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Financial crisis could be positive for securitisation in Asia

The availability of cheaper and easier financing alternatives and the diverse market environment are impeding the growth of securitisation markets in the region, but there are signs of change, argues Standard & Poor's.

From Shanghai to Sydney, the Asia-Pacific region contains a rich tapestry of diverse cultures and economies. The spectrum is also broad in terms of each country's sovereign creditworthiness, economic development, and market sophistication.

While some countries possess legal and regulatory structures to support domestic and cross-border securitisation markets, relatively few have well-developed capital markets by international standards, and fewer still have the legal framework, stability, scale, and operational infrastructure to support vibrant and stable securitisation sectors.

Although data on the aggregate size of the securitisation markets in Asia-Pacific is not readily available, in the below table we estimate the current securitisation outstandings by country.

Despite a strong history of trade cooperation and agreements within the region and beyond, Asia-Pacific's domestic capital markets are fragmented. Consequently, Asia-Pacific investors have tended to look to the US and European markets for investment opportunities rather than to their own region. Standard & Poor's Ratings Services believes these factors impede the growth and recovery of individual securitisation markets, as well as efforts to foster greater regional cohesion.

However, we also believe the global financial crisis, a growing sense of independence and confidence in the region, increasing wealth, and a desire by several policy-makers to foster greater regional cohesion may spur changes that will improve the region's long-term prospects for greater integration of capital markets and the ongoing development of securitisation markets around the region.

The impact of the global financial crisis

The impact of the global financial crisis on individual countries has underscored the diversity of Asia-Pacific's securitisation markets. The effects vary both by nature and degree among the individual markets, with the most pronounced occurring in securitisation markets with the following characteristics:

  • Markets with heavy reliance on cross-border investors and, in particular, structured investment vehicles (SIV)/conduit investors -- for example, Korean cross-border transactions and Australian residential mortgage-backed securities (RMBS);
  • Sectors where foreign banks dominate securitisation activity. After the crisis, a few of these banks have scaled back or exited noncore markets -- for example, the Japanese conduit commercial mortgage-backed securities (CMBS) sector;
  • Sectors where securitisation was the predominant source of funds -- for example, the Australian non-bank RMBS sector and Japanese conduit CMBS sector; and
  • Jurisdictions where government interventions to protect and stabilise the banking systems had broader unintended consequences for securitisation. This was most pronounced in Australia.

And yet, the credit performance of most Asia-Pacific securitisation transactions remains sound.  In our opinion this reflects several factors:

The relative strength of banking systems and asset quality in the region leading into the global financial crisis

The Asia-Pacific countries have endured and recovered from several shocks to their financial systems in the past few decades, leading to significant structural reforms in many of the region's financial markets. These events include Australia's recession in the early 1990s, which revealed significant credit quality issues in several banks; the 1997/1998 Asian financial crisis; Korea's credit card crisis in 2003; and Japan's decade of restructuring following the bursting of the 1990s asset price bubble.

As a result of these events, the region's banks recapitalised, improved risk management and credit systems, and maintained higher credit quality through the most recent credit boom relative to their US and European counterparts. In particular, subprime lending comprised a negligible proportion of regional banking assets.

The performance of Asia-Pacific's economies relative to other regions

The economic deterioration started later in Asia-Pacific than in the rest of the world, providing a strong performance buffer for a large proportion of the region's amortising transactions, which have relatively short weighted-average lives and sequential payment structures. In addition, the slowdown was shallower and the recovery started earlier than in the US and Europe.

Further, lower interest rates resulting from looser monetary policies have, to a certain extent, alleviated the financial stress among borrowers and offset the impact of modest rises in unemployment on delinquencies and default rates of consumer portfolios.

The nascent state of Asia-Pacific's securitisation markets 

Asia-Pacific's securitisation markets are relatively less mature and lack the depth and scale of markets in the US and Europe. Further, the Asian cultures are far more traditional in their use of credit, demonstrated by their very high savings rates. As a consequence, only a small proportion of securitisation transactions in Asia-Pacific comprise highly leveraged loans, or loans to lower credit-quality borrowers, who are most vulnerable to performance issues when economic conditions deteriorate. 

Further, reflecting the lack of market depth, scale, and maturity, transaction structures remained quite straightforward. For instance, very few transactions relied on the ability to resell assets in a liquid market to repay noteholders.

The path to recovery and growth may not be easy

Each market within the Asia-Pacific region may have to forge its own path to recovery and growth, depending on local conditions. In our opinion, this process may not be easy, due to the region's longstanding challenges to the development of securitisation. In addition, the extent and timing of global and local regulatory and market developments in response to the global financial crisis will likely play a part, as uncertainty around the scope and timing of these developments and their impact on securitisation markets may stall recovery efforts.

Asia-Pacific's domestic banking systems are highly competitive, with a strong emphasis on relationship banking. Further, high savings rates in most markets (except in Australia and New Zealand) provide banks with a low cost, stable base from which to fund lending, as the savings comprise predominantly bank deposits. This reduces the impetus of the banks to use securitisation to diversify and/or increase their funding bases.

