Covered bonds allow banks to borrow money with assets used as security for the loan. By covering the bond with a pool of assets, banks can pay a reduced interest rate. Covered bonds will enable cheaper, more stable and longer-term funding for the financial system, and improve the flow of credit in the Australian economy, says the government.
“With continued volatility in global financial markets, allowing our financial institutions to issue covered bonds is a critical economic reform to strengthen and diversify our financial system’s access to funding in offshore wholesale capital markets,” said deputy prime minister and treasurer Wayne Swan.
Despite the positive effects, the introduction of covered bonds will mean tax changes are required; otherwise the taxes incurred could negate the benefits of covered bonds as a source of funding. The tax implications relate to consolidation, stamp duty and non-resident withholding tax, but should be manageable, say advisers.
Following Swan’s announcement on Wednesday, Commonwealth Bank and ANZ Banking Group have completed covered bond issues. ANZ has raised $1.25 billion (A$1.23 billion) from US debt markets, while National Australia Bank is also expected to complete covered bond issues in the future.
Covered bonds give investors the first right to the relevant assets, which are ring-fenced from other creditors. Institutions typically use special purpose vehicles (SPVs) to hold ring-fenced assets when investors buy covered bonds, and this could cause a tax liability for banks.
“The permitted model is an SPV structure which allows financial institutions to issue covered bonds directly and the financial institution provides funding to an SPV to enable it to acquire the pool of eligible assets,” said Emanuel Hiou, partner at Deloitte. “The SPV’s role is to hold the cover pool of assets for the benefit of the bond holders.”
Australian banks must consider a number of potential tax implications now that they have the ability to raise funds at more competitive prices through covered bonds.
“The Australian tax consolidation regime requires a subsidiary to be wholly owned to be a member of a tax consolidated group,” said Hiou. “In the context of SPV structures for the issue of covered bonds, this is important to ensure that the transfer of mortgage assets to the SPV is tax neutral.”
For tax consolidation the SPV must be bankruptcy remote from the bank issuing the covered bonds. Any stake in an SPV is not included in the bank or financial institution’s assets.
The financial institution may establish the SPV and there is no requirement for the SPV to be independent of the financial institution. This suggests that it should be possible for the SPV to be wholly owned by the financial institution, said Hiou.
Further, provided this is the case, the SPV can be a member of the financial institution’s tax consolidated group.
“Accordingly, any transfer of mortgage assets to the SPV should be disregarded for tax purposes and therefore should not give rise to any income tax consequences,” said Hiou. “Similarly, any transfer of assets from the SPV back to the financial institution at the conclusion of the arrangement should not have any income tax consequences for the SPV.”
Transferring the pool of mortgage assets to the SPV may, in some states, also have stamp duty consequences.
“As with typical mortgage securitisation structures, the stamp duty consequences may be able to be managed if the various stamp duty exemptions for mortgage securitisation structures which exist in many states can be utilised,” said Hiou.
“Where covered bonds are offered to overseas investors, the offer should be able to be structured to qualify for the section 128F interest withholding tax exemption for publicly offered debentures,” he added. “This exemption will be satisfied if, for example, the bonds are offered to at least 10 investors who are in the business of providing finance or investing in securities in capital markets.”
