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Asia-PacificFebruary 5 2007

Securitisation makes headway

With the relevance of developing a securitisation market in China unclear and demand in doubt, a second batch of pilots is nevertheless in the offing. Samantha Lafferty reports.
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When China Development Bank and China Construction Bank won approval to securitise assets in 2005, it was mooted as the regulatory strike that would ignite the market in China. Then, for almost a year, everything went quiet and the experiment was dismissed as little more than a flag-flying exercise. Now, Chinese regulators are in the throes of giving the nod to as many as 10 domestic banks and asset management companies.

After several false starts, industry experts are confident that this next batch of trials will be the catalyst for a genuine securitisation market in the world’s fastest-growing economy. “It is highly likely that this could lead to something real,” says Larry Lee, managing director and head of Fitch Ratings China. “The second pilot will open the door to big issuance going forward and a viable securitisation market in China.”

Fitch Ratings expects China to rapidly become the fourth-largest market for securitisation in the region behind Australia, Japan and Korea. Standard Chartered forecasts that as much as $5bn of transactions will be approved in the first quarter of 2007. Already, the People’s Bank of China and the China Banking Regulatory Commission, the two organisations that regulate securitisations by financial institutions, have sanctioned China Cinda Asset Management’s plan to off-load Rmb4.75bn ($608.6m) of bad loans it acquired from Bank of China in an asset-backed securitisation.

Other corporations tipped to be favoured by the regulators include Orient Asset Management, one of Cinda’s peers, China Development Bank, Pudong Development Bank, China CITIC Bank, China Merchant Bank, China Construction Bank, Agricultural Bank of China, which specialises in loans to the agricultural industry, and the Industrial and Commercial Bank of China, which makes working capital loans to the industrial and commercial sectors, according to people familiar with the matter.

Asian markets

The securitisation market across Asia tells a mixed story. The economic crisis in Asia halted securitisations in Thailand and Indonesia until 2002. The market in South Korea rapidly grew into the largest for securitisation in ex-Japan Asia after its law was passed in 1998. This was buoyed by the rampant growth of its consumer finance industry until that market was knocked off course by the credit card crisis in 2003, which halved issuance the following year. Mortgage-backed securities replaced credit card issuance as the mainstay of Korea’s securitisation market but even that has brought its problems, with transactions down by a fifth in the first half of 2006.

The Korean cross-border market was worth $4bn in 2005, while the domestic market was valued at more than six times that figure. Like Korea, the vibrant securitisation markets in Taiwan and India are driven by domestic, rather than cross-border, transactions.

China may also opt for a thriving domestic market, according to Adrienne Showering, a partner specialising in securitisation at law firm Mallesons Stephen Jaques. “The Chinese have been watching other territories,” she says. “In Taiwan and Korea, there is not a lot of cross-border securitisation. China could go like Taiwan. Once they know how to securitise, they may do in-country securitisation rather than cross-border.”

Search for relevance

Before any kind of viable securitisation market develops in China, the banks and regulators must address several issues, not least the reason for wanting to develop the market. “The Chinese market is in its infancy,” says William Ross, head of asset-backed securities and structured bonds for Asia Pacific at HSBC based in Hong Kong. “We have established a basic infrastructure for execution. We have got a domestic investor base that is starting to develop. What is less clear is the relevance of the product.”

One certainty is that Chinese banks have a mountain of bad loans on their books, even after restructuring efforts to reduce them, which included setting up four asset management companies focused on dealing with the loans of the big four commercial banks. The China Banking Regulatory Commission has in the past called the reduction of non-performing loans (NPLs) its “major challenge”. By securitising the NPLs, the banks will improve their capital adequacy ratios.

Demand in doubt

Chinese banks also have plenty of liquidity, something that may limit the demand for securitisation, as it did in Hong Kong until 2004 when the government toll road, the Hong Kong Link, was securitised. “The Chinese banks are awash with liquidity so it is difficult to see anytime soon when they will securitise in a big way for funding,” says HSBC’s Mr Ross.

“Given the depth of their alternatives, it is difficult for them to justify the cost of securitisation solely as a funding tool. Instead, foreign financiers will be the drivers for the market because they need securitisation. They rely on it in their home markets and they do not have access to the huge deposits of the banks in China,” he says.

