OREANDA-NEWS. The covered bond framework outlined by Brazil in October of 2014 will be subject to more detailed legislation and congressional approval before it can be implemented, as highlighted in a new special report by Fitch Ratings.

Covered bonds, known as letras imobiliarias garantidas (LIG) in Portuguese, would provide Brazilian financial institutions with another source of mortgage funding. Fitch expects the final LIG framework to share some similarities with long-standing covered bond frameworks from other countries.

'Pending legislation will determine how the LIG framework addresses important issues to covered bond investors such as segregation of cover assets, liquidity measures to bridge asset and liability maturity mismatches, minimum asset quality requirements and cover pool administration' says Jayme Bartling, Senior Director at Fitch.

Under the proposed LIG framework, covered bond holders would benefit from dual recourse to the issuing entity and the cover assets. Moreover, the framework outline calls for the segregation of cover assets such that investors have priority interest over the cover assets in event of issuer insolvency, explicitly ranking senior to fiscal and labor claims.

The regulatory 5% overcollateralization (OC) stipulated in the framework outline is likely to support only a limited uplift above the issuer's rating. Currently, the LIG framework does not specify whether any contractually established OC above the regulatory minimum will be available to covered bond holders.

Pending legislation to address liquidity measures to bridge maturity mismatches and administrator roles and responsibilities before and after an issuer's insolvency will be key features in Fitch's assessment of discontinuity risks.

'The Brazilian framework could achieve what the Chilean mortgage bond framework is unable to do, which is to enable substantial protection for covered bond investors,' says Bartling.