I am delighted to have the opportunity to bring this Bill before the Seanad. Although it is technical, this is an important Bill which will enable the further development of the international financial services sector here and provide a new and efficient form of financing to domestic credit institutions. We will, of course, discuss the technical aspects in detail on Committee Stage. What I would like to do today is explain the purpose of the Bill, set out broadly how it will operate and place it in a European context.
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. This will underpin the strength of the Irish financial system and the continued attractiveness of Ireland as a base for financial institutions. To do this, this Bill provides for the introduction of new financial instruments – the asset covered securities of the title – by Irish institutions into the eurozone market. These securities will be backed by assets held by the institutions concerned, in particular mortgages and public sector loans.
The Bill provides 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. 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 which this preferential status offers to the holders of the securities is one of the key features of the product. Because of the reduced risk to investors, it will be possible for financial institutions to borrow more cheaply and easily. This is an important basis to the Bill.
The product which we are introducing is not new to the European capital markets. It is similar to the 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.
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. This is because 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 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 to 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 type of regulatory supervision required which is unique to Pfandbriefe type securities.
I would now like to set out the key features of asset covered securities. The first point is that asset covered securities are securitised bonds backed by a pool of high quality assets. In a conventional securitisation of the type we are used to in this country, the bond is secured on a defined and unchangeable set of assets which are removed from the issuing institution's balance sheet. Essentially, this means that the issuing institution sells the collateral for the bonds to an independent trust which then issues the bonds backed by this collateral. The principal and income earned on this collateral is used to meet payments to the bondholders who no longer have to worry whether or not the issuing institution as a whole is creditworthy.
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 institutions balance sheet but are ring fenced. 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, an option that is not available through conventional securitisation. By replacing non-performing assets with new assets, 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 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, I believe, 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.
I would now like to describe for the House the main features of the Bill. The Bill 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 cover asset pools, specifications on the type and location of assets which may be included in cover asset pools 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. It should be noted that to provide some flexibility and diversity in the cover asset pools, the legis lation allows up to 20% of the pools to consist of high quality assets other than mortgage credit or public credit assets.
An important feature of the Bill is the appointment of a cover assets monitor by a designated credit institution to supervise the cover assets pool. The cover assets monitor acts like a trustee on behalf of the holders of an institution's asset covered securities and may be either an individual or an institution. The role of the monitor is to supervise the detailed operation of the cover assets pool. The institution must obtain the consent of the cover assets monitor before including assets in the cover assets pool so the monitor can verify that the assets to be included are permitted assets, conform to the valuation criteria for the asset class and ensure that none of the prescribed limits on any of the asset types is breached. The appointment of the cover assets monitor will ensure that designated credit institutions are regulated closely and that they operate cover assets pools in the best interests of security holders and in accordance with the legislation.
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 the setting out of detailed measures to ensure that 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 this Bill and the amendment of the Building Societies Act to enable building societies to issue securities under this Bill to enhance their powers to fund through the issue of securities generally and to ensure that 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 ensuring that it meets the needs of domestic credit institutions. It will be studied closely by rating agencies and investors in the sector and it has an important role to play in launching Irish-based asset covered securities and making 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 are attractive to long-term institutional investors. They offer financial institutions the prospect of raising funds in a cost effective manner and, as a consequence, they can have a substantial and beneficial impact on competitiveness. We are part of the European mainstream now and we must compete in the wider euro area capital markets. This 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 I commend it to the House.
