Development of China's Corporate Bond Market

1
Securitization and Asset-Backed Securities (ABS)
Market
June 8-11, 2004 Colombo, Sri Lanka Noritaka
Akamatsu Financial Sector Operations Policy The
World Bank
2
Outline

• What Why?
• Technical issues
• Demand and Supply
• Policy framework

3
What is Securitization?

• Securitization is a generic term for a
  transaction in which future cashflows or
  financial assets are pooled into tradable and
  liquid securities or other obligations.
• By pooling assets, it diversifies and reduces
  risks of the portfolio and, with additional
  credit enhancement arrangement, can produce
  highly creditworthy instruments to market.

4
Traditional Securitization Structure
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Assets / Cashflows for Securitization

• NPLs
• Residential mortgage
• SME loans
• Infrastructure projects (credit and cash flows)
• Auto loans
• Credit card receivables
• Trade receivables (cash flows)
• Receivables under aircraft and equipment lease
  (cash flows)
• Etc., etc.

6
Figure 3.3 Rated Cross-Border Asset
Securitizations
in 2001
Whole business
Auto loan
9.1
receivables
6.8
Line of credit
receivables
CBOs
11.0
22.0
Corporate loans
Leases and loans
4.5
10.1
Credit card
receivables
36.4
Source Moody's
7
Figure 3.1 Emeging Asia Securitized and
Non-Securitized
Corporate Issuance, 1995-2000 (US million)
40,000
Securitized bonds
Non-Securitized Bonds
30,000
20,000
10,000
-
1995
1996
1997
1998
1999
2000
Source HKMA,
Further Study on Securitization and Credit
Enhancement in Asia
8
Figure 3.2 Growth of East Asian Asset-Backed
Market,
1995-2000 (US billion)
14
Korea
Thailand
12
Singapore
Malaysia
10
Indonesia
Hong Kong
8
6
4
2
-
1995
1996
1997
1998
1999
2000
Source HKMA,
Further Study on Securitization and Credit
Enhancement in Asia
9
Why Securitize?

• Efficient resource allocation
• Supporting problem resolution and financial
  stability
• NPLs
• Economic growth
• Infrastructure finance
• SME financing

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Efficient resource allocation

• Cash-poor lenders sell credits to cash-rich
  investors in the form of marketable securities.
• Housing mortgage loans
• Auto loans
• Credit cards

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Supporting problem resolution and financial
stability

• Tool to assist in disposal of NPLs
• Banks can remove NPLs from their books by
  securitising them into marketable instruments.
• Transaction can be structured into attractive
  investment.
• Reduce concentration risk of banks in mortgage
  lending (a financial stability factor).

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Economic Growth

• Facilitate SME financing
• Banks will be more willing to lend to SMEs if
  they can free up credit lines through
  securitising.
• Control exposure to SME risk while making new
  loans
• Mechanism to raise finance for infrastructure
• Project cashflows secure securities in
  international and domestic markets
• Lower cost, higher quality, longer maturity
• Support the growth of mortgage market
• Provision of housing finance at competitive cost

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Experiences with bond market development

• Must corporate bond markets develop first?
• Not necessarily as long as benchmarks exist,
  i.e., money and government securities markets.
• The legal, accounting and tax regimes must be
  made supportive.
• Does securitization entail new risks?
• Operational risks exist with servicers. However,
• It reduces and diversifies financial system and
  instrument risks.
• Better quality asset than basic corporate bonds
  logical progression in terms of risk

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Technical Issues

• Legal
• Regulatory
• Taxation
• Accounting
• Credit information and guarantees
• Market infrastructure
• Pricing and interest rate

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Typical Legal Impediments

• Check points
• True sale and bankrupty remoteness achieving
  risk separation with SPV
• Civil code vs. Common law
• Procedures required for formalization of transfer
  of assets
• Recognition of ABS as securities

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True Sale and Risk Separation

• Two typical forms of SPV
• SPC Is it possible under company and securities
  laws?
• Trust
• Common issues with Trust Law
• Number of beneficiaries required, qualification
  of trustees, trust registration process, etc.
• Interpretation / explanation and implementing
  rules to resolve problems
• Consider ABS Law
• Often effective in overcoming many impediments in
  a civil code jurisdiction (e.g., Korea)

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Transfer of assets

• Impediments to asset transfer typical of civil
  law jurisdictions, especially
• Notification
• Registration
• Need to reduce costs and difficulties of
  notification and registration
• Possible remedies
• Interpretation / explanation of Trust Law
• Regulations on registration e.g., objection
  period and process, transfer of security,
  mortgage registration

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Sale of securities / obligations

• Issue of securities / obligations
• Transfer / distribution of trust beneficiary
  interest can be problematic if it is not
  considered as securities under the securities
  law.
• Allow trust companies to issue securities and/or
  beneficiary certificates
• Remedies
• Interpretation / explanation of Trust Law / Trust
  Company Law to allow issuance of securities and
  to clarify that certificates represent an
  undivided interest in trust assets.

