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More on securitisation in Hong Kong
State of the Market:
Updated on July 22, 2009 (by Nidhi Bothra)
From the first securitization issuance in 1994 by Bank of America to the securitization of future toll receivables in 2004 by the government the Hong Kong, securitization market in Hong Kong has come a long way. Unlike many of the civil law jurisdictions in Asia (eg, Korea, Japan and Taiwan), Hong Kong did not have to introduce specific legislation to facilitate securitization. The legal system in Hong Kong remains a system which is largely based upon English law.
Though the regulatory regime of Hong Kong is such that a variety of assets may be securitized but the cornerstone of Hong Kong markets remains to be residential mortgage backed deals. Hong Kong Mortgage Corporation (HKMC) has had a great role to play in the development of the housing market and secondary mortgage market in Hong Kong. The The Bauhinia program, launched by HKMC was Hong Kong’s first $3 billion multi-currency series segregated mortgage-backed securities program, which was launched in December 2001. This was the largest-ever Hong Kong dollar-denominated residential mortgage security.
Parallel streams of true sale and synthetic securitization were well accepted. The first securitization bond offering by the government available to retail investors took place in 2004. The Government launched the sale of $6 billion in bonds, based on revenues from government-owned tunnels and bridges. The net proceeds of this securitisation were to flow into the Capital Works Reserve Fund to help finance infrastructure projects. The deal received AA-, Aa3 and AA+ from Standard & Poor’s, Moody’s and Fitch respectively. They were the first securitization bonds to be listed on the Hong Kong stock exchange and the first securitisation of Hong Kong-based toll roads.
The overall activities in the credit derivatives and securitization market grew in 2007. The annual survey of HKMA showed that there was an increase of 61% and 103% growth in the market activity of credit derivatives and securitization respectively. Residential mortgage loans continued to be the most popular underlying assets in the securitization transactions. A large number of synthetic transactions were undertaken in the year 2007 as their share grew from 22% in 2005 of all the securitization transactions to 61% in 2007. The aggregate of gross notional amount of credit derivatives increased manifold from HK$ 794 billion in 2005 to HK$2736 billion in 2007. Of these credit derivatives transactions credit default swaps continued to be the most popular products traded in, accounting for 95% of the gross positions by the end of 2007. In terms of the tenor of the contracts entered into, medium term maturity contracts having a maturity of 1 to 5 years were dominant accounting for 72% of the gross positions. Legislation introducing Basel II as it applies to Hong Kong banks came into effect on January 1 2007.
Assignment of receivables:
Under Section 9 of the Law Amendment and Reform (Consolidation) Ordinance there is no need for equitable assignments to be in writing unless they relate to land (Section 5(1) of the Conveyancing and Property Ordinance). There are disadvantages in having an equitable rather than a legal assignment. For example, the purchaser of the debt has no right to take any action to enforce the debt against the debtor. The only person entitled to do so is the seller of the assets; therefore, the SPV will need to join the originator as a party to any legal action against the obligor. In addition, the originator and the obligor may amend the terms and conditions of the receivables without the involvement of the SPV and the obligor can obtain a good discharge from the obligations from the originator. Most securitisations that use an equitable assignment of assets require representations and warranties from the originator to the effect that it will not undertake these activities in relation to the receivables without consent.
There is no withholding tax on interest payments in Hong Kong and Hong Kong does not tax capital gains. Furthermore, there is no value added tax or goods and services tax in Hong Kong. To ensure the tax neutrality of a Hong Kong-incorporated SPV, it is important to ensure that its profit matches its allowable deductions.
In Hong Kong, stamp duty is payable on transfers of interests in land, including the transfer of mortgages (although the collector of stamps has been willing to adjudicate that a mortgage transfer is not subject to stamp duty). The rates are sliding rates up to 3.75 per cent for prices paid for the property in excess of HK$6.72 million. Otherwise, stamp duty is chargeable only on certain transfers of stock.
Once termed as the most securitisation friendly jurisdiction there have been low levels of securitization activity in Hong Kong both before and after the onset of the current credit and liquidity turmoil. Unlike some other Asian jurisdictions which have still managed to bring new issues to the market in recent months, Hong Kong has remained dormant with no reported new issues in 2007 (Global Securitisation and Structured Finance Report 2008).
The task force on Unregulated Financial Markets and Products (TFUMP) was established by IOSCO’s technical committee in November 2008, to introduce greater transparency and oversight to unregulated markets. The objective was to recommend regulatory action and to restore confidence in currently unregulated financial markets – Hong Kong (SFC) is a member country taking the initiative forth.
