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Covered Bonds In New Markets: A Shifting Paradigm


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Covered Bonds In New Markets: A Shifting Paradigm

(Editor's Note: This article is an update to our article "Conflict And Market Conditions Drag On Covered Bond Issuance In New Markets," published on Sept. 15, 2022.)

In this report, we take a closer look at the issuance outlook, regulatory and legislative developments, and key characteristics of covered bond markets in Central and Eastern Europe (CEE), Asia, Latin America, and Africa.

Ample Liquidity And Weaker Lending Growth Will Drag On Issuance

Starting from the second half of 2021, surging inflation and the consequent normalization of monetary policy in most advanced economies led to a rebound in covered bond volumes. Despite global bank wobbles causing a marked slowdown in mid-March 2023, European investor-placed benchmark issuance exceeded €89 billion in the first four months of 2023, the highest for the past decade, on the back of hefty targeted longer-term refinancing operation (TLTRO) redemptions and in anticipation of reduced European Central Bank (ECB) intervention (see "Global Covered Bond Insights Q2 2023: The Implications Of Rising Interest Rates," published on April 12, 2023). Volumes surged outside Europe too, especially in countries were issuers partially replaced central bank funding with covered bonds, such as Canada.

Chart 1


We expect that issuance in new markets will increase further this year, supported by new issuers in countries with an established legislative framework, such as Korea and Singapore. But plenty of available liquidity and weaker lending growth will limit the overall increase. Further growth will come once new legislative frameworks are established, granting issuers in new markets access to covered bond investors.

The Harmonization Directive Will Impact Markets Beyond Europe

The EU's Directive For The Harmonization Of Covered Bond Frameworks (the Directive) introduces a common definition of European covered bonds. The transposition of the Directive is largely complete in CEE, with countries such as Croatia and Bulgaria passing their covered bond laws in the first half of 2022 (see "Conflict And Market Conditions Drag On Covered Bond Issuance In New Markets," published on Sept. 15, 2022). However, the lack of issuance from these new jurisdictions shows that the approval of a dedicated legislative framework is not sufficient for the establishment of covered bond programs: limited funding needs probably reduced the incentives to do so.

The Directive also defines the pathway to achieve third-country equivalence. Currently, covered bonds issued by credit institutions outside the European Economic Area (EEA) and purchased by European investors receive less favorable regulatory treatment than covered bonds issued by EEA-based credit institutions. However, European authorities could, in future, decide to grant equivalent treatment to covered bonds issued by non-EEA credit institutions. Alignment of third-country covered bond frameworks with the Directive will be a key factor. Article 31 of the Directive stipulates that the European Commission will submit a report on third-country equivalence to the European Parliament and Council by July 2024. The report may be accompanied by a legislative proposal on whether or how an equivalence regime should be introduced.

While the creation of a European benchmark could facilitate the introduction of new dedicated frameworks in other regions, it could also delay the process if local legislators decide to wait and understand the conditions to achieve equivalent treatment of covered bonds.

Almost a decade after the introduction of the draft law, Morocco approved in 2022 the first dedicated covered bond framework in Africa. While covered bonds can play a significant role in supporting housing finance in the continent, the experience in Morocco shows that the legislative process can be fraught with difficulties. Georgia also approved a dedicated covered bond legislation in 2022. We understand that covered bonds will initially be used as collateral under existing funding operations with the central bank, and only at a later stage will they be distributed to private investors, probably initially domestic ones. This points to significant changes that covered bonds may experience as they expand outside Europe.

Covered Bonds Will Evolve As They Expand Internationally

Covered bonds--an overwhelmingly European phenomenon for most of their 250-year history--have recently proved very popular in new markets such as Australia, Canada, Korea, and Singapore. These developed economies aligned their models to European best-practice: local banks typically issue 'AAA'-rated covered bonds, backed by prime residential mortgage loans, and under an established legal framework. But the greatest growth potential is probably in emerging markets, where the middle class will expand the most in the coming decades. Countries such as China, India, Mexico, and Indonesia could greatly benefit from a dual recourse instrument helping them mobilize private capital toward financing their growing economies. As dual recourse financing expands in these markets, we can also expect to see new issuers, assets, structures, and ultimately investors, challenging the established definition of what constitutes a covered bond.

