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Dáil Éireann debate -
Tuesday, 23 Oct 2001

Vol. 542 No. 5

Asset Covered Securities Bill, 2001: Second Stage.

I move: "That the Bill be now read a Second Time."

The purpose of this Bill is to allow international banks based in Ireland and domestic banks and mortgage providers to access international capital markets on the most competitive terms and in doing so to underpin the strength of the Irish financial system and the continued attractiveness of Ireland as a base for financial institutions. To do this, the Bill provides for the introduction of new financial instruments – the asset covered securities of the title – by Irish institutions into the euro zone market. These securities will be backed by assets held by the institutions concerned, in particular, mortgages and public sector loans.

The Irish asset covered securities will be similar in nature to the famous German pfandbriefe securities. These pfandbriefe are the largest single bond type in Europe. They allow German institutions to access finance on exceptionally good terms, with consequent knock-on benefits for the strength of their financial system and the availability of credit. In recent years other European countries have taken the view that their institutions should also be able to access this source of funds. For example, France, Spain and Luxembourg have introduced enabling legislation to facilitate the issuance of these types of securities.

The intention of the Bill is that asset covered securities issued by a financial institution will be statutorily secured on a pool of underlying assets held by the same financial institution. These underlying assets are primarily mortgages or public sector loans. The key feature of the product is the enhanced security offered to the holders of the securities. Because of the reduced risk to investors, it will be possible for financial institutions to borrow more cheaply and easily. In the event of the insolvency of the issuing institution, the cover assets must be used first to meet the claims of the holders of the securities. Ordinary creditors of the institution may not make a claim against these assets until the full obligation due to the investors in the securities has been discharged.

The enhanced security afforded by the preferential creditor status, the specification of strict matching of assets and liabilities and the regulatory environment for the product have resulted in the German pfandbriefe attaining a triple A credit rating and becoming an extremely popular investment. The establishment of an asset covered securities market under Irish law will assist in the further development of the international financial services sector here, provide a new and efficient form of financing to domestic financial institutions which will enable them to remain competitive in the European market and help to underpin domestic capital markets.

As I have indicated, securities similar in nature to the proposed product have long been a feature of European capital markets. They are longest established in Germany where they have a demonstrated history of 125 years. No issue has ever defaulted. Asset covered security markets are also long established in Austria and Sweden. As I have already mentioned, other European countries have introduced enabling legislation in recent years to facilitate the issuance of similar securities.

The availability of asset covered securities has contributed to stability in the continental European markets due to their long-term primarily fixed rate nature. Their high credit rating enables issuing institutions to raise long-term funds at interest rates only marginally higher than those of a sovereign borrower. Of course, this confers a significant competitive advantage. Introducing this type of bond into Ireland will allow Irish based banks and building societies to take advantage of this cheaper funding source and ensure that they are able to continue to compete against other European credit institutions within the Irish and the broader European markets.

Enabling legislation is required to allow Irish credit institutions issue asset covered securities because the legal basis for the new securities must be clearly established. It is also necessary to provide a legal framework for the level of regulatory supervision required to ensure the product conforms with the highest quality standards of other similar bonds available in the European markets.

I would now like to set out the key features of asset covered securities. Asset covered securities are securitised bonds. They are secured on a pool of high quality assets. However, in a conventional securitisation the bond is secured on a defined and unchangeable set of assets which are removed from the issuing institution's balance sheet. By contrast, asset covered securities will be secured on a pool of assets called the cover assets pool. These assets, even when put into the pool, remain on the issuing institution's balance sheet but are ringfenced. This means that, in the event of the issuing institution getting into financial difficulties, these assets must be used to meet the institution's obligations to the holders of its asset covered securities before they can be used to meet the claims of any other creditors.

The most important feature of the cover assets pool is that it is dynamic in nature. This means that non-performing or redeemed assets may be replaced in the pool by new assets. In this way the high quality of the cover assets pool can be maintained. It is this dynamic feature of the cover assets pool allied to the conservative management of the pool which enables institutions to obtain high credit ratings and to issue asset covered bonds at low interest rates.

There are two distinct types of asset covered security. The first is a public credit covered security. These securities are usually issued by specialist banks whose main activity is the provision of finance to Governments, municipalities and local authorities. The securities are primarily backed by public sector assets such as sovereign bonds, local authority loans and Government guaranteed loans. The second type of asset covered security is a mortgage covered security. These securities are usually issued by institutions whose main activity is the provision of mortgages. These securities are primarily backed by mortgage assets.

