If you compare it to the last two years, this year has been much more active and involves more asset types. For example we have seen two synthetic collateralized debt obligations (CDO), one of which was a balance sheet deal, the other an arbitrage transaction. We have also seen consumer assets like credit cards and auto loans securitized in Korea, which is different to the past couple of years when it was mainly commercial assets.
In general terms, the market has remained pretty much the same with Korea being most active and Hong Kong still pretty quiet. Singapore is coming up quite strongly with a few domestic deals involving properties and an international deal, DBS Bank's balance sheet CLO.
Has there been any change in volume?
This volume this year has been around double of what we saw last year. In 2000, there was around $1.6 billion and this year we are going to see about $3 billion. The market is pretty good right now.
What do you feel have been the key developments in the last year?
One thing worth noting has been the development of local markets in certain places. In April, the Securities Commission in Malaysia set out the guidelines for securitization. Taiwan drafted legislation in October and that is set to pass by the end of the year or early next year.
Another notable case is the Philippines. Before Estrada was forced out, he issued a presidential order last year to ask government ministries to co-ordinate with each other and come up with a framework so that non-financial institutions could securitize their assets. This was supplementary to the guidelines in 1998 for financial institutions to securitize their assets.
There has been tremendous interest in these places to develop their local markets. Korea's domestic market has also continued to develop. We have seen residential mortgage-backed securitizations (RMBS) for the first time and there has also been a lot of activity with primary CBOs. Basically, this has helped provide an alternative funding source to the small and medium sized entities that have not found it easy to get bank loans.
We have also seen interest in other Asian countries to develop guidelines, China being one of them with residential mortgages and non-performing loans (NPLs) in mind. People are looking at securitization as one of the ways to help solve NPL problems.
A lot of ABS experts see China as the market with most potential. What is your take on this and what does China need to get the market going?
In order for China to do securitization, it probably needs two things. One is a necessary legal and regulatory framework that allows for the clear separation of assets into the SPV. They also need to clarify the taxation issues related to asset transfers, which will determine whether the securitization vehicle is tax neutral or not.
You also need passages within the legislation to deal with foreclosures, bankruptcy; title transfers, etc. so that when there are problems there's still a way to realize the value of the underlying assets.
The legal aspect is the fundamental impediment because if you don't have that there are going to be problems.
What is happening on that front in China?
We have seen this year the passing of the Trust Law, so they have established ways of dealing with trust-related issues, which is something that wasn't so clear before. Fundamentally, there have been contract laws and bankruptcy laws but basically these are still pretty new and most have not been tested in the courts. It is still not certain how insolvency or bankruptcy would be dealt with.
In terms of how securitization ties in with company laws, SPVs are usually shell companies: there are no employees or fixed office space with minimum equity. This is something the government does not like because in the past they have tried to discourage fly-by-night companies. You have to have a certain amount of registered capital, fixed office space and certain legal representatives.
Consequently, these SPVs are totally different to that idea so how to deal with that is a big issue. China has a civil law jurisdiction as well, which is another matter. In common law countries like the UK, Hong Kong and Malaysia it's easy because you have precedents, but in civil law countries you need to pass certain laws that cover all the different company, tax and trust issues.
The SPV concept is not covered in the current legal system so China will have to pass special laws.
Is there one civil law country that has securitization laws that could be replicated in China and other places?
There are a lot of examples you could look at. In Europe, France has civil law, as does Italy, which is now a major securitization market. In Asia, both Japan and Korea have specific laws that deal with securitization issues so China can look at these existing laws.
Having said that, not one of them is perfect. If you look at Korea, revolving structures are not specifically accommodated in the ABS law. You can get around that by using certain measures but the law itself does not cover it. It also does not deal with certain tax issues: there has to be some other law that deals with it. The same thing happens in Japan as well.
In those two markets, the deals still get done so it suggests that there is a real willingness on the part of the legislators and regulators to foster securitization.
Absolutely. In common law jurisdictions the governments do not usually deal with commercial ventures, but in civil law countries, the government's involvement is very important. If a government has the will to do something it makes things very easy. Japan and Korea are both examples of this.
However, it is sometimes the case in Asia that countries can be slow in accepting new ideas. They like to see how other countries do things and test ideas step by step. But as soon as they realize that real advantages can be gained from something, they can move pretty quickly.
Going back to 2001, what do you think have been some of the key deals in the cross-border market?
The synthetic deals have been very interesting. The two deals that we have been working on recently are the DBS CLO done by DBS and JP Morgan and the arbitrage CDO done by ING Barings with OUB Asset Management.