While covered bonds in new markets have so far primarily targeted the traditional European investor base, Brazilian covered bonds have initially attracted domestic investors. And we have seen how Georgian banks will initially use covered bonds as collateral under the local central bank's liquidity facility, rather than placing them with international investors. More generally, we can expect that a larger share of covered bonds issued outside Europe will target domestic investors, at least initially. While covered bonds are typically issued by banks, we can assume an increasing interest from non-bank financial institutions, such as housing finance companies in India, or even non-financial entities. And some of these new issuers will consider covered bonds backed by non-traditional assets, such as unsecured loans to small and mid-sized enterprises (SMEs) or auto loans. Turkish banks have already issued SME covered bonds, as unsecured SME loans are eligible collateral under the local legal framework. Banks elsewhere may consider issuing SME covered bonds even if SME loans are not eligible collateral under the local framework, or even in the absence of a local framework. This is because covered bonds can be issued in certain legal contexts without a dedicated regulatory framework. Issuers can establish programs that replicate the main features of legislation-enabled covered bonds by means of contractual arrangements (so-called structured covered bond programs). For example, the first Japanese programs have been established based on a contractual structure, due to the lack of a dedicated legislation. These contractual arrangements grant greater flexibility outside of an established legal framework, for examples in terms of eligible collateral (see "S&P Global Ratings' Covered Bonds Primer," published on June 20, 2019).

Regional And Country Focus

Central and Eastern Europe

After a relatively strong start to the year, driven by issuance from Slovakia, we expect that investor-placed benchmark issuance will remain subdued over the coming months. Although most CEE economies continued to expand briskly in early 2022, growth has since visibly slowed amid worsening geopolitical and financial conditions. Persistently high inflation is eroding consumer purchasing power and financial conditions have tightened. Additionally, CEE countries' geographical and economic proximity exposes them to spillovers from the Russia-Ukraine war, which is affecting the region via rising energy prices, as well as trade, financial, and confidence channels. Finally, consumer confidence in CEE has dropped to its lowest levels since the start of the COVID-19 pandemic (see "Economic Outlook EMEA Emerging Markets Q1 2023: Tough Choices Ahead," published on Nov. 29, 2022).

Chart 2


Table 1

Weaker lending will drag on issuance
Real GDP growth (%) CPI (average, year-on-year; %) Systemwide domestic loans as a percentage of systemwide domestic core customer deposits Nonperforming assets/systemwide loans (year end; %) Loan growth (%)
2021 2022 2023* 2021 2022 2023* 2021 2022 2023* 2021 2022 2023* 2021 2022 2023*
Bulgaria 7.6 3.4 1.3 2.9 13.0 8.8 80.1 84.7* 94.8 7.3  7.08* 7.3 8.9 8.00* 4.6
Croatia 13.1 6.3 1.5 2.6 10.8 7.3 84.7 80.6 90.3 6.4 4.7 7.7 2.6 10.0 (5.9)
Czech Republic 3.5 2.5 0.2 3.3 16.8 8.0 71.9 62.9 64.0 2.2  2.00 2.5 8.9 5.7 4.0
Estonia 8.0 (1.3) 0.3 4.5 19.4 8.9 110.9 119.3 121.6 0.2 0.2 0.2 7.9 11.3 6.4
Hungary 7.1 4.6 0.3 5.2 15.3 18.5 93.4 110.0 109.3 2.5  3.09 5.5 16.1 12.0 11.2
Latvia 4.1 2.0 (0.3) 3.2 17.2 9.3 79.6 76.0 69.8 4.6 3.5 3.2 3.3 17.3 5.5
Lithuania 6.0 1.9 0.4 4.6 18.9 8.7 79.6 92.7* 94.5 1.2 1.08* 1.3 3.4 2.6 2.4
Poland 6.7 5.2 0.9 5.2 13.2 11.8 99.5 97.7 97.7 5.4  4.49 5.0 5.6 1.3 4.6
Romania 5.8 4.8 2.3 4.1 12.0 10.5 81.9 90.3 87.8 3.5  3.00 2.7 14.8 12.2 9.8
Slovakia 4.9 1.7 1.2 2.8 12.1 10.7 119.0 129.4 131.6 2.2  2.05 2.6 7.1 7.1 (0.7)
Slovenia 8.2 5.4 0.8 2.1 9.3 6.5 80.0 81.4 81.5 2.5 2.2 2.8 4.5 10.2 3.0
Turkey 11.6 5.4 2.1 19.6 72.3 44.6 116.6 110.9 109.7 3.1 2.1 5.0 36.7 54.1 25.0
*Forecast. Source: S&P Global Ratings.

