0. Fostering Asian Bond Markets using Securitization and Credit Guarantee Presented by Doo Yong Yang (KIEP)
This presentation is based on the Korean Proposal for ABMI by Gyutaeg Oh (Korea Fixed Income Research Institute) and Jae-Ha Park (Korea Institute of Finance)

1. Contents
Background
Development of the Asian Bond Market
Our Initiative
Proposals for Recycling
Comparison with Other Initiatives

2. Background

3. Reasons for Developing Asian Bond Markets
Prevention of Crisis
Recent Pattern of Capital Flows in Asia
Huge current account surplus => From capital importer to exporter
Rapid increase in foreign reserves($1.2 trillion)
Import safe assets and export risky assets
=> Asia’s savings are NOT being recycled into Asia`
Asian Crisis
BANK-Dependent
Financial Structure
Double Mismatch Problem
(Maturity + Currency)
Risks of
Financial Crisis
Foreign borrowing
without hedge

8. Impediment to recycling: Double Mismatch
Maturity and Credit Quality Gap
Asian
Issuers
Asian
Savings
Asian
Bond
Markets
Long-Term
Low Credit
Quality
Short-Term
High Credit Quality

9. Currency Mismatch Problem
Foreign currency swap markets are not well developed in Asia
Asian
Issuers
Savings in
Capital
Abundant
Countries
Asian Bond
Markets
Currency risk
Country risk
Issue bonds denominated in local currency

10. Benefits of Recycling Asian Savings into the region: An Example
Country I
SMEs
Capital-Abundant Countries in Asia
Capital Market or
Financial
Intermediation
in Asia
Country II
SMEs
Portfolio
Investment
Country III
SMEs
Diversification
More Choices
Better Return/Risk
Economic Development
Crisis Prevention

11. Development of Asian Bond Market Initiative

12. Works on Process
November 2002 : ASEAN +3 Finance and Central Bank Deputies’ Meeting (AFDM+3)
February 2003: AFDM+3
Korea made a proposal for fostering bond market in Asia by using securitization and Credit enhancement
Thailand proposed creating securitized debt instruments and establishment of an Asian Credit Guarantee Facility
Singapore proposed establishment of an Asian Credit Rating Board
Two working groups
New Schemes of Securitized Debt Instruments (Thailand)
Regional Credit Guarantee Facilities (Korea)

13. Works on Process Three Additional Working Group
Settlement Systems and Foreign Exchange Regulation (Malaysia)
Promoting the Issuance of Bonds Denominated in Local Currency (China)
Establishment of Regional Rating Agency (Singapore and Japan
Other Fora
APEC Regional Bond Market Initiative
Executives’ Meeting of East Asia Pacific Central Banks (EMEAP) Asian Bond Fund

14. Our Initiative

15. Objectives
Establish a process that facilitates Asian savings to be smoothly invested back in the region
Mobilize savings from capital-abundant countries to
• Promote financing of both SME and government of
developing countries
• Facilitate NPL resolution and infrastructure financing in
the region

16. Focus of our Initiative
Asian Bond Market Initiatives proposed by various countries and forums are aimed at three objectives:
(1) Develop local bond markets
(2) Facilitate recycling of Asian savings within the region
(3) Develop regional bond market
Our Initiative focuses on the recycling issue and calls for international cooperation because
• development of domestic bond market has been
studied by many countries.
• developing regional bond market takes too long

17. Characteristics
Active use of securitization and credit guarantee to mitigate credit quality gap
• In Asia, credit and currency risks are the most important
factors impeding smooth recycling of savings
Securitization coupled with credit enhancement is a good solution to address this problem
• Can issue higher-credit securities than collateralized
assets enough to be accepted by investors
• SMEs can finance funds in the bond market

18. Characteristics
Risk should be assumed by key players who have keen interest in recycling issues (or through international cooperation in the region)
Emphasis on local currency-denominated financing to mitigate the currency risks assumed by issuers
• Asian bond markets denominated in USD are small in
size and not well developed in Asia
However, our Initiative can be directly applied for convertible currency denominated financing also
Korea’s experience exemplifies these points

