Regulated covered bonds

This page should not be interpreted as formal FCA guidance.

The UK covered bond market was established in July 2003 under UK general law. In March 2008 the Treasury introduced dedicated covered bond legislation (Regulated Covered Bond Regulations 2008) for the UK market. The Regulations implement Article 22(4) of the UCITS Directive, Article 22(4) of the Third Non-Life Directive and Article 24(4) of the Consolidated Life Directive. We supervise RCB programmes.

Covered bonds: key features

Covered bonds are a type of secured bond that is usually backed by mortgages or public sector loans. In the UK, the assets backing the bond are transferred to a separate legal entity (a ‘Special Purpose Vehicle’ or SPV) and form collateral for the bonds.

The asset pool of a covered bond is dynamic and so, for example, mortgages which are refinanced or which fall into arrears can be replaced with new mortgages of similar credit quality and characteristics, for as long as the issuer of the bond remains solvent.

An important feature of covered bonds is that investors have dual recourse, both to the issuer and to the underlying pool of assets.

• Under normal circumstances, covered bonds are an obligation of the issuer, so investors can expect that the issuer will make interest and principal payments on the agreed dates.
• If the issuer of the covered bond defaults on its obligations to covered bond holders or becomes insolvent, the asset pool becomes static and the SPV takes responsibility for administering the asset pool to continue to make payments to bondholders on the agreed dates.
• If there are insufficient assets in the asset pool to meet obligations to covered bond holders, they become unsecured creditors of the failed issuer for the residual amount.

Regulated covered bonds

A regulated covered bond or regulated covered bond programme complies with the Regulated Covered Bonds Regulations 2008 (the RCB Regulations), and Regulated Covered Bonds Sourcebook (the RCB Sourcebook), and is registered by the FCA. Structured (unregulated) covered bonds are not subject to these requirements.

All regulated covered bonds are listed on the RCB register on our website. There may be a delay of up to 7 days between an RCB registering and us publishing it there.

The regulatory benefits of covered bonds

Increased investment limits: UCITS schemes and non- UCITS retail schemes can hold up to 25% of their assets in RCBs issued by one issuer, compared to 5% in the case of structured (unregulated) covered bonds; although UCITS schemes will need to ensure that when they invest more than 5% in covered bonds issued by a single body, the total value held must not exceed 80% in value of the scheme property of the UCITS (COLL 5.2[1] and COLL 5.6.7R[2]).

From the start of the Solvency II directive on 1 January 2016, insurers (other than small non-directive firms) can invest freely in RCBs, subject to their risk appetite and the constraints of their capital requirements and the Prudent Person Principle. For non-directive firms the current PRA rules will continue. These allow non-directive insurance companies to take credit for up to 40% of the value of their assets held in RCBs issued by a single approved counterparty, but only 5% in structured (unregulated) covered bonds issued by a single approved counterparty. 

Preferential prudential risk weighting: the following may benefit from a preferential regulatory capital requirement reduction in risk weight of up to 60%:

• investors subject to the CRD with an exposure to covered bonds which meet the requirements in article 129 of the EU Capital Requirements Regulations (EU No. 575/2013)[3] (the CRR)
• investors not subject to the CRR with an exposure to covered bonds which meet the requirements in BIPRU 3.4.106R to BIPRU 3.4.110R[4]