Public credit covered securities are, at all times, secured by a pool of assets of at least equal nominal value and yielding at least equal interest. Mortgage covered securities are similarly secured, but based on a very conservative valuation of the assets concerned. The ultimate investors in asset covered securities are normally institutions wishing to hold high quality securities offering a modest yield premium over comparable Government securities.

The introduction of asset covered securities will greatly assist the financial services sector in the new era of EMU, globalisation, deregulation and new technology. It will remove the structural disadvantage which could otherwise affect Irish capital markets through the undercutting by foreign financial intermediaries of the rates offered by their Irish counterparts. The mortgage sector is probably the best example of what I am referring to here. The advent of the euro with its consequent elimination of exchange rate risk, the mutual recognition of credit institutions throughout the EU and the advance of e-commerce which will enable institutions to penetrate a market without establishing a branch network all pose particular issues for the domestic mortgage sector. Such a situation could allow foreign institutions to cherry pick customers and provide increased competition to the domestic mortgage sector.

Of course this is not a bad thing and I am all in favour of competition in this area. However, I do want to ensure that the domestic mortgage sector is well equipped to compete. Specifically we need to ensure that domestic institutions are enabled to raise funds on terms similar to foreign institutions which are in a position to raise capital through the issue of their own mortgage covered securities.

The introduction of mortgage covered securities will enable Irish mortgage institutions to raise funds more efficiently and to compete with their European counterparts. They should also facilitate the introduction of more attractive and longer term fixed rate mortgages which will provide greater security for borrowers.

The issue of public credit covered bonds is a more specialised operation. It is likely that issuance of these bonds will be mainly concentrated in the IFSC. The Government is committed to maintaining a vibrant and growing international financial services industry in Ireland, building on the success of the IFSC and further boosting employment in the sector. To do this we need to be proactive in providing the environment which will attract new business here. The enactment of this Bill will do precisely that.

By enabling the issuance of these new securities, the Bill will also help to underpin our bond markets as a whole, including the market in Irish Government bonds. With the advent of EMU the Government has had to adapt to a situation where it is no longer a monopoly supplier in a small market but one of the smallest of 12 competing issuers into a very large one. The passing of this Bill should result in a significant increase in the volume of Irish bonds in circulation. This will make all Irish bonds more attractive to large institutional investors and will assist in maintaining activity in the Irish market in times when the State is not issuing bonds. This will help to ensure that there is significant investor demand for all Irish bonds. In short, this product is one which presents advantages to the industry, the State and the consumer.

I would now like to describe for the House the main features of the Bill. It provides for the establishment of designated credit institutions, i.e., designated mortgage credit institutions and designated public credit institutions which may issue securities under the terms of the Bill. Designations must be approved by the Central Bank and only credit institutions already regulated by the bank may apply for designated status. The sector will be regulated by the Central Bank.

The Bill contains restrictions on the types and amount of business activity other than core mortgage or public sector lending in which designated credit institutions may engage. This is to ensure that designated credit institutions engage only in conservative lending practices.

The Bill also contains detailed provisions on the issuance of asset covered securities. These include the issuance by designated credit institutions of mortgage or public credit covered securities secured on mortgage credit or public credit asset pools; specifications on the type and location of assets which may be included in cover asset pools. It should be noted that to provide some flexibility and diversity in the cover asset pools, the legislation allows up to 20% of the pools to consist of high quality assets other than mortgage credit or public credit assets; and specification of requirements for matching of securities and cover asset pools with respect to duration, principal, interest and currency and allowing for the use of hedging contracts in this regard.

An important feature of the Bill is the appointment of a cover asset monitor by a designated credit institution to supervise the assets pool. The cover asset monitor acts like a trustee on behalf of the holders of an institution's asset covered securities. His or her role is to supervise the detailed operation of the cover asset pool. The institution must obtain the consent of the cover asset monitor before including items in the cover assets pool in order that the monitor can verify that the assets to be included are permitted assets, conform to the valuation criteria for the asset class and ensure none of the prescribed limits on any of the asset types is breached.

