French Obligations Foncières and MBS FCCs following
recent amendments to the Securitization Law
Understanding the UK Covered Bond Structure
New opportunities opened up in the Italian market:
covered bonds (Law 80/2005)
pascal agboyibor, martin bartlam and
French Obligations Foncières and MBS FCCs following
recent amendments to the Securitisation Law
Orrick Herrington & Sutcliffe*
France has set up one of the first legal regimes allowing entities granting mortgages to raise
resources in order to finance and refinance mortgaged loans with the Decree dated 30 July
1852 creating the Crédit Foncier de France which role was to grant and acquire mortgaged
loans to public or private entities or individuals.
Since the 1960s, French public authorities have constantly attempted to set up a favourable
refinancing framework for mortgaged backed securities essentially through the following
main stages of development:
- the creation in 1966 of the marché hypothécaire (mortgage market) which allowed
credit institutions to refinance mortgage backed loans and to offer investors
reliable financial instruments i.e. billets à ordre (promissory notes) and titres au
porteur (bearer securities);
- the establishment in 1985 of the Caisse de refinancement hypothécaire, now the
Caisse de refinancement de l’habitat (mortgage/housing refinancing fund) which
enabled the extension of the term of collected resources through the issuing of
- the set up of the legal framework for securitisation, by virtue of Law no. 88-1201
of December 23rd 1988 (as amended) for collective investment undertakings in
transferable securities which also set up the Fonds Communs de Créances (“FCC”),
the French securitisation vehicles, (the “Securitisation Law”);
- the establishment of Obligations Foncières and Sociétés de Credit Foncier by Law 99-532 of
June 25th 1999 amended by Law n°2001-1168 of 11 December 2001, Law n°2003-706
of 1st August 2003 and Ordonnance n° 2005-429 dated 6 May 2005 (the “1999 Law”).
Obligations Foncières are expressly designed by law to be bonds issued by the Sociétés de Crédit
Foncier (“SCF”) and secured by means of statutory preference right over a ring fencing pool of
assets and which benefit from the highest ratings with very low refinancing costs and high
liquidity. As such, and from an international perspective, Obligations Foncières stand for the
French covered bonds.
Nevertheless, since the 2003 amendments to the Securitisation Law, and the capacity
* The author was helpfully assisted in the drafting of this analysis by Xavier Ledru, associate at Orrick, Herrington & Sutcliffe.
offered to the FCC to issue bonds (subject to French law or not) and other debt
instruments, no doubt that the FCCs loaded with mortgaged loans represent renewed and
alternative tools for CMBS and RMBS.
1. The SCF acting as Covered Bonds Issuer.
The Obligations Foncières were given their present shape by virtue of the 1999 Law. They
are amongst the most reliable financial instruments on the French market. Despite their
name, they can be issued against either mortgages or claims against public entities, not
necessarily real estate related. They traditionally fall into the international category of
“covered bonds” which includes the German Pfandbriefe and Spanish Cedulas.
1.1. General Framework.
The French framework is built around the following mechanism:
- an credit establishment transfers certain highly collateralized or publicly guaranteed
debts to a specialized refinancing entity, the Société de Crédit Foncier;
- in counterpart, the SCF issues, onto the debenture market, bonds secured by a
preferential right (droit préférentiel/privilège) on the underlying debts, guaranteeing
to the bearer of such bonds the principal and the interests.
Obligations Foncières issued by SCFs generally benefit from a very competitive rating from
rating agencies. Issued amounts as well as the standardised amortisation structure of issued
bonds (in fine in most cases) ensure excellent liquidity. Obligations Foncières do not bear an
acceleration risk as opposed to FCC Units which amortisation can be accelerated further
to certain predetermined events. Furthermore, Obligations Foncières present substantially
lower refinancing costs compared to rates generally applicable to senior AAA notes issued
by standard securitisation vehicles.
As regards issuers, Obligations Foncières offer banks the opportunity for a quasi on-balance
sheet securitization of assets. Underlying assets are registered as collateral and remain on
the balance sheet of the institution originating the assets and bonds respectively. In the
event of bankruptcy of the issuer, Obligations Foncières holders have a preferential right on
the cash flows generated by the registered assets.
Aside from these core ring fencing elements, several other feature increase investor protection
and thus the rating and acceptance of Obligations Foncières by international investors.
SCFs are credit institutions licensed as financial companies (sociétés financières) by the
Comité des Etablissement de Credit et des Entreprises d’Investissement (Committee of Credit
Institutions and Investment Companies).
As such, they have to respect prudential ratios and can only enter into banking transactions
in accordance with (i) the terms and conditions set out in their license or (ii) applicable
laws and regulations. Depending on the nature of their activities, they also have to meet
share capital and equity requirements.
SCFs sole purpose is to acquire and grant eligible guaranteed loans and loans to public
entities in order to finance the issuance of Obligations Foncières benefiting from a preferred
right in case of a bankruptcy in accordance with article L.515-19 of the Code monétaire et
SCFs may therefore act as traditional credit establishments but also as refinancing
structures as they acquire eligible assets from other primary lenders. They can also achieve
both activities and therefore allow themselves a flexible growth.
Typical Obligations Foncières Structure
1.2. Eligible Assets.
The receivables held by SCFs have to meet certain criteria in order to be considered as
“eligible” and for an SCF to be authorised to acquire them. Eligible receivables are the
- loans secured by a first rank mortgage or equivalent real estate security. Mortgaged
assets must have a loan-to-value of at least 60%. Such percentage is increased to
80% if the loan has been granted to individuals in order to finance their
acquisition or construction of housing and up to 100% for loans to which the
guarantee of the Fonds de Garantie à l’Accession Sociale (Fund of Guaranty for
Social Accession) has been granted;
- loans guaranteed by credit institutions or insurance undertakings having at least
12 million euros of stockholders equity, up to a limit of 20% of the SCF’s assets
and provided that the debtor has made a personal contribution of (i) 20% of the
price of the underlying asset if such asset has been purchased for professional
purposes, (ii) 10% if such asset has been purchased for housing purposes and (iii)
5% if the contribution is made up of deposits to a Plan d’Epargne Logement
(contractual housing savings account);
- loans granted to and guaranteed by, States, public institutions, local authorities or
their representations in the European Economic Area (“EEA”), Switzerland, the
USA, Canada and Japan, as well as loans entirely granted by these States to their
agencies and local authorities;
- units or notes issued by FCCs or similar entities subject to the Laws of an EEA
State, Switzerland, United States of America, Canada or Japan provided that the
assets of such FCC or similar entity are composed of not less than 90% of
receivables with similar guarantees to those attached to the above referred loans.
Subject to a case by case analysis, a vast majority of instruments issued by
European securitisation vehicles of the EEA should be treated as “eligible” for the
purposes of the 1999 Law. However, specific units bearing the risk of default of the
underlying debtor are excluded;
- other notes issued on regulated stock exchanges meeting requirements defined by
the European Central Bank (i.e. securities traded within the European System of
Central Banks as well as debt receivables on credit institutions with less than one
year maturity or bonds issued by other SCFs) within the limit of 20% of the SCF
- a very important feature added by the Securitisation Law is the inclusion of
ongoing contracts receivables (créances à exécutions successives) on public entities
within the scope of eligible receivables. Such receivables are assimilated to loans to
public entities, including receivables arising out of leasing contracts to which a
French public entity is a party as lessee. SCFs acquiring receivables resulting from
a leasing agreement can also acquire part of or all of the receivables resulting from
the sale of the leased equipment.