These factors result in a weakening of activity in the mortgage markets. The rapid increase in interest rates caused a significant increase in the cost of debt, particularly for floating rate loans, and may weaken banks' asset quality. Governments in some countries such as Hungary and Poland have intervened to support retail mortgage borrowers, introducing interest rate caps on mortgage loans, windfall taxes on banks, and payment holidays, for example. However, government interference puts an additional cost burden on banks and could further undermine investor sentiment.

Covered bond issuances from the region so far in 2023 have shorter maturities than those typically seen previously, which points to the challenging environment issuers face when executing transactions, as uncertainty about the course of the war in Ukraine and macroeconomic and financial conditions are putting a strain on investor sentiment. At the same time, high yields and the availability of customer deposits may also deter some issuers from entering the market.

We also believe issuers in CEE will continue to focus on the issuance of MREL-eligible debt (minimum requirement for own funds and eligible liabilities), further decreasing the need for covered bond issuance.

While the outlook for the year ahead is challenging, structural factors remain supportive for growth in the CEE region, in our view. We expect convergence with Western European income levels to continue (see "Economic Outlook EMEA Emerging Markets Q1 2023: Tough Choices Ahead," published on Nov. 29, 2022). We believe that issuance will increase once economic and financial conditions stabilize, and mortgage lending picks up again. In addition, the slowdown in retail deposit growth, due to rising household expenditures and the release of savings built up during the pandemic period, may compel banks to increase wholesale funding if other sources of funding become uneconomical.

The transposition of the harmonization Directive will be a supporting factor for covered bond issuance in the region, through the adaptation of a legislation in countries that do not have one or by aligning the existing legislation to a common framework.

Hungary.   Local covered bond issuance is supported by regulatory initiatives, such as the mortgage funding adequacy ratio (MFAR) regulation, which requires banks to finance at least 25% of outstanding household mortgage loans with mortgage-backed bonds. Since its introduction in April 2017, the Central Bank of Hungary (Magyar Nemzeti Bank; MNB) increased the MFAR requirement twice. Amid an uncertain macroeconomic and financial environment, the MNB postponed its additional planned tightening measures of the MFAR--aimed to apply from October 2023--including an increase of the MFAR requirement to 30%, restrictions on cross-ownership of mortgage bonds by banks, and required stock market listing. We understand that currently there is no new deadline set.

Various mortgage bond purchase programs by the MNB further support Hungarian covered bond issuances and contributed to the development of a green covered bond market. However, in April 2022, the MNB announced the suspension of its green mortgage bond purchase program. The MNB currently maintains its rollover facility for maturing mortgage bonds subject to certain conditions.

