.
All Dutch covered bond programmes require the issuer to
establish a reserve fund equal to one month’s interest
payments on the covered bonds, plus certain costs and
expenses for one month if the issuer’s short term rating is or
falls below P-1/F1/A-1 or A-1+ (this differs per programme).
To mitigate liquidity risk on principal payments all Dutch
covered bond programmes use either:
• a pre-maturity test which is taken on each business
day during the period up to 12 months preceding the
maturity of the relevant covered bonds. The pre-
maturity test is failed if on the relevant test date the
issuer’s short term rating is, or falls below P-1/F1+/A-
1+. A breach of the pre-maturity test requires: (a) the
issuer to cash-collateralise hard bullet maturities; or
(b) the CBC to procure alternative remedies such as a
guarantee of the issuer’s obligations, a liquidity facility