Application, ongoing supervision and stress testing, changes to programmes

The RCB regime – key facts

• The regime is based on dedicated legislation, the Regulated Covered Bond Regulations 2008, amended in 2011.
• The Regulations provide for the full segregation of covered bond asset pools from the issuer in a separate legal entity (a ‘Special Purpose Vehicle’ or SPV) on which bond holders have a priority claim if the issuer becomes insolvent.
• Only deposit-taking institutions with their headquarters in the UK can become regulated covered bond issuers, and the SPV holding the asset pool must also be based in the UK.
• Only eligible property, as defined in legislation, can be used as collateral in regulated covered bond asset pools.
• Approval must be sought from us before any changes can be made to programme that we judge to have a material impact on the programme’s ability to meet the requirements under the Regulations.
• The Regulations require the assets backing a regulated covered bond programmes to be maintained in a way that ensures ‘there will be a low risk of default in the timely payment’ of the bonds.
• Issuers are subject to an extensive initial application process and regular stress testing and supervisory monitoring of their regulated covered bond programmes by us, independently of issuer‘s own stress testing and any rating agency scrutiny.
• Overcollateralisation requirements are set by our stress testing policy. These are determined on a post-insolvency basis and based on the risk profile of each individual programme.
• We have a wide range of enforcement powers to ensure issuers comply with the Regulations, including the power to issue directions, for example to add assets into the asset pool, which are enforceable by the courts.
• On the insolvency of a regulated covered bond issuer, we continue to supervise the SPV holding the asset pool, and do so in line with our legal duty to have regard to the need to preserve investor confidence in the regulated covered bond market.

Applications for RCB status

Eligible firms: firms who hold permission under part 4 of the Financial Services and Markets Act 2000 to carry on the regulated activity of 'accepting deposits', and who have their registered office in the UK can apply to become a regulated covered bond issuer.

Application process: applicants must complete the application form RCB 2 Annex 1D[5] It covers registration of issuers, covered bonds and covered bond programmes. We will normally not consider applications for issuer registration separately from the application for registration of a covered bond or covered bond programme. If you are already registered as an issuer, complete the same form to register any subsequent covered bonds or covered bond programmes.

Under the RCB Regulations we have up to six months to register an issuer, covered bond or covered bond programme. If we need to ask for more information, we will consider the application as incomplete until we receive all the necessary information. We will notify applicants of our decision in writing and, where appropriate, update the RCB register within seven days of making a decision.

Application form: the application form can be submitted electronically or in hard copy. It is available in the Forms section[6] of the FCA Handbook. The information in the application form must demonstrate the ability of the issuer and the covered bond or covered bond programme to comply with the Regime. As part of the application process, applicants must obtain written advice and reports from suitably qualified and experienced independent third-party advisers, such as lawyers and asset pool accountants, which consider compliance with the relevant requirements of the Regime.

The RCB Sourcebook provides examples of what, as a minimum, we would expect such advice and reports to cover. The issuer's senior management must confirm that they comply with the Regime's requirements. These confirmations will be published on the RCB register.

FCA assessment: we conduct an on-site and desk-based review of applications for RCB status. This includes us assessing the appropriateness of the issuer’s:

• the competency of the proposed oversight and governance framework in prudently managing risks of the programme;
• the systems, controls, policies and procedures in relation to risk management, underwriting, arrears and valuation, as well as compliance with the Regulations;
• the proficiency of cash management and servicing functions;
• the quality of eligible assets in the cover pool (considering borrower history, income verification, loan-to-value [LTV] ratios, income multipliers, arrears, seasoning, loan purpose, property types and terms of the loans);
• the availability of the assets in the cover pool to mitigate the various risks inherent in their programmes such as asset-liability mismatching, market value, interest rate and currency risks;
• the ability of the assets on the issuer’s balance sheet to be substituted in to meet cover pool requirements;
• the ability of the programme to make timely payment on outstanding regulated covered bonds;
• the legal structure’s compatibility with the Regulations; and
• independent legal and audit opinions on the compliance of the issuer and programme with the Regulations.

Ongoing supervision

Issuers must maintain and administer the pool of assets supporting regulated covered bonds in such a way that there is timely payment of claims attaching to the bond (Regulation 17). Issuers are required to give us information on how they meet this requirement.

Based on the information received, we review each regulated programme once a year. This review includes us assessing the oversight and governance of the programme, relevant systems and controls and interaction with compliance and internal audit.

Stress testing

We continue to monitor and analyse the impact of changes to the programme through regular modelling of each programme’s ability to meet its obligations under a range of stressed scenarios. We also set overcollateralisation requirements for each individual programme.

Our stress testing does not rely on analysis undertaken by other parties such as stress testing carried out by issuers, credit rating agencies, or contractual stress tests built into the legal documentation of individual covered bond programmes.

We stress test regulated programmes once a quarter, or when a new series or tranche of regulated covered bonds is issued from a programme. We conduct additional stress testing as required, for example whenever an issuer proposes material changes to a regulated programme, when material volumes of assets are transferred out of the asset pool, or in response to any wider market stresses.

Key variables in our cashflow modelling

• default rate and timing;
• loss severity and timing;
• refinancing sale price of assets;
• prepayment rate and timing;
• resilience of counterparties and hedges;
• movements and interactions of interest rates such as Libor, base rate and issuer SVRs;
• off-sets;
• GIC rate; and
• servicing costs.

We incorporate into our modelling the:

• actual asset characteristics, eg. asset type, amortisation profile, interest characteristics;
• outstanding liabilities, eg. maturity, coupon and currency characteristics; and
• structural features, eg. derivative mechanics, reserve funds, extension period optionality and minimum yield requirements.

Notification requirements

Annual: senior management must confirm that the issuer complies with the RCB Regulations and Sourcebook requirements once a year, using form RCB 3 Annex 1D[7]. As part of the annual confirmation, senior management must have obtained appropriate written advice and reports from suitably qualified and experienced independent third parties on compliance with the Regime. These reports should address the same aspects as at registration of the covered bond or covered bond programme. Issuers must also provide a copy of the Asset Pool Monitor report to the FCA when sending the annual confirmation.

We also expect the issuer's senior management to ensure that legal advice obtained at registration is reviewed when necessary and to supply updated programme documentation to the FCA.

Monthly: each issuer must submit the Asset Pool Notification Form (RCB 3 Annex 2D[8]) each month and publish it on a secure, password-protected website. This includes LTV ratios, arrears, seasoning, borrower history, income verification and geography. Annex 2D also requires confirmation of the asset pool’s capability to make timely payments on the bonds under the ACT.

Quarterly: In addition, if an issuer or owner proposes to add or remove assets in the asset pool in a way that will change the level of over collateralisation by 5% or more, it must notify the FSA using the Asset Pool Notification Form at least five business days prior to the proposed transfer, giving details of the size and composition of the transfer.

Each issuer must also submit the Asset & Liability Profile Form (RCB 3 Annex 3D[9]) each quarter as well as the Loan-Level Data Form (RCB 3 Annex 7AD[10]) each quarter and publish it on a secure, password-protected website. Guidance on how to complete this form is set out in RCB 3 Annex 7BG[11].

On Issuance/Cancellation: before issuing regulated covered bonds, issuers must give us details of their plans. We use this in our stress testing of regulated covered bond programmes. Issuers must also tell us if they intend to cancel any regulated covered bonds.

Issuers must submit the New Issuance Indicative Terms Form (RCB 3 Annex 4D[12]) at least three business days before the date of any proposed issuance. They must also submit the New Issuance Form (RCB 3 Annex 5D[13]) on the date of issuance alongside the final terms of the covered bonds being issued and signed copies of swap documents.

Issuers must notify the FCA if it proposes to cancel (in full or in part) regulated covered bonds, at least three business days before the cancellation will take effect. Issuer must submit the Bond Cancellation Form (RCB 3 Annex 6D[14]) on the date of cancellation.

Each issuer must also submit the Asset & Liability Profile Form (RCB 3 Annex 3D[9]) on the date of any new issuance or cancellation (in full or part) of regulated covered bonds.

Changes to regulated covered bond programmes

An issuer must seek approval from us when considering any material changes to the contractual terms of a RCB or RCB programme. The issuer or owner must give us details of the proposed change, its impact on the RCB or RCB programme and confirm it has obtained appropriate advice to ensure the RCB or RCB programme continues to comply with the Regime. An owner must also seek our approval when considering transfer of the asset pool to another owner.

Where we deem this change to have a material impact on the RCB programme’s ability to continue complying with the requirements set out in the RCB Regulations and Sourcebook, we will independently assess the proposed change before granting approval.

Fees

An issuer applying for registration as an RCB issuer must pay a registration fee. This must be paid in full on the date or before we receive the completed application form for the application to be complete.

RCB issuers are also subject to an annual fee for ongoing supervision or when making changes in respect of their respective RCB programmes.

Further information on fees and payment methods are in Chapter 3 of the Fees Manual[15].