South Korea has become the first Asian country to have dedicated covered bond legislation after the country’s parliament passed the relevant law in mid-December, with Fitch expecting issuance soon after it comes into force in March.

Korean National Assembly

The Act on Issuance of Covered Bonds was passed in a plenary session of the National Assembly on 19 December 2013, just over 11 months after the draft legislation was approved by South Korea’s cabinet. It is due to come into force three months after promulgation, with Fitch putting the effective date in March.

“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,” said the rating agency shortly after the law was passed in parliament.

The financial regulator in Singapore released covered bond issuance guidelines on Tuesday, and said that it will review the case for legislation at a later date. (See separate story.)

The South Korean law has not changed much from the framework that was proposed in early 2013, according to Fitch, which said that the provisions in the act are largely similar to those in other jurisdictions.

The minimum level of overcollateralisation (OC) under the law is 105%, and issuance is limited to 8% of an issuer’s total assets, noted the rating agency. It estimates that up to $111bn (Krw117tr, Eu80.87bn) of covered bonds could be issued under the act, based on the assets of the main Korean banks.

The covered bond legislation is partly intended to reduce Korean households’ exposure to interest rate shocks by facilitating longer term, fixed rate mortgage lending, added Fitch, but it also allows for municipal bonds, mortgage bonds or shipping and aircraft loans to serve as collateral in addition to residential mortgages. Liquid assets used as substitution assets are limited to 10% of the cover pool.

Fitch noted that the legislation does not outline any mechanism to minimise liquidity risk for investors and bridge maturity mismatches between the cover pool and the covered bonds.

The rating agency expects issuance under the Act soon after it comes into force in March.

Korean covered bond issuance has already taken place, but has been limited to one deal from Kookmin Bank, backed by mortgages and credit card receivables and issued on a contractual basis, and pooled issuance via Korea Housing Finance Corporation (KHFC), which issues under legislation specific to the institution. The Financial Services Commission also issued guidelines for covered bond issuance in June 2011.

Fitch said it expects banks that issue covered bonds under the act to also continue to utilise funding through KHFC because the choice “will give the banks a way of further diversifying their funding strategy”.

“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,” it added.