Securitisation is one of the fastest-growing and evolving sectors of the capital markets around the world. To those not directly involved in its complex dealings, it can seem arcane and impenetrable, typified by highly complicated deals and an alphabet soup of acronymsùABS (asset-backed securities), RMBS (residential mortgage-backed securities), CMBS (commercial mortgage-backed securities), and CDOs (collateralised debt obligations).
One of the little-known advantages of securitisation is its capacity to act as a tool for social development. In this article, we will explore what some of the benefits of developed securitisation markets are, and examine the roadblocks to be overcome for the continued development of securitisation in the Asian markets.
Securitisation In The Asia-Pacific Markets
The first markets to adopt securitisation in the Asia-Pacific region were Australia and Japan. In Australia, the residential mortgage-lending sector was revolutionized by securitisation in the early 1990s. A market that had been dominated by traditional loans from major banks was suddenly swamped by nonbank originators and smaller regional financial institutions funding their loans through the issuance of residential mortgage-backed securities. These new entrants had identified an opportunity to enter a lucrative sector of the financing landscape that existed at that time.
The effect of added competition was to tighten lenders' profit margins on home loans by more than 2%, which dramatically increased housing affordability. The average Australian homeowner may not have heard of securitisation, but many Australian homeowners are beneficiaries of it.
The securitisation market in Japan developed at around the same time, but the reasons for its evolution were quite different. Only a small number of issuers were active in Japan in the 1990s, but the Asian financial crisis and the ensuing credit crunch meant that access to funds was severely constrained, changing the market significantly.
Recognizing the emerging credit problems, the Japanese government passed several laws that facilitated the first of Japan's domestic securitizations. At that time, nonbank lenders and leasing companies needed access to funds, which they could not get from the major banks. The answer lay in the capital markets, with securitization.
The Balance Of The Asian Markets
The securitisation story is a little different in the rest of the Asia-Pacific marketplace, with much slower uptake of structured finance opportunities. The rest of the Asian market is markedly different from the more sophisticated Australian and Japanese markets. With Asia's middle class expanding rapidly, the benefits of cheaper and more widely available housing are becoming more apparent. But, so far, the Asian capital markets have been generally unable to unlock the benefits of securitization. Opportunities for securitisation in the Asian market are not always obvious, but they do exist.
One of the least understood and most remarkable characteristics of securitisation is its capacity to act as a tool for social development, such as housing and infrastructure. In emerging markets such as India, the Philippines, Indonesia, and China, the development of public-private partnerships for infrastructure projects like toll roads and hospitals, or even for commercial property, can be hampered by a lack of long-term funding through traditional bank loans. Securitisation allows future revenue streams and cash flows of such projects to become the collateral for their construction. As markets develop and confidence in these kinds of securitised products grows, so does investor appetite.
Such benefits have been seen in many parts of the world, but so far they are yet to make a meaningful impact in Asia. The use of securitization technologies and issuance levels generally across Asia (excluding Japan and Australia) are still quite limited. The market comparisons in the charts below highlight some of the major differences in those markets and show which markets are still in their nascence.
Reasons For The Slow Uptake In Asia
Despite some variations in the reasons for the growth of structured financial deals in each market, some factors hold true across the region:
Lack of regulatory and legal framework
For a securitisation market to exist, a regulatory framework needs to be in place to support it. Such frameworks should clearly state, among other things, the capital reserve requirements and relevant risk weightings for various classes of securitised debt. There should be bankruptcy laws in place to protect mortgages and investors in the event of an originator becoming insolvent. Without such frameworks, governments may be nervous to allow a system that puts the homes of thousands of its people at risk. And, investors would not be prepared to invest in securitized assets that cannot be traded freely.
It is very difficult to establish a securitisation market on a trial basis, as lenders must be willing to commit large pools of assets to achieve the necessary economies of scale. Historical asset performance is one of the keys to providing an accurate assessment of credit risks, but in a new market that can be very difficult to compile. Unless securitisation looms as the only funding alternative, governments may have to offer other incentives to originators before they will invest the considerable time and effort involved in this kind of financing.
In their efforts to increase levels of home ownership, governments can subsidise mortgage corporations; competing with discounted mortgages can be almost impossible for originators attempting to package mortgages into a securitised product.
High levels of bank liquidity
Asia holds one-third of the world's wealth, with household savings rates at about 40% of total assets, which is double the figures for Europe and the US. However, most of that money languishes in savings accounts in banks, and household ownership is less than 10%, compared with 80% in Western countries.
The tendency to have cash languishing in bank accounts can be a blow to the further development of capital markets on several levels. This pool of savings accounts allows banks to view residential mortgage loan portfolios as their premier assets. With such high levels of liquidity backing them, they can offer these mortgages at lower margins, making it uneconomical for originators of securitised bundles of loans to match those rates. As a result, this great pool of savings generates a much lower return than it would if it were put to more efficient use. The banks themselves could bundle these mortgages into securitised products, but that would take them off balance sheet, and banks are reluctant to "dispose" of such assets in this way.
Benefits For Emerging Markets
There remains one area where securitisation offers banks in Asia a clear and immediate advantage, and that is in the risk management of their own balance sheets. In the traditional mortgage market explained above, banks bear the entire risk of their mortgage portfolios, a situation they may need to address under the impending Basel II framework, or at the very least should be managing on an ongoing basis for prudent management purposes.
By creating and issuing synthetic securities backed by pools of assets that meet desired risk profiles, a bank can effectively create insurance against the value of its loan portfolio. Instead of taking out a policy with an insurance company, the bank buys its insurance through capital market investors. Such synthetic securitisations are already a reality in several markets, where banks have used them against their corporate and small-to-medium enterprise portfolios.
These synthetic securities then allow the banks to optimize their balance sheets. Instead of relying on margin income from long-term mortgages, they can derive fees from the creation and issuance of synthetic securities. Their balance sheets cease to house loan pools and, instead, book origination profits.
A side effect of implementing the frameworks and infrastructure necessary for securitization is that capital markets become more transparent and accessible. They now offer more flexibility in the level of risk and return that investors seek, and have become more efficient at utilizing existing levels of liquidity.
In some markets, securitisation has been known as a "lender of last resort." The benefits of introducing securitisation when times are good are that it allows for a more orderly introduction and it can be tailored more broadly to a range of assets and instruments, rather than being limited to fixing a specific and immediate problem.
Efficiency in capital markets is a significant step toward attracting more interest from international investors. If multiple markets across Asia can create such systems, a stronger intra-regional market may develop, one in which consistent regulatory and tax environments facilitate more cross-border issuance, and perhaps even create the strength to better withstand external shocks to the region's export-oriented economies.
An emerging market company's ability to borrow capital from international investors can be vital for its economic survival, particularly during an economic crisis. Securitization can allow borrowers to tap foreign markets for US dollars or other hard currencies. Therefore, borrowers can issue securitised debt to access international markets for funds otherwise unavailable, either locally or internationally, on an unsecured basis.
A balanced and developed capital market framework can broaden investment options, improve stability, and deliver transparency and accountability to issuers and investors alike, which feeds continual confidence in the system.
Securitisation can develop and open up capital markets and provide a stabilising and reliable framework to help insulate markets from external shocks. With more developed and robust capital markets, the effects of financial crises and international impacts may be dramatically different from what was seen during the most recent financial crisis in Asia.
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