The key provision of the Bill and the basis on which asset covered securities are issued is the provision of preferential creditor status to the holders of asset covered securities. This is dealt with in Part 7 of the Bill. It provides that the insolvency or potential insolvency of a designated credit institution does not affect the claims and rights of the holders of asset covered securities issued by the institution. In the event of insolvency, the cover assets pool will continue in operation until such time as the claims of the holders of the securities have been met. Only then will excess assets, if any, be distributed to the other creditors of the institution.

Other features of the Bill which should be mentioned are as follows: the setting out of detailed measures to ensure an institution's obligations to the holders of its securities continue to be met in the event of the insolvency of the institution or the revocation of the institution's designation; the reciprocal recognition between Ireland and other states of priority of claims similar to those provided for in the Bill; and the amendment of the Building Societies Act to enable building societies to issue securities under the Bill, to enhance their powers to fund through the issue of securities generally and to ensure the rights of members are not adversely affected by these changes.

Overall, the Bill treads a balance between conservatism and innovation. On the conservative side, the Bill is clearly modelled on the German Pfandbriefe legislation. This is because of the German model's long and successful history, its market acceptance and the volume of securities in issue. It is expected that the similarity of the product to the Pfandbriefe will assist in its quickly gaining market acceptance.

However, the Bill also contains some innovative features which address issues raised by credit rating agencies regarding the operation of asset covered securities markets generally. These features should help in gaining high credit ratings and ready market acceptance for the Irish product. They include specific interest rate risk management requirements, express powers to enter into hedging contracts to manage risk and clear provisions on what happens if an institution gets into financial difficulties. Much effort has gone into making the Bill a state-of-the-art product and I very much see it as a flagship to launch Irish based asset covered securities and make them competitive in the wider European market.

The introduction of the euro is leading to the development of an integrated and competitive capital market in the euro area. Mortgage and public credit covered securities are now becoming a standard feature of European markets. They are a recognised asset class in their own right and attractive to long-term institutional investors. They offer financial institutions the prospect of raising funds in a cost effective manner and, as a consequence, can have a substantial and beneficial impact on competitiveness. We are now part of the European mainstream and must compete in the wider euro area capital markets.

The Bill will enable Irish lenders to finance their activities as efficiently as their European counterparts and demonstrates the Government's commitment to the further development of Irish capital markets and the IFSC. It introduces a product for which there is a proven market demand and which has benefits for the industry, the State and the consumer. I, therefore, commend it to the House.

I welcome this opportunity to address the House on the Asset Covered Securities Bill, 2001. While the Bill is technical in nature, running to 100 sections, quite complex and complicated – I am sure it would take some of the financial wizards to get through its intricacies – nonetheless, Fine Gael will be supporting it through the House.

Competition is the order of the day in the provision of financial services. Too often mortgage companies based in this country do not provide the type of competition that should be provided. However, the introduction of a company from abroad in recent times brought about real competition in the mortgage market and a reduction in the levels of interest payable, which is welcome. Many young people who take out mortgages for new houses are not fully aware that there should be major competition between the various mortgage companies. Many take on mortgages without realising that if they shop around they can get better value. I experienced this approximately three or four years ago when the financial institution with which I was dealing for a long time offered me terms on the purchase of a property. When I further investigated the matter to get competition I found that I could get far better returns from a different institution. When I went back to my regular financial institution with the figures I had obtained I was amazed that it could come forward with figures that were starkly different from its first set of returns that would be needed by me. This is something perhaps ordinary borrowers rather than big time borrowers are not fully aware of. Many mortgage companies provide a level of mortgages at interest rates which are not competitive. Perhaps one of the messages we can send out today is that if one is seeking a mortgage, one can shop around and get competition.

The introduction of the Bill will put Ireland in a better position to offer lower mortgages across the board. I might be a bit foolish in thinking mortgages will come down dramatically as soon as the Bill is introduced. Nonetheless, it will help to make lending institutions more competitive and will, I hope, stem the flow of capital out of the country. As a lot of capital is leaving the country to European markets, perhaps the availability of more secure funds will help to keep some of it at home.

I welcome the fact that the Central Bank will play a key role in scrutinising applications of institutions which wish to operate this bond system. It is good that the Central Bank will play a crucial role in the financial affairs of this country.

I welcome the introduction of the Bill which the Fine Gael Party will support.

When I first read the Bill I thought it was pretty dry. To say the least, it is one of the driest Bills on which I have had the good fortune to comment in my time as finance spokesperson for my party. Having read it a second time, I confirm that view. Nonetheless, I acknowledge that it is a Bill of some importance to financial institutions, but potentially mortgage holders.

