Covered bond guidelines issued by South Korea’s financial regulators are credit positive and provide the country’s issuers with a “roadmap” to navigate, while also benefitting investors by reducing uncertainties about the consequences of an issuer bankruptcy and establishing disclosure requirements, a Moody’s analyst said in a report released today (Tuesday).

South Korea’s Financial Services Commission (FSC) and Financial Supervisory Service (FSS) on 30 June issued best practice guidelines that the regulators described as intended to provide a framework for covered bond issuance to help diversify banks’ financing instruments and encourage more long term and fixed rate mortgage lending.

FSC chairman Kim Seok Dong in a parliamentary audit session on 10 October said that the commission will consider establishing covered bond legislation to allow South Korean banks to issue the debt. The comment was made in response to a question from a member of parliament.

According to FSC spokesperson Ernst Lee, the commission will review the necessity for Korean banks to issue covered bonds, and will look at making improvements to covered bond guidelines issued at the end of June.

“FSC is studying cases of other countries for covered bond issuance and will try to synchronise with market demands in terms of timing,” he told The Covered Bond Report.

In the absence of a covered bond framework only one Korean bank has issued a covered bond on standalone basis – Kookmin Bank, under Korea’s ABS Act – although Woori Bank recently awarded Royal Bank of Scotland the mandate to arrange a covered bond programme. Korea Housing Finance Corporation (KHFC) has issued covered bonds, but this is under an act governing the institution and the bond is backed by pooled collateral from its member banks.

“Korea is a heavily regulated civil law country and issuers are cautious to obtain regulatory blessing before issuing a new instrument in the market,” said Jerome Cheng, vice president, senior credit officer at Moody’s. “Although Korean banks recognize the merits of issuing covered bonds and are interested in issuing them, it is not surprising that before the regulator published the guidelines, they have taken a wait-and-see approach.”

He described the publication of the guidelines as providing issuers with a roadmap.

“This roadmap includes various checkpoints including the eligibility criteria of the issuers, the main issuance terms and requirements of covered bonds, the types of covered pool assets, and the operational and administration aspects of the covered bonds,” he said.

No concept of eligible issuing entities existed before the June guidelines, according to Moody’s, with eligible issuers under the guidelines including Korea Development Bank, Export-Import Bank of Korea, Industrial Bank of Korea, banks with paid-in capital over Won25m (Eu15,900) and a BIS ratio over 10% as of the last fiscal year, and securitisation entities set up by such banks.

Cheng said that the guidelines provide clarity on dual recourse, and that they clarified that investors will have a pari passu senior unsecured claim against the issuer’s bankruptcy estate for the remaining outstanding amount.

“Prior to the announcement of the guidelines, covered bonds could be issued in various structures under the current Korean legal framework,” said Cheng. “Although these structures should give investors similar legal protection, investors are still concerned about the ring-fencing of the covered pool from the bankruptcy estate of the issuer and the right of recourse against the issuer on the unpaid amount.”

Restrictions on the type of assets that are eligible as collateral – cash, first priority prime residential mortgage loans meeting certain criteria, and MBS issued by KHFC – are credit positive, and a minimum 5% overcollateralisation provides “minimum protection to the investors”, he said.

He identified as another credit positive feature the process by which an issuer has to evaluate the satisfaction of the asset eligibility and overcollateralisation requirements and provide the evaluation results for the covered bond administrator to review at each month-end or quarter-end.

The appointment of third party transaction parties improves the monitoring of assets, he said, noting that the “most crucial” task of managing the covered assets and the cashflows from the covered assets upon a bankruptcy of the issuer will be carried out by an administrator, whose role is clarified by the guidelines.

Pre-closing information on Korean covered bonds is made available on the basis of regulatory filing requirements, according to Cheng, with the guidelines also setting a minimum standard for the disclosure of information on a post-closing basis.

“[This] is positive for investors because it increases transparency and thus enhances protection to investors,” he said.

The guidelines provide that:

- the issuer shall disclose the aggregate covered bonds outstanding amount and the face amount (or fair market value) of the covered pool on a quarterly basis

- the administrator shall disclose its review result on issuer’s evaluation of the asset eligibility and the overcollateralisation ratio at month-end or quarter-end

- the asset monitor shall disclose its asset eligibility review result at month-end or quarter-end