In respect of the location of the underlying assets, such assets shall be located in a EEA
country, in French overseas territories, in Switzerland, United States of America, Canada or
Japan. The value of these assets shall be prudently determined and shall exclude any
element of speculation.
1.3. Transfer of receivables.
The transfer of loans giving rise to the issuance of Obligations Foncières by SCFs is carried
out, as in the case of FCC securitisation, by simply delivering a assignment form
(bordereau). The transfer is enforceable between the parties and towards third parties
from the date of execution of the assignment form notwithstanding any bankruptcy
proceedings to which the assignor of the relevant receivable may be subjected. Similarly
to the mechanism set out for securitisation, the delivery of the assignment form entails,
without any further formalities, the transfer of all ancillary rights attached to the
transferred receivables and of the securities guaranteeing each loan, including mortgages.
The information of the debtor is subject to the same rules as in the case of securitisation:
the debtor shall be informed only if the company in charge of the collection and custody
is, for any reason, no longer entitled to do so. Such information can be effected by single
1.4. Bankruptcy Remoteness.
One comparative advantage of Obligations Foncières issued by SCFs is their high degree of
bankruptcy remoteness expressly designed by Law.
Holders of Obligations Foncières are given a preferential treatment: in case of default by
the lending establishment, the claims of Obligations Foncières holders will take
precedence over any other creditor and, as a consequence, over customarily privileged
claims such as:
- the company employees’ “superprivilege” as defined in articles L.143-10 et seq. of
the French Labour Code (Code du Travail);
- privileged claims such as legal fees, debts to suppliers having granted additional
delays as referred to in article L.621-32 of the French Code de Commerce;
- privileges of the French social security and tax administration;
- others creditors depending on their rank.
In addition, French law expressly states that all proceeds from eligible loans or any
assimilated receivables, notes and securities, the proceeds of forward financial instruments
instruments entered into by the SCF as well as receivables resulting from deposits made by
the SCF shall be solely employed in order to reimburse any outstanding amount due to the
holders of Obligations Foncières.
Finally, the guarantee for the holders of Obligations Foncières to be paid any amounts due do
them is reinforced by the protection granted to such holders in case of judicial proceeding
affecting the parent company of the SCF or the custodian or collection company.
1.5. Custody and Collection of Receivables.
Custody and collection of the loans, receivables, assimilated receivables and financial
instruments, bonds and other resources of the SCF can only be ensured by a credit
institution. Such credit institution is entitled to act in justice as well as to enforce any
rights in the name and for the account of the SCF in order to obtain an executory title.
1.6. Cover Ratio.
SCFs shall ensure, at any time that they respect a cover ratio at least equal to 100% of
privileged resources. For this purpose, the assets of SCFs are weighed depending on several
criteria linked to the quality of the security attached to eligible assets acquired or loans
granted by such SCFs.
1.7. Authorised Transactions.
In order to finance their activities, SCFs may issue Obligations Foncières but also bonds or
raise funds which do not benefit from any legal privilege. SCFs are also authorised to own
any real or movable property necessary for the achievement of their object or resulting from
recovered debts. However, SCFs are not allowed to issue promissory notes pursuant to
articles L.313-42 to L.313-48 of the CMF.
Article L.515-13-III of the CMF authorises SCFs to assign the instruments held by them by
contracting repos and other similar instruments and securities lending. Such transactions
allow SCFs to manage their balance sheet and their needs in liquidities. SCFs may also
assign part of, or all of the receivables held by them. These assignments are not taken into
account for the purpose of determining the above mentioned cover ratio.
SCFs may also enter into forward financial instruments in order to hedge the transactions
effected to manage eligible loans and other privileged resources. Any amounts payable to
the an SCF pursuant to such forward financial instruments, after any applicable netting,
shall benefit from the privilege. However, sums due under forward financial instruments
entered into in order to hedge bonds issued or funds raised not benefiting from the
privilege do not benefit of such privilege.
1.8. Capital Adequacy.
Interest to make use of the SCF results from the weighing of Obligations Foncières for the
purpose of calculation of the capital adequacy ratio of credit institutions. In terms of capital
adequacy ratio, Obligations Foncières should be weighed up to 10% as opposed to RMBS or
CMBS which require up to 50% capital adequacy. Although Basel II shall affect such figures,
Obligations Foncières should keep a comparative advantage as risk weighing requirements for
RMBS and CMBS are scheduled to decline to 20%. Besides, IAS 39 should make it more
difficult to take assets off-balance sheet and Obligation Foncières should therefore stay attractive
as assets stay on the balance sheet and funding costs remain lower.
Until recently, SCFs were the only vehicle available in order to issue covered bonds in
France for the reason that it was not possible for FCCs to issue debt securities other than
units. However, since 2003, several amendments made to laws and regulations applicable
to securitisation allowed the FCC to act as an issuer of structured bonds. As a result FCCs
and SCF can now be used to refinance the same assets.
2. The FCCs acting as “Covered Bonds” Issuer.
The FCC was originally set up to serve French credit institutions refinancings, including
mortgage loans refinancings. Recent changes (described below) may otherwise promote the
FCC as an alternative tool for French MBS market, especially in the context of loans and
receivables ineligibles with respect to the Obligations Foncières legal requirements. Also, in view
of new possibilities offered to the FCC by synthetic transactions, the FCC may present certain
advantages for synthetic securitisation with mortgage loans underlying assets.
The French securitisation legal framework relies on a special securitisation vehicle, the
FCC, created by the Securitisation Law now codified in the CMF under Articles L.214 -5
and L.214-43 to L.214-49. Until 2003, the sole purpose of the FCC was to purchase
receivables and issue units representing interests in such receivables. The FCC does not
benefit from a separate legal personality. It is a co-ownership among the unit holders.
The 1988 Securitisation Law was completed by an implementation decree of 9TH March
1989 (the “1989 Implementation Decree”). Both the 1988 Securitisation Law and the
1989 Implementation Decree have been constantly amended with the intent of adapting
the legal and regulatory framework to market practice and requirements.
The subsequent 1993, 1996, 1998 and 1999 amendments have globally extended to
commercial companies the right to securitise their assets (which was previously limited to
credit institutions), authorised the purchase of additional debts by the FCC, the issuance
of new units after the initial issuance, the institution of umbrella FCCs with two or more
compartments and authorised the assignment to the FCC of future receivables.
In 2003, within the framework of the Financial and Security Law of 1 August 2003, several
amendments made to the Securitisation Law modernised and liberalised the legal regime of
securitisation transactions in France (the “2003 Amendments”). The 2003 Amendments
mainly cover the following fields:
- the right of the FCC to issue debt securities in addition to units;
- the protection of the assets of the compartments in the case of umbrella FCCs.
- the extension of the right of the FCC to enter into forward financial instruments;
- the transfer and enforcement of security interests;
- the effectiveness of the assignment in the course of international securitisations;
- the protection of monies collected by the originator;
- the conditions to act as custodian and;
- the protection of the assets of the compartments in the case of umbrella FCCs.
Although the 2003 Amendments entered into force in August 2003, an implementation
decree (the “New Implementation Decree”) was long awaited. It was finally enacted on
24TH November 2004 and published on 25TH November 2004.
The New Implementation Decree supersedes the 1989 Implementation Decree and provides
important details on the composition of the assets of the FCC, the borrowing capacity of the
FCC, the rules on the use of forward financial instruments by the FCC and the right of the
FCC to sell part or all of the debts acquired before their maturity.