The Bill effectively sets out the basis for refinancing by financial institutions. In the past Irish building societies, in particular, have refinanced on the basis of retail deposits, but more recently they have done so on the basis of mortgage backed securities or securitisation. I had the opportunity to discuss this issue yesterday with some of the Minister's officials. Following that meeting they gave me a note stating that the level of securitisation in this country is now quite sig nificant and, more particularly, that of approximately 3 billion of mortgage asset holdings now securitised, approximately 2 billion has been securitised in the last two years. As I do not follow the financial markets to the degree that I can say whether that should be the case, I would be interested to hear the Minister of State's explanation of the reason that is the case. It seems if that level of mortgage holdings or the holdings of building societies is being securitised, it must surely have some impact on the rights of building society members or members of mutualised societies.

The Minister of State makes it clear that the Bill does not affect the rights of members of building societies or mutualised societies. I find it difficult to understand how that is the case. If one thinks about it in the context of securitisation, effectively what is happening is that the institution is disposing of its income stream and the right to the mortgage payments. Surely that must have some impact on the rights of the person or the mortgage since the mortgage is now, in effect, held by a different institution or, alternatively, held by a different body established specifically for the purpose in the interest of securitisation. As I cannot see how the rights of members are secured in those circumstances, I would like to be reassured by the Minister of State that that is the case. That question should be approached both in the context of the existing securitising mechanisms and in the context of the Pfandbriefe, the legislative basis for which is set out in the Bill.

As the Minister of State pointed out, this is, in effect, setting out a new option for refinancing as far as the Irish context is concerned, but it is interesting to look at the experience in the rest of Europe. The total level of Pfandbriefe held in Europe currently, which I understand is about 600 billion, is enormous. Most of this is held in Germany or the Nordic countries – Denmark and Sweden – where the experience generally has been fairly positive. In recent years different variants of Pfandbriefe have been introduced in France, with the Obligation Fanciers, and also in Spain, Austria and Luxembourg, as the Minister of State pointed out. There are different features in different countries. I agree that the Minister of State has managed to strike a reasonable balance between the more conservative and more innovative options. I would have gone for a somewhat more conservative option than the one the Minister of State has chosen, which I will go into later if I get an opportunity to do so.

Going back briefly to the point I made about building societies and mutualised societies, it is probably fair to say that whereas two or three years ago many members of building societies would have been happy to troop along to AGMs to vote away their rights and effectively demutualise the companies and transform them into banks, the experience of those building societies which have been since transformed into commercial banks is such that I am not sure that enthusiasm would still exist. The recently demutualised building societies have been quick to go down the road of the banks in restricting services to customers and closing down branches, which those of us fortunate enough to be members of mutualised societies very much appreciate. Having the non-profit motive at the centre of those societies confers certain advantages which the recently demutualised bodies do not have.

We have to ask ourselves the reason we are introducing this Bill. We are primarily introducing it to facilitate foreign lending institutions, probably located in the IFSC, which will probably do most of their creative lending abroad, but there is also the possibility, as Deputy McGrath rightly pointed out, that it will be used by domestic institutions, building societies in particular. That could and should have some benefits down the road for Irish mortgage holders.

We should emphasise – those of us who support the European project do not do this often enough – that since the introduction of the euro in 1999, albeit as a virtual currency, the average rate of interest here has come down considerably and with it the average rate at which mortgages are repaid. That said, the interbank rate, which currently stands at 3.75% within the euro area, is still a clear two to two and a half points lower than the rate generally charged, even for fixed rate mortgages over a relatively short period of time. There is still some scope, therefore, in that range of 2% to 2.5% for mortgages to come down further. This instrument should facilitate Irish building societies in being able to access cheaper money on a more reliable basis over a long period of time. As a result, I hope it will be possible for them to provide lower fixed rate mortgages over a longer period of time. If they do, this Bill will have been a success and will be of some benefit to individual mortgage holders, something which we all want.

I accept what the Minister of State said in relation to facilitating the IFSC. Unlike my colleague, Deputy Stagg, as a 21st century social democrat rather than a 20th century socialist, I am happy to facilitate the capital markets and the IFSC in so far as we must do so, albeit something that does not fill me with any great enthusiasm.

Deputy Stagg is not a 20th century socialist.

