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Introduction
Mortgage covered bonds are one of today’s most common structured finance products. Although they have a prominent presence in the marketplace today, these bonds have historical roots in the Pfandbrief of 18th century Prussia. In the aftermath of the Seven Years War, King Frederick the Great implemented new a mortgage finance mechanism and provided for the issuance of mortgage covered bonds in their simplest form to improve liquidity of the assets of the Prussia’s landed gentry, as their financial position had heavily deteriorated due to the wars.[1] Almost two hundred and fifty years from the first issuance of the Pfandbrief, mortgage covered bonds enable creditors to obtain funds from the secondary mortgage markets at low costs. In addition, through securitization, a creditor’s long-term illiquid mortgage loans can turn into liquid capital market instruments. These instruments remain on the balance-sheet of the issuer and provide an investor-friendly mechanism, as factors such as default and prepayment risks are not transferred to the investor. This article focuses on the issuance of mortgage cover bonds (“MCB”) under the framework of the Turkish capital markets, the nature of cover assets and responsibilities of the cover pool monitor, and the conditions required by the Capital Markets Board (“CMB”) for their issuance.
MCB Issuance
The concept of the MCB is defined under Article 59/1 (Mortgage and asset covered bonds) of Capital Markets Law No. 6362[2] (“CML”) as the debt instruments issued within the scope of the issuer’s general liability which are collateralized by cover assets. According to the CML, the MCBs are essentially regulated under the CMB’s Communiqué on Covered Bonds under serial number III-59.1 (“Communiqué”) and its other regulations regarding debt instruments to the extent applicable. The Communiqué provides the framework for both asset covered bonds and MCBs, whereas some provisions relating to MCBs have major differences from the asset covered bonds.
As per Article 31 of the CML (Issue limit and authority regarding capital market instruments qualified as debt instruments), the authority to issue capital market instruments qualifying as debt instruments may be transferred to the board of directors by the articles of association. In this case, the board of directors’ decision should as a minimum specify the issuance of the MCB as well as the nominal value of the MCB that is planned to be in circulation and the method of sale. MCBs can be issued by public offering, or be sold solely to qualified investors, or be sold by private placement – provided that the unit nominal value is at least TRY 100,000. In case there is a private placement of MCBs to international investors, there is no unit nominal value requirement. In accordance with the provisions of the Communiqué, MCBs can only be issued by mortgage finance institutions or housing finance institutions.
If MCBs are offered to the public in Turkey, issuers are required to apply to the CMB with the documents listed in the Appendix-1 of the Communiqué in order to obtain the CMB’s approval for the prospectus. The issuers should apply to the CMB with the documents listed in Appendix-2 of the Communiqué to obtain CMB’s approval for the issuance certificate in case there is domestic offering without public offering, or if MCBs are to be sold to international investors. MCBs can be sold in tranches within the issuance ceiling determined by the CMB. However, for sale of each tranche during the time limit for the validity of the prospectus, the issuer has to apply to the CMB. For domestic offerings without a public offering, the sale of each tranche within the issuance ceiling determined by the CMB is conducted through Merkezi Kayıt Kuruluşu A.Ş. and there is no additional requirement for the issuer following the approval of the issuance certificate.
Cover Assets and Cover Pool Monitor
As per Article 12 (Cover register) of the Communiqué, issuers are required to keep a cover register “..to monitor the cover assets in special accounts separate from their own assets, to open separate accounting records that will enable daily monitoring of every record that is made, or to establish an infrastructure adequately distinguishing the cover assets…” and the records entered to the cover register will be taken as the basis for all transactions and disputes relating to the cover assets.
Cover assets are defined under Article 9/2 (Cover assets) of the Communiqué. These assets are (i) receivables of banks and financing corporations arising from housing finance, (ii) receivables arising from financial lease agreements entered into for housing finance, (iii) receivables or commercial loans of banks, financial leasing companies, and finance corporations secured by a mortgage, (iv) receivables arising from the instalment of house sale contracts by TOKI[3] whereby the mortgage finance institutions make the issuance, (v) substitute assets, and (vi) other assets whose characteristics shall be determined by the CMB. The qualifications required for cover assets are stated under Article 10 (Characteristics of Cover Assets).
As per Article 13 (Management and protection of cover assets) of the Communiqué, assets in the cover pool cannot be disposed of, pledged, attached by third parties – including for the collection of taxes or other public receivables – and cannot be subject to injunctive decisions of courts or included in the bankruptcy estate of the issuer. This is true even if the management or the supervision of the issuer is transferred to public institutions until the MCBs are completely redeemed.
The Communiqué requires appointment of a cover pool monitor before the issuance of the MCB through a written agreement. The cover pool monitor’s responsibilities are outlined in Article 23 (Duties of cover pool monitor). These include supervising the compliance to the cover matching principles following formation of the cover register, examining and confirming the accuracy of the entries made to the cover register in order for assets to be added to and removed from it, determining the entries to be amended by reviewing the underlying loan documentation and other information and documents, and inspecting whether the cover assets meet the cover matching principles set and whether the stress test measurements are accurate.
The cover pool monitor is authorized to request any information or document from the issuer regarding the cover assets and to review the related entries made to the cover register. The cover pool monitor is also authorized to obtain information from the employees. In addition, the cover pool monitor may request all kinds of information and documents from independent auditors, valuation and rating institutions, and trade registry directorates or relevant listing agencies. In case the cover pool monitor encounters any obstruction in its access to the information and documents that it has requested, it shall promptly notify the CMB.
Measures
If the issuer fails to fulfill its payment obligations arising from MCB either partially or fully, the cover pool monitor must be promptly notified. Consequently, the collections made from the cover assets which have been accumulated in a separate account opened in the name of the MCB holders becomes due and payable from the date of such nonpayment and used solely for the fulfillment of the obligations arising from the MCB. If the issuer partially or fully fails to fulfill its payment obligations and the cover pool does not meet the obligations, MCB investors can also have recourse to the other assets of the issuer without waiting for collections under the cover pool.
The CMB has the authority to appoint an administrator in case one of the following events occurs:
- transfer of the management or supervision of the Issuer to a public institution,
- cancellation of the Issuer’s operation license,
- bankruptcy of the Issuer.
The administrator manages the cover pool and makes payments arising from the total liabilities to the extent the revenue generated from the cover pool is sufficient without assuming any liabilities. When the administrator is appointed, the revenue generated from the cover assets will primarily be used for payments made to the MCB holders and the counterparties of the agreements executed for the purposes of protecting the cover assets.
Conclusion
MCBs are issued following the approval of the prospectus or the issuance certificate by the CMB. As part of this process, the cover register includes cover assets regarding the MCB and the cover pool monitor supervises the adequacy of the cover assets and has various powers in line with the protection of such assets. In case the abovementioned events occur regarding the issuer, the CMB can appoint an administrator. The administrator manages cover assets without assuming any liabilities.
(Authored by İdil Yıldırım and first published by Erdem & Erdem on November 2021)
[1] Schwarcz, Steven L.: “The Conundrum of Covered Bonds”, The Business Lawyer, Issue 66, May 2011, 563-564.
[2] Capital Markets Law No. 6362, OG No. 2851330, 12.2012.
[3]The Ministry of Environment and Urbanization Housing Development Administration of Turkey