• In Latvia, a new type of securities - covered bonds 
Publication:

In Latvia, a new type of securities - covered bonds 

02 August 2021

On 27 May this year, the Saeima accepted and on 23 June, the Covered Bonds Law came into force, which provides the introduction of a new type of securities - “covered bonds”.

The law is based on and implements Directive (EU) No 1095/2010 of the European Parliament and of the Council of 27 November 2019. 2019/2162 on the issue of covered bonds and public supervision of covered bonds. The Covered Bonds Act replaces the former Mortgage Bonds Act, but it is much more modern and suitable to the European single market for financial services.

Covered bonds are a popular way of raising finance among European banks and increase their lending opportunities, thus facilitating the financing of mortgages and public sector loans. These are covered bonds - a set of enclosed assets to which investors in covered bonds will have a claim. Collateral or cover assets may include the issuer's claim rights arising from various agreements. The dual cover, the claim against the issuer and the portfolio of cover assets, is called the 'double recourse' mechanism and provides these securities with high security and liquidity. The assets of a credit institution that cover investors' claims are separated from the other assets of the credit institution by creating a specially established company that guarantees investors and creditors of covered bonds for the repayment of the principal amount of covered bonds.

The law will also provide for specific procedures for cross-border issues of covered bonds, i.e. will provide an opportunity to offer these securities to investors outside Latvia.

Expected impact of covered bonds on the financial services market

It is planned that covered bond issues will, on the one hand, increase the number of free credit resources in credit institutions, and on the other hand, will allow banks to reduce lending rates, thus encouraging credit growth and allowing credit institutions to compete with alternative financiers.

From the investors' point of view, investors, especially institutional investors, will have the opportunity to invest and purchase safe financial instruments. Attracting investments for the implementation of new projects will also be promoted; loans will become usable for long-term investments.

Indirectly, the new law will promote the successful implementation of housing construction and other special state support programs related to long-term lending. Credit institutions will have access to an independent source of long-term funding that will improve the stability of public finances in times of economic downturn and crisis.

Given that the credit rating of covered bonds can reach even the highest credit rating level (AAA), it is expected that the price of borrowed financial resources will be significantly lower than the price of borrowed funds by issuing unsecured bonds and will create savings for credit institutions.

Potential issuers and target audience

Only credit institutions will be able to issue covered bonds.

The Covered Bonds Law harmonizes the national regulatory framework between the three Baltic States, thus ensuring the possibility to issue this type of financial instruments at the Baltic level. The size of the housing market separately in each of the Baltic States - Estonia, Latvia, and Lithuania - is significantly smaller than in the other EU Member States, where there is currently a covered bond market. According to experts, the possibility of covered bond issues at the national level should be assessed critically for the following reasons:

  1. the costs of setting up a covered bond program are relatively high;
  2. covered bonds are considered to be a liquid financial product, however, in order to ensure high liquidity, a sufficient amount of bonds must be in circulation. In addition, the amount in circulation is essential for the admission of covered bonds to regulated markets;
  3. in order for interested potential investors to be offered different types of covered bond programs, preferably with different maturities.

In view of the above, the Covered Bonds Law introduced the possibility to combine bank assets from the three Baltic States in the cover portfolio in order to ensure more favorable conditions for securities issues on the international market. Several unrelated credit institutions may participate in the same covered bond issue, provided that each of them is licensed in one of the EU Member States. In that case, one of the participating credit institutions is the issuer and the others are disposers who simply transfer the covered assets to the covered bond company. The transferor does not become a shareholder of the covered bond company; the relationship between the transferor and the issuer is governed by the cover asset management agreement.

Theoretically, small Latvian credit institutions could find cooperation partners in other European Union member states (not necessarily in Estonia and Lithuania) and create such a coverage portfolio and issue bonds that are interesting enough for Western European investors or even investors outside Europe.

BDO services for credit institutions involved in the issuance of covered bonds:

  • Advice on the intended structure of the issue and the risks associated with it;
  • Establishment of a covered bond company;
  • Development of the relevant internal documents of the credit institution and the covered bond company, as well as the business continuity plan of the covered bond company;
  • Legal services related to (1) the conclusion of a disposal agreement and the disposal of cover assets, (2) the conclusion of a cover portfolio management agreement, and (3) the conclusion of a guarantee agreement between the issuer and the covered bond company;
  • Advice relating to the management and supervision of the cover portfolio and the disclosure obligations of the covered bond company;
  • Representation at an investor meeting, resolution of issues related to investor relations;
  • Performance of the duties of an investor trustee appointed by the Issuer.