We expect moderate covered bond issuance over the next year. Hungarian Banks comply with the 25% MFAR requirement with a buffer (the banking sector average MFAR was about 29% as of September 2022) and with the MFAR increase being delayed, banks have no immediate issuance pressure. Demand for housing loans fell sharply in the last quarter of 2022 as consumer purchasing power and confidence dropped amid rising inflation and interest rate hikes. Hungary saw particularly large interest rate hikes last year. In October 2022, the MNB had to urgently intervene to preserve exchange rate stability after the Hungarian forint came under pressure, and increased its effective interest rate to 18% from 13% in September 2022. In addition, the Hungarian government's interest rate freeze on retail mortgage loans--introduced as of January 2022 and originally foreseen until summer 2023 but recently extended until the end of 2023--might narrow the available pool of assets suitable for cover pools. Finally, with the suspension of the MNB's green covered bond purchase program an important buyer of covered bonds has gone for the time being.

Czech Republic.   Local banks use covered bonds to diversify their funding sources, despite their strong deposit base. With a total outstanding amount of €22.5 billion as of year-end 2021, the local covered bond market is the largest in CEE, representing about 9.5% of GDP, and has continued to grow.

Although covered bonds are issued predominantly in Czech koruna, there have been a limited number of euro benchmark issuances from the country. Most recently, UniCredit Bank Czech Republic and Slovakia A.S.--aiming to diversify its wholesale funding franchise--issued two €500 million covered bond transactions, in October 2022 and February 2023, respectively. UniCredit Bank Czech Republic and Slovakia is the first Czech bank that has adapted its international mortgage covered bond program to issue covered bonds on the international capital markets under the new Czech covered bond regulatory framework following the implementation of the EU Covered Bond Directive. Its cover pool contains loans secured on properties in the Czech Republic and Slovakia, denominated in Czech koruna and euros, respectively.

We expect further covered bond issuance to be limited this year. The growth in lending for house purchases in the Czech Republic, which has been among the strongest in recent years, growing between 5%-10% annually over 2015-2021, dropped in the second half of 2022, as demand for housing cooled substantially amid the rise in interest rates. Loan affordability has also been further reduced due to high inflation and the tightening of macroprudential policies through the Czech National Bank in April 2022. At the same time, stable retail deposits are still funding banks. Although we expect some reduction in deposits from increased use of cash reserves due to elevated inflation rates, higher interest rates than in the eurozone and limited alternative domestic investments will likely keep deposit volumes high, limiting banks' wholesale funding needs.

Poland.   Banks benefit from a strong domestic deposit base, which was spurred by economic growth and increasing wages and wealth levels over the past decade. The country's ratio of domestic loans to core customer deposits was about 98% as of year-end 2022 and is expected to improve slightly, limiting banks' wholesale funding needs. The Polish covered bond market has decelerated slightly with the total outstanding volume of covered bonds at the end of 2021 being 18% lower compared to year-end 2019. As of year-end 2021, Polish covered bond issuance in euros accounts for about 61% of outstanding volume, down from 65% a year before. The last euro benchmark issuance from the country was from PKO Bank Hipoteczny in July 2022.

We believe that Polish covered bond issuance will remain flat in the near future. Elevated inflation and volatile financing conditions are weakening loan demand, while the rise in interest rates--the National Bank of Poland increased its policy rate by a cumulative 6.65 percentage points since late 2021—-together with the Polish Financial Supervision Authority's recommended changes in the rules for calculating creditworthiness have also reduced loan affordability. The spike in interest rates caused a significant increase in cost of debt for borrowers with predominantly variable rate loans. To support retail mortgage borrowers, the Polish government in 2022 implemented its support program, comprising three pillars: payment holidays over 2022/2023; an increase of the borrower support fund funded by banks; and the replacement of WIBOR (the main reference rate in Polish zloty) with a new benchmark WIRON expected to be finalized in 2025. Government interference might further undermine investor sentiment. The transition to a new benchmark is introducing operational and commercial challenges for banks and creates additional uncertainties regarding the effect on existing documentation, in particular for instruments maturing after the 2025 deadline for WIBOR cessation. The suspension of payments under the mortgage loans also adversely impacts interest coverage limits for existing cover pools, and might narrow the pool of assets available for cover pool inclusion.

Further, Polish banks have to fulfill their MREL requirement by the start of January 2024, and we believe their focus will be on issuing MREL-eligible debt.

