On 5 August 2015, the President of the Republic of Poland signed an amendment to the Act of 29 August 1997 on Covered Bonds and Mortgage Banks and related laws (the “Amendment”). These new changes will come into force on 1 January 2016.

The main goal of the Amendment is to enhance the availability of well-diversified funding sources from capital market investors to the Polish banking sector. While Poland has had covered bonds since 1997, tax treatment and limits on pension fund investments in these securities has limited their use. These new regulations turn Polish covered bonds into high quality instruments, appealing to international investors and giving Polish pension funds a realistic choice for putting their funds into well-secured, low risk investments.

Polish legislators felt that this goal could be achieved by changing the recently adopted Restructuring Law of 15 May 2015 to the extent that it relates to covered bond issuers, i.e. mortgage banks.

The Amendment excludes mortgage banks from the provisions of the Restructuring Law. Instead, changes are made to the Bankruptcy Law of 28 February 2003, bankruptcy proceedings of mortgage banks. These new regulations under the Bankruptcy Law are intended to ensure proper satisfaction of the claims relating to covered bonds in the event of bankruptcy.

Some of the special features introduced by the Amendment for the bankruptcy proceedings of mortgage banks are briefly listed below.

• Upon the announcement of a mortgage bank’s bankruptcy, the due dates of its obligations to the holders of the covered bonds are extended by 12 months.

• A separate bankruptcy estate (which shall be used for satisfying the claims of covered bond holders) has been introduced. The separate bankruptcy estate shall consist in particular of: (i) the mortgage bank’s receivables entered into the covered bonds register; (ii) the funds obtained as a result of repayment of claims entered into the covered bonds register; and (iii) the assets obtained in exchange for the assets entered into the covered bonds register.

• A new institution, the covered bonds holders’ assembly, has been introduced. This covered bonds holders’ assembly may decide – to the extent permitted by law – about the type of bankruptcy procedure which shall be implemented in any specific case.

•  The composition proceedings (introduced by the new Restructuring Law of 15 May 2015) shall not apply to mortgage banks.

However, the Amendment devotes most attention to the tests that should be conducted by the insolvency administrator. The results of those tests indicate which type of bankruptcy proceedings will be chosen. The testing procedure is based on the following principles. For the purposes of bankruptcy proceedings against a mortgage bank, the insolvency administrator must promptly (not later than within 3 months from the date of the announcement of bankruptcy of a mortgage bank) perform an asset coverage test on the bankruptcy estate.

The asset coverage tests should also be carried out at least every 6 months during the bankruptcy proceedings. The asset coverage test consists of verifying whether the debtor’s assets allow full repayment to the covered bond holders.

If the result of this test is positive, the liquidity test is then conducted. Further liquidity tests should be carried out at least every 3 months during the bankruptcy proceedings. The liquidity test consists of verifying whether the debtor’s assets allow full repayment to the covered bond holders within the extended maturity dates.

The asset coverage test and liquidity test results are considered positive if the separate bankruptcy estate is sufficient for full satisfaction of the covered bond holders’ claims.

The results of the tests shall be provided to the Polish Financial Supervision Authority and the judge – commissioner.

In the case of positive asset coverage and liquidity tests: (i) the covered bond holders’ claims are satisfied in accordance with the terms and conditions of issuance; and (ii) the insolvency administrator may conclude new agreements concerning the financial instruments. However, in such a case, the covered bond holders’ assembly may adopt a resolution obliging the insolvency administrator to take action aimed at selling all the claims and rights in the separate bankruptcy estate. If such a resolution is adopted, the covered bond creditors will be repaid before the extended maturity date.

In the case of a negative liquidity test, the “pass – through” procedure shall apply. It means that: (i) the payment of the nominal value of the covered bonds shall be extended by 3 years from the latest due date of the claim entered into the covered bonds register; and (ii) generally, the payment of the nominal value of the covered bonds may be satisfied earlier than during extended periods of maturity. Also, the covered bond holders’ assembly may adopt a resolution on non-implementation of the “pass – through” procedure if the assembly agrees to liquidate the separate bankruptcy estate and sell the property on the covered bonds register. The “pass – through” procedure is based on the models that already function in other European countries and is aimed at preventing the adverse effects of immediate liquidation of the bankruptcy estate of a mortgage bank. This procedure should help to avoid the negative effects of a sudden sell-off of assets and optimize the realisations.

If the asset coverage test has a negative result, the insolvency administrator does not conduct the liquidity test and the “pass – through” procedure is implemented. The covered bond holders’ assembly may however adopt a resolution on liquidation of the separate bankruptcy estate and sale of the property on the covered bonds register. If such resolution is adopted, the insolvency administrator will begin the liquidation of assets in accordance with the procedure described in detail in the Amendment.

The Amendment represents an effort towards protection of the interests of creditors in the event of bankruptcy of the covered bonds issuer. Passage of this legislation should increase the safety of covered bonds in Poland, enabling the bonds to get higher ratings and attracting more international investors.