On November 9, 2011, a group of Democrat and Republican U.S.
senators introduced legislation to
create a regulatory framework for an American covered bond market.
Specifically, the United States Covered Bond Act
sets out the legal context for such a market and clarifies
investors' rights in the event of an issuer's
By way of background, covered bonds are debt products issued by
financial institutions and backed by a cover pool of assets, such
as high-quality mortgages and public sector loans. Although they
operate similarly to asset-backed securities, there is an important
difference: if the issuer defaults the investor has preferential
claim to the loans. Covered bonds are therefore seen as a safe
source of funding for financial institutions.
European banks have issued covered bonds for hundreds of years,
and the product has become increasingly popular in other
jurisdictions in recent years. According to the bill's
sponsors, however, U.S. financial institutions have lagged behind
due to the lack of a regulatory framework. Senator Hagan indicated
that the proposed legislation "would level the playing field
for U.S. financial institutions."
American investors' demand for this product is high, as
such investors have funded over $37 billion of covered bonds issued
by foreign financial institutions so far in 2011. Seeking to make
the most of such high demand, senators in support of the bill wish
to allow American institutions of all sizes to issue the debt
Not everyone is fully supportive, however. The Federal Deposit
Insurance Corporation, a government entity that guarantees US bank
deposits, has expressed concerns that the use of covered bonds may
reduce the banks' assets for their deposit funds.
A similar covered bond bill was
passed in June by the House of Representatives Financial Services
Committee, though it has not been voted on by the full House. Both
bills seem to have bipartisan support, which bodes well for the
timely implementation of covered bond legislation in the U.S.
In Canada, covered bonds have become a popular source of funding
for domestic banks during recent years. Canada, however, also lacks
a legislative framework for covered bonds. The Department of
Finance issued a consultation paper on May 11,
2011, setting out the main elements of a proposed legal framework
for covered bonds.
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The Canadian Office of the Superintendent of Financial Institutions ("OSFI") recently ruled that a bank cannot promote comprehensive credit insurance ("CCI") within its Canadian branches under the Insurance Business (Banks and Bank Holdings Companies) Regulations (the "Regulations").
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