Indeed, for many potential issuers of securitised products in Asia-Pacific, securitisation is not a necessity. For instance, Hong Kong, which has one of the most developed and international capital markets in the world, has had only a nascent securitisation market for years due to easy availability of competitive bank financing. For individual securitisation markets to grow and prosper, in our opinion, securitisation would need to provide a compelling value proposition relative to other funding sources.

The region comprises countries with distinctive and diverse cultures, different stages of economic development, sovereign credit quality, currencies (several of which are not widely traded in foreign exchange and swap markets), regulatory environments, and legal systems. Legal precedent is scarce for securitisation issues, and without the ability to write legislation to facilitate securitisation, these obstacles add layers of complexity for issuers and transaction participants, and increases time and costs of execution. For investors considering some of these newer markets, it may be too demanding to invest the time and effort to understand the complexities of an individual market if they aren't certain they'll be rewarded with a flow of ongoing opportunities in the future. 

With the exception of Australia and New Zealand, historically Asia-Pacific's securitisation markets have been opaque. However, a growing global emphasis on market transparency, led by the International Organisation of Securities Commissions (IOSCO), may help to change this. Initiatives are underway in the US (Project Restart) and in parts of Asia-Pacific. For instance, Japan's Securities Dealer Association introduced the SIRP, or Standardised Information Reporting Package, on June 1, 2009, to help improve transparency and comparability among transactions.

While global and local policy-makers are developing and implementing various reforms, the ultimate impact of specific changes, as well as the combined effect of the myriad of local and global reforms, remains uncertain. We believe it will likely take well into 2010 for the implications of many of these significant changes on the design of, and future demand for, securitisation products to become more apparent.

Nevertheless, it's likely that for as many doors that close, others will open. We believe securitisation can and will continue to provide valuable contributions to the credit creation process, risk management, and funding diversification needs and imperatives of issuers, investors, and policy-makers. 

Catalysts of change may drive greater regionalisation

Despite these challenges to recovery and growth, changes seem to be emerging across the region. A noteworthy one is the rise of Asia-Pacific as an economic power. The region has become a significant global force in terms of the world's investable funds, and it's home to two of the world's economic growth engines, China and India. This has fueled a growing sense of independence and confidence.

Asia-Pacific investors are also significant holders of US securitisation in particular and as a result of the crisis some of these investors are beginning to rethink their strategies to include a more regional focus. In our opinion, this might be evidence of a positive effect from the global financial crisis on Asia-Pacific, especially when it comes to the future development of its domestic capital markets, securitisation capability, and greater regional integration of its financial markets.

With increasing intra-regional trade and investment flows, and the push by regional policy-makers toward closer integration of business and capital markets, over time, regional investors are likely to encounter a broader cross-section of asset classes and currency opportunities for investment. These options may become an attractive alternative or a complement to investments in their own markets, and the larger US and European markets. In the long term, regional investors may be able to construct diverse regional fixed-income portfolios, which may lead to shifts in investment styles.

In our opinion, Asia-Pacific's more established securitisation markets will likely recover, reinvent themselves, and find new ways to bring value and opportunity to investors, issuers, markets, and economies in the region. For instance, this year brought the first covered bond issue in Asia by Korea's Kookmin Bank. For the less developed emerging markets, continued efforts of policy-makers and a compelling value proposition emerging for securitisation in those markets will, in our opinion, be needed to underpin development and growth of those markets. 

Commitment and collaboration are key

Restoration of investor confidence in securitisation markets is at the core of recovery and future growth in the sector. While time is a healer, the region also needs to take tangible steps to help boost investors' confidence in securitisation and to foster increased regional collaboration to develop Asia-Pacific's securitisation markets. In our opinion, such steps need to focus on:

  • Improved transparency, standardisation, and access to documentation, data, tools and models to help investors make more informed investment decisions with less reliance on rating agencies;
  • Clarity, harmonisation, and/or mutual recognition between global securities regulators, bank regulators, and accounting standard setters;
  • Increased education about securitisation products to better inform potential investors of their relative strengths and risks;
  • Increased coordination between industry bodies to understand local and regional investor preferences and needs in terms of transparency as well as asset and structural preferences;
  • Ensuring that securitisation markets in Asia-Pacific are up-to-date with global regulatory and industry standards and developments, so as to keep the door open to global markets and investors when the markets pick up, which we believe will inevitably occur;
  • Ensuring the simplicity, quality, and performance of new issues, because, in the long run, performance will speak for itself; and
  • Ultimately striving for an ideal state where regulatory safeguards provide protection without stifling innovation, and the short-term benefits of leverage and cheap funding are balanced against longer-term stability and sustainability. 

The broader market fundamentals and drivers in each country, as well as policy-makers' aspirations, may provide clues as to how and where securitisation may emerge more strongly. They may also identify areas where the financial industry and policy-makers can work together to innovate and address market gaps. If they sustain a commitment to change, we believe greater collaboration will draw countries toward each other, and attract regional investors to new opportunities.

In our opinion, securitisation will be a viable funding, risk-management, and debt-structuring technique for Asia-Pacific companies and financial institutions, while at the same time providing more fixed-income investment opportunities to regional investors.

The author of this article, Fabienne Michaux, is a managing director of structured finance for Asia-Pacific at Standard & Poor's. 

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