Covered Bond Directive: Norwegian implementation

On 13 January, the Financial Supervisory Authority of Norway (“FSAN”) released a consultative paper relating to the new EU legislation on covered bonds.[1] The consultative paper includes proposals to amend the existing Norwegian covered bond legislation to comply with the new EU legislation, which must be implemented by 8 July 2021 and take effect no later than 8 July 2022. FSAN has not expressed any particular view on when the proposed changes should take effect in Norway.

We are pleased to see that FSAN has taken a conservative approach and mainly proposed changes where strictly necessary to comply with the EU legislation. However, some of the proposals may warrant a closer look by market participants. Below we discuss a selection of the proposals set out in the consultative paper and the possible consequences for Norwegian covered bond issuers if the proposals are adopted as presented.

 

Covered bonds will be divided into two classes

The Covered Bond Directive introduces two distinctive covered bond classes, namely European Covered Bonds and European Covered Bonds Premium. The former must fulfil only the requirements in the Covered Bond Directive, whereas the latter must also fulfil the requirements in CRR Art. 129. FSAN proposes that the Norwegian terminology should be, respectively, obligasjoner med fortrinnsrett standard and obligasjoner med fortrinnsrett pluss. Today, Norwegian issuers mainly issue CRR Art. 129 compliant covered bonds and we expect most Norwegian covered bonds to fall within the premium category after implementation of the directive. To the extent that any Norwegian issuers would like to issue non-premium covered bonds, they must notify FSAN and create a separate cover pool for such non-premium bonds.

Less strict LTV requirements

Current Norwegian covered bond legislation is in some respects stricter than the new EU legislation. For instance, CRR Art. 129 allows for inclusion of residential property mortgages with a loan to value (LTV) ratio up to 80 per cent., while Section 11-4 of the Financial Undertakings Regulation (Nw. finansforetaksforskriften) only allows for an LTV ratio up to 75 per cent. If FSAN’s proposal to incorporate CRR Art. 129 by reference is implemented (which we expect it will), the amount of applicable cover assets for Norwegian covered bond issuers with cover pools consisting of residential property mortgages will increase. As of today, 22 out of 24 Norwegian covered bond companies issue residential mortgage backed covered bonds, meaning that this change will be of benefit to most issuers.

More hedging counterparties may become eligible

CRR Art. 129 permits covered bond issuers to enter into hedging arrangements with credit institutions qualifying for credit quality step (CQS) 3 or better, subject to certain conditions. The current Norwegian requirement is CQS2. Since Norwegian legislation cannot be stricter than CRR Art. 129 on this point, FSAN’s proposal means that Norwegian covered bond issuers will, subject to the approval of FSAN, be able to transact with CQS3 hedging counterparties if the limiting of potential hedging counterparties to CQS1 or CQS2 institutions only would cause a concentration risk. According to FSAN, the number of potential CQS1 and CQS2-qualifying hedging counterparties available to Norwegian covered bond issuers today is sufficient to conclude that there is currently no concentration risk in the Norwegian market.

The statutory overcollateralisation (OC) requirement will be increased

The new EU legislation introduces an OC requirement of 5 per cent., while the current Norwegian statutory requirement is 2 per cent. FSAN proposes to amend the Norwegian statutory requirement to 5 per cent. to comply with the EU requirement. However, almost all Norwegian covered bond issuers are currently contractually obligated to ensure that their cover pools are overcollateralised by more than 5 per cent., and since CRR art. 3 (12) defines overcollateralisation as the entirety of the “statutory, contractual or voluntary level of collateral that exceeds the coverage requirement”, it could be asked whether FSAN’s proposal to amend the Norwegian statutory OC requirement is really necessary. In any case it appears that the introduction of such a statutory requirement in Norway should not have any practical implications for Norwegian covered bond issuers today. A lower requirement of 2 per cent. is proposed for issuers with cover pools consisting of government or municipal loans, which currently comprises one Norwegian issuer.

A new liquidity buffer requirement

The current liquidity requirement in the Norwegian covered bond legislation is not sufficiently detailed to meet the requirements of Art. 16 of the Covered Bond Directive. FSAN proposes amendments to specify that issuers’ liquidity reserves must cover net outflow for the next 180 days, and that is not permissible to apply the extended maturity date for ‘soft bullet’ covered bonds when calculating the net outflows. These new requirements will lead to increased costs for many Norwegian covered bond issuers.

To avoid the “double liquidity” requirement created by Regulation (EU) 2015/61 (“LCR Regulation”), FSAN proposes to deduct the 30 day liquidity requirement under the LCR Regulation from the 180 day requirement under the Covered Bond Directive. Notably, issuers will be required to hold LCR liquidity outside of the cover pool whereas the remaining liquidity requirement must be held as substitute assets in the cover pool. In order to rectify this anomaly, a change to the LCR Regulation is likely needed.

Restrictions on soft bullet triggers will be introduced

Most if not all Norwegian covered bond issuers have included ‘soft bullet’ conditions in their covered bonds. A ‘soft bullet’ is an extended maturity feature which allows the issuer to unilaterally postpone the repayment of the principal of a covered bond on its scheduled maturity date if the issuer is unable to make the repayment on time. The ‘extended’ maturity date is usually one calendar year after the scheduled maturity.

FSAN’s proposal allows for the continued use of soft bullet structures in Norwegian law. As regards the directive’s requirement for “objective criteria” to determine the triggers for extended maturity on covered bonds, FSAN has decided to take a wait-and-see approach and refrain from making any proposal until it is clear what other EU member states have proposed in this regard.

Issuers can no longer appoint their external auditors as cover pool monitors

Current Norwegian legislation provides that the issuer’s external auditor can act as cover pool monitor. However, Art. 13 (4) of the Covered Bond Directive excludes this option, and FSAN has proposed to amend the Norwegian legislation accordingly. FSAN proposes that the cover pool monitor must be a certified auditor, and that Norway should not adopt the optional provision in the Directive that allows for internal cover pool monitors. As it is common for Norwegian issuers to appoint their external auditors as cover pool monitors today, we expect that this change will lead to additional costs for the issuers.

New requirements for reporting and publication of investor information

The Covered Bond Directive imposes certain reporting duties on covered issuers not found in current Norwegian covered bond legislation, and the FSAN’s consultation paper thus includes proposals to implement such rules in Norwegian law. This includes the new requirements for detailed investor information set out in Art. 14 of the Covered Bond Directive, and the regulatory reporting required by Art. 21.

1 Directive (EU) 2019/2162 (“Covered Bond Directive”) and Regulation (EU) 2019/2150 implementing certain amendments to Art. 129 of Regulation (EU) No 575/2013 (“CRR”). References herein to CRR Art.129 are references to the provision as amended by Regulation (EU) 2019/2150.
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