2.1. The capacity to issue Debt Securities.
Until 2003, the FCC could only issue units representing purchased receivables. Even though
under French law it is expressly provided that the units are securities (valeurs mobilières),
experience has shown that for local regulatory or market practice reasons, foreign investors
were reluctant to invest in French FCC units which led certain investors to use two-level
structures involving foreign SPVs in order to issue commercial paper or notes.
Since the 2003 Amendments, the FCC is authorised to issue debt securities (titres de
créances) which is intended to allow the FCCs to be used for broader categories of asset-
backed financings and attract new types of international and domestic investors. In
particular, as a result of the 2003 Amendments, the FCC is now able to refinance
securitisation transactions through the direct issuance of French commercial paper (billet
de trésorerie) on the French commercial paper market.
In addition, according to the New Implementation Decree, the FCC may now issue debt
securities subject to foreign laws, which could be Euro or US commercial paper or notes or
other titres de créances permitted by applicable foreign law.
The New Implementation Decree also provides that an FCC (or any compartment thereof )
must be comprised of at least two units in addition to any debt securities issued. An
important provision is the subordination of payments due to unit holders vis-à-vis debt
2.2. Capacity to purchase debt securities.
One important clarification made by the New Implementation Decree is a reference to
debt securities as being among the receivables that an FCC can purchase. Not only can an
FCC purchase bonds and notes, it also provides that an FCC can directly subscribe to debt
securities (including bonds or notes).
Typical FCC Structure
2.3. Transferred receivables.
One fundamental feature of the FCC as compared to SCFs is its capacity to purchase a
wide variety of receivables, existing or future, due to a bank or any commercial company,
subject to French or foreign law. As a result, an FCC can securitise receivables ranging from
credit cards to champagne stocks receivables, including mortgage backed securities,
notwithstanding their loan-to-value or underlying debtor personal contribution
Subject to the direct subscription to debt securities, receivables are assigned to an FCC by
way of a simple assignment form (bordereau) which must, however, contain a few
mandatory provisions. The assignment is valid and effective between the parties and against
third parties from the date of execution of the assignment and no further formality is
2.4. Transfer of securities attached to the receivables.
Although the 1988 Securitisation Law clearly stated that security interests and ancillary
rights attached to the receivables were automatically transferred to the FCC as of the
execution of the assignment deed, issues were raised in practice as to the transfer of certain
types of security interests - and as the purpose of the FCC was only to purchase and own
receivables (as opposed to tangible assets), it was unclear whether the FCC could own
secured assets upon enforcement (for example real property mortgages).
For the avoidance of doubt, the 2003 Amendments have expressly confirmed that any
security interest (including a mortgage) securing the transferred receivables is automatically
transferred with the receivables without any further formalities.
As a consequence, the FCC may now operate as a covered bonds issuer, and several
securitisation tranches have been used recently in order to serve as collateral for the
issuance of covered bonds. Furthermore, FCC units issued against mortgage backed
securities should benefit from the same rating as Obligations Foncières provided that
underlying debts have the same characteristics, in particular in respect of personal
contribution and loan-to-value percentages. Recently, Ordonnance n° 2005-429 dated 6
May 2005 amended the Securitisation Law and stated that the FCC’s purpose was not
“solely” to purchase receivables in order to make clear the fact that the FCC was now
entitled to act as a synthetic securitisation vehicle and to purchase any type of security
Such advantages make the FCC an attractive vehicle for residential and commercial
mortgage backed securities and should allow investors to securitise a wide range of
receivables notwithstanding underlying loans characteristics, and as the case may be, use
such FCC as a complementary tool to Obligations Foncières issuances.
The presentation above is a non exhaustive review of the French legislation on the matters
Understanding the UK Covered Bonds Structure
Orrick Herrington & Sutcliffe
Introduction and Basic Characteristics
UK covered bonds are bonds issued by credit institutions backed by a pool of high quality assets
held by that credit institution. The high quality of the underlying assets combined with the
preferential treatment on insolvency enables the bonds to achieve a high credit rating often
higher than that of the institution itself. Issues will take the form of a covered bond programme
allowing multiple issuance in large volumes on a cost effective basis. Investors are presented
with high grade liquid assets qualifying for low capital regulatory costs (to those investors for
whom regulatory capital is important) which is helping to establish the rapid growth of the
covered bond market in Europe. The structure on which this is achieved is however very
different in the case of UK covered bonds from that of other European covered bonds.
Difference in Legislative Basis
In Continental Europe and Ireland specific legislation protects investors by ensuring that a
ring fenced pool of assets is available to meet claims of investors if the Issuer itself is unable
to meet payments from ongoing cash flow.
The legal framework will normally specify the nature of the assets that may be included in
the ring fenced pool and will provide for regulatory oversight of the covered bonds. Assets
will normally be restricted to residential or commercial mortgages and government or quasi
In the UK there is no legislative basis specifically to provide for covered bonds. UK
covered bonds are therefore simply transaction structures which aim to replicate as closely
as possibly the main economic characteristics of traditional European covered bonds.
UK Structured Covered Bonds
UK structured covered bonds are typically bonds issued by a funding vehicle (or special
purpose entity (“SPE”)) of a credit institution and guaranteed by that credit institution
and members of its group. Structured covered bonds rely on traditional securitisation
technology to provide credit support and isolate the pool of assets to secure the
programme. Preferential treatment on insolvency will be provided through normal security
principles rather than based on specific legislation.
UK structured covered bonds will normally take the following form:
(1) A credit institution will sell mortgages (or other applicable assets) to a subsidiary SPE to hold.
(2) The SPE will fund the acquisition of the mortgages (or other assets) by borrowing by way of an intra group loan
from an Issuer SPE.
(3) The Issuer funds the intra group loan used for the acquisition of mortgages through the issue of bonds, the
proceeds of which are lent to the holding SPE.
(4) Holding SPE guarantees payments by Issuer on the bonds and secures the guarantee on the assets acquired
from the credit institution. Security is granted in favour of a Trustee for the benefit of all secured parties.
(5) Members of the group of which the credit institution forms part will guarantee the Issuer’s obligations.
English Legal Structure
Creditor friendly security law and insolvency provisions in the UK allow the issue to achieve
a credit rating higher than that of the credit institution itself without specific statutory
protection. (HBOS was able to issue AAA bonds when its own rating was only AA).
UK covered bonds have to date been based on pools of residential mortgage assets. Some
of the main elements of a typical UK structured covered bond in respect of a mortgage pool
is described below.
The SPE can take one of several forms determined by the relevant parties. UK covered
bonds have used the English limited liability partnership due to its independent legal
status but transparency for tax purposes. An independent legal entity is necessary to
isolate the assets in a manner that is bankruptcy remote from the credit institution and
The owners of the SPE and the SPE itself will covenant as set out below.
