In Sweden, the issuance of covered bonds is governed by the Swedish Covered Bonds Issuance Act (‘CBIA’), which came into force on 1 July 2004 and has been revised a couple of times, lastly this summer with the regulation required by the Covered Bond Directive (CBD) and adaption to amendments in the Capital Requirements Regulation (CRR). The CBIA prevails over the general bankruptcy regulation and grants covered bond investors a priority claim on the eligible cover assets. A regulation and guidelines from Finansinspektionen, the Swedish Financial Supervisory Authority (‘SFSA’), complement the legislation. In the SFSA regulation and guidelines, some detailed criteria are specified regarding authorisation to issue covered bonds, cover pool requirements, coverage requirements and the cover register. The regulation has been revised to implement some parts of the CBD.
Structure of the issuer
The CBIA allows for all banks and credit institutions to issue covered bonds, provided that they have obtained a special authorisation from the SFSA. The issuer has to meet certain criteria to qualify for the authorisation. These criteria include the submission of a financial plan showing the issuer’s financial stability for the coming three years, the conversion of any outstanding mortgage bonds into covered bonds and the conduct of business in compliance with the CBIA. The SFSA has the right to withdraw the authorisation should the institution be in material breach of the CBIA or have failed to issue covered bonds within one year of receiving the authorisation (Figure 1). If the SFSA withdraws an authorisation, the SFSA may lay down a plan to wind down the operation.
The cover assets correspond to the covered bond holders claims on the issuer and remain on the balance sheet, i.e. there is no transfer of the cover assets to a separate legal entity. The covered bonds are direct, unconditional obligations on the part of the issuer. The cover pool is dynamic, and the outstanding covered bonds are secured by the whole cover pool; the individual cover bonds are not linked to any specific cover assets.
In the event of insolvency of the issuer, the cover pool is bankruptcy-remote and not included in the general insolvency estate of the issuer but is exclusively available to meet outstanding claims of covered bond holders. Moreover, covered bond holders enjoy ultimate recourse to the insolvency estate of the issuer, ranking pari passu with unsubordinated creditors.
Eligible cover assets are mortgage loans, loans to the public sector and exposures to credit institutions. There is no requirement for separate cover pools for mortgage and public sector cover assets; both asset classes can be mixed in a single cover pool. However, most of the cover assets are mortgages (more than 95% of the assets in the cover pools).
For mortgagees to be eligible as cover assets they should be secured by:
- real property intended for residential or commercial use;
- site-leasehold rights intended for residential or commercial use;
- a pledge against tenant-owner rights; or
- similar foreign collateral (EEA).
Mortgages to commercial property are limited to 10% of the total value of the cover pool. If the purpose of the commercial property is agriculture this limitation is not valid. The collateral for the mortgage loans has to be located in Sweden or the European Economic Area (EEA). Neither asset-backed nor mortgage-backed securities are eligible as cover assets. The mortgage loans have to meet valuation criteria and certain loan-to-value ratios specified in the CBIA and the SFSA regulation (see section IV).
Eligible public sector assets are securities and other claims according to Capital Requirement Regulation (CRR) article 129(1) point (a) and (b).
Cover assets can also be exposures to credit institutions according to CRR article 129(1) point (c) that fulfil credit quality step 1 or 2. If the asset just fulfil credit quality step 3 an approval from the SFSA is needed. Assets that fulfil the requirement for the liquidity buffer are also allowed.
Non-performing loans due over 60 days cannot be included for the purpose of meeting the matching requirements set forth in the CBIA.
The CBIA provides for the use of derivatives for hedging of interest and currency risk. The derivatives must be structured so that an early termination is not triggered by an issuer default or on the counterparty’s demand. Collateral, a guarantee or replacement language is required from the counterparty in the event of the rating falling below the minimum rating level. There are no reciprocal requirements on the covered bond issuer, but the derivative counterparty has a priority claim on the cover pool. The derivative contracts are included in the net present value coverage calculation, the purpose of which is to ascertain a good balance between the value of the assets and the liabilities in the covered bond programme.