19. (2yr 8.5billion, 3yr 36billion)
Korea’s experience in SME Financing using CBO Scheme
23 SMEs
Corporate bond (72billion won)
Small Business
Asset sales
SPC
Credit Enhancement
by Housing Bank
(10billion)
Senior bond
(2yr 8.5billion, 3yr 36billion)
Subordinate bond
(27.5 billion)
Sold to investors in the market
Repurchased by originator,
i.e. Small Business

20. Proposals for Recycling

21. Countries participate on a voluntary basis
Proposal 1 : SME Financing
Goal:
Promote SME financing of developing countries in local currencies by mobilizing savings from capital-abundant countries
Means:
Adopt securitization with proper risk sharing and minimal moral hazard problems
Countries participate on a voluntary basis

22. Example 1-1: Scheme for Proposal 1
Issued in Local Currency
Issued in A currency
Country I
SME
Loans/
Bonds
Senior
SPC in
Country A
Senior
Junior
Junior
Country II
SME
Loan/
Bonds
Senior
Credit guarantee
Junior
Government
Agency (GA)
Country III
SME
Loan/
Bonds
Senior
Risk to Investors
Credit
Currency
Liquidity
Interest GA
basket
Yes
Junior

23. Capital importing countries
Major Points of Example 1-1
Two-Tier Securitization: one in developing countries and the other in capital-abundant countries
Capital importing countries
• Government FI/agency securitize SME loans/bonds
• Junior tranches: assumed by local institutions which
are in charge of selecting the firms included in the pool
=> minimize moral hazard problems
• Senior tranches: guaranteed by local credit guarantee
agencies; some are sold in the local bond markets, the
remainder transferred to capital abundant countries

24. Establish SPC in capital abundant countries
Major Points for Example 1-1 : continued
Establish SPC in capital abundant countries
• Underlying assets are senior tranches (denominated
in local currency) transferred from developing
countries
• Well-known government agencies (eg. KCGF, JBIC)
will guarantee the senior tranches issued in those
SPC will issue currency-basket-linked bonds (denominated in capital abundant country’s currency) and sell to the investors
 Currency risks are assumed by investors

25. Major Points for Example 1-1 : continued
Cooperation among institutions which assume junior tranches is critical for a successful implementation of this scheme

26. Example 1-2: Another Scheme for Proposal 1-1
Issued in Local Currency
Issued in A currency
Country I
SME
Loans/
Bonds
SWAP
Senior
SPC In
Country A
Senior
Junior
Junior
Country II
SME
Loans/
Bonds
SWAP
Senior
Credit guarantee/swap
Junior
Government
Agency (GA)
Country III
SME
Loans/
Bonds
SWAP
Senior
Risk to Investors
Credit
Currency
Liquidity
Interest GA NO
Yes
Junior

27. Investors do not assume currency risk
Major Points for Example 1-2
Investors do not assume currency risk
Currency risk is assumed by swap providers
GA in country A provides the SPC with currency swaps
Then GA hedges currency risk using back-to-back swaps with
• swap dealers when developing countries have
currency swap markets
• central banks of developing countries in case swap
markets are not available
Other points are the same as those of example 1-1

28. Adopt securitization with proper risk sharing
Proposal 2 : NPL Disposal and Infrastructure Financing
Goal:
Facilitate disposal of NPLs and infrastructure financing in the region by mobilizing saving from capital-abundant countries
Means:
Adopt securitization with proper risk sharing
Countries participate voluntarily

29. Example 2: NPL Disposal and Infrastructure Financing
Issued in Local Currency
Issued in A currency
Country I
NPLs or
Infra Loan
SWAP
Senior
SPC In
Country A
Senior
Junior
Junior
Country II
NPLs or
Infra Loan
SWAP
Senior
Credit guarantee/swap
Junior
Government
Agency (GA)
Country III
NPLs or
Infra Loan
SWAP
Senior
Risk to Investors
Credit
Currency
Liquidity
Interest GA NO
Yes
Junior

30. The two-tier securitization scheme is similar to that of SME financing
Major Points of Example 2
The two-tier securitization scheme is similar to that of SME financing
• Underlying assets are NPLs or infrastructure loans
Each country has different financial and legal systems
• Korea, Japan: Well established ABS law and ABS
market volume
• China: Trust law is set up
• Thailand, Malaysia,Philippines:
ABS law and market volume developing

