The South Korean financial regulator today (Tuesday) introduced a draft covered bond law it intends to submit for parliamentary approval by December, with issuer eligibility criteria, minimum OC, and an issuance cap among features of the bill.

Financial Services Commission offices, Seoul

The bill for a Covered Bonds Act is intended to be submitted for parliamentary approval by December, following a 40 day notice period finishing on 3 December and a review by the ministry for government legislation.

According to an English language press release from the Financial Services Commission (FSC), eligible issuers will comprise banks, Korea Housing Finance Corporation (KHFC), Korea Finance Corporation (KFC), and other “equivalent” institutions as designated by a presidential decree. Financial institutions must have equity capital of more than Kwn100bn (Eu69.5m/US$90.6m) and a BIS capital ratio of more than 10%, “capable of ensuring proper funding, operation and risk management”.

Three types of assets can serve as collateral, according to the commission’s statement: cover assets, liquid assets, and other assets. Cover assets are defined as mortgage loans and government and public sector debt, liquid assets as cash and certificates of deposit issued by other banks with a maturity less than 100 days, and other assets include recovery from cover assets and derivative contracts for hedging against currency and interest rate risks.

A minimum overcollateralisation level of (more than) 105% is specified.

Issuers will be required to register issuance plans and cover pool details with the FSC.

The English language press release is not clear about the level at which covered bond issuance will be capped.

“The issuer who completed registration may issue covered bonds with a ceiling set by Presidential Decree (tentatively 4%) within the range of 8% of the issuer’s total assets at the end of previous fiscal year,” said the commission.

Korean media reports have variously cited a 4% cap and an 8% cap, suggesting the original Korean documentation could also be ambiguous.

[UPDATE] According to one market participant the draft law sets an 8% cap based on total assets as at the end of the last fiscal year. A 4% limit was included in best practice guidelines issued in the summer of 2011, as a proportion of total liabilities. [UPDATE ENDS]

The stipulation of an issuance ceiling continues a trend among jurisdictions that have recently turned to covered bonds, with Australia and Belgium including limits in their legislative frameworks and New Zealand, which is in the process of legislating on covered bonds, also capping issuance.

Korea’s covered bond bill also addresses management of the cover pool, according to the FSC’s press release, which states that the issuer should manage the cover pool separately from other assets and “keep a separate balance sheet”.

“The issuer should maintain a collateral ratio and eligibility of a cover pool by adding and replacing assets and select an auditor to ensure independent audit and supervision of a cover pool,” it added.

Issuers should establish a risk management system related to the issuance and repayment of covered bonds, and disclose the value of the cover pool at least once every financial quarter and disclose the results on its website.

The FSC will have the power to require issuers to submit covered bond-related materials, conduct investigations and order corrective measures.

The bill, at least as described via headline “key contents” in the FSC’s press release, does not appear to depart in any significant way from best practice guidelines released last summer. Loan-to-value limits are not referred to in the commission’s press release from today, although reports in Korean media suggest that these were included in the commission’s original statement with a 70% limit for mortgages.

The move to legislation comes after the Korean financial regulator felt the best practice guidelines were insufficient to kick-start a covered bond market. It today said that since the global financial crisis there has been a growing need for legislative frameworks on covered bonds to ensure financial markets’ stability and provide financial institutions with a stable funding channel.