We understand that the Polish Financial Supervision Authority is considering introducing a new long-term financing ratio requirement, which would require banks to issue covered bonds covering part of the amount of the mortgage loans granted. This would support covered bond issuances.

Slovakia.   Local issuers have been the most active in the CEE covered bond market since an updated covered bond law was introduced in January 2018. Covered bonds are currently funding about one fifth of the domestic mortgage portfolio. The year 2023 started strongly in Slovakia, similar to the strong issuance dynamic observed in more established covered bond markets. By the beginning of April, Slovakia's three major banks --Slovenská sporitelna, VUB Banka, and Tatra banka--had each issued €500 million in covered bonds, matching the 2022 total benchmark issuance volume. We believe two factors have supported this: TLTRO redemptions, and the expectation that quantitative tightening will further reduce covered bond demand as the ECB stops its asset purchases, which led some banks to front-load their issuance plans. Slovakian issuers have typically tried to secure longer term funding by issuing covered bonds with maturities of five years and longer. However, year-to-date 2023 issuances have much shorter maturities of around three years, pointing to the difficult environment issuers currently face when executing transactions.

Despite a very strong start to the year, we expect further issuance for the rest of the year to be moderate. The front-loading of issuance in the first quarter of 2023 will reduce funding needs for the rest of the year, while the slowdown in loan demand should result in a deceleration in bank loan growth. At the same time however, continued market volatility could be supportive of covered bond issuances if other funding sources become uneconomical, while the recent drop in bank deposits could also incentivize banks to increase their wholesale funding.

Baltics.   In Estonia a covered bond legislation was first adopted in February 2019. In late 2021, amendments to the law took place covering the implementation of the covered bond Directive and the alignment of the covered bond law in the three Baltic states. Latvia adopted a new covered bond law fully compatible with the covered bond Directive in May 2021, and in Lithuania a covered bond law entered into force shortly after the July 8, 2022, deadline.

The legal frameworks of the Baltic countries were drafted under a mutual agreement to allow standardization of conditions and facilitate the cross-border transfer of assets, wherever possible. This enables local banks that operate cross-border to combine the assets from one, two, or all three of the Baltic States under one covered bond program. Having a combined outstanding mortgage market of €24.2 billion as of year-end 2021, the alignment of the frameworks significantly increases the volume of available mortgage loans for cover pool purposes and allows issuers to optimize funding costs.

The latest benchmark issuance from the region was done over a year ago when Estonia's Luminor Bank issued its second benchmark transaction in May 2022. In the same year it also issued a total of €750 million of retained issuances. The second issuer from the region, LHV Pank AS has not issued since it debuted with two smaller issuances in the summer of 2020. As of end-March 2023, Luminor Bank's cover pool comprises residential mortgages from all three Baltic States, while LHV's pool only includes Estonian residential mortgage loans.


Korea and Singapore pioneered covered bond issuance in developed Asia. As customer deposits primarily fund local banks, their main motivation in establishing covered bond programs was to manage asset liability mismatch risk and diversify their funding sources. In 2018, the first covered bond program was set up in Japan. Because there is no dedicated local covered bond legislation, the program was based on a contractual structure.

Despite a surge in liquidity following the COVID-19 pandemic, Asian banks remained active in the covered bond market, a testament to the strategic importance that the product plays in their funding strategies.

Chart 3


We expect that issuance in developed Asia will be restrained by the availability of customer deposits, limited funding needs in foreign currencies, and weakening loan growth. Further growth will probably come through new issuers entering existing markets and legislative and regulatory initiatives.

We see greater growth potential in developing Asia, where we expect that housing finance needs will grow substantially, but legislative developments will be essential.

South Korea.   Covered bonds can be issued through the Covered Bond Act and the Korea Housing Finance Corp. Act. The Korean Housing Finance Corp. (KHFC) has issued covered bonds since 2010, joined by Kookmin Bank in 2015. Since then, KHFC issued the first social covered bond from Asia and the first Korean euro-denominated covered bond in 2018, and KEB Hana Bank established its own program and inaugural euro-denominated issuance in January 2021.

