American investors lack confidence in the proposed regulatory framework for covered bonds, particularly regarding potential involvement from the Federal Deposit Insurance Corp. and the possibility the bank regulator will supersede investors’ interests in the event of a bankruptcy. Testifying Friday before the House subcommittee on capital markets and government-sponsored enterprises, Ralph Daloisio, chairman of the American Securitization Forum, said the industry trade group still supports establishing a covered bond market in the U.S. with the appropriate regulatory framework. Daloisio is also managing director at Natixis. “The right kind of legislation has the power to create a new channel of efficient credit flow through our financial system while facilitating an accelerated and more orderly exit of U.S. governmental mortgage support for the private sector,” Daloisio said. On Tuesday, Rep. Scott Garrett (R-N.J.), who chairs the subcommittee, introduced a bill he hopes will establish a clear regulatory framework for the structured finance product, which has long been available overseas. The FDIC said it has significant concerns with the proposed legislation and believes the bill fails to maintain the balance between investors’ demands and government exposure, “providing investors with lopsided benefits at the direct expenses of the Deposit Insurance Fund.” The regulator maintains the DIF by charging financial institutions an insurance premium. Daloisio said investors normally have recourse to the underlying bonds in a covered pool, as well as the issuer itself, during a bankruptcy in a functioning covered bond market. But some are concerned the FDIC will step in and prevent investors from accessing the covered bond collateral in a timely manner. “In good times, investors might be willing to overlook the risk posed by a regulatory regime but when stress arises, the markets will focus their attention on weakness and extract a painful toll,” Daloisio said. “If we are to start a new and promising financial sector, the centerpiece has to be a legislative framework that deals directly with the treatment of covered bonds in the event of an issuer’s insolvency.” The FDIC, which has indicated a desire to oversee the covered market in the U.S., said the covered bond structure outlined in Garrett’s bill “will skew the market, limit long-term demand for the debt, and thwart the nascent efforts to enhance market discipline in the wake of the financial crisis.” Bert Ely, a longtime financial services consultant, told the congressmen he believes the Treasury Department should be the only regulator of covered bonds to ensure consistent application of the rules governing the bonds. Patrick Dolan, a partner at Dechert LLP in New York, said amendments that the FDIC seeks to Garrett’s bill will curtail the market for covered bonds before it even gets started. “The changes proposed…will likely eliminate the covered bond market that the bill intends to create because investors would be uncomfortable with the uncertainty that the proposed changes would create,” Dolan said. He said potential losses to the Deposit Insurance Fund from covered bond programs will be “marginal at best, especially in light of the new deposit insurance premiums that are set to take effect April 1.” Dolan said one main distinction between Fannie Mae and Freddie Mac and the proposed covered bond programs is covered bonds offer significantly more assets classes in which to invest. “The proposed covered bond program is intended to increase liquidity and encourage banks to distribute loan funds once the economy fully recovers,” Dolan said. Write to Jason Philyaw.