Securitization and Asset-Backed Securities (ABS) 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 ORIGINATOR (assets) Transfer of assets from originator Proceeds from sale of securities / obligations SPV Securities / Obligations Funds INVESTORS

5. 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

10. 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

11. 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).

12. 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

13. 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

14. Technical Issues • Legal • Regulatory • Taxation • Accounting • Credit information and guarantees • Market infrastructure • Pricing and interest rate

15. 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”

16. “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)

17. 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

18. 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.

19. 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

21. 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.

23. 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.

24. 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).

25. Technical Issues • Legal • Regulatory • Taxation • Accounting • Credit information and guarantees • Market infrastructure • Pricing and interest rate

26. 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)

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

28. Technical Issues • Legal • Regulatory • Taxation • Accounting • Credit information and guarantees • Market infrastructure • Pricing and interest rate

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

30. 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.

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

32. 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.

36. 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.

38. 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

39. 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.

40. 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.

41. 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