Introduction of a "Green Covered Bonds" regime in Luxembourg and modernisation of the existing framework
03 July 2018
On 26 June 2018, the new Luxembourg law on “green covered bonds” amending certain provisions of the Luxembourg Act of 5 April 1993 on the financial sector* (the Law) was published in the Mémorial. Luxembourg is well-known in the sphere of European capital markets for its innovative approach to green finance, as has recently been demonstrated by the success of the Luxembourg Green Exchange platform (LGX).
In a nutshell, the Law introduces a new category of covered bond linked to renewable energy projects, specifies the regime applicable to this new type of covered bond and clarifies the existing framework applicable to banks issuing covered bonds, notably to align it with recent European Banking Authority guidelines**.
1. Introduction of “green covered bonds” in Luxembourg
As a reminder, “covered bonds” are debt securities issued by specialist banks and guaranteed by cover assets specifically allocated to this purpose. Prior to the introduction of "green covered bonds", there were already four types of covered bonds under Luxembourg law:
(i) “public” covered bonds issued in respect of lending to public sector entities;
(ii) “mortgage” covered bonds issued in respect of mortgage lending;
(iii) “movable assets” covered bonds issued in respect of loans secured by rights in rem over movable property; and
(iv) “co-operative” covered bonds issued in respect of lending to co-operative banks.
Covered bonds, irrespective of their type, are structured to be particularly safe by virtue of the double-recourse protection offered to bondholders in the form of a preferential claim over the cover assets and an ordinary claim against the issuer as a whole.
The new “green covered bonds”, or “renewable energy covered bonds”, are guaranteed by rights in assets or securities linked to renewable energy, which include all energy produced from non-fossil renewable sources, i.e. wind energy, solar energy, thermal, geothermal, hydrothermal and marine energy.
Banks issuing covered bonds may now grant loans secured by rights in rem in (or by charges on) assets generating renewable energy and by rights of substitution in essential project contracts and then issue, on that basis, bonds secured by those rights (or charges).
For the avoidance of doubt, a right of substitution is the right of the bank issuing covered bonds to take the place of the relevant renewable energy companies in their rights under essential project contracts, in the event of default of such company under loans granted to them. Essential project contracts include building agreements, operating agreements and electricity supply agreements.
A quantitative limit is set to the cover assets, in that such claims and guarantees may only serve as cover assets up to a percentage ranging from 50% to, in certain circumstances, 80% of the estimated realisation value of the assets producing renewable energy by which the bonds are covered. Valuation principles will be defined by the CSSF.
2. Modernisation of the existing covered bonds regime
The Law aligns the existing framework applicable to banks issuing covered bonds with recent European Banking Authority guidelines designed to harmonise the covered bonds framework throughout the European Union.
To minimise liquidity risks, banks issuing covered bonds now must have an adequate liquidity buffer covering a 180-day period. The Law further specifies how such buffer needs to be assessed (on a daily basis).
Greater transparency in the Luxembourg covered bonds market is achieved by the requirement to publish information on the cover asset items, the covered bonds issues, the structure of such issues and, finally, on the bank issuing covered bonds itself. The publication procedure as well as the frequency of such publications will be clarified by the CSSF.
The Law also clarifies the use by Luxembourg covered bond banks of derivatives as a tool for hedging exposures in their cover assets. The Law now expressly lays down certain of the key terms required for the derivatives to be eligible as cover assets (derivatives for hedging purposes only; no early termination by the counterparty upon the occurrence of insolvency events affecting the bank or any separate and distinct “estate compartment” of the bank (as referred to in the Law)). These requirements have already been largely adopted by derivatives counterparties, so the Law can be seen as a useful clarification of applicable minimum criteria.
* Law of 22 June 2018 amending the Law of 5 April 1993 on the financial sector and introducing green covered bonds, Mémorial A n°521 of 26 June 2018.
** EBA Report on covered bonds – Recommendation on harmonisation of covered bonds frameworks in the EU, 20 December 2016.