31. Major Points of Example 2
Therefore, establishment and harmonization of legal, accounting, loan collection systems among participating countries is necessary for the first tier securitization

32. Adopt securitization with proper risk sharing
Proposal 3 : Government Financing
Goal:
Promote government (agency) financing of developing countries in local currencies by mobilizing saving from capital-abundant countries
Means:
Adopt securitization with proper risk sharing
Countries participate voluntarily

33. Example 3-1: Scheme for Proposal 3
Country I
GBs
SPC or Bond Fund
in Capital Abundant
Countries A
Issuing
Pass-Through securities
Institutional
Investors
in country A
Country II
GBs
Sold to
Country III
GBs
Risk to Investors
Country
Currency
Liquidity
Interest
Yes
basket

34. Establish SPC in capital-abundant countries
Major Points for Example 3-1
Establish SPC in capital-abundant countries
Underlying assets of the SPC are government bonds (denominated in local currency) issued in developing countries
SPC will issue currency-basket-linked pass-through securities (denominated in capital abundant country’s currency) sold to country A’s investors:both currency risks and country risks are taken by investors

35. Example 3-2: the other scheme for Proposal 3
Exchange-Traded Funds
Country I
GBs
SPC or
Bond Fund in
Capital
Abundant
Country A
Investors
(Retail/
Institutional)
Stock
Exchange
in Country A
Country II
GBs
Country III
GBs
Risk to Investors
Country
Currency
Liquidity
Interest
Yes
basket
Small

36. • Pass-through securities can be redeemed with underlying assets
Major Points for Example 3-2
The pass-through securities are listed on stock exchanges (Exchange-Traded Funds (ETFs))
• Pass-through securities can be redeemed with
underlying assets
The ETFs scheme improves liquidity
The ETFs scheme broadens investor base
Other points are the same as those of Example 3-1

37. Example 3-3: Another Scheme for Proposal 3
Currency Swap by
Gov’t Agency (GA)
Country I
GBs
Institutional
Investors
in country A
SPC or Bond Fund in
capital abundant
Country A
issuing
Pass-Through securities
Sold to
Country II
GBs
Country III
GBs
Risk to Investors
Country
Currency
Liquidity
Interest No
Yes

38. GA will provide currency swaps with the SPC
Major Points for Example 3-3
GA will provide currency swaps with the SPC
Investors assume neither currency risk nor country risk (but they assume GA credit risk)
If GA hedges currency risk using back-to-back swaps with central banks of developing countries,
then GA will assume country risk and central banks of developing countries will assume currency risks
Other points are the same as those of Example 3-1

39. Contribution is made on a voluntary basis
Proposal 4 : Establish Regional Credit Guarantee Facility
Goal:
Establish a multi-lateral agency (regional credit guarantee facilities) to develop Asian bond markets
Necessity:
Improve efficiency by creating an agency specializing in structuring securitization deals and providing credit guarantee and swap arrangements
Contribution is made on a voluntary basis

40. Example 4-1: Securitization with Regional Credit Guarantee Facilities
Issued in Local Currency
Issued in A currency
Country I
SME
Loans/
Bonds
SPC in
Country A
Senior
Senior
Junior
Junior
Country II
SME
Loans/
Bonds
Senior
Credit guarantee
Junior
Regional Credit
Guarantee Facilities
Country III
SME
Loans/
Bonds
Senior
Risk to Investors
Credit
Currency
Liquidity
Interest
AAA/AA
basket
medium
Yes
Junior

41. Example 4-2: Securitization with Regional Credit Guarantee Facilities
Issued in Local Currency
Issued in A currency
Country I
SME
Loans/
Bonds
SWAP
SPC in
Country A
Senior
Senior
Junior
Junior
Country II
SME
Loans/
Bonds
SWAP
Senior
Credit guarantee/swap
Junior
Regional Credit
Guarantee Facilities
Country III
SME
Loans/
Bonds
SWAP
Senior
Risk to Investors
Credit
Currency
Liquidity
Interest
AAA/AA NO
Yes
Junior