Other bankers are more optimistic. Lesi Zuo, head of asset-backed securitisation in north-east Asia at Standard Chartered, says he expects more demand for securitisation in China as banks and other companies look for options to improve capital adequacy ratios, manage assets and liabilities better and explore alternative sources of funding. It will help banks to stave off overseas rivals once the country opens the doors to competition as part of its commitment to the World Trade Organisation (WTO), he says.

“The regulator wants to improve the product provision of banks before they open the doors to competition,” says Mr Zuo. “The regulator is thinking how to make better use of these products.”

Consumer finance boost

A secondary driver for China to have a thriving securitisation market is the boost it would give to the consumer finance industry. If investors are willing to pick up the securitised loan portfolios, banks may be more aggressive in their development of consumer finance. This hinges on a shift in China’s economy to more closely resemble that of the US, with consumer spending becoming the major component.

However, Mr Ross says that the common perception of China is wrong. “The world sees China as a nation of 1.3 billion consumers,” he says in an interview at his office in Hong Kong. “The Chinese see themselves as a nation of 1.3 billion producers.”

In a culture that preaches financial prudence rather than extravagance, Chinese citizens have traditionally been unwilling to pay for their consumption through borrowing. Private savings in China amount to about $1200bn, the equivalent of the country’s annual gross domestic product. To some extent, there is already a swing towards borrowing among the country’s younger population, but perhaps not enough for the country to build a credible consumer finance industry.

There is also a lack of appetite for developing such an industry on the part of the banks, which already have high volumes of non-performing loans (NPLs) on their books. They are rightfully deterred by the poor state of the country’s credit rating and evaluation systems.

While some bankers are cautious about the demand for securitisation in China, there is less debate about the process being slow and often difficult. Standard Chartered’s Mr Zuo, who advised China Construction Bank on its Rmb3bn residential mortgage-backed securitisation transaction in 2005, warns that the practice of bringing a securitisation transaction to the market in China can be lengthy.

Branch inconsistencies

Standard Chartered was hired as a financial adviser to China Construction Bank at the beginning of 2004. At that time, there was no regulatory framework in place, which gave Mr Zuo scope to advise the regulators about international market standards for such deals. One of the problems he encountered was the huge number of branches China Construction Bank had – more than 14,000 – which were run without proper centralised systems. When he came to securitise the loans, he found inconsistencies in the way data was interpreted at individual branches, he says.

“In China, securitisation is a big issue. It is not just about holding their hands through the process, but also about sorting out the internal systems. That is something pretty challenging,” says Mr Zuo.

Another hindrance is investor education. Chinese investors are less sophisticated than those in countries such as the US. Mr Ross says it is unrealistic to expect significant investor knowledge and rapid growth of an investor base for securitisation in China. He cites the example of the UK securitisation market, which took from 1985 to 1998 to develop. Other bankers echo this concern.

“We still feel that investors do not understand everything,” Mr Zuo says. “Investors do not spend time looking at the transaction themselves. They see that the government is involved and when it goes wrong they jump on the government. That is why the government is very cautious about pushing the market forward. The China Construction Bank deal closed last year and yet people still call to ask how it works. This could be very dangerous.”

Regulatory hurdle

The biggest problem for the securitisation market in China is that no specific regulations are in place. Instead, pilots are authorised on an individual basis under trust laws. The second round of experiments is widely expected to lead to consistent laws. There has already been a vast improvement in regulation in the country since China joined the WTO, according to lawyers.

“Securitisation needs strong and effective bankruptcy laws and things have been promulgated but the rules have not been tested,” says Ms Showering.

Until specific securitisation laws are in place, the market will not get off the ground and foreign investors are unlikely to be attracted. There is a need for moves beyond individual applications and pilot schemes for every securitisation so that banks can securitise assets when they need to. Bankers will be watching how quickly rules are devised once the latest pilot schemes are complete.

The consensus is that there will be a two-speed market. “For local players, it can happen very fast. For foreign players it will be a longer process. Alter this second pilot scheme, it may be opened to all local banks, but foreign players will only be allowed in late,” says Mr Zuo.

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