Each of the entities owning an interest in the SPE will agree to certain covenants in the
Programme documents. Key covenants will include a covenant that subject to the terms of
the transaction documents, it will not sell, transfer or otherwise dispose of its interest in
the SPE without the prior written consent of the SPE and, whilst the covered bonds are
outstanding, the security trustee. Whilst any amounts are outstanding in respect of the
covered bonds, each of the owners undertakes not to terminate or purport to terminate the
SPE or institute any winding-up, administration, insolvency or similar proceedings against
The SPE covenants that it will not, save with the prior written consent of the management
board (and, for so long as any covered bonds are outstanding, the consent of the security
trustee) or as envisaged by the Programme documents:
(a) create or permit to subsist any security interest over the whole or any part of its assets
or undertakings, present or future;
(b) dispose of, deal with or grant any option or present or future right to acquire any of
its assets or undertakings or any interest therein or thereto;
(c) have an interest in a bank account other than as set out in the Programme documents;
(d) incur any indebtedness or give any guarantee or indemnity in respect of any such
(e) consolidate or merge with or transfer any of its property or assets to another person;
(f ) have any employees, premises or subsidiaries;
(g) acquire assets other than pursuant to the Programme documents; or
(h) engage in any activities or derive income from any activities within any specified
jurisdiction that could present regulatory or tax issues or hold any property if doing so
would cause it to be engaged or deemed to be engaged in a trade or business within
(i) enter into any contracts, agreements or other undertakings;
(j) compromise, compound or release any debt due to it; or
(k) commence, defend, settle or compromise any litigation or other claims relating to it or
any of its assets.
Sale of the Mortgages to SPE
Under the terms of the covered bond programme (the “Programme”) underlying loans
(“Loans”) and the security that relates thereto (“Security”) are sold to the SPE by way of
a mortgage sale agreement (the “Sale Agreement”) entered into at the outset of the
transaction by the credit institution (“Seller”), the SPE and the Security Trustee. Any
entities within the Seller group may accede to the Sale Agreement and such other
documents as the Security Trustee may require in order to become additional Sellers under
the Programme. Subject to certain requirements being met no consent will be required
from bondholders for an additional Seller to be added to the Programme.
Covered Bond Pool
The covered bond pool will consist of Loans and the Security relating thereto sold from
time to time by Sellers to the SPE in accordance with the terms of the Sale Agreement.
Each Loan will be separately identified and will comprise the aggregate of principal,
interest, costs, charges and expenses or any other moneys due or owing by the
underlying borrower to the relevant Seller with respect to that Loan under the terms of
the relevant mortgage contract. Each Loan will be secured by a first fixed charge by way
of legal mortgage as security for the payment obligations of the borrower in respect of
Bond holders will not receive detailed statistics or information in relation to the Loans
in the cover pool, as it is likely that the make up of the pool will be constantly
changing due to the ongoing programme of sales of Loans to the SPE under the Sale
Agreement, additional Sellers coming into the structure and Loans being sold out of
the pool pursuant to obligations of Sellers to repurchase Loans in certain
circumstances (eg misrepresentation, breaches etc.) and pursuant to Sellers rights of
pre emption under the Sale Agreement. Regulation of the cover pool will instead be
based on Loans being required to meet certain eligibility requirements and certain
representations and warranties in relation to the Loans being required to be met as
discussed further below.
Nature of Loans
The types of Loan sold under the Programme may vary from time to time but will be
subject to eligibility criteria being satisfied at the time of the relevant transfer as set out in
the Programme documents. Eligibility criteria will include issues relating to the nature,
maximum amount and yield arising in respect of the Loan in addition to general portfolio
requirements as to there being no current event of default or reason for the credit rating on
the bonds to be adversely affected by the purchase of the relevant Loans.
Each Loan will be sold by the Seller to the SPE by way of equitable assignment. Legal title
to the Loans and the Security will remain with the Sellers until the requirements for a legal
assignment have been complied with. Conditions for a legal assignment to be completed
will only be complied with (including serving underlying borrowers with notice of the sale)
in certain limited circumstances. The relevant circumstances will include certain events of
default, insolvency events, rating related events and circumstances in which the
effectiveness or validity of the Security may be in jeopardy.
Sellers representations and Warranties
Each Seller will make a number of representations and warranties in respect of the
underlying assets in the Sale Agreement. The parties will rely on these representations and
warranties rather than due diligence carried out by the respective parties in relation to the
Loans and related Security. The representations and warranties relate to key elements of
the Loans in respect of their eligibility to the covered bond pool. Issues covered include
the basis on which the Loan was originated, outstanding balances, currency, maturity, the
nature of the underlying borrowers and the lending criteria applied in approving the Loan,
the geographical location of the underlying assets, the nature of the Security, valuation
reports, insurance and similar requirements in respect of the borrower, the underlying
assets, the operational requirements of the Seller and title to be delivered under the Sale
Repurchase of Loans
If a Loan is found not to comply with the representations and warranties or is more than
3 months in arrears as of a relevant date, the Seller may, in accordance with a notice served
on it in respect thereof, be required to repurchase such Loans together with related Security
in an amount equal to the current balance applicable to the affected Loans and related
expenses at the relevant repurchase date.
The credit institution will typically act as original servicer in respect of the underlying
assets on the basis of a servicing agreement entered into between the credit institution, the
SPE and the Security Trustee. The servicer will carry out servicing functions in respect of
the portfolio including:
• keeping records and accounts
• keeping title deeds in safe custody
• keeping a register in respect of the portfolio
• providing monthly reports
• assisting with asset coverage reports
• recovering amounts due in respect of Loans
• enforcing any Loan which is in default
In the event of a rating downgrade below a threshold level the servicer may be substituted
by an alternative servicer of required rating.
The credit quality of the covered bonds is based on a combination of the rating of the
credit institution and its group entities and the quality of the asset pool on which the bond
is secured. The credit quality of the credit institution (and any group guarantors) under
the group guarantee is important as this enables the bondholders to claim as a general
unsecured creditor in the event of an insolvency of the credit institution in addition to the
claim the bondholder has as a secured creditor in the assets constituting the cover pool
In order for the covered bonds to achieve a higher credit rating than that of the credit
institution it is however necessary to isolate a pool of assets with a loss profile sufficient to
achieve the AAA rating level required. For this purpose it will be necessary to establish to
the satisfaction of the relevant rating agencies that the credit pool is sufficient to ensure
timely payment of principal and interest on the bonds and the legal structure as described
above is able to withstand the insolvency of any of the relevant entities.
Maintenance and Protection of the Cover Pool
An example of mechanisms used to monitor the ongoing credit quality of the asset pool
and to provide timely payment in the event of difficulties in cashflow or credit quality of
the pool are described below.
Asset Coverage Test
The asset coverage test is intended to ensure that the SPE can meet its obligations under
the covered bond guarantee. The asset coverage test builds in a degree of over
collaterilisation to take into account various factors affecting the credit pool. The SPE
must ensure that on each calculation date the aggregate amount of Loans and other
assets in the asset pool (after adjusting for certain factors (described below) will be in an
amount equal to or in excess of the aggregate principal amount outstanding of the
covered bonds as calculated on the relevant calculation date. If the asset coverage test is
failed on any calculation date, and such failure is not remedied on or before the next
following calculation date, then this will trigger certain obligations in relation to
repayments on the covered bonds as described below. The asset coverage test is a formula
which adjusts the current balance of each Loan in the portfolio and has further
adjustments to take account of set-off on a borrower's current or deposit accounts held
with each Seller, set-off associated with certain drawings made by borrowers and failure
by Sellers, to repurchase defaulted Loans or Loans that do not materially comply with
the representations and warranties on the relevant transfer date in accordance with the
The amortisation test is intended to ensure that if, following an event trigger as described
in the asset coverage test and the service of a notice to pay on the SPE (but prior to service
on the SPE of an acceleration notice), the assets of the SPE available to meet its
obligations under the covered bond guarantee fall to a level where covered bondholders
may not be repaid, an SPE event of default will occur and all amounts owing under the
covered bonds may be accelerated. The SPE must ensure that on each calculation date
following an event trigger as described above the aggregate Loan amount (adjusted to
reflect current balances and average maturity) will be in an amount at least equal to the
aggregate principal amount outstanding of the covered bonds as calculated on the
relevant calculation date. The amortisation test is a formula which adjusts the current
balance of each Loan in the portfolio and has further adjustments to take account of
Loans in arrears.