Valuation and LTV criteria
The principles for the valuation of collateral for the mortgages in the cover pool are specified in the CBIA. The valuation relating to residential properties may be based on general price levels. The value of any other eligible property class must be based on the market price and determined on an individual basis by qualified professionals. The market value should reflect the price achievable through a commercial sale, without time pressure and excluding any speculative or temporary elements. Issuers are required to monitor the market value of the property in line with CRR article 129(3), and in the case of a significant decline review the valuation and ensure that the loan to value (LTV) of the related mortgage loan remains within the limits.
For the various mortgage types eligible as cover, the following maximum LTV ratios apply:
- 80% of the value for real estate, site-leasehold rights and tenant-owner rights where the property is intended for residential use;
- 60% of the value for real estate, site-leasehold rights and tenant-owner rights where the property is intended for commercial use, which may be exceeded up to a maximum level of 70% if all conditions prescribed in CRR article 129(1) point (f) are met.
The LTV limits are relative, not absolute. A loan with a higher LTV ratio can be included in the cover pool up to the legal threshold. The balance is refinanced through other funding instruments.
The issuer is required to test and analyse how changes in property values may affect LTV ratios and the value of the cover pool at least once a year. The tests should be based on conservative assumptions.
The CBIA requires the nominal value of the cover assets to at all times be at least 102 percent of the aggregate nominal value of claims arising from outstanding covered bonds. The cover assets, including derivatives, should, on a net present value basis, always be at least 102 percent of the corresponding net present value of outstanding covered bonds, taking into account the effects of stress-test scenarios on interest and currency risks set by the SFSA. The stressed scenario that should be tested regarding interest-rate risk is a sudden and sustained parallel shift in the reference swap curve by 100 bps in an unfavorable direction, and a twist in the swap curve. The currency risk should be tested for a 10% sudden and sustained change in the relevant foreign exchange rate for the currency of the covered bonds and the currency of cover assets. There is a minimum overcollateralisation (OC) requirement of two percent. Both the statutory OC and any additional OC for structural enhancement purposes are bankruptcy-remote and protected in the event of issuer insolvency.
The issuer shall ensure that the cash flow with respect to the assets in the cover pool, any derivative agreements and the covered bonds are such that the issuer is always able to meet its payment obligations towards the bondholders and derivative counterparties. The issuer should be able to account for these funds in the register.
The issuer must cover at any time the cumulative maximum net cash outflow for the next 180 days with a liquidity buffer. The issuer may hold assets defined as liquid under level 1 or 2A of the EU Liquidity Coverage Regulation or short-term exposures to credit institutions of credit quality step 1 or 2. Under certain conditions the SFSA can allow some specific other assets (level 2B and deposits from institutions CQS 3).
The issuer can use covered bonds with extendable maturity structures. The bonds can be extended after an approval by the SFSA, and such approval can only be achieved if the SFSA is convinced that the extension will prevent a default of the issuer. If the issuer uses extendable bonds, it is the extended maturity date that is used to calculate the liquidity buffer.
The issuers are required to disclose information regarding their cover pool and outstanding covered bonds every quarter in line with the requirement in CBD article 14. This is being done publishing the harmonized transparency template (HTT) and a national transparency template (NTT) on each issuer’s website.
In addition to the publicly disclosed information, the issuers are required to give their respective cover pool inspector (see section VII) additional information, specified in the SFSA regulation, and do quarterly reporting to the SFSA.
Cover pool monitoring and banking supervision
The covered bond issuers are subject to special supervision by the SFSA. The SFSA supervises the issuers’ compliance with the CBIA and related regulatory provisions. If an issuer is in material breach of its obligations under the legal framework, the SFSA can issue a warning or revoke the authorisation to issue covered bonds altogether. The SFSA may also revoke an authorisation if the issuer waives the license or if the institution has failed to issue covered bonds within a year from the date of the authorisation.
For each issuer, the SFSA appoints an independent and suitably qualified cover pool inspector (cover pool trustee), who is remunerated by the covered bond issuer. The duties of the cover pool inspector are to monitor the register and verify that the covered bonds, the derivative agreements, and the cover assets are correctly recorded. The inspector also ensures compliance with calculation of coverage and market risk limits in accordance with the framework. The inspector is also required to monitor the revaluations of underlying collateral that has been conducted during the year. The issuer is obliged to provide the covered bond inspector with any information requested relating to its covered bond operations. The inspector submits a report of his or her assessment to the SFSA on an annual basis and is required to notify the SFSA as soon as he or she learns about an event deemed to be significant.
