Mortgage bond banks
Banks that issue covered bonds operate within a specific legal framework laid down in the law of 21 November 1997, as modified. This law established the covered bond issuing bank and reserves to them the exclusive right to do so.
The covered bond is a debt security guaranteed by cover assets specifically allocated to this purpose.
Luxembourg legislation specifies three types of mortgage bond:
- "public" covered bonds guaranteed by debt owed to or guaranteed by public institutions in the EU, the European Economic Area (EEA), the OECD, the public sector or local entities;
- mortgage backed bonds, guaranteed by rights to real estate or securities linked to real estate; and
- since 2008 the lettre de gage "mobilière", or moveable asset backed bond, guaranteed by rights in or securities linked to assets other than real estate (e.g. ships, aeroplanes, boats and trains) that are listed in public registers in the EU, EEA or OECD. The list is not restrictive: additional cover assets can be authorised by the regulatory authority.
Unlike asset-backed securities (ABS), covered bonds are accounted for in the balance sheet of the bank.
Covered bond issuing banks benefit from a legal exception, in that holders of covered bonds have preferential rights on the issuer’s covering assets in the case of bankruptcy of the latter. This optimal level of protection generally results in such securities benefiting from a AAA credit rating.
Given the international scope of Luxembourg law on covering risks related to OECD member states, Luxembourg covered bond issuing banks are able to develop an affective asset diversification policy. This means that Luxembourg covered bonds are less vulnerable to the risk of downgrades from specific public borrowers.