Tom Parlon (Laois-Offaly, Progressive Democrats)

The purpose of this Bill is to amend and update the Asset Covered Securities Act 2001, which established the legislative foundations for the launch in 2003 of the Irish asset covered securities market. Ireland has since then moved quickly to confirm its role in this expanding specialist activity and by the end of 2005, we had become the sixth largest market in Europe for this type of security. It has been a particular success of the Irish Financial Services Centre, generating significant employment, incomes and tax revenue for Ireland and enhancing Ireland's reputation as a centre of excellence in international financial service provision. The term "asset covered securities", ACS, is really our brand name for covered bonds issued under the Irish ACS statutory framework. They are bonds which are issued by designated credit institutions — specialist banks — set up under licence issued by the Financial Regulator.

The covered bonds legislative and regulatory framework established under the 2001 Act is widely regarded as a best practice regime and an improvement in certain respects on other long-established jurisdictions in this market. However, competition between covered bonds issuers in the various member states is intense and several states have subsequently introduced innovative refinements to their covered bond regimes. In addition, while covered bonds issuance used to be largely a European banking activity, some American banks have now resorted to this European technique, thus bringing further pressures and opportunities to the market. The amendments proposed in this Bill will maintain and enhance Ireland's competitive position in this area, secure existing employment and create opportunities for further growth.

A number of factors underlie the urgency with which this legislation is being brought. The Bill is needed to effect some necessary technical changes to the 2001 Act to provide more legal clarity and facilitate greater flexibility when operating some provisions of the 2001 Act. Financial services are a highly competitive industry in terms of innovation in the nature of the services and products being offered and the scope allowed by the legislative regimes in the different jurisdictions in which financial centres are located. A competitive opportunity can be gained from being an early mover when a new innovation becomes feasible but, once reforms are announced, they can be followed quickly by similar measures in other centres and the advantage will be lost if proposals are not brought to market as expeditiously as possible. Imitation may well be a supreme form of flattery but in the world of financial services, it is a challenge and a competitive threat.

I wish to outline the background to this important niche sector of the financial services industry. Covered bonds are bonds, or debt instruments, which are issued to investors and backed by, or secured on, a ring-fenced cover pool of eligible assets, currently restricted under Irish legislation to residential mortgage loans or public sector debt. Investors in covered bonds have a preferential claim on the assets in the cover assets pool in the event of a default by the issuing bank. The assets in the pool, which essentially are the loans in the pool, serve as collateral backing for the bonds, and the interest and principal repayments on those loans are used to meet the interest payments due to the bondholders and, eventually, to redeem the bonds. Meanwhile, the funding raised from the bond issue can be used to make further loans.

The process of issuing covered bonds is the most cost efficient form of secured long-term funding available to Irish banks. This activity takes place entirely within the wholesale end of the banking sector and the bonds are not for retail customers. This means that the investors are, for the most part, professional institutional investors such as pension funds, investment funds and banks, including central banks. The investors who buy our covered bonds are located worldwide. Thus, Irish covered bonds are now a global capital markets product. The attraction of these bonds is that they provide investors with access to a security that is supported by high quality assets over which the investors maintain a robust, preferential claim. One of the features of the cover assets pool is its dynamic nature, which means non-performing or redeemed assets must be replaced in the pool by new assets. In this way, the high quality of the cover assets pool can be maintained. This dynamic feature of the cover assets pool, allied to the conservative management of the pool, enables institutions to obtain high credit ratings for such bonds and to issue covered bonds at low interest rates.

There are two distinct types of asset covered security, the first of which is a public credit covered security. These securities are issued by specialist banks associated with credit institutions, the main activity of which is the provision of finance to Governments, municipalities and local authorities. The securities are backed by public sector assets such as sovereign bonds, local authority loans and Government guaranteed loans. The second type of asset covered security is a mortgage covered security. These securities are issued by institutions with significant mortgage loan portfolios. Where a designated credit institution has been authorised as a designated public credit institution and a designated mortgage credit institution, it must keep a separate cover assets pool for each of the different types of securities it issues. The backing cover assets, that is, mortgage loans and public sector debt, cannot be mixed in the same cover assets pool.