Another positive aspect of the Hong Kong market generally is that investors are not turning their back on alternative asset classes. Hong Kong continues to be one of the most developed markets for structured products, many of which are sold to retail investors. This strong investor appetite, coupled with the government's support of the financial services industry, has led to volume growth and product sophistication in the non-asset backed space. This is reassuring for ABS originators and arrangers and will hopefully provide some incentive for them to return to the market in the near future.
Late-breaking additions: 11 July, 2000
This page was comprehensively revised.
State of the Market:
During the heydays of Asian boom, Hong Kong led economic activity in the region. Obviously, therefore, Hong Kong is the center for securitization activity in Asia. A document of the Fitch IBCA estimates that in 1999, Hong Kong will contribute approximately 60% of all securitisation volume in Asia.
As one of the earliest instances of Asian securitization, securitisation in Hong Kong began in 1994 with the residential mortgage securitization for Bank of America. This was followed rapidly by other residential mortgage deals for Citibank, Cheung Kong and Standard Chartered Bank as well as a credit card transaction for Chase.
As the number of transactions in Hong Kong has increased, rating agencies, monoline insurers and investors have become increasingly comfortable with Hong Kong. In particular, the main concerns on mortgage securitization such as assignability, stamp duty and the requirements of the Land Registry have been thought through on a number of occasions and closing such deals has become a relatively well-trodden path. The return to China of Hong Kong in July of last year seems to have made little difference, and during the second half of last year a large number of residential mortgage transactions was being documented, some of which closed prior to the currency problems.
One of the important developments in mortgage securitisation in Hong Kong is the development of the Hong Kong Mortgage Corporation (HKMC) (set up in March 1997), which is the equivalent of Fannie Mae, which has recently (Nov. 1997) begun to acquire its first pools of residential mortgages. The portfolio of mortgages held by the Corporation was HK$11.39 billion as of December 1998. However, the potential for securitisation of mortgage funding in Hong Kong can be judged by the fact that this amount represents only 2.48% of the outstanding mortgage loans in Hong Kong.
HKMC has already begun its operations. In October 1999, HKMC listed seven already issued MBSs and a new bond-issuing program of HK$20 billion on the Hong Kong Stock Exchange to enhance the liquidity of MBSs. The MBS market will grow in Hong Kong as Hong Kong banks’ mortgage loans stand at about 30% of total exposure on average – securitization can be used to bring down the exposure already being objected to by bank regulators, particularly after the 1997 crisis.
Outside of HKMC too, securitization activity is increasing. In August 1999, a large-scale Commercial Mortgage Backed Securities (CMBS) issue was issued using a commercial mortgage held by Wharf Holdings.
Legal initiatives to promote securitisation:
Hong Kong is probably the most securitization-friendly jurisdiction in Asia. The legal system is based in general terms on English Law (with familiar concepts, eg, equitable/legal assignment)
What is equitable assignment?
making it quite straight-forward to structure "true sale" transactions from a legal, regulatory and accounting perspective. The legal framework, in particular bankruptcy law, is well developed, with a mixture of legislation and case law. Most securitisation transactions in Hong Kong follow the "equitable assignment" route, without giving a notice to the obligors. Registration of equitable assignments is not insisted upon. However, transfer of mortgages would require registration with the Land Registry offices.
The regulatory environment is sophisticated, with a set of guidelines for regulatory off-balance sheet treatment for regulated institutions. These guidelines, issued by the Hong Kong Monetary Authority in 1995, revised in 1997, largely follow the Bank of England model. These guidelines put in certain conditions subject to which a securitisation can give a capital relief to the originator bank. Some of the prominent conditions are : (a) transfer of the receivables to an unrelated party; (b) no right or obligation to buyback; (c) no recourse. The provision of credit enhancement by buying subordinated debt of the SPV would be directly deducted from the capital of the bank being a direct credit substitute.
Taxation of securitisation:
Unlike virtually in every other Asian country, in Hong Kong there is no withholding tax on interest payments to a non-resident, making the securitization off-shore of interest-bearing receivables much simpler.
Stamp duties, generally a major irritant for securitisation transactions, is not applicable on equitable assignments. However, transfer of mortgages would be treated as transfer of interests in land, and would attract duty @ 2.75%.
A typicality of Hong Kong's Income -tax law (Inland Revenue Ordinance) is that the obligors whose payables have been securitised may not be able to claim a deduction for the interest being paid by them unless the interest qualifies under sec. 16 (2) of the Ordinance. One of the alternative conditions in the Ordinance is that the recipient of such interest should be liable to tax in Hong Kong. Thus, the SPV, even if it is incorporated in an off-shore location, would have to come forth for taxation in Hong Kong. This leads to a necessary double taxation on the residuary income of the originator, since the SPV being taxed in Hong Kong can only claim a deduction for the interest being paid by it.
Hong Kong does not have any Value-added tax.