It will be interesting to see what happens with this product because for one thing they offer banks the opportunity to hedge their risk on an on-balance sheet basis. They can get benefits in terms of capital adequacy ratios improvement and better balance sheet risk profile management.
Arbitrage CDOs on the other hand are a product of people in Asia becoming more confident, coupled with the development of the credit default swap market, which is a deeper and more liquid market now than it was. Investors are comfortable with synthetics and not having ownership rights of hard assets.
Do you think we will see a lot of Asia banks doing CDOs to improve capital adequacy?
I would hope so because with securitization you can either transfer the assets for balance sheet management or sell the risk with synthetics. This is not so that banks can raise finance because they are already very liquid it just means that for certain assets they can get capital relief by synthetic securitization. This allows them to deploy capital more efficiently.
Another thing is that amendments to laws in Singapore requests that banks sell their non-core assets, notably real estate. When they do that, in order to mitigate the market value impact of selling all the real estate in the open market, banks could do securitization deals.
Will that just apply to banks in Hong Kong and Singapore?
In order for this to work, the regulations have to be clear on what kind of treatment the synthetic deals will get and whether it will allow the risk on a bank's books to be eliminated. If the regulators are not up to speed, you won't get the benefit in terms of capital relief.
Regulators in Singapore and Hong Kong are generally closer to what is happening in the markets so these will be the main countries where this activity will come from. That said, the Koreans are keen to use these techniques to help the banking system address the issues that have resulted from banking system reform and recent mergers and acquisitions.
In the other countries, the regulators are also looking into this product but by and large they are not quiet there yet.
How have you assessed developments this year in the non-core countries such as Malaysia or Taiwan? Is there a genuine desire to promote the markets?
I think so. In Malaysia, it is not only regulators that want to develop the market but private sector practitioners as well. The asset management company Danaharta is doing something this year and there have also been CDOs. People are also looking at commercial real estate transactions as well.
In Taiwan, the interest in the private sector has been there for some time. I was in Taiwan a couple of years ago and people were keen for the government to address the main issues. If a law does get passed there, I would expect a number of domestic deals to get done there in 2002.
Cross-border issuance out of Taiwan is another story because of the withholding tax problem on such deals. You need the laws or regulations to exempt cross-border deals from this and I think the government recognizes the impediments. Improving the NPL problem in the banking system is a major matter and people are looking at securitization as one way of sorting this out.
As for the Philippines, the legal system is one thing, but you also need to know the value of assets. Another thing you need to have is a relatively deep and active bond market, for trading purposes or for the investor base. You need to have investors that are willing to buy these products.
In the Philippines, the domestic bond market is very small and trading is inactive. In order for the country to do domestic securitizations you need to have the laws and the financial markets.
It is the same case in China, because the government has done most of the borrowing in recent years. Corporate issuance has been very limited.
But as for the regional market as a whole, there have been some important developments regarding institutional investors. In Hong Kong, we have seen the MPF set up. Where is the money going to go? You cannot invest all the money in the equity markets because of volatility. Life insurance companies and mutual fund companies are being set up across Asia and there is a need for fixed income securities that they can invest in.
Securitization provides a higher credit quality, higher certainty of repayment; higher ratings and I think it will appeal to those investors.
How do you view the prospects for the market in 2002?
I think next year will be better than this year, although you must be cautious because of the uncertainties in the global economy, such as how the interest rate environment will change.
That said, this market is different to those in the US and Europe, with a bit of a lag effect. In Asia, with the development of the local markets I would say things would be better.
On the cross-border side I would expect in excess of $3 billion in issuance.
What about asset classes?
We will see more synthetic deals. In Korea, I expect the consumer asset deals to continue from finance companies and I expect banks to do something following the mergers that have been done.
In Hong Kong, I think there will be some consumer assets securitized as well as commercial loans, maybe some residential mortgage deals. Singapore will do more property-related deals, Taiwan the same and maybe credit cards as well.
I do not expect the domestic market to be very active in the Philippines but there may be a couple of cross-border deals. One of the assets people have talked about there is worker remittances because there has been between $5 billion and $10 billion yearly flow from overseas workers sending money back to their families.
Malaysia will probably see consumer assets and CDO transactions. I would not expect a lot of cross-border deals there, or from Taiwan, because of the lack of long term cross currency swaps and withholding tax, respectively. Thailand will probably be quiet as well because of the lack of a swap market and the relatively long time it takes to foreclose assets. In India, we will probably see some RMBS deals.