Local institutional investors may have only limited interest in holding Australian banks' covered bonds, according to a leading fixed-income portfolio manager.This week, Tyndall Investments issued an assessment of the prospects for the embryonic covered bond market, focusing on the constraints issuers will face.And yesterday, Fitch Ratings issued a review of the covered bond legislation, noting that several issues that would play a part in its rating process aren't covered in the draft bill.In December, the Government announced, as part of its Competitive and Sustainable Banking System package, that it would amend the Banking Act to allow banks to issue securities with assets (residential and commercial mortgages) assigned to provide security for the debt. The legislation is still in draft form.The move is aimed at creating a new source of AAA-rated funding that will help reduce financial institutions' funding costs, as well as provide funding diversification.Tyndall's view is that, domestically, the size of Australian issuance will be constrained by investors' existing senior debt exposures.Tyndall said: "For investors who are able to invest in senior bank paper, and have comfort with the issuer's name, covered bonds may be less appealing since they can use up limits on exposures to these names with lower-yielding investments."For example, when the BNZ November 2017 covered bond was marked at a spread of 56 basis points over the swap rate, the slightly shorter-dated BNZ March 2017 senior bond was marked at a 125 basis point spread."An important feature of covered bonds is that investors have dual recourse to the bank and the collateral (the cover pool, which is refreshed regularly), while investors in senior bank debt can only claim on the bank, and RMBS investors can only claim on the collateral.Due to this dual recourse feature, covered bonds are considered a better credit risk compared with unsecured senior bank debt. The certainty of payment and the support of the bank make them a preferred asset over most RMBS.Being able to access the covered bond market is considered a credit positive for the rating of a bank.However, Fitch said its rating of covered bonds would be hampered by the fact that the draft legislation was silent on three important points: minimum over-collateralisation levels; mandatory liquidity protection for mortgage covered bonds; and transparency standards regarding cover assets.Part of Fitch's rating methodology involves assessing the likelihood of an interruption of payments on the bonds in the event of an issuer default. In the event of a default, the special purpose vehicle set up to hold the cover pool would be managed by an administrator.Fitch said: "The legislation does not clearly require the administrator to pay interest and principal when due. In the absence of such a provision, the agency will question whether the administrator is able to sell the cover assets."