Total employment in Ireland's international financial services sector now stands at more than 19,000. This is in addition to the 40,000 or so employed in the wider financial services sector at domestic level. Employment in international financial services is highly lucrative for the Exchequer, with the total yield of corporation tax from IFSC companies in 2006 standing at more than €1 billion according to the Revenue Commissioners. That amount represents almost 16% of the total corporation tax yield of €6.7 billion for the State in 2006.

The term "asset backed securities" covers a wide spectrum of financial products but covered bonds are at the low-risk end of that spectrum because the activity is governed by specific and bespoke legislation. The covered bond issuer must be a credit institution and is subject to tight regulatory and prudential supervision. There is regular interaction between the issuer and the Financial Regulator to the extent that it could be described as micro-regulation. The set of eligible cover assets is tightly restricted and set down in the legislation. In Ireland's case, it is currently limited to residential mortgage loans and public sector debt which must also meet certain credit quality requirements. The cover assets pool must contain sufficient cover assets to meet bondholders' claims throughout the entire term of the bonds in issue.

Where the investors are themselves credit institutions, the bonds can be particularly attractive owing to the favourably low level of capital that must be held against that class of investment. To qualify for this concessionary treatment, it is crucial for the bond issuer that the bond issue gain a triple-A rating from the international credit rating agencies. That rating is only awarded after very close vetting by those agencies, which act in the interests of investors, and means that the proposed bond offering is fully and securely collateralised by high quality assets in accordance with the terms of the governing legislation. All of the bonds issued to date under the Irish covered bonds framework have qualified for the triple-A rating.

While this technique is new to Ireland, it is not exactly a recent innovation and has been around in the form of the German Pfandbriefe model for about 150 years. However, it was only in the past decade that other member states with developed financial services industries began facilitating this type of activity. It is believed that the availability of asset covered securities has contributed to stability in continental European markets owing to their long-term primarily fixed rate nature. Their high credit rating enables issuing institutions to raise long-term funds at interest rates only marginally higher than those of a sovereign borrower. This confers a significant competitive advantage on the banks which can access this cheaper form of credit.

With an increasing proportion of savings in Ireland going directly into investment funds and pension schemes rather than being held on deposit with banks, it has become important for our banks to be able to draw on diversified sources of funding in order that the financial system can support economic activity effectively. I trust it will be clear to Senators from what I have outlined thus far that this specialised financial service is operationally important for the domestic side of our banking industry in terms of raising funding as well as strategically vital for the internationally focused side of the industry.

The parent Act, which we are now amending, dates from 2001. It might seem somewhat premature to overhaul a relatively recent Act so quickly. However, the financial sector is particularly conscious of the need to have solid legal backing for its activities. Large sums are at stake in many activities and there must be absolute legal certainty as to the rights and duties of the contracting parties. Certain provisions of the 2001 Act are deemed by the industry to be in urgent need of clarification to ensure greater legal certainty, particularly as regards aspects of complementary activities such as hedging contracts and the associated provision of hedging collateral. Accordingly, it is necessary to make a range of technical changes to provide greater legal certainty and more operational flexibility as regards various elements of our existing regime. At the same time, the opportunity is being taken to modernise the regime in the light of changes made in other jurisdictions and in EU legislation. We now have a "window of opportunity" to exploit reforms introduced under the EU's recent capital requirements directive, or CRD as it is now generally called. It is not only a question of aligning our regime with the provisions of the CRD to gain some competitive advantage over other issuers because if we do not align our ACS framework quickly with the CRD's, then our covered bonds will become less attractive as investment products for foreign banks and other entities which hold these bonds. As a "first mover" in incorporating the CRD's reforms into our ACS regime, we gain a competitive advantage for those who issue those bonds under our legislative and regulatory framework.

I will outline for the House the technical changes needed to meet the operational needs of this specialist sector. First, the industry has been seeking clarification of the term "duration" in the 2001 Act. It relates to the weighted average term to maturity of the mortgages or loans held in the cover asset pool. The proposed revised definition is in line with standard industry usage. Second, derivatives such as swaps are used to hedge various risks such as currency risks, credit risks or interest rate risks. The proposal is that the associated collateral lodged by the hedge counter party would be protected in the event of the bank's insolvency, as with the assets in the cover assets pool, but maintained separately from those "cover assets" in the pool. This will serve to reassure hedge counter parties and further facilitate the collateralisation of hedge pool contracts.

