Standard & Poor’s partner Taiwan Ratings Corp on Wednesday reported that following a spike in issuance globally there has been a surge in local market interest in covered bonds in Taiwan, but that several obstacles mean that development of a Taiwanese market could take some time.

The rating agency noted that as of June 2012 some $3tr of covered bonds were outstanding globally, with covered bonds having become one of the preferred alternative sources of funding for issuers and investors amid global financial market instability.

Bank of Taiwan

“This product has gradually gained acceptance in major banking systems partly because it can help to reduce issuers’ reliance on traditional senior unsecured debt, which at some times of financial stress could provide another liquidity source for banks,” said Taiwan Ratings’ analysts. “And it’s for the same reason that we believe covered bonds are gaining attention in Taiwan’s rapidly developing financial market.”

The interest in covered bonds mirrors that elsewhere in the Asia-Pacific region, which the rating agency noted had driven the emergence of legislation, with Australia having rolled out a covered bond law, New Zealand having draft legislation before parliament, and Singapore and South Korea considering formal frameworks.

However, Taiwan Ratings said that in spite of the perceived benefits of covered bonds, several obstacles have so far prevented their issuance in Taiwan. A main hurdle has been the lack of a supportive legislative framework, which the rating agency said would make it difficult to assess risks in covered bonds.

This could be exacerbated by low issuance volumes, with Taiwan Ratings saying that rare repeat issuance could complicate risk analysis and prolong origination processes.

“Taiwan’s capital market is smaller and less well established than markets in Europe or the US,” it said. “In addition, the local capital market has historically been slow to accept new financial products, and there have been rare instances where a specific deal structure has been reused in structured finance products or other new financial instruments in Taiwan.

“These factors hinder the development of a consistent issuance framework, reliable market practices, and standardised documentation for new capital market products in Taiwan.”

A connected problem identified by Taiwan Ratings is the possibility that incentives for Taiwanese banks to issue may be low.

“Taiwanese banks generally have large deposit bases to support their funding needs, and their reliance on wholesale funding is low, unlike their peers in Australia, New Zealand, and Korea,” it said. “The prevailing low interest rates in Taiwan have enabled most local banks to obtain cheap funding sources, which reduces their incentive for alternative funding instruments such as covered bonds.

“Moreover, low interest rates may lead to concerns over cashflow adequacy and the pool evolution of covered bonds because low-yield-generating assets might be unable to absorb the covered bonds’ interest or other payment burdens.”