Segregation of cover assets and bankruptcy remoteness of covered bonds
The issuer is required to keep a register of the eligible assets in cover pool, derivative contracts, and out- standing covered bonds. The law specifies the form and content of the register, which shall be easily accessible for the SFSA and the cover pool inspector. The registration ensures that the covered bondholders and derivative counterparties have a legally enforceable priority claim on the cover pool in the event of issuer insolvency. Prior to an issuer being declared insolvent, cash flows accruing from the cover assets must be accounted for in the register by the issuer. In the event of issuer default, covered bond holders and derivative counterparties have the same priority claim on such cash flows as they have on the cover pool. Any cash flows accruing from the cover assets after issuer insolvency should also be recorded in the cover pool register.
In the event of issuer insolvency, the registered cover assets, registered derivatives and the covered bonds are segregated from the general insolvency estate. Covered bonds are not accelerated as long as the cover pool fulfils the requirements set out in the CBIA, which also allows for “temporary, minor deviations”. An issuer default does not trigger early termination of any registered derivative contracts. Covered bond holders and registered derivative counterparties have a priority claim on the cover pool and cash that derives from the pool, ensuring timely repayment to original agreed terms, as long as the cover pool is compliant with the CBIA. The cover pool does however not constitute a separate legal estate.
Under the Swedish Bankruptcy Code, the insolvency of a parent company does not automatically trigger the insolvency of its subsidiary.
Cover pool default and preferential treatment
In the event of dissolution of the cover pool may the covered bonds become accelerated. Covered bond holders and derivative counterparties would have a priority claim on the proceeds from the sale of the cover assets, ranking pari passu among themselves but prior to any other creditors. If the proceeds are insufficient to repay all liabilities on the outstanding covered bonds, covered bond holders and derivative counterparties would have an ultimate recourse to the insolvency estate of the issuer, ranking pari passu with unsubordinated creditors.
Survival of OC
Any OC present in the cover pool at the time of the issuer’s insolvency is bankruptcy-remote provided that it is recorded in the cover pool register. Full repayment of outstanding claims related to the covered bonds and registered derivatives is required before the cover assets would be available to satisfy any claims from unsecured creditors.
The law does not provide for the appointment of a special cover pool administrator. The receiver-in-bankruptcy represents the interests of both the covered bond holders and the unsubordinated creditors. The receiver can use the OC to pay advance dividends to other creditors of the bankrupt issuer, if the pool contains more assets than necessary. If the cover assets later prove to be insufficient, these advance dividend payments can be reclaimed.
Access to liquidity in case of insolvency
In the cases of the issuer’s insolvency, the law does not enable the receiver-in-bankruptcy to refinance maturing covered bonds by issuing new covered bonds. The receiver cannot substitute ordinary cover assets for other assets. However, the receiver can utilise available liquid assets included in the cover pool and is allowed to sell assets from the cover pool to create the necessary liquidity.
The receiver-in-bankruptcy also has a mandate to, on behalf of the bankruptcy estate enter into loan agreements and other contracts for the purpose of maintaining sufficient coverage and liquidity and managing the currency and interest rate risks. The receiver should only enter into agreements if, on the date of execution of the agreement, the agreement is deemed to be in the bondholders’ and derivative counterparties’ interest and if the assets in the cover pool are deemed to fulfil the legal requirements. When the receiver enters into an agreement, the counterparty has a claim on the bankruptcy estate that ranks ahead of all creditors.
Risk-weighting and compliance with European legislation
The Swedish covered bonds are compliant with CRR article 129 and CBD. Since the bonds are compliant with CRR article 129, the applicable risk-weight for the Swedish covered bonds will be ten percent for those banks that use the standard method. Because the CBIA require compliance with CRR article 129, the bonds can be labelled “European Covered Bond Premium” and “svensk säkerställd obligation”.
Covered bonds issued in other jurisdictions enjoy the same preferential capital treatment in Sweden, subject to the relevant foreign supervisory authority having assigned the covered bonds preferential risk-weights (principle of mutual recognition).
The Swedish UCITS Act (Lag (2004:46) om värdepappersfonder) allows for Swedish UCITS to invest up to 25% of their assets in Swedish covered bonds, instead of the 5% generally applicable to other asset classes.