The FINANCIAL -- The passing of the Korean Covered Bonds Act makes South Korea the first Asian country to have dedicated covered bond legislation, which Fitch Ratings considers as a positive development for the wider Asia-Pacific covered bond market. Fitch Ratings, Inc. expects issuance under the Act to occur soon after it comes into force in March 2014.
The Act is little changed from the framework proposed in February 2013. It defines eligible issuers, the segregation of the covered assets post-insolvency of the issuer, eligible assets, the appointment of an independent monitor, and regulatory reporting requirements. The provisions in the Act are largely similar to those in other jurisdictions.
The Act is partly intended to reduce Korean households' exposure to interest rate shocks by facilitating longer-term, fixed rate mortgage lending. But it also allows for a range of assets to be used as collateral for covered bonds. As well as residential mortgages, collateral can be municipal bonds, mortgage bonds or shipping and aircraft loans. The minimum level of collateralisation is set at 105% and covered bond issuance is limited to 8% of the issuer's total assets. Liquid assets used as substitution assets are also limited to 10% of the cover pool, according to Fitch Ratings, Inc.
Fitch estimates that up to around USD111bn of covered bonds could theoretically be issued under the Act, based on the assets of the main Korean banks. For comparison, Australia's covered bond law caps issuance by limiting the value of assets in cover pools to a maximum of 8% of total Australian assets on the issuing bank's balance sheets. In New Zealand the figure is 10% of total assets, according to Fitch Ratings, Inc.
Unlike assets that secure the Korean Housing Finance Corporation (KHFC) issuance, which are taken off the originating bank's balance sheet, cover assets will remain on the issuer's balance sheet and will be recorded in a register. The cover assets are intended to be ring-fenced, for the benefit of covered bond investors, from the claims of the issuer's other creditors in the event of issuer insolvency.
Fitch will need to fully assess the strength of the asset segregation in detail to determine whether the cover assets and their cashflows are safe from commingling, claw back, set-off and other claims from secured creditors.
The Act does not outline any mechanism to minimise liquidity risk for investors and bridge maturity mismatches between the cover pool and the covered bonds. While Fitch has not fully assessed the feasibility and liquidity of large mortgage portfolio refinancing in South Korea, the agency takes a positive view of the fact that KHFC is already used as a refinancing platform.
Fitch expects banks that issue covered bonds under the Act will also continue to utilise funding through KHFC. This choice will give the banks a way of further diversifying their funding strategy, according to Fitch Ratings, Inc.