In order to provide for liquidity in the event of deterioration of the asset pool but at a time
when the short term rating has also deteriorated a reserve fund is established.
If at any time prior to an event trigger as described above the issuer's short-term,
unsecured, unsubordinated and unguaranteed debt obligations or deemed ratings, as
applicable, cease to be rated A-1 + by S&P, P-1 by Moody's or F1+ by Fitch, the SPE
will be required to establish a reserve fund (the “Reserve Fund”) on an account at a
fixed minimum investment return which will be credited with available revenue receipts
up to an amount equal to the scheduled interest due on the next following interest
payment date on each Series of covered bonds. The Reserve Fund will be funded from
available revenue receipts after the SPE has paid all of its obligations in respect of items
ranking higher than the reserve requirement in accordance with the priority of payment
A reserve ledger will be maintained by the cash manager to record the balance from time
to time of the Reserve Fund. Following the occurrence of an event trigger and service of a
notice to pay on the SPE, amounts standing to the credit of the Reserve Fund will be added
to certain other income of the SPE in calculating available revenue receipts.
Where a series of covered bonds are redeemed on a bullet basis at maturity there is a risk
that the SPE will have insufficient cash to meet the necessary payments on the due date.
The pre-maturity test is intended to provide liquidity for such bonds when the Issuer’s
credit rating has fallen. The pre-maturity test will apply on a daily basis and will be
triggered in the following circumstances:
(a) the Issuer's short-term credit rating or deemed rating, as applicable, from the relevant
rating agency falls below a threshold level (eg A-1 (or lower)) and the final maturity
date of the series of hard bullet covered bonds will fall within 6 months from the
relevant pre-maturity test date; or
(b) the Issuer's (i) long-term credit rating or deemed rating, as applicable, from the
relevant rating agency falls below a threshold level (eg A2 (or lower)) and the final
maturity date of the series of hard bullet covered bonds will fall within 6 months from
the relevant pre-maturity test date or (ii) short-term credit rating or deemed rating, as
applicable, from the relevant rating agency falls below a threshold level (eg P-2 (or
lower)) and the final maturity date of the series of hard bullet covered bonds will fall
within 12 months from the relevant pre--maturity test date.
Once the pre-maturity test is triggered the SPE will offer to sell randomly selected Loans
to purchasers subject to the Sellers right of pre emption.
The SPE will normally enter into hedging arrangements with a nominated swap provider
to hedge against possible variances in the rates of interest payable on the Loans making up
the asset pool and the rate of interest payable on the intra group loan funding the
acquisition of the cover pool. Underlying Loans may pay interest on a variety of bases
(fixed rate, variable rates, discounted rates, etc) and the swaps will be required to smooth
the payment profile. Other hedging arrangements may also be put in place to hedge
against currency mismatches and timing mismatches in respect of payments under the
UK structured covered bonds do not currently benefit from the reduced capital weighting
applicable to traditional covered bonds and from an investor’s perspective will be the risk
weighted at 20% (as a claim on an OECD credit institution) instead of 10% which applies
to most traditional covered bonds. UK practitioners have argued that this is unfair
treatment of UK credit institutions which would like to benefit from a reduced capital
weighting for investors. Under the new Capital Requirements Directive the definition of
covered bonds eligibility for reduced weighting is in line with the UCITS Directive article
22(4). The requirements are:
• Special legal framework
• Issuer must be a credit institution
• Bondholders must have a prior claim on the cover pool in the event of the Issuer’s
• Cover pool must provide sufficient collateral coverage of bondholders’ claims for
full term of the bond
• Eligible cover assets must be legally defined
• Covered bond issuance is subject to special prudential supervision
• Exposures relate to:
– governments, central banks, multilateral development organisations
– public sector entities, regional government and local authorities
– residential mortgage (max 80% L to V )
– commercial mortgages (max 70% L to V)
• Backing pool contains assets of only specifically defined type and credit rating
• Issuers at bonds covered by mortgage loans must meet minimum mortgage
property and monitoring requirements
Whilst UK structured covered bonds meet most of these requirements it is clear that no
specific legal framework establishes or regulates the UK covered bond regime and the
reduced capital weighting will not apply.
Under the existing capital regime the capital weighting to the credit institution issuing the
bonds will depend on the weighting applicable to the assets being held (e.g. for residential
mortgage assets this currently stands at 50%). The weighting to investors holding the
bonds will rank as a claim on an OECD bank at 20%.
With the introduction of Basel II weightings of high grade assets are likely to move
markedly. Residential mortgage assets held on balance sheet by credit institutions are
expected to be weighted at 35% or below. The weighting for investors under the
standardised approach will be driven by the external rating of the bonds they hold (eg AAA
assets = 20%) whilst for credit institutions operating under the IRB approach based on
their internal rating models capital weightings for certain high grade assets could be
reduced to as low as 7%.
Exchange of Covered Bonds
Due to the existing differential in capital treatment between United Kingdom structured
covered bonds and traditional covered bonds the conditions of the covered bonds permit
the Issuer to exchange, without the consent of the bond trustee, the security trustee or
the covered bondholders, any existing covered bonds then outstanding for new covered
bonds following the coming into force in the United Kingdom of any legislation similar
to covered bond legislation in force in any other European Union country or any rules,
regulations or guidelines published by any governmental authority that provides for
bonds issued by United Kingdom issuers to qualify for the same benefits available
pursuant to covered bond legislation in force in any other European Union country.
This is subject to requirements that each of the rating agencies then rating the existing
covered bonds confirms in writing that any such new covered bonds will be assigned the
same ratings as are then applicable to the existing covered bonds. Any such new covered
bonds will qualify as covered bonds under such new legislation, rules, regulations or
guidelines and will be in identical form, amounts and denominations and will be subject
to the same economic terms and conditions as the existing covered bonds then
Whilst covered bonds are viewed as a relatively safe instrument from a regulatory
perspective the FSA as UK regulator has stated that it has a concern over banks issuing
covered bonds above a material level. Material is not stated but FSA has accepted it would
be happy with issues of up to 4% of total assets.
Above the materiality level it is possible that the FSA would penalise banks issuing above
that level by an adjustment of regulatory capital under Pillar 2.
The concerns of the FSA appear to be that:
(1) the new issuance prefers a group of secured creditors who in the event of a winding up
rank ahead of unsecured creditors. The banks unsecured creditors are therefore in a
(2) in addition to the effective subordination of unsecured creditors there is a concern that
the preference will be for the bank to maintain the quality of the credit pool backing
the bonds to the detriment of the bank’s general unsecured creditors in the event of
(3) embedded triggers could also move a problem from one guarantor in a group that
suffers a rating downgrade to other guarantors thereby further weakening the strength
of the group.
With the introduction of Basel II the importance of structured covered bonds in the UK
funding mix is likely to increase. Reduced weighting for the credit institutions and a
reduced weighting for investors applying IRB internal models will likely even out the
position of UK structured bonds with traditional European covered bonds. This improved
weighting combined with the introduction of international accounting standards (which is
expected to lead to increased difficulties with obtaining off balance sheet treatment) may
result in more regulatory capital based securitisations being replaced with covered bond
issues (possibly combined with credit derivative structures).