Well said.

He would regard that as a compliment. I would be interested to know the reason the German banks in the IFSC appear to be so anxious to get into this particular market based in Ireland since it is possible for them, through their parent companies based in Germany, to do more or less the same work.

Essentially, there are three issues in dealing with this nature of security. The first is the nature of the security we are giving bond holders. That is critical. In that regard the Minister of State has gone for the highest possible level of legal security. That is probably a good thing because from what I have seen of the experience in countries where they have gone for a lower level of security, the market simply has not taken off. That is true, for example, in countries such as Austria. It is right, therefore, that we are giving the highest possible level of security to bond holders. There is a difficulty with this, however, in so far as it means that if one does not have that level of security and is rated as an unsecured creditor, one is very much down at the bottom of the heap and stands to gain virtually nothing in the unlikely event that a financial institution that issues these bonds goes bust. I am reassured, as the Minister of State's officials told me yesterday, that within the complex of the Central Bank there is a structure whereby individual depositors are safeguarded against these extraordinary circumstances.

The second issue is the composition of the asset pool. In that regard the Minister of State has been a little risqué in allowing, for example, for the substitution of assets and the holding of public credit in OECD countries other than Ireland up to the extent allowed in the Bill. As long as the limits contained in the Bill are properly enforced – that assumes that they are enforceable – I imagine that will command the confidence necessary to get the level of credit rating that it needs. If it does not, then it will not get the credit rating and will not work. It is as simple as that.

The third question is whether this operation should be carried out by specialised banks. I know this has been and continues to be a major issue in other countries such as Germany, where Pfandbriefe were effectively invented and are a major part of its capital markets. The Minister of State has chosen to go the middle road in so far as he said that existing credit institutions may seek to be specially designated. I am not sure if that is the right approach to take in this instance. There is an argument for saying that two, three or four institutions should be designated which will specialise in this type of bond. That is the approach taken in some countries, particularly eastern European countries, and it would have merit. There is an argument for a measure of conservatism given that we are dipping our toes into the water for the first time.

The issue for us in relation to any of these types of product is how we regulate them. The issue of Central Bank regulation is one that has come up in the House in recent years on a number of different occasions. The layers of responsibility which the bank has have been added to and are being added to again in the Bill. The Bill emphasises yet again the need to get in place soon the single regulatory authority which will be able to deal with these diverse levels of regulation.

The position of the cover asset monitor is critical. We have to emphasise that this individual, company or set of individuals must be in a position to have the information needed, not just to oversee, but to effectively manage the assets and ensure the assets which are comprised within the assets pool meet the strict criteria set down in the Bill. If the credibility of the monitor is not established or if he or she cannot do his or her job or does not have the legislative wherewithal to do the job, the whole system will collapse like a house of cards.

I want to reflect briefly on the bond market generally. As the Minister of State is aware, when the euro was introduced as a real currency in 1999 we all expected that it would produce a major shake-up in the bond market and might effectively eliminate the demand for Irish bonds altogether. I understand that what has happened since is that most institutions which hold bonds are now doing so on a portfolio basis and that Irish bonds will typically make up 1% or 2% of the market. Obviously, that is as much as we can reasonably hope for in the circumstances. In 2000 the NTMA refinanced Irish debt by reissuing bonds. Having said that, it has not issued any bonds this year. I will be interested to know from the Minister of State if it intends to issue bonds between now and the end of the year or in the first quarter of next year. We should not look to issue bonds just to maintain the liquidity of the market, which sometimes the NTMA looks to do, but have to maintain the position in the market which ensures there is a market for Irish bonds in the event that we need to engage in Government bonds in the future.

This is an interesting Bill, one that provides an important part of our financial infrastructure, but there are regulations and safeguards without which, to all intents and purposes, the Bill would be worthless. It is essential, therefore, that the supervisory mechanism and the monetary position be defined carefully in a way that ensures it gets the ratings required and makes the impact we want in the financial markets.

I thank both Deputies for their con-

tributions. Many issues have been raised which will form part of a lengthy debate on Committee Stage. The legislation is significant and the product of wide collaboration between my Department, the Irish Bankers Federation, the Irish Mortgage and Savings Association, their legal representatives and the Attorney General. I look forward to dealing with the questions raised by Deputy McDowell and Deputy McGrath on Committee Stage.

Question put and agreed to.
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