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Securitization and Asset-Backed Securities (ABS) Market

June 8-11, 2004Colombo, Sri Lanka

Noritaka AkamatsuFinancial Sector Operations & PolicyThe World Bank

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Outline

I. What & Why?

II. Technical issues

III. Demand and Supply

IV. Policy framework

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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.

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ORIGINATOR (assets)

SPV

INVESTORS

Proceeds from sale of securities / obligations

Transfer of assets from originator

Securities /

Obligations

Funds

Traditional Securitization Structure

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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.

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Figure 3.3: Rated Cross-Border Asset Securitizations in 2001

Auto loan receivables

6.8%

CBOs22.0%

Corporate loans4.5%

Credit card receivables

36.4%

Leases and loans10.1%

Line of credit receivables

11.0%

Whole business9.1%

Source: Moody's

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-

10,000

20,000

30,000

40,000

1995 1996 1997 1998 1999 2000

Securitized bonds

Non-Securitized Bonds

Figure 3.1: Emeging Asia Securitized and Non-Securitized Corporate Issuance, 1995-2000 (US$ million)

Source: HKMA, Further Study on Securitization and Credit Enhancement in Asia

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-

2

4

6

8

10

12

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1995 1996 1997 1998 1999 2000

Korea

Thailand

Singapore

Malaysia

Indonesia

Hong Kong

Figure 3.2: Growth of East Asian Asset-Backed Market, 1995-2000 (US$ billion)

Source: HKMA, Further Study on Securitization and Credit Enhancement in Asia

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Why Securitize?

Efficient resource allocation

Supporting problem resolution and financial stability NPLs

Economic growth Infrastructure finance SME financing

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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

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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).

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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

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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

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Technical Issues

Legal Regulatory Taxation Accounting Credit information and guarantees Market infrastructure Pricing and interest rate

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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”

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“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)

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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

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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.

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Technical Issues

Legal Regulatory Taxation Accounting Credit information and guarantees Market infrastructure Pricing and interest rate

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Regulatory Impediments

Check points:

Approval process

Market segments

Investor base

Capital treatment

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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

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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.

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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.

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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).

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Technical Issues

Legal Regulatory Taxation Accounting Credit information and guarantees Market infrastructure Pricing and interest rate

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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)

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Accounting framework

Standards for accounting treatment of ABS are needed.

Need appropriate accounting standards for on- and off-balance sheet treatment.

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Technical Issues

Legal Regulatory Taxation Accounting Credit information and guarantees Market infrastructure Pricing and interest rate

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Credit Information System

Information quality: Accounting and disclosure

Loan classification and provisioning

Credit information bureau system

Internal credit management systems

Rating agencies

Credit guarantees

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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.

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Credit information bureau

Credit information bureau system is more than useful for creditors.

Do you have one in your country?

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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)

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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.

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Technical Issues

Legal Regulatory Taxation Accounting Credit information and guarantees Market infrastructure Pricing and interest rate

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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.

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Technical Issues

Legal Regulatory Taxation Accounting Credit information and guarantees Market infrastructure Pricing and interest rate

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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.

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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

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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.

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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.

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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