South Korea passes Covered Bonds Act
Covered Bonds Legislation in South Korea
January 1, 2014
South Korea passed its Korean Covered Bonds Act to reduce Korean households' exposure to interest rate shocks by facilitating longer-term, fixed-rate mortgage lending. It is the first Asian country to have dedicated covered bond legislation. This is seen as a positive development for the wider Asia-Pacific covered bond market and the market can expect issuance under the Act to occur soon after it comes into force in March 2014. Banks that issue covered bonds under the Act will also continue to utilise funding through Korean Housing Finance Corporation (KHFC). This choice is expected to give the banks a way of further diversifying their funding strategy.
The framework of the legislation provides definitions of 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 framework also allows for a range of assets to be used as collateral for covered bonds, such as residential mortgages, municipal bonds, mortgage bonds or shipping and aircraft loans.
The minimum level of collateralization 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. Unlike assets that secure the 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 required to be ring-fenced, for the benefit of investors, from the claims of the issuer's other creditors in the event of issuer insolvency. The Act however does not outline any mechanism to minimise liquidity risk for investors and bridge maturity mismatches between the cover pool and the covered bonds.