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Technical Issues

• Legal
• Regulatory
• Taxation
• Accounting
• Credit information and guarantees
• Market infrastructure
• Pricing and interest rate

20
Regulatory Impediments

• Check points
• Approval process
• Market segments
• Investor base
• Capital treatment

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Approval Process

• Often fragmented and complicated due to
  fragmentation of authority
• Bank regulator / Central bank, securities
  regulator, ministry of finance, ministry of
  housing / construction, tax authority, etc.
• Remedies
• Clarify roles and responsibilities of each
  agency.
• Transparency of processes and requirements

22
Market Fragmentation and Choice

• Exchange or OTC market?
• Should banks be allowed to act as agents /
  brokers / dealers (and investors)?
• Remedies
• Determine in which markets ABS to be sold
• ABS should be sold first among institutional
  investors only.

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Restricted Investor Base

• Are institutional investors (insurance, pensions
  mutual funds) allowed to buy non-listed
  securities?
• Are banks allowed to buy instruments other than
  public debt?
• Remedies to widen investor base
• Banks, insurance companies and funds allowed to
  purchase ABS in OTC bond market initially,
  subject to a credit rating requirement.

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Capital Treatment

• Capital adequacy rules for banks in securitsation
  (e.g. origination and purchase) is needed based
  on Basel framework.
• There should not be chances for regulatory
  arbitrage between the origination and the
  purchase.
• Loan classification and provisioning Need
  enforceable rules for banks to write down bad
  loans (not to discourage them from selling NPLs
  to realize residual value).

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Technical Issues

• Legal
• Regulatory
• Taxation
• Accounting
• Credit information and guarantees
• Market infrastructure
• Pricing and interest rate

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Taxation issues

• Clear tax rules needed on various elements of ABS
  transaction.
• Business tax?
• Income tax?
• Stamp duty (potentially prohibitive)?
• General goal Tax neutrality (i.e., transfer of
  assets to trust or SPV is not subject to taxation)

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Accounting framework

• Standards for accounting treatment of ABS are
  needed.
• Need appropriate accounting standards for on- and
  off-balance sheet treatment.

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Technical Issues

• Legal
• Regulatory
• Taxation
• Accounting
• Credit information and guarantees
• Market infrastructure
• Pricing and interest rate

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Credit Information System

• Information quality Accounting and disclosure
• Loan classification and provisioning
• Credit information bureau system
• Internal credit management systems
• Rating agencies
• Credit guarantees

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Information quality Accounting and disclosure

• Adequate disclosure by financial institutions and
  corporations is needed based on international
  standards.
• Supporting accounting and auditing services need
  to gain experience.

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Credit information bureau

• Credit information bureau system is more than
  useful for creditors.
• Do you have one in your country?

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Banks internal credit management systems

• Banks need to develop internal credit management
  systems to support securitization and subsequent
  operations as the servicers.
• Loan documentation needs to be standardized
  (e.g., mortgage / auto / SME loans)

33
Credit Rating and guarantee

• Need to develop credit rating culture.
• Consider requiring credit rating for investment
  in ABS by institutional investors, subject to
  transparent criteria for recognizing qualified
  agencies.
• Rating agencies need a credit information system.
• Need a credit guarantee industry able to support
  credit enhancement in securitization.

34
Technical Issues

• Legal
• Regulatory
• Taxation
• Accounting
• Credit information and guarantees
• Market infrastructure
• Pricing and interest rate

35
Market infrastructure

• Registration system needed
• For assets (e.g. real estate) and for security
  (e.g. mortgages).
• Multiple pledging must be controlled / prevented.
• Consider developing a multi-entry point
  integrated system (to register both assets and
  security interests)
• Consider adopting a national guidance to simplify
  and standardize fees and procedures for
  registration.

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Technical Issues

• Legal
• Regulatory
• Taxation
• Accounting
• Credit information and guarantees
• Market infrastructure
• Pricing and interest rate

37
Interest Rate Policy

• Spread between interest rate on underlying credit
  assets and that on the securitized instruments
  should provide adequate room to cover cost of
  securitization.
• Interest rate controls, if any relevant ones,
  need to be liberalized.

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Demand and Supply

• Supply Securitizable assets
• Mortgage credits outstanding in banks.
• Existing and potential infrastructure project
  cash flows
• Disincentives for banks
• Liquidity in the banking system
• Capital adequacy
• Interest rate regulation
• Demand asset size and growth of institutional
  investors

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Policy Actions

• Issues cut across areas of responsibilities of
  many authorities.
• Central bank, securities regulator, finance
  ministry, housing/construction ministry, tax
  authority, etc.
• Establish an Interagency Committee to support
  securitization and debt market development.
• Create a mechanism for consultation with market
  participants.
• Plan for short, medium and long term actions.

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Short term

• Taskforce to take stock of existing policy
  initiatives of various agencies
• Focus on issues not requiring legislation or
  institutional development
• Regulations on MBS (including capital, covering
  at least transfer and investment), NPL, trading
  market, etc.
• Rules on tax, accounting, notification and
  registration fees and procedures
• Interpretations / explanations on Trust Law,
  Mortgage Law, etc.

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Medium / Long term

• Introduce ABS Law
• SPV, asset transfer, securities issuance
• Develop ABS support structures
• 2ndary mortgage corporation, etc.
• Develop a credit guarantee industry.
• Amend Company and Securities Laws
• Bring ABS into the securities framework and part
  of public markets
• Amend Company and/or Securities Law rather than
  in ABS Law to allow shell companies to issue
  debt.
• Develop an integrated registration system