42. Example 4-3: Securitization with Regional Credit Guarantee Facilities
Currency Swap by
Regional Credit Guarantee Facilities
Country I
GBs
SPC or Bond Fund
in Capital Abundant
Country A
Issuing
Pass-Through securities
Institutional
Investors
in Japan
Sold to
Country II
GBs
Country III
GBs
Risk to Investors
Country
Currency
Liquidity
Interest No
Yes

43. Prior Experience in Asian Region: ASIA Ltd
Asian Securitization & Infrastructure Assuarance Ltd (ASIA Ltd)
Asia’s first and only financial guarantee company
Organized by ADB and CapMAC in 1996
incorporated and regulated in Singapore
US$250 million in total claims paying resources
shareholders include: MBIA (formerly CapMAC), ADB, Government of Singapore Investment Corporation, AIG, Employees Provident Fund of Malaysia, DEG, FMO, Korea Long Term Credit Bank
Arranged, guaranteed, reinsured $2.5 billion in Asian financing over a two-year period
Asian debt crisis led to downgrade of its claims-paying ability rating in 1998
Company in a “run-off” mode

44. ASIA Ltd Experience
At the time ASIA Ltd was building its book of business in , its risk management practices appeared to be prudent based on the assumption that country risk among Asian countries was not highly correlated.
With hindsight, it would further mitigate portfolio concentration and correlation:
By Location:
Limit exposure to any one country through structuring and reinsurance
By Currency:
Limit cross border risk through emphasis on local currency business, structuring and reinsurance
Business concept was sound, but (timing and) business model needed improvement

45. Specifications of the proposed regional credit guarantee facilities
Business Purpose: Initially “public”, but “commercially viable”
Capitalization: Paid-in US$ 500 million ~ 5 billion
Part of its capital could be in local currencies
3. Leverage: 20:1 ~ 40:1
4. Target Rating: AAA ~ AA
5. Geographical Coverage: Include developed countries, in addition to less developed countries in the region
6. Line of Business: Multi-line (including guarantee; swap transactions, ABS arrangements, market making etc)
7. Staffing: Professionally managed by experienced staffs in this field
8. Proper risk management instituted

46. Characteristics of our proposal on regional credit guarantee facility
Involves stronger commitment of capital injection from participating countries during stress periods
Mitigates moral hazard problems by instituting proper ownership structure
Limits exposure to any one country through
structuring and reinsurance
Limits cross border risk through emphasis on local currency business

47. Roles of Credit Guarantors in the Capital Markets
Promise to make timely payment of interest and principal
• unconditional, irrevocable and immediate
• right, but not the obligation, to accelerate payment to the
beneficiary
Guaranteed transactions carry the rating of the financial
guarantors; in effect, the guarantors “rent” their high
ratings to the transactions
The guarantors are also selling their strong credit,
structuring, surveillance and remediation skills

48. Benefits of Credit Guarantees to Issuers in Capital Markets
Alternative access to funding
High investment grade ratings
Structuring expertise
Ease and certainty of execution
Confidentiality during periods of stress
Reduced borrowing costs
Increased marketability
Expanded investor base

49. Benefits of Credit Guarantees to Investors
High investment grade ratings and protection
Irrevocable, unconditional and timely payment of full
principal and interest
Eliminates credit losses, downgrade risk, and “headline”
risk
Enhance secondary market liquidity
Price protection
Disciplined risk management, rigorous surveillance and
remedial management

50. Major Considerations in Setting up a Credit Guarantee Company
Business Purpose
Rating and Investor Acceptance
Capital and Shareholders
Management & Staff Skills
Target Market & Market Attractiveness
Product Definition
Regulations and Licensing
Risk Management

51. Comparison with Other Initiatives

52. Asian Bond Markets Initiative by MOF, Japan
The initiative includes comprehensive proposals
Three similarities to Korean proposals:
• Creation of Asset-Backed Securities Markets including
Collateralized Loan Obligations (CLO)
• Sovereign bond issues by governments (government
financial institutions) to provide long-term financing to
local private enterprises
• Introduction of bonds denominated in currency baskets
Korean initiative is consistent with three proposals of Japan

53. Thank you very much !