Bulgaria Update: Covered bonds – a new opportunity or same old thing?

On 8 July 2022, the new Covered Bonds Act (“CBA”) entered into force, transposing the European Directive (EU) 2019/2162 on the issue of covered bonds and covered bond public supervision (the “Directive”), aimed at harmonising the legal regime for covered bonds in EU Member States.

The new Covered Bonds Act repeals the Mortgage Bond Act (“MBA”) adopted in 2000 and introduces a few fundamentally new provisions.

• ‍The debt instrument ‘covered bond’ has been introduced

For the purposes of the CBA and the Directive, covered bonds shall mean debt securities issued by a credit institution (bank) which are secured by assets serving to satisfy the covered bond investors (the bondholders) in their capacity as preferred creditors.

Covered bonds are based on the so-called ‘dual recourse’ concept, as they are debt instruments allowing for dual security, i.e. the bondholders are entitled to satisfy claims both from the assets of the issuing bank and from other, additional assets called the ‘cover pool’. Covered bonds are characterised as low-risk, long maturity, income-generating instruments.

Prior to the entry into force of the CBA, Bulgarian legislation regulated only the most typical type of covered bonds – mortgage bonds, which may comprise mainly assets in the issuing bank’s portfolio secured by mortgages on immovable property. In this sense, the fundamental difference between mortgage bonds and covered bonds is that the latter can be secured by a much wider range of eligible assets.       

• ‍The cover pool is regulated in detail

The cover pool may include explicitly specified categories of high-quality cover assets, which the law divides into primary and secondary assets. The primary assets in the pool may be:

– loans receivables secured by mortgage on immovable property;

– loans receivables secured by mortgage or pledge on ships under specific conditions;

– claims against EU Member States  governments, central banks of the European System of Central Banks (ESCB),  local authorities in the Union and other public sector entities;

– claims against third country central governments, third country central banks, multilateral development banks, international organisations under specific conditions.     

Secondary assets in the pool may be:

– any claims against institutions which qualify for the credit quality step 1, i.e. institutions which have received a first class rating from a licensed EU credit rating agency. 

The amount of primary assets shall be at least 85% of the principal amount of the covered bonds in conversion, while the amount of secondary assets shall not exceed 15%. Primary assets shall be of the same type, in exceptional cases and with the BNB’s express permission, the issuing bank may include in the pool other types of assets which have similar structural characteristics, life cycle and risk profile.

The Act expressly provides for the possibility that the following types of instrument may be included in the coverage pool:

• derivative contracts (e.g. interest rate swaps/futures/options, credit default swaps, foreign exchange forward contracts, etc.)  
• other covered bonds.

In practice, covered bonds are in most cases secured by mortgages or public debt. Prior to the adoption of the CBA, the MBA stipulated that mortgage bonds were covered by other claims, mainly against public sector organisations that formed so-called ‘replacement coverage’ – necessary to replace loans repaid in whole or in part from the ‘main coverage’ – claims on mortgage loans. Given the broader range of assets, bondholders of a covered bond issue would be entitled to receive both the traditional cash band payments on – principal and interest – and other payments on specific assets included in the cover pool, such as repayment under derivative contracts.

It remains to be seen to what extent Bulgarian banks will take advantage of the new broader coverage options.

• An obligation to maintain a ‘coverage register’ is  provided   

The issuing bank is required to maintain a register of the covered bonds issued by it containing the required identification data on all covered assets, as well as on the debtors under the claims constituting the covered assets. To maintain the register, banks are required to adopt policies and procedures to ensure the information security coverage register against unauthorised access and unauthorised data modification, data loss and other risks. The method of segregation in the accounting balance sheet set out in the MBA remains. The issuing bank is obliged to account for and keep separately from the other assets in its accounting balance sheet, the assets recorded in the coverage register in so that they can be identified at all times. The rule for not including the assets from the coverage pool in the issuing bank’s insolvency estate also remains, with the difference being that under the CBA the condition for non-inclusion of assets in the insolvency estate is their recording in the coverage register on the date of commencement of insolvency proceedings, rather than the date of declaration of insolvency as under the MBA.

•  Intragroup pooled structures for issuing covered bonds

The Act allows covered bonds issued by a bank from a certain group (‘internally issued covered bonds’) to be included in the coverage pool of covered bonds issued by another bank belonging to the same group (‘externally issued covered bonds’) in compliance with expressly stated requirements. Therefore, Bulgarian banks, part of groups, will be able to participate in intragroup financing through the issuance of covered bonds using intragroup structures, without limitation of their role in them.

• ‍Specialised public supervision

The Bulgarian National Bank (BNB) will have the powers of a competent authority by issuing permissions for covered bonds issuance, will have free access to the office premises of the issuing bank, will have the right to request documents and information, to adopt guidelines for the issuing banks in relation to the issue of covered bonds, as well as to conduct stress testing of the issues and their cover pool.

•  Special administrator of the covered bonds

BNB will have the power to appoint a special administrator of the covered bonds to manage these bonds separately from the other assets of the issuing bank. The appointment of a special administrator is provided for in two cases. Mandatory appointment is provided for when the issuing bank is unable to continue its operations as its license has been withdrawn or it has received permission for voluntary liquidation.

Appointment is also possible at the BNB’s discretion generally upon the occurrence of circumstances that give rise to concerns about the continuity and reliability of the administration of the covered bonds by the issuing bank, including when it is in default for more than 30 days with respect to the payment of interest or principal on the covered bonds or under a derivatives contract. The Act provides that only a natural person who meets the requirements for a receiver under the Bank Insolvency Act may be a special administrator.

•  The concept of ‘cover  monitor’ has been introduced 

The primary function of the cover monitor is to perform ongoing monitoring of the cover pool and ensure compliance with all requirements in relation to it. The appointment of such a monitor is only optional for the issuing bank, it is not its obligation. A separate cover monitor may be appointed for each covered bond issue or programme. 

The motives to the bill point out that the CBA will bring the national regulatory framework into line with the European Union regulatory framework aimed at facilitating the use of covered bonds by credit institutions and creating favourable conditions for markets of this instrument in member states where capital markets are underdeveloped. It is yet to be seen to what extent this objective will be achieved and to what extent the possibility of issuing covered bonds will be used in practice by the Bulgarian banks as a means of financing the real economy.

By Dimitrov, Petrov & Co., Bulgaria, a Transatlantic Law International Affiliated Firm.  

For further information or for any assistance please contact bulgaria@transatlanticlaw.com

Disclaimer: Transatlantic Law International Limited is a UK registered limited liability company providing international business and legal solutions through its own resources and the expertise of over 105 affiliated independent law firms in over 95 countries worldwide. This article is for background information only and provided in the context of the applicable law when published and does not constitute legal advice and cannot be relied on as such for any matter. Legal advice may be provided subject to the retention of Transatlantic Law International Limited’s services and its governing terms and conditions of service. Transatlantic Law International Limited, based at 42 Brook Street, London W1K 5DB, United Kingdom, is registered with Companies House, Reg Nr. 361484, with its registered address at 83 Cambridge Street, London SW1V 4PS, United Kingdom.