China securitisation: where to from here?

The market will continue to advance in terms of issuance volume and infrastructure buildup but Chinese regulators will adopt a cautious approach, writes S&P's Vera Chaplin.

China securitisation: where to from here?

China's securitisation market has seen the highest level of issuance this year since its pilot program in 2005. What's been driving issuance?

Securitisation is growing fast in China. In the first nine months of 2014, the amount issued under the China Banking Regulatory Commission (CBRC) and People's Bank of China (PBOC) program totaled about Rmb170 billion, compared with about Rmb100 billion between 2005 and 2013.

A range of factors are converging to spur the development of the market. Firstly, the Chinese government is continuing to look at ways to support China’s broader economic policy initiatives, including reducing the economy’s reliance on banks. The government, therefore, has had a strong incentive to support the development of a securitisation market, which offers an alternative funding source and balance-sheet-management tool. Consequently, the government has introduced regulatory guidelines and other measures for the market, such as a securitisation pilot program.

Secondly, there is better information flow globally about the securitisation market and its associated risks. This has enabled market participants to leverage experiences from other markets and, consequently, raise confidence in the market.

Thirdly, issuer types and asset coverage are broadening. For example, a series of auto loan securitisations were launched in China in March 2014, and the first residential mortgage-backed security since 2007 was also issued in July 2014.

Do you expect this growth momentum will continue?

China's securitisation market will continue to advance in terms of issuance volume and infrastructure buildup, in our opinion, thanks to ongoing government support for securitisation initiatives, the accumulation of experience and knowledge through the country’s managed pilot program, and growing demand from originators and investors.

However, like most market participants, we believe Chinese regulators will adopt a cautious approach to developing the market. We expect regulators to focus on aligning the products with the government's economic and financial market reform initiatives, instead of simply providing new financial instruments.

We believe China's policymakers will employ securitisation in a way that guides the market toward supporting a country-level industry development plan and develops a financial market management strategy.

What can be done to develop China’s securitisation market further?

Although we have seen more confidence on deal structuring and risk analysis from issuers, investors, and important third parties, some market concerns persist. In our view, a range of development opportunities remain in this relatively new market. These include clarification of enforceability on particular contracts, details on recovery analysis, loss projections for a potentially less-promising future economic environment, cash-flow test assumptions, and the ability to have qualified servicer replacement.

China has already introduced many initiatives that may improve the soundness of asset segregation and bankruptcy remoteness, as well as address some perfection issues in the asset-sale process. Even so, there are still some market concerns about the potential effectiveness of guarantee contracts as credit substitutes for loans in collateralised loan obligation transactions and post-default recovery. While there are many market practices that would help address these concerns, some investors expect more official, detailed, and court-acknowledged procedures. What’s more, some market participants would clearly prefer a stable legislative and regulatory floor for securitisation, rather than the current regulatory guidelines that could be subject to changes or challenges.

Compared to more mature markets, there is also a lack of information from measures such as stress-test periods. This applies to loss data, servicing, and legal practices.

 

Are China’s policy initiatives in line with global practices?

The administrative initiatives introduced by regulators in China are generally consistent with those in the global market and have been introduced in parallel with other markets. This suggests that Chinese regulators are planning to develop a local market that operates in line with global operating standards.

For instance, the credit asset securitisation pilot program by the PBOC and CBRC has introduced a risk-sharing requirement for securitisation originators to hold at least 5% of new issuance throughout the life of a transaction. This requirement is planned, or already has been adopted, in other markets. Although we have not seen a direct link of this risk retention rule to an underwriting quality requirement in China's securitisation regulations, a “skin-in-the-game” regulation may enhance responsible underwriting to some extent.

Currently, banks make up most of the securitisation investors in China, and they are also originators in other cases. This has prompted investor concerns over the banks' mutual risks in securitisation issuance. We believe an expanded universe of investors would include more variety and knowledge-sharing, which could in turn facilitate the market's development. The more important element for any emerging market, in our opinion, is adequate information disclosure by originators, including origination standards and validation. We note that Chinese regulators have introduced some mandatory requirements on this front.

Do you expect more growth in auto loan securitisation?

Auto loan securitisation, a typical consumer credit transaction in other securitisation markets, has established a foundation in China, with six transactions rolled out between March and August 2014. The quick development of this market highlights sellers and buyers' increased acceptance of such products in China. Among the commonly cited drivers for auto-loan securitisation are businesses' needs to find alternative funding channels to support quick business expansion, broaden their investor base, and enhance their balance-sheet management. We believe such demand is rooted in China's increased demand for automobiles and the availability of financing to support such purchases.

China has surpassed the US as the world's largest new car market, and we expect the automobile market in China to keep growing. Despite representing a small portion of overall car sales, financed purchases are expected to increase in the form of loans or financial leases provided by commercial banks, auto manufacturer-captive finance companies, and other financing companies.

In our view, the expansion of securitisation into the auto-loan sector, and the involvement of captive finance subsidiaries of international car manufacturers, is positive for the development of China’s securitisation market. It plays an important role in sharing practices from other markets where the performance of such transactions have been tested, and it draws interest from offshore investors who are familiar with the asset class.

The author of this article is Vera Chaplin, Managing Director of Structured Finance at Standard & Poor’s Ratings Services.

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