Regulation of Danish covered bonds
In Denmark, mortgage lending and covered bond issuance are governed by the Danish Mortgage-Credit Loans and Mortgage-Credit Bonds etc. Act and the Danish Financial Business Act as well as a number of executive orders on eg ALM and property valuation. These set out the frameworks governing the lending and funding of Danish mortgage banks. The main purpose of the legislation is to ensure a high degree of security for Danish covered bond investors.
Nykredit issues two types of covered bonds: "særligt dækkede obligationer" (SDOs), which comply with both the UCITS Directive and the CRD/the CRR, and traditional covered bonds, "realkreditobligationer" (ROs), which are UCITS-compliant.
The legal and structural frameworks applying to Danish mortgage banks have in many ways been the pillars of the efficient and successful Danish mortgage system and are probably the most important reason for its long unblemished history, which dates back to 1850.
Danish legislation has been updated regularly and was most recently amended in the summer of 2017 to secure, for instance, the continued covered bond status of Danish mortgage bonds under the stricter CRD criteria.
The Danish mortgage finance system is generally considered to be very safe when it comes to the ability of issuers to meet their obligations to bondholders, and no Danish mortgage bank has ever defaulted.
Nykredit and Totalkredit's bonds are characterised by a high degree of security as a result of both legislation and Nykredit's credit policy. The credit ratings assigned by Standard & Poor's directly reflect the security of the bonds. The Danish market is generally characterised as a AAA covered bond market, and all new bond issues by Nykredit and Totalkredit are AAA rated.
The security behind Danish covered bonds rests on the following:
- Bonds are primarily issued against mortgages on real property within specified LTV limits
- The Danish FSA supervises bond issuers' compliance with the regulatory framework
- Continuous compliance with LTV limitsIf property prices fall, issuers must provide additional collateralThis is a tightening compared with the previous rules, according to which compliance with LTV limits was only required at the time of loan origination
- Specific requirements for regular independent valuation of the properties included in the cover pool
- Mandatory overcollateralisation (only applicable to mortgage banks)
- Strict ALM requirements (balance principle). The balance principle ensures that issuers can assume only very limited market risk in the form of interest rate risk, foreign exchange risk, option risk and liquidity risk
- In case of the insolvency of an issuer, legislation provides for protection of investors' security in a capital centre or cover register. In principle, investors will therefore be unaffected by the insolvency of an issuer, provided that the cover pool contains sufficient assets.
Danish covered bonds are issued as either ROs, SDOs or SDROs. RO denotes traditional mortgage covered bonds.The main difference between SDROs and SDOs is that only mortgage banks may issue SDROs. Furthermore, the eligibility criteria for SDO cover assets are slightly more comprehensive.
Covered bond investors have a preferential claim on all cover assets in case of the insolvency of the issuer. Bondholders rank pari passu with derivatives counterparties, provided the derivatives contracts are concluded for the purpose of hedging market risk. Cash flows to derivatives counterparties and bondholders must remain unaffected by the insolvency of the issuer. Accordingly, derivatives counterparties are not entitled to demand termination of the contracts in case of insolvency, and payments cannot be accelerated.