Contributed By Kim & Chang
In order to insulate financial assets from the insolvency risk of the originator, there should be a 'true sale' (ie, not a secured loan) or a 'true trust' (ie, not a security-purpose trust). This ensures the insulation of the assets from any insolvency risk in connection with the originator’s insolvency proceedings (ie, general rehabilitation proceedings or bankruptcy proceedings) under the Debtor Rehabilitation and Bankruptcy Act (DRBA) and the originator’s corporate restructuring proceedings under the Corporate Restructuring Promotion Act (CRPA).
Article 13 of the ABS Act of Korea (the 'ABS Act') sets forth the requirements of a true sale with respect to the transfer of the assets to an SPE in a securitisation transaction implemented under such law. Article 13 is a 'safe harbour' provision that deems a sale as a true sale and does not result in the creation of a security interest (ie, a secured loan transaction). The requirements are as follows:
The ABS Act does not set forth a 'safe harbour' provision in order to deem a trust as a true trust rather than as the creation of a security interest (ie, a security-purpose trust) with respect to the entrustment of the assets in a securitisation transaction. In practice, whether a trust qualifies as a 'true trust' is decided by paragraphs 2-4 of Article 13 of the ABS Act.
The safe harbour provision of the ABS Act does not technically extend to securitisation transactions that do not fall within its purview. Qualification as a 'true sale' transaction must be decided on a case-by-case basis, depending on the transaction details and the intent of the parties. In