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[Dhaval Bothra and Rajdeep Bhattacharjee are students at Symbiosis Law School, Pune]


Covered bonds are a global asset class that has existed for centuries now. A covered bond is a debt instrument issued generally by banks and NBFCs which is backed by a pool of high-class assets which is known as a cover pool. Furthermore, a separate legal entity is created called the Special Purpose Vehicle (SPV), which holds the cover pool assets. Instead of such assets, the bonds are issued to the investors.

Through the SPV, a double recourse model is provided to the investors and in the case of bankruptcy and/or insolvency of the institutions issuing the bonds, they will have a guaranteed recourse on the assets present in the SPV. Moreover, according to the RBIs Master Circular on Basel III Capital Regulations, the SPV must be an entity which is bankruptcy remote which means that it must be structured in a manner to shield the assets in the cover pool from the insolvency/bankruptcy of the issuer. Therefore, owing to this, in case of liquidation, according to Section 53 of the Insolvency & Bankruptcy Code, 2016 (IBC), the bondholders would have a claim over the assets in the cover pool on a priority basis as they are treated as secured creditors under the Code. Furthermore, according to Section 238 of the IBC, no other law shall be applicable concerning the differential treatment of the investors of covered bonds. This was upheld in Gujarat Urja Vikas Nigam Limited v Amit Gupta & Ors.

A parallel of covered bonds to India is European Secured Notes (ESNs). These are also debt instruments which are issued by institutions of similar nature in Europe and are backed by a pool of assets that act as collateral and are issued by an SPV.

The fundamental similarity between the ESN structure in Europe and the bankruptcy remote SPV in India is that both are intended to shield the underlying assets from the originator’s insolvency or bankruptcy risks. This gives investors additional assurance that, in the event of the originator’s default, the underlying assets will be available to satisfy their claims. However, despite the similarity, there exists a wide difference in the structural and regulatory ambit especially concerning the SPV, which shall be discussed further under the following heads;

- Class of Assets under the SPV

- Level of Protection provided

Under these three heads, the comparison shall be drawn to further put forward a model for implementing the ESN structure in India.

Class of Assets under the SPV

In India, the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) play a crucial role in regulating Special Purpose Vehicles (SPVs) for Covered Bonds. The RBI has established specific criteria for qualifying assets held by SPVs, which primarily include residential mortgage loans, loans to government agencies and statutory bodies, and loans against property within India as per the Master Directions on Standard Asset Securitisation 2021 and the Master Directions on Transfer of Loan Exposures 2021. The transparency and compliance of SPVs are ensured through regulatory reporting obligations. This requires them to disclose information about the composition, quality, cash flows, and regulatory compliance of the cover pool.

The separation of assets in the cover pool is a key aspect of the Indian Covered Bonds framework. By ring-fencing these assets, they are protected from being included in the bankruptcy estate of the issuer. This safeguard ensures that the assets remain available for the repayment of Covered Bond debt, even in the event of issuer default. The dual recourse structure of Covered Bonds in India provides an additional layer of security for bondholders, allowing them to seek repayment from both the issuer and the assets in the cover pool in case of default. Managing asset-liability matching is a critical consideration for SPVs in India. They strive to minimise maturity mismatches and align the cash flows from cover pool assets with the payment requirements of the Covered Bond debt. This approach ensures that the timing and availability of cash flows from the cover pool assets are synchronised with the bond repayment obligations, reducing potential risks and enhancing the stability of the structure.

In a different context, European financial regulators have been exploring the concept of ESNs as a new funding instrument. ESNs offer banks and primary lenders a means to raise refinancing against their portfolios of Small and Medium Enterprise (SME) loans. Similar to covered bonds, ESNs incorporate a dual recourse structure, providing investors with recourse to the issuer’s assets in case of default.

The potential of ESNs to refinance SME loan portfolios has garnered interest from European regulators, taking inspiration from successful structures like covered bonds. Past examples, such as Commerzbank’s SME-backed structured covered bond program, have influenced the development of ESNs. Efforts have been made in countries like France and Italy to establish regulatory frameworks that enable the use of similar instruments.

Level of Protection

The primary dichotomy that can be drawn between covered bonds in India and ESNs, is the level of protection that each of them provides to their respective investors. Though their structure and purpose are similar; the level of protection imparted by ESNs to its investors is higher. The fundamental difference is the nature of the assets in the cover pool and the regulations thereof.

According to the European Banking Authority guidelines (EBA), there are a set of stringent regulations laid down to protect the investors which include;

- The assets of the cover pool must be strictly segregated and should be devoid of any third-party claims. True sale/pledge or use of the provisions of Directive 2002/47/EC can result in segregation. In comparison, the Indian Covered Bond Framework permits segregation to be obtained through (i) a cover register, (ii) transfer to an SPE via the contractual assignment, or (iii) segregation in a specialised credit institution. Hence, in case of insolvency, since the transfer is complete and absolute in the ESN structure, the access to the cover pool assets and the procedure of claims is much smoother and easier than in cases of covered bond structure in India, especially due to the moratorium provisions of the IBC, 2016.

- The cover pool in ESNs should have a minimum over-collateralization of 130% of the loans’ principal and interest. The EBA mandates a minimum over-collateralization level of 130% because it falls between the observed over-collateralization levels for less risky covered bonds (118%) and asset-backed securities (138%), which tend to carry higher risk. In the Indian covered bond landscape, according to RBI Guidelines, the over-collateralization must be between 50 to 80%, depending upon specified delinquency triggers. This depicts the protection gap between the ESN structure and covered bonds in India.

- Unlike covered bonds, the ESN structure mandates that the granularity of the cover pool be sufficiently high, containing at least 500 exposures for risk diversification; and the cover pool be free of material concentration, with the aggregate exposure value to a single obligor in the cover pool not exceeding 2% of the total exposure value of all exposures in the cover pool.


The incorporation of the ESN structure in covered bonds in India can provide several benefits and improvements to the existing framework. The ESN structure allows for a broader range of eligible assets, such as public sector loans, commercial loans, and auto loans, resulting in greater asset diversification. It also introduces stricter eligibility criteria, geographical diversification requirements, and improved investor reporting, giving investors greater transparency and confidence. Indian-covered bonds can strengthen investor protection, improve risk management, and align with international best practices by incorporating the ESN structure.

However, implementing the ESN structure in India would necessitate changes to the legal and regulatory framework, such as defining eligibility criteria, establishing underwriting standards, ensuring regulatory oversight, and improving investor reporting. Therefore, to successfully integrate the ESN structure into the Indian-covered bond market and realise its potential benefits, regulatory authorities, market participants, and industry stakeholders would need to work in tandem.

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