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To add liquidity and to develop a robust capital market through new and innovative
solutions, Rep. Scott Garrett, R-N.J., introduced the U.S. Covered Bond Act, 2010 with
Rep. Paul E. Kanjorski, D-Pa., and Financial Services Committee Ranking Member
Spencer Bachus, R-Ala. The Act is similar lines to the European covered bonds.
Covered bonds have been a major source of liquidity for many European nations’
mortgage markets. The Covered Bond Act, establishes the regulatory oversight of
covered bond programs, subjects covered bonds to appropriate securities regulations by
federal regulators and provides several provisions in case of default and insolvency of
covered bond.The Act includes the following:
Covered Bonds have been defined as senior recourse debt obligation that has an original
term to maturity of not less than 1 year, issued by an eligible issuer and secured by a
perfected security interest in a cover pool of assets which is owned directly or indirectly
by the issuer of the obligation. Is not a deposit as defined under section 3 of the Foreign
Deposit Insurance Act.
Procedure:
• The covered bond regulator sets up the covered bond regulatory oversight
program
• The covered bond program is approved by the regulator. The regulator being the
Secretary of the Treasury or any other officer of the Department of Treasury as
may be authorized by the Secretary in this regard.
• Before approving the covered bond program the regulator has to consult the
primary Federal regulator.
• Covered Bond regulator shall maintain a covered bond registry for all approved
programs
• In a cover pool there will not be more than one eligible asset class
• For each covered bond program there is a need to establish minimum over
collateralization requirement from time to time based on credit, collection and
interest rate risk; established by the covered bond regulator
• The covered bond issuer will have to appoint an indenture trustee (unaffiliated
entity) to monitor the cover pool.
• The cover pool securing the covered bonds shall have to satisfy an asset coverage
test. This test is to be conducted every month by the issuer and the test would
measure whether the assets in the cover pool satisfy the minimum
collateralization requirements. The results of the monthly test are to be disclosed
to the primary Federal regulator, if any, covered bond regulator and the
bondholders.
• In case the covered bond fails to satisfy the asset coverage test and the failure is
not cured within the time specified in the transaction documents; it would amount
to default and would result in the creation of an estate. The issuer shall submit the
schedule of the eligible assets and substitute assets to the indenture trustee on
monthly basis
Creation of estate in case of event of default: The estate created shall be not be taxable
as a separate entity and no assets and liabilities shall be a taxable event
Before this present Act, in 2008, FDIC had issued the first formal guidance on covered
bonds, the "Final Covered Bond Policy Statement" later, in the same year, the
Department of the Treasury published "Best Practices Guide for US Residential Covered
Bonds." This Act is the legislative follow-up to Garrett’s original legislation, The Equal
Treatment for Covered Bonds Act, which was first introduced in 2008. The Covered
Bond Act, 2010 has been welcomed by the industry players and is hoping to be the
alternative investment solution for the markets