Section 2(n) inserts a new definition of the term "include" in the 2001 Act. This definition is needed to make it clear that the insertion of an asset or hedge collateral into the cover assets pool does not mean the continued maintenance of that asset in that pool because it is necessary to actively manage the assets in the pool on an ongoing basis. This new definition has, in turn, triggered a raft of consequential amendments throughout the Act whereby the word "included" is replaced by the term "comprised". Timely modernisations are also included, in line with trends in other jurisdictions. For instance, the 2001 Act requires that the asset covered securities be fully, that is, 100%, collateralised. It is proposed to strengthen investors' rights by introducing mandatory overcollateralisation of 3% in the case of residential mortgage loan and public sector loan pools. Several major reforms now proposed arise from the coming into effect on 1 January last of the EU's CRD. The CRD was designed to give effect across the Community to the new Basel II capital accord.

However, the directive also opened up new opportunities as regards the regulatory treatment of covered bonds. Perhaps the most significant innovation being advanced is a new type of designated credit institution — a designated commercial mortgage credit institution — which will be enabled to issue covered bonds secured on commercial mortgage loans. The Bill includes a provision for commencement orders and the sections relevant to commercial mortgages may be commenced at a later date to allow time for the details of the regulatory regime to be set out by the Financial Regulator in consultation with the industry. The mandatory overcollateralisation in the case of a commercial mortgage cover assets pool will be 10%.

Among other innovations in our ACS regime following on from the CRD are the following: the definition of "public credit" is being modified to bring it into line with the directive definition and New Zealand and Australia are being added to the existing list of non-EEA countries — currently comprising of Canada, Japan, the Swiss Confederation and the USA — whose assets may be included in a cover assets pool; to reflect the developing nature of the ACS business, it is proposed to provide for the use of loans to highly rated multilateral development banks such as the IBRD, the EBRD the EIB, the Asian Development Bank and so on. It will also cover loans to international organisations such as the IMF and BIS; the pool eligibility criteria for so-called "substitution assets" — essentially temporarily surplus cash from the "cover assets pool" held on short-term deposit with highly-rated banks — are being brought into line with the CRD. This involves, inter alia, reducing the Irish limit for substitution assets of 20% on a pool asset basis to 15% on a covered bonds outstanding basis; the amendments also provide for the inclusion of residential and commercial mortgage backed securities, that is, units of mortgage securitisation issues, in the respective cover assets pools and also meet the requirements of the CRD in this regard; and the current provisions that restrict the level of public credit covered securities to 50 times the designated credit institution's own funds level are being modified as a result of the changing risk weighting of public sector loans under theCRD.

Senators will be aware this is quite technical and complex legislation but I assure them the reforms I have outlined have been carefully drafted in consultation with industry legal experts, the Financial Regulator and the Parliamentary Counsel. The proposals have also been formally vetted and cleared by the ECB, which confirmed that it had no problems with them. While the Financial Regulator was consulted about these proposals, it was also a partner from the outset in the drafting of these provisions. The regulator attended round table meetings with the Department and industry representatives and even held separate bilateral meetings with industry representatives when they wanted technical issues clarified. The regulator suggested many adjustments, which the Department was glad to take on board, and some of the amendments were even proposed by the regulator on his own initiative.

I trust that it will be clear to the House that it is essential that we update the provisions of the 2001 Act for legal, operational and strategic reasons and that we move expeditiously in this regard to protect the competitiveness of ACS issuers who operate under our legislative and regulatory framework. Failure to fast-track these reforms could see some ACS issuance relocate out of Ireland. On the other hand, quick action on our part will serve to safeguard this activity here, with all the benefits associated with that in terms of high-quality employment and revenue for the Exchequer. It may encourage other issuers to locate here, with all the associated benefits that would bring in terms of more high quality jobs and tax revenues. I commend the Bill to the House.