The non statutory basis for UK structured covered bonds also provides an added degree of
flexibility. Under the UK model there is no restriction on loan to values, monitoring or
reporting obligations or indeed the types of asset that may constitute the cover pool. These
issues are limited only by agreement of the parties. It may be that more assets (including
PFI type structures) will find a use for the flexible structured covered bond model.
This is of course all subject to the important caveat that the FSA may formalise its current
informal concerns on material issuance.
Covered bonds as a new opportunity opened up in
the Italian market (Law 80/2005)
Orrick, Herrington & Sutcliffe *
Even though the Italian securitisation law (law 30 April 1999, n. 130, hereinafter, “Law 130”)
was enacted relatively late if compared to other European countries, the Italian
securitisation market keeps being one of the most active in Europe. Securitisations have
gained growing significance in the Italian market and since Law 130 came into force, the
Italian securitisation market has become the second largest European market in relation
to issuances volume.
In order to enhance the competitiveness and growth of the Italian securitisation market,
the Italian Legislator has enacted Law 14 May 2005, no. 80 (“Law 80/2005”), by means
of which two new articles have been inserted into Law 130 providing for covered bonds:
Article 7-bis and Article 7-ter.
Covered bonds play a significant role in European capital markets and in the funding of
mortgage and sovereign lending in Europe and the covered bonds market is attracting
serious attention from Italian banks looking to expand their funding choices in addition
Prior to the analysis of the new covered bonds legislation as introduced into Italian legal
system by Law 80/2005, it is to be taken into account that the essential characteristics of
covered bonds vary across the different national legislations, for reasons that are better
1.1. The European Union legislation
As well known, the term “covered bonds” is used to refer to different types of mortgage
* The author was helpfully assisted in the drafting of this analysis by Alessia Frisina, associate at Orrick, Herrington & Sutcliffe.
1 As a matter of completeness, it is to be said that the Italian market has already seen a covered bond transaction: the CDP
Covered Bond Programme by Cassa Depositi e Prestiti S.p.A.. While still waiting for the approval of the regulatory framework
on Italian covered bonds, Cassa Depositi e Prestiti S.p.A. – the Italian State-owned bank – launched its first issue of this new
Italian asset class, pursuant to a law which was enacted specifically for it in 2003 (Article 5, paragraph 18, of the Italian law-
decree 30 September 2003, no. 269, converted into law by Article 1 of law 24 November 2003, no. 326).
bonds in the European Union (“EU”) whether these are backed by mortgage assets or
public sector loans or other types of assets such as mortgage backed securities. One of the
elements that favoured the use of covered bonds as an instrument of funding has been
the privileged position that the EU legislation has given to them. However, the EU
legislation does not provide for a complete and uniform regulation for this kind of
financial instruments, since it is composed of specific provisions of the numerous
directives that have been issued in the last years with the purpose of harmonizing the
national legislations on the subject. A very important role is however played by the
Undertakings for Collective Investments in Transferable Securities directive (the
“UCITS Directive”)3. In particular, pursuant to Article 22(4) of the UCITS Directive ,
which defines a common minimum standard for covered bonds, Member States of the
EU have the discretionary right to raise the limits for the holdings in the bonds of one
single issuer from the standard 5% to 25%, shall the bonds fulfil the following criteria:
(i) the bonds must be issued by a credit institution registered in the EU; (ii) the credit
institution must be subject by special law to special public supervision designed to
protect bondholders; (iii) the sums deriving from the issue of these bonds must be
invested in conformity with the law so that, for the whole maturity period, the bonds are
covered; (iv) in the event of a failure of the issuer, the assets must be used on a priority
basis for the reimbursement of principal and payment of accrued interest.
From the abovementioned definition it can be inferred that covered bonds are an
instrument of collection used by the banks to finance specific assets, which, should a
default of the issuer take place, are destined in a priority way to the reimbursement of
the capital and the interests of the bonds. However, the UCITS Directive leaves to the
Member States the possibility to issue more specific provisions.
Member States must send the Commission a list of the aforementioned categories of
bonds together with the categories of issuers authorised, in accordance with the laws and
supervisory arrangements mentioned in the UCITS Directive, to issue bonds complying
with the criteria set out in the same UCITS Directive. A notice specifying the status of
the guarantees offered shall be attached to these lists. The Commission, on its side, shall
immediately forward that information to the other Member States together with any
comments, which it considers appropriate, and shall make the information available to
A favourable treatment is accorded to covered bonds which fulfil the UCITS Directive.
Specifically: (a) Member States may raise the 5% limit laid down for the investments of
its assets in transferable securities or money market instruments issued by the same body
2 Council Directive of 20 December 1985 on the coordination of laws, regulations and administrative provisions relating to
undertakings for collective investment in transferable securities (UCITS) (85/611/ECC).
3 As modified by the Directive 2001/108/EC of the European Parliament and of the Council of 21 January 2002 amending
Council Directive 85/611/EEC on the coordination of laws, regulations and administrative provisions relating to underta-
kings for collective investment in transferable securities (UCITS), with regard to investments of UCITS.
to a maximum of 25%; and (b) there is the possibility to benefit of a risk-weighting of
10% for the bonds defined in article 22(4) of the UCITS Directive.
Having this regulation been introduced by means of a directive, some room for
discretion is left to the Member States that have to issue specific provisions to
implement the EU legislation. This explains why the covered bond laws, across other
EU countries, even if based on common principles, differ in the shaping of the specific
2. Article 7 bis
2.1. The structure
Pursuant to Article 7-bis of Law 130, as amended by Article 2 of Law 80/2005, the
structure of a covered bond transaction is as follows (please, see table 1):
(i) a bank transfers (a) claims arising from mortgage loans or loans secured by voluntary
mortgages; (b) claims owed by public entities or guaranteed by a public entity;
and/or (c) notes issued under a securitisation transaction backed by the claims
mentioned under letters (a) and (b) above (the “Assets”), to a special purpose vehicle
(the “SPV”), whose sole corporate purpose is the purchase of such claims and the
granting of a guarantee for the securities issued by the bank which is not necessarily
the bank transferring the Assets (Article 7-bis, paragraph 1);
(ii) the SPV purchases the Assets by means of a loan granted or guaranteed to it by a
bank which could also be the bank transferring the Assets;
(iii) the bank transferring the Assets or another bank issues securities (the “Bonds”);
(iv) the Assets purchased by the SPV are applied by the assignee to (a) satisfy the rights
attaching to the Bonds; (b) satisfy the counterparties of derivative agreements
entered into for hedging the risks related to the Assets and counterparties of
secondary finance transaction; and (c) pay the costs of the transaction.
2.1.1. Main features
As mentioned, Law 80/2005 introduces a covered bond legislation into the Italian legal
system. Under a strictly legal point of view, a covered bond transaction differs for several
aspects from a traditional securitisation transaction structured as a true sale of receivables
by way of assignment to a Law 130 special purpose vehicle (i.e. a vehicle whose sole
corporate purpose is the undertaking of one or more securitisation transactions).
Nevertheless, Law 80/2005 applies the advantages and benefits of structuring a
securitisation transaction to covered bonds as well, in terms of, among other things,
formalities to be complied with to obtain the enforceability of the transfer and in terms
of claw back.
