At the end of 2021, the Luxembourg parliament approved the law of 8 December 2021 on covered bonds (the Law on Covered Bonds) implementing Directive (EU) 2019/2162 of 27 November 2019 on the issue and the public supervision of covered bonds (the Covered Bonds Directive) and reshaping the existing Luxembourg framework for this type of financial instruments, known in Luxembourg as “lettres de gage”.
Covered bonds in a nutshell
Covered bonds are debt securities issued by specific issuers (e.g. credit institutions or covered bonds banks (banques d’émission de lettres de gage)) secured against a ring-fenced pool of assets, offering by virtue of law a dual recourse protection for covered bondholders: (i) a direct recourse as preferred creditors against the pool of cover assets linked to the specific covered bonds and (ii) against the issuing entity as ordinary creditors. Covered bonds are considered as a sound and reliable source of investment for investors giving, at the same time, alternative sources of funding for credit institutions to help financing the real economy.
New legal framework
Until the entry into force of the Law on Covered Bonds, covered bonds could only be issued by specific credit institutions approved by the Luxembourg Supervisory Commission for the Financial Sector (Commission de Surveillance du Secteur Financier) (the CSSF) as covered bonds banks (banques d’émission de lettres de gage). Going forward, a new “universal banks” regime has been established where all credit institutions incorporated in Luxembourg are authorised to issue covered bonds without the need for a specific license. The scope of issuers has thus been considerably widened in order to boost the use of covered bonds by Luxembourg issuers.
That being said, the CSSF’s prior approval for a credit institution to set up one or more covered bonds programmes will nevertheless be required in accordance with the requirements set out in the Law on Covered Bonds. Also, certain ratio will nevertheless apply to such credit institutions to ensure that the scope of their commitments under the asset pools linked to covered bonds do not exceed a certain percentage of their aggregate commitments.
New forms of covered bonds
The Law on Covered Bonds further extends the forms of covered bonds that can be issued, by introducing (along the existing four forms of lettres de gage, i.e. (a) mortgage, (b) public, (c) movable assets and (d) renewable energy covered bonds) two new types of covered bonds deriving from the Covered Bonds Directive:
- European covered bonds (obligations garanties européennes), issued in respect of loans secured by physical assets (typically real estate) subject to public registration or in respect of loans granted to or secured by public sector entities; and
- (high-quality) European covered bonds (obligations garanties européennes (de qualité supérieure)), issued in respect of loans secured by high quality eligible assets (including certain public sector, immovable and movable property assets) meeting the criteria set out under article 129 of the Regulation (EU) 575/2013 of 26 June 2013 on prudential requirements for credit institutions and investment (CRR).
Improved transparency and investors protection
The Law on Covered Bonds provides for greater transparency and investor protection, by introducing new rules on the structural characteristics of covered bonds (including in respect of the covered bonds introduced by the Covered Bonds Directive), the prior approval of covered bonds programmes by the CSSF, the disclosures to be made to investors and specific reporting to the CSSF. The CSSF is also empowered with the customary powers for it to supervise and investigate where necessary compliance by covered bonds issuers with any rules applicable to them.
Worth bearing in mind, the issuance of covered bonds in Luxembourg will – as any issuance of securities in Luxembourg – fall within the scope of the Luxembourg law of 16 July 2019 on prospectuses for securities, and may require a prospectus to be approved by the CSSF, unless one of the exemptions foreseen thereunder would apply. Covered bonds can also be admitted to trading on one of the markets operated by the Luxembourg Stock Exchange (the LuxSE). Nowadays, over 250 issuers from multiple jurisdictions have listed their covered bonds on the LuxSE.