Philipp Mössner of Bonn & Schmitt introduces the Luxembourg mortgage bond market
While the Luxembourg financial centre is well known for being the second largest fund centre in the world, some niche activities appear less often in the spotlight. One such activity is Luxembourg’s bespoke legal framework for issuing mortgage bonds. In existence since 1997, it offers both an optimal level of investors’ protection and a favourable regime to fund sources for banks. After a short general introduction on mortgage bonds, this article will give first an overview on the Luxembourg mortgage bond regime and report then on the latest modifications to this regime.
Mortgage bonds, also called “covered bonds” in the financial arena, are debt securities, which are guaranteed by the issuer and a cover pool of high-quality assets issued under a specific regulatory regime. Unlike ABS, mortgage bonds allow recourse to the issuer and lack of credit risk transfer. Since they are accounted for in the mortgage bank’s balance sheet, mortgage bond liabilities are generally more transparent than securitisation transactions with an SPV as issuer of the bonds. Mortgage bonds have the advantage of allowing banks to diversify their funding structure and assist in the asset-liability management. Given their better credit quality mortgage bonds are regularly rated much higher than other debt securities.
In Luxembourg, the regulatory framework in respect of the issuing of mortgage bonds is embedded in the law of April 5, 1993 on the financial sector, as amended. Mortgage banks are credit institutions that have as their principle activity the granting of loans secured by, among others, rights in rem in moveable or immoveable property or by charges on real or moveable property, by bonds or public entities and the issuing on that basis of debt instruments secured by those rights. Mortgage banks may also conduct other banking or financial activities, but only as far as these are incidental and ancillary to the main activity. The denomination “mortgage bond” and “mortgage bank” are protected and no entity may issue securities under this denomination, if it is not complying with the mortgage bond regime. Mortgage banks are required to draw up a register, the mortgage bond register, which contains details of all assets serving as collateral. Furthermore, all mortgage banks must have a special approved statutory auditor who must not be the same as the auditor auditing the accounts. The special auditor is appointed by the financial regulatory authority, the “CSSF”, on a proposal of the mortgage bank, and reports to the CSSF. It’s duty is, among others, to ensure that the collateral of the mortgage banks is duly furnished and registered in the mortgage bond register and that the value is in fact as of the prescribed amount and continues to exist. Such collateral guarantees to the holders of mortgage bonds that they will receive the full amount of debt owed to them by the mortgage bank. It may not be attached or be subject to any execution or enforcement measure by other creditors. Hence, mortgage bondholders have preferential rights over the collateral registered in the mortgage bond register. In case of a collective liquidation of the mortgage bank, such collateral will consequently not form part of the assets to be realized in favour of the general body of creditors.
Luxembourg’s mortgage bond regime was recently modified by the Law of 27 June 2013 (the “Law”). The amendments introduced by the Law were inspired by the previous modifications to the German legislation in respect of mortgage bonds. The Law modernised the liquidation procedures applicable to mortgage banks and included some further improvements such as the introduction of a new type of mortgage bond, the mutual mortgage bonds.
Prior to the adoption of the Law, a mortgage bank in financial difficulty would have been wound up or directed to suspend payments as a whole, even if the financial difficulties arose merely from the incidental/ancillary activities and not from the principal activity of issuing mortgage bonds. Thanks to the recent modification, the mortgage bank’s estate would now be automatically divided into an insolvent and a solvent part when the Luxembourg district court rules to open a suspension of payments or winding up procedure. The insolvent part relating to the incidental and ancillary activities will be wound up immediately. However, the solvent part containing the mortgage bonds’ activities will be split into different, separated asset compartments (compartiments patrimoniaux) and will continue to run under the management of a special administrator as a so-called “mortgage bank with limited activity”. However, in case the financial difficulties originate from the principal activity and the due repayment of all mortgage bonds is at stake, the mortgage bank will be liquidated as a whole.
The Law also created a new category of mortgage bonds, the mutual mortgage bonds, which extended the scope of activity of mortgage banks in order to make this activity more attractive for financial institutions. Mutual mortgage bonds include, among others, the granting of loans to credit institutions which are established in the EU, in the EEA or in a member state of the OECD, and which participate in an institutional guarantee system and the issuing of mutual mortgage bonds secured by the debt entitlements resulting from these loans.
The modifications recently introduced by the Law further enhanced the attractiveness of the Luxembourg mortgage bond regime. Mortgage bondholders are more efficiently protected, which also positively affects the ratings assigned by international rating agencies to mortgage bonds. In our view, the mortgage bond regime is a well-tailored legal framework that deserves more attention despite being a niche activity in the shadow of the more prominent fund industry.
Bonn & Schmitt
About the author
Philipp Mössner is a partner in the capital markets group of Bonn & Schmitt. His principal areas of practice include capital markets, securities law, banking and finance and corporate law. He has a broad experience in international capital markets and banking and finance transactions, regularly advising financial institutions, issuers, borrowers and security agents in relation to Luxembourg law.
Prior to joining Bonn & Schmitt, Philipp obtained an LLM from McGill University, Canada, and a PhD degree (summa cum laude) from the University of Tübingen, Germany.