Covered bonds are debt securities guaranteed by cover assets specifically allocated to this purpose. Banks that issue covered bonds are subject in Luxembourg to a specific regulatory regime provided for in Part I, Chapter I, Section 3 of the Luxembourg law of 5 April 1993 on the financial sector (as amended). Under such regime, the law foresees a monopoly for banques d’émission de lettres de gage to issue covered bonds under Luxembourg law.
Luxembourg legislation currently specifies three types of covered bonds
- “public” covered bonds, which are guaranteed by debt owed to or guaranteed by public institutions in the European Union, the European Economic Area (EEA), the Organisation for Economic Co-operation and Development (OECD), the public sector or local entities
- mortgage backed bonds, which are guaranteed by rights to real estate or securities linked to real estate
- since 2008 movable asset-backed bonds (letter de gage mobilière), which are 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 (additional cover assets can be authorised by the regulatory authorities)
Since January 2017, the Luxembourg government has moved to provide for a fourth type of covered bond, the so-called “green covered bond” or renewable energies covered bond (lettres de gage énergies renouvelables). As its name indicates, this type of covered will be guaranteed by rights in or securities linked to renewable energies and should reinforce the Luxembourg position as centre of competence and excellence in the field of green finance.
One of the main advantages of covered bonds is that, unlike asset-backed securities (ABS), covered bonds are accounted for in the balance sheet of the bank.
Covered bond banks benefit further from a legal exception, insofar as covered bonds holders have preferential rights on the issuer’s covering assets in the case of bankruptcy of the latter. This level of protection generally results in such securities benefiting from a AAA credit rating.
Finally, in light of the international scope of Luxembourg law related to OECD member states, Luxembourg covered bond issuing banks are able to develop an effective asset diversification policy, leading to Luxembourg covered bonds being less vulnerable to the risk of downgrades from specific public borrowers.