Herebelow, we have outlined briefly the main features of a covered bond transaction:
(i) the segregation principle applying to securitisation transactions shall also apply to
covered bond transactions. In fact, pursuant to Article 7-bis, the Assets purchased by
the SPV shall constitute assets segregated for all purposes from the assets of the SPV
and from assets relating to other transactions entered into by the SPV. In addition,
no creditors, other than the holders of the Bonds, the counterparties to the derivative
agreements, counterparties to other agreements relating to the transaction can
benefit of this segregation;
(ii) with the exception of Article 106, paragraph 2 and Article 106, paragraph 3, letters
b) and c), of Legislative Decree 1 September 1993, no. 385 (the “Consolidated
Banking Act”), the provisions contained in Title V of the same Consolidated
Banking Act, shall apply to the SPV4;
(iii) provisions concerning the formalities and the enforceability of the transfer of claims
under a securitisation transaction shall apply to the transfer of the Assets. The main
consequence that follows from the referral made by Article 7-bis to the general
provisions applying to securitisation transactions is that the transfer is perfected by
way of publication in the Official Gazette and registration in the register of
companies where the SPV is enrolled and, consequently, the transferee (SPV) may
enforce the transfer against assigned debtors and other parties. Articles 1264 and
1265 of the Italian Civil Code shall not apply5. In addition to the general regime set
forth by Law 130, a special regime of exemption shall apply to claims owed by public
entities (in this respect, see paragraph 2.1.2);
(iv) the Ministry of Economy and Finance shall enact an implementing regulation of Article
7-bis, in relation to several key issues of the structure (Article 7-bis, paragraph 5);
(v) in accordance with Article 53 of the Consolidated Banking Act, the Bank of Italy
shall enact an implementing regulation concerning the requirements to be complied
with by the bank issuing the Bonds, the criteria to be adopted by the banks to
evaluate the Assets and the relevant formalities to integrate the Assets, as well as the
formalities to check the compliance with the obligations of the banks set forth by the
same Article 7-bis, also through auditors (Article 7-bis, paragraph 6).
4 Title V of the Consolidated Banking Act sets forth certain requirements for financial intermediaries. Mainly, Title V provides
for: (i) the enrolment of the financial intermediary in the general register held by the Italian Exchange Office (Ufficio Italiano
Cambi), or, should certain requirements be complied with, in the special register held by Bank of Italy; and (ii) the require-
ments necessary for the entities holding relevant participations or holding managing or controlling positions in such finan-
5 These provisions regulate the effectiveness of an assignment of claims in normal cases, establishing that to be effective
against the assigned debtor the assignment has to be notified to the debtor or has to be accepted by him. Otherwise, shall
the debtor pay to the assignor, he will be released from his obligation.
2.1.2 Claims owed by a public entity
As mentioned above, Law 80/2005 allows the transfer to the SPV of claims owed to the
bank issuing the Bonds (or to another bank) by public entities.
Law 80/2005 provides for a special regime concerning the effectiveness and validity of
Critically, when claims owed by Italian public entities are transferred, the transfer is
subject to certain formalities. Specifically, pursuant to Articles 69 and 70 of the Royal
Decree 18 November 1923, no. 2440, for each transfer agreement: (i) to be effective
against the assigned debtor (the public entity), the transfer is to be notified through a
court bailiff to the public entity; (ii) the deed of assignment of these claims shall be a
public deed (atto pubblico) or private deed duly notarised; (iii) if the claim arises out
from an agreement which is still in the process of being performed (contratto in corso), to
be valid the transfer is to be accepted by the assigned debtor-public entity; and (iv) if a
plurality of public entities owe claims to a single creditor, the latter shall transfer the
claims owed by each entity separately. While the mentioned provisions would apply to a
securitisation transaction carried out in accordance with Article 1 of Law 130, Article 7-
bis, as introduced by Law 80/2005, provides for an exceptional regime in relation to
covered bond transactions stating that the mentioned provisions shall not apply.
2.1.3 The servicer
Under Law 130, an essential role in securitisation transactions is played by the servicer
who is the entity entrusted with the servicing of the assigned receivables, the payments
and ancillary settlement activities. A servicer to a securitisation transaction must be a
bank or a company enrolled in the special register kept by the Bank of Italy under Article
107 of the Consolidated Banking Act. In addition, a servicer is responsible for ensuring
that the securitisation transaction complies with all aspects of Italian law and the
mandatory requirements of any prospectus. In this respect, the Bank of Italy guidelines
(issued on 23 August 2000) stressed the “monitoring functions” of the servicer, i.e. the
functions of the servicer to check that the sums relating to each transaction are held in
separate accounts, funds from different transactions are no commingled, interests of the
holders of the securities are at all times protected and that payments are made promptly.
The role of the servicer to a covered bond transaction seems to be the same since there
is a general referral to provisions concerning it made by Article 7-bis. The only main
change introduced by Article 7-bis, paragraph 4, is that, whether the servicer is an entity
other than the bank transferring the Assets to the SPV, such information is to be
published in the Official Gazette (in addition, if the assigned debtor is a public entity,
the appointment of the new servicer shall be communicated to the latter by registered
letter with return receipt).
2.1.4 The guarantee
As mentioned, Law 80/2005 sets out a principle of destination pursuant to which the
Assets purchased by the SPV are applied by the latter to satisfy rights attaching to the
Bonds, to satisfy the counterparties of derivative agreements entered into for hedging the
risks involved in the Assets and the counterparties of secondary finance transaction, as
well as to pay the costs of the transaction. In addition to such a destination, the SPV is
allowed to grant a guarantee for the Bonds (being it also one of its corporate purposes).
As regards such a guarantee, on one hand, Article 7-bis, paragraph 5, states that a further
regulation by the Italian Ministry of Economics and Finance, upon hearing of the Bank
of Italy, shall be enacted in this respect, specifying: (i) the percentage relationship
between the securities issued by the bank and guaranteed by the SPV and the assets
which can be assigned; (ii) the type of assets to be assigned and the type of assets which
can be used by the bank to strengthen and integrate the first assets assigned; and (iv) the
type of guarantee released by the SPV.
As a consequence, until such a regulation is enacted, and considering the general referral
contained in Article 7-bis – this Article, in relation to the sole corporate purpose of the
SPV, generally refers to the “granting of a guarantee for the bonds issued by the same banks
or by other banks” – it will not possible to better qualify and further analyse the guarantee
2.1.5 Non-applicability of claw-back action
Article 7-bis, paragraph 4, last sentence, provides that Article 67, paragraph 3, of Royal
Decree 16 March 1942, no. 267 (the so called “Bankruptcy Law”) shall apply to loans
granted to the SPV and also to the guarantee granted by the latter. The mentioned
Article 67, paragraph 3, provides for certain cases in which claw-back provisions shall
not apply. It has to be concluded that the claw-back action is not enforceable in respect
of the above-mentioned loans.
2.2 Tax provisions
Article 7-bis, paragraph 7, provides that, for tax purposes, the assignment of the Assets
may be deemed as an off-balance transaction any time: (i) the price paid for the
6 In the first version of Article 7-bis, the Italian legislator had made reference to the Italian fidejussione which is a typical instru-
ment to provide personal securities for the fulfilment of an obligation by means of a third person’s promise to carry out the
obligation of the principal debtor, in the event he does not, and virtually offering the creditor the possibility of enforcement
on the guarantor’s goods if also the guarantor’s obligation is not fulfilled. Such reference has been deleted in the version pas-
sed by the Parliament.
assignment is equal to the value of the claims as reported in the asset and liability
statement; and (ii) the loan to the SPV is granted or guaranteed by the assigning bank.
2.3 Liability of the bank issuing the bonds
In this paragraph it is briefly analysed the liability of the issuing bank towards the
holders of the Bonds.
In accordance with the general principle of liability of the debtor (responsabilità patrimoniale
del debitore), established by Article 2740 of the Italian Civil Code, the debtor guarantees the
fulfilment of its obligations with its existing and future assets, which constitute a sort of
legal guarantee of the debtor’s obligations. This guarantee is made up of all the debtor’s
assets. Article 2740 provides that exceptions to such general principle of liability can be set
out only by specific provisions of law. However, Article 7-bis does not contain any limitation
to this general principle in relation to the bank issuing the Bonds.
On the contrary, a specific exception to the principle of liability of the debtor is
represented by the segregation of the Assets purchased by the SPV, which constitute
assets segregated for all purposes from the assets of the SPV and from assets relating to
other transactions entered into by the SPV. The segregation is made in favour of the
holders of the Bonds, the counterparties to the derivative agreements, and the
counterparties to other agreements relating to the transaction.
2.4 Multi-originators transactions
Article 7-bis does not set out any restrictions to the possibility of having a sort of multi-
originators covered bond transaction, i.e. a transaction in which the Assets are originated
by a plurality of banks.
3. Article 7-ter
As we mentioned, Law 80/2005 has introduced also Article 7-ter to Law 130.
In accordance with Article 7-ter, Article 7-bis, paragraphs 5 and 6, shall apply to the
establishment of destined assets (which qualify as Assets) and the destination of the
relevant cash flows carried out in accordance with Article 2447-bis of the Italian Civil
Code to guarantee the holders of the Bonds to which Article 7-bis refers.
3.1 Article 2447-bis
As well known, Article 2447-bis provides for two kinds of segregated business assets
(i) the “operational segregated business asset”, provided for by Article 2447-bis, letter
a), according to which a company may establish one or more segregated business
assests – that are segregated from the other assets of the company – made of assets
that are exclusively destined to a specific business;
(ii) the “financial segregated business asset”, provided for by Article 2447-bis letter b),
according to which a company may agree with third parties a funding agreement to
the reimbursement of which are destined, as a whole or partially, the revenues of a
According to Article 7-bis, it seems that the bank issuing the Bonds could establish an
operational segregated business asset in relation to specific business (the issuance of the
Bonds and the repayment of the holders of the Bonds). The result should be that in case
of default of the bank, only the holders of the Bonds could rely on the segragated assets.
However, it is not clear if the establishement of this kind of segregated asset will be a
guarantee for the holders of the Bonds, additional to the general legal guarantee provided
for by Article 2740, or if the segregated Assets will be the only assets on which the
holders of the Bonds can be satisfied.
For the obligations undertaken in relation to a specific business the company’s liability
is limited to the operational segregated business asset, save for the case in which the
company, with the resolution establishing the segregated business asset, has undertaken
to partially guarantee the obligations undertaken.
The assets that are included in the operational segregated business asset shall constitute
assets segregated for all purposes from the assets of the company and, for the effect, no
creditors, other than the creditors of the specific business, are entitled to obtain
satisfaction of their claims through the above mentioned assets. Furthermore, on the
assets that are included in the operational segregated business asset, no actions from
creditors different from the creditors of the specific business are allowed.
In case of bankruptcy, the assets that are included into the operational segregated
business asset do not enter into the bankruptcy liabilities but are separately liquidated in
favour of the creditors of the specific business.
Covered bonds are a new challenge for the Italian market and Law 80/2005 may be the
answer to Italian banks looking to expand their funding choices.
It should be emphasised that when structuring a financial transaction many different
issues are to be taken into consideration, therefore a deep and accurate analysis of the
specific parties and matters involved in a specific transaction will have to be carried on.
This document is intended to provide a brief summary of the new covered bond
legislation. It should not be relied upon as a substitute for legal advice.
7 The structure in the table assumes that the bank issuing the covered bonds is the bank which transfers the Assets.
Pascal Agboyibor is a qualified lawyer in Paris and partner of the European Finance and
Structured Finance practice groups (Tel. +33 1 5353 7520 - email@example.com). He has
extensive experience in both structured finance and project finance. Most recently, he was
involved in commercial receivables and commodities stocks securitisation programs. He also
advises lenders, sponsors, guarantors and governments in financing infrastructures projects.
• "Securitisation in the Oil Sector," 8th Africa Oil and Gas Trade and Finance Conference",
Marrakech, Morroco, April 2004;
• "Use of Securitisation as tax advantaged structured financing," Structured Finance Institute, Hotel Lutetia, Paris,
• "Legal Regime of the French FCC Units," EFE Conference, Paris, June 2002.
• "Overview of the French Securitisation Market: review of the current changes in the legal and regulatory frame-
work," Euromoney’s Global Securitization Review 2004/2005, October 2004.
• "Un nouveau décret pour les opérations de titrisation", Dalloz, February 2005.
Martin Bartlam is a qualified solicitor in England & Wales and is a partner in the finan-
ce department of Orrick in London (Tel. +44 0 20 7422 4777 - firstname.lastname@example.org).
Mr Bartlam has extensive experience in UK and international financing activities and is
one of the leading practitioners in the London market for structured finance, internatio-
nal securities and structured lending transactions.
Prior to joining Orrick, Mr Bartlam was a partner and head of the finance
department at Jones Day. Previous experience includes hands-on banking
transactional work as head of structured products at Credit Lyonnais in London
(now Calyon) and as a member of the debt structuring team of Greenwich Natwest (now RBS)
His publications include:
• "Finding the Law in European ABS" - an analysis of receivables financing in Europe for Finance
2003, a Legalease special report
• "Challenges Ahead" - a review of the outlook for energy companies from 2004 for Financier
Patrizio Messina is a qualified Italian lawyer; he is a partner in Orrick’s Rome office and
a member of the firm’s European Finance Group (Tel. +39 06 4521 3999 -
email@example.com). He focuses primarily on structured finance, with particular
emphasis on securitisation, derivatives, debt issues, public finance, and general banking.
Mr. Messina has advised major Italian and international investment banks on
structured finance transactions such as synthetic CDO, revolving CDO, CBO,
corporate infrastructure ABS concerning receivables due by public entities, real
estate securitisations, credit linked notes, index linked bond issues, personal loans
securitisation, and several residential and commercial mortgage securitisations.
Mr. Messina has acted for major public entities and Italian and international investment banks for
public finance transactions such as securitisation of receivables due by a Regional Entity to local health
enterprises, public real estate securitisations, EMTN programmes issued by Italian public entities,
complex derivatives transactions for an Italian municipality and several derivatives transactions for
Italian public entities. Furthermore, Mr Messina has acted on aviation finance transactions.
His practice also includes regulatory and compliance issues as applied to financial instruments, finan-
cial services and asset management.
Mr. Messina is a regular speaker at seminars and conferences, in both the academic and commercial
worlds, as well as a regular contributor to publications in his field such as recently published "New
Horizons for the Italian Securitisation Market" in "Global Securitisation and Structured Finance
2004", published by Globe White Page and "Securitisation and Italian Public Entities" in "Journal of
International Banking Law and Regulation", Volume 19, Issue 1, 2004.
He holds a number of external advisory positions.
He is member of the European Securitisation Forum Legal, Regulatory & Capital Subcommittee.
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