Joyce Steven: Reserve Bank of New Zealand (Covered Bonds) Amendment Bill — First Reading 
Text is incorporated into the Bound Volume 
Joyce Steven: Reserve Bank of New Zealand (Covered Bonds) Amendment Bill — First Reading 
[Sitting date: 22 May 2012. Volume:680;Page:2258. Text is incorporated into the Bound Volume.] 
Hon STEVEN JOYCE (Associate Minister of Finance) 
 on behalf of the Minister of Finance: I move  
That the Reserve Bank of New Zealand (Covered Bonds) Amendment Bill be now read a first time. 
 At the appropriate time I intend to nominate that this bill be referred to the Finance and Expenditure Committee for its consideration.  
This bill is an important part of the Government’s programme to improve the resilience of the New Zealand financial system to volatility in international markets. Turmoil in financial markets over recent years has underscored that such policy needs to be an absolute priority for Governments. New Zealand banks depend on offshore wholesale markets to obtain funding. It is thus essential that the New Zealand banking sector has access to these markets on the same terms as banks in other jurisdictions. The Reserve Bank of New Zealand (Covered Bonds) Amendment Bill aims to support this objective. The bill applies in relation to New Zealand banks’ issuance of covered bonds although it makes provision for the framework to be extended to other entities such as non-bank deposit takers in the future should it become relevant to them.  
A covered bond is a dual recourse instrument under which bondholders both have an unsecured claim on the issuer and hold a secured interest over a specific pool of assets set aside by the bank called the cover pool. Covered bonds can be distinguished from senior unsecured debt instruments issued by banks where the bondholder is simply an unsecured creditor of the bank and also from mortgage bank securities where the bondholder holds a secured interest in the cover pool but has no claim on the issuer.  
The issuance of covered bonds by New Zealand banks supports the Government’s goal of improving the resilience of the New Zealand financial system to market volatility in a number of ways. First covered bonds provide access to an alternative investor base thus increasing the funding diversity of the financial system. This investor base is significant. The covered bond market is one of the largest debt markets in Europe. Covered bond investors also tend to be relatively longer-term investors such as pension funds and insurance companies. Secondly covered bonds are typically issued at a longer term than senior unsecured debt and hence provide a mechanism for banks to reduce reliance on short-term funding with its associated refinancing risk. Thirdly covered bonds have proved to be a resilient form of funding at times when other funding markets are inaccessible including during the global financial crisis. Aspects of covered bonds such as dual recourse to the issuing bank and the cover pool reduce the risk to investors making them more attractive to investors in uncertain times.  
Covered bonds can therefore contribute to financial system stability by reducing the probability of a bank’s default. They can also have a positive impact on the economy by supporting banks’ ability to maintain their lending activities if other funding markets tighten. However the issuance of covered bonds does have the effect of reducing the value of the asset pool that would be available to a bank’s unsecured creditors including depositors in the unlikely event that a bank failed. This is because those unsecured creditors would rank behind the covered bondholders in respect of the cover pool assets in a failure. This may therefore increase unsecured creditors’ losses in a failure. In order to minimise any potential impact on creditors and depositors the Reserve Bank has imposed a limit on banks’ issuance of covered bonds through the use of its powers to set conditions of registration. In this regard the value of assets that a bank may encumber in favour of a covered bond programme is restricted to 10 percent of the total assets of the bank. That balances the benefits of a lower probability of default with the need to minimise creditors’ losses should a default situation in fact occur.  
This bill establishes a legislative framework for the issuance of covered bonds. Internationally legislative frameworks for the issuance of covered bonds are commonplace. They are also a prerequisite for investment for some investors. New Zealand banks have been issuing covered bonds under contractual arrangements for the past 2 years. However a legislative framework for issuance would improve New Zealand banks’ access to the covered bond market and would impact positively on the credit ratings of covered bond programmes both of which would help to reduce the cost of issuance for New Zealand banks. In 2011 Australia passed legislation putting in place a legislative framework for covered bonds. In developing this legislative framework the Reserve Bank has considered international best practice as well as the views of stakeholders including issuers investors and the public. It is my understanding that New Zealand banks are strongly supportive of the framework’s introduction. 
The legislative framework introduced by the bill aims to provide legal certainty as to the treatment of cover pool assets in the event an issuing bank was to be placed into statutory management or liquidation. This legal certainty is provided firstly by requiring the registration with the Reserve Bank of covered bond programmes subject to the programmes meeting certain registration requirements. In this regard the key requirement is that the assets of the cover pool be segregated from the assets of the issuer by way of sale of those assets to a separate company referred to as a special purpose vehicle. 
The registration process also requires the issuer to appoint an independent cover pool monitor to the covered bond programme. This will help to improve investor confidence in New Zealand covered bond issues by providing independent verification of information provided by issuers in relation to the assets of the cover pools.  
The bill then provides certainty for registered issues as to the application of the law in relation to the assets held by a covered bond special purpose vehicle in the event an issuing bank is placed into statutory management or liquidation. The bill limits the application of these two regimes so that special purpose vehicles under registered covered bond programmes can continue to operate outside the statutory management or liquidation of the issuer. This provides certainty to covered bond investors that the failure of the bank that issued the cover bond will not undermine their rights in regard to the cover pool assets.  
Registration of covered bond programmes will increase the transparency of banks’ covered bond issuance and offer greater clarity for investors and depositors as to which assets are set aside for the benefit of covered bondholders. From the commencement of this all covered bonds issued by a registered bank will need to be made under a registered programme. There will be a 6-month transition period for the registration of existing covered bond programmes.  
In conclusion the Reserve Bank of New Zealand (Covered Bonds) Amendment Bill will ensure New Zealand - registered banks continue to have effective access to the covered bond market reducing the likelihood of liquidity problems affecting an issuer and promoting the sound and efficient operation of the New Zealand financial system. I nominate that the Reserve Bank of New Zealand (Covered Bonds) Amendment Bill be referred to the Finance and Expenditure Committee for consideration.