The Korean Financial Services Commission a few years ago adopted several measures to encourage covered bond issuance, including reduced registration fees for bond issuance and lower capital requirements for covered bond investors. These measures incentivized the issuance of South Korean won-denominated bonds, and since 2019 five financial institutions, including KHFC, have issued covered bonds in the domestic market.

We expect Korean issuers to continue using covered bonds, both domestically and internationally, to diversify their funding base and mitigate asset-liability risk.

Singapore.   The regulatory framework for the issuance of covered bonds by banks incorporated in Singapore was established on Dec. 31, 2013, and refined on June 4, 2015, through the Monetary Authority of Singapore (MAS)'s Notice 648.

With the legislative framework in place, the three major domestic banks have already set up their programs and issued cumulatively the equivalent of more than €15 billion as of May 2023. An increase in the asset encumbrance limit to 10% from 4% of the issuer's total assets since October 2020 has provided more headroom for further issuance and will probably attract new banks to the market. However, overall supply will likely be limited because banks in Singapore are mostly funded by depositors and have limited funding needs in foreign currencies.

Japan.   Since there is no dedicated legal framework in Japan, when Sumimoto Mitsui Banking Corp. (SMBC) issued the first Japanese covered bond in November 2018 it based its program on a contractual structure. Likewise, Sumitomo Mitsui Trust Bank launched its inaugural covered bond in October 2020 with a structure similar to SMBC's. Given the availability of domestic deposits, it appears that the main reason for establishing covered bond programs is to attract foreign currency funding.

The Japanese covered bond market can grow considerably. Local lenders are already using collateralized funding, such as residential mortgage-backed securities (RMBS), and they have now started adding covered bonds to the mix; outstanding mortgage loans are about Japanese yen (¥) 210 trillion, of which only 15%-20% is currently used as collateral for RMBS, leaving ample capacity for covered bond issuance; Japanese banks have considerable assets denominated in foreign currencies and covered bonds could constitute a competitive source of funding for these assets; and from a risk and regulatory perspective, covered bond issuance can reduce the duration mismatch between the assets and liabilities. However, the current lack of a dedicated legal or regulatory framework could constrain further issuance, especially for regional banks.

China.   On May 26, 2022, the National Association of Financial Market Institutional Investors (NAFMII) announced a pilot program for covered bonds. The main goal of the notice is to support projects relating to affordable housing and low-rent homes. NAFMII set out requirements for the registration of covered bond programs, use of proceeds, and information disclosure. Eligible underlying assets include property and land-use rights, while chattels and intangible assets may also be designated as eligible asset classes in the future. Compared with auto asset-backed securities and RMBS, the transaction structure of domestic covered bonds is more flexible. Asset segregation can be achieved either through the true sale of assets to a special-purpose entity (SPE) or pledge of covered assets. Following the rollout of the guidelines, the first self-labeled domestic covered bond was issued in the interbank market in late June 2022, backed by the operating income of a hotel property. In our view, there are still legal and structural hurdles to overcome before covered bonds are issued in China in line with international practices.

Generally speaking, issuers in China have expressed increased interest in dual-recourse issuance in the past few years. Since larger banks benefit from abundant liquidity and strong deposit bases, the appetite for covered bonds mainly reflects increasing risk awareness--specifically, the importance of having alternative tools for banks to plan for rainy day funding, rather than current funding needs. Aside from limited supply, there are several other legal and regulatory questions that should be considered. The incumbent asset issue is a primary challenge for covered bond issuance. China has regulations on the protection of depositholders, and the arrangement to ringfence specific banks' assets to benefit covered bondholders could be complicated without a dedicated legal framework. Moreover, legally, depositholders enjoy a very high ranking in the allocation waterfall after banks' liquidation in the region. Because these assets' ringfencing and deposit ranking relate to the sovereign banking laws, regulators may find it difficult to have flexibility, even if they support the development of covered bond issuance.

India.   The country has a significant shortage in affordable housing and a young and growing population. Moreover, household debt as a percentage of GDP is below that of other emerging markets. These factors highlight the potential for a significant growth in the housing finance sector. Currently, customer deposits are Indian banks' primary source of funding, but issuers and regulators are considering alternative sources of wholesale funding, including covered bonds. In 2019, for example, the Reserve Bank of India (RBI) constituted a Committee on the Development of Housing Finance Securitisation Market, which recommended, among other things, an enhanced role for the National Housing Bank and further amendments to reduce transaction costs for securitizations. Like other Commonwealth countries, such as Australia and the U.K., India does not have specific legislation governing securitization. Rather, the legal framework for India's securitization market is based on existing trust, contract, and property law, and a series of guidelines issued by the RBI.

Starting from 2019 a number of local entities, mainly non-bank financial institutions, issued self-labeled domestic covered bonds. These bonds replicate some of the structural features of traditional covered bonds—chiefly the dual recourse principle—but don't appear to meet other criteria, for example in terms of public supervision or asset quality. Underlying asset types included gold loans, vehicle loans, and small business and wholesale loans. In September 2021, RBI has issued new asset transfer guidelines which, together with further clarifications in December 2022, made it difficult to structure domestic covered bonds in their current form.

While we have not seen international issuance yet, we anticipate non-domestic covered bonds may at least initially be issued under a general-law framework, with an appropriate supportive regulatory framework. In our view, key clarifications required will include whether the issuance of covered bonds is permitted under Indian legislation generally, whether existing securitization guidelines can be applied to covered bonds, how asset segregation can be achieved, the treatment of assets in an issuer insolvency scenario, and whether there are any challenges from a tax perspective, including stamp duty and withholding tax.

Latin America

Covered bonds in this region have a short and limited track record. Panama was the first country to see a covered bond issuance in October 2012. Since it does not have a dedicated legal framework, covered bonds were based on contractual agreements. Chile also saw limited and locally distributed covered bond issuance in the past. One factor preventing financial institutions in the region from issuing covered bonds was the lack of a dedicated legal framework. However, things are changing thanks to the legislative and market developments in Brazil.

In 2014, Brazil enacted Provisional Measure No. 656, which outlined a framework for Brazilian local covered bonds ("letra imobiliária garantida"; LIGs), and which became Law No. 13,097 in January 2015. Banks only began issuing LIGs in 2018, with private domestic placements. As of Q1 2023, three banks have issued almost Brazilian real (R$) 100 billion. Since 2020, the Brazilian Securities Exchange Commission allowed public placements for LIGs, which could further support domestic issuance. The market is still waiting for legal and regulatory clarification on how international issuance could be achieved. Once this clarification is obtained, we believe that Brazilian banks will try to issue LIGs offshore targeting foreign investors.


In 2022, Morocco was the first country in the region to approve dedicated covered bond legislation. Since the presentation of the draft law, it took almost a decade to approve the final law, which is a testament to the difficulties a legislative process may encounter.

Similarly, in 2015, South African regulators considered allowing banks to issue covered bonds in the context of a broader discussion regarding resolution regimes and the anticipated introduction of retail depositor guarantees. However, domestic investors remain resistant to the idea of covered bonds, due to their concerns about the potential pressure on the pricing of their senior unsecured debt, the losses if an issuer becomes insolvent, and what could happen to the ratings on this debt. As of today, banks are still not allowed to issue covered bonds.

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Antonio Farina, Milan + 34 91 788 7226;
Natalie Swiderek, Madrid + 34 91 788 7223;
Secondary Contacts:Leandro C Albuquerque, Sao Paulo + 1 (212) 438 9729;
Jose Coballasi, Mexico City + 52 55 5081 4414;
Jerry Fang, Hong Kong + 852 2533 3518;
Yuji Hashimoto, Tokyo + 81 3 4550 8275;
Calvin C Leong, Melbourne + 61 3 9631 2142;

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