Moody's Investors Service has examined the Australian legal framework for covered bonds, concluding that there are "relatively few prescriptive requirements". Instead, Australian issuers and investors are reliant on a set of legal guidelines that assume certain contracts will be in place. These contracts are therefore a component of the regulatory framework.The Moody's report provides a broad and detailed examination of the Australian system, as one part of a series of reports on individual covered bond jurisdictions.The Australian legal framework and contractual practices for covered bonds include the following, classed by Moody's as "strong" features: the law contains no restrictions on asset sales by the guarantor in order to refinance maturing covered bonds and, overall, contractually the restrictions are very limited; although the law allows both residential and commercial mortgage loans to be included in the cover pool, current programs typically only permit residential mortgage loans; and foreign assets are not permitted in cover pools.The Australian legal framework and contractual practices for covered bonds also include the following weaker features: over-collateralisation above the legal minimum level of three per cent may contain high loan-to-value loan parts; and the law does not require coverage tests for interest rate, currency or liquidity risks, although program documents address these risks.The report says that the features of the legal framework are just some of the factors Moody's considers when determining its ratings. Relevant issuer research, including pre-sale reports, new issue reports and performance overviews, should also be consulted.Among the "relative weaknesses" it sees in the covered bond law are: the law does not place any limits on the proportion of commercial mortgage loans in the cover pool (however, contractually, primary assets in the cover pool are typically restricted to residential mortgage loans); and the law does not provide any net present value test for determining cover pool asset coverage relative to the covered bonds, nor does it prescribe any valuation requirements, except that the most recent property valuation should be used to determine LTV."The lack of any provision in the law addressing interest rate risk is a weakness, although in practice issuers hedge the risk with internal swaps containing sufficiently high triggers for collateral posting and counterparty replacement to add some protection," writes Moody's."In addition, the majority of loans are variable rate and can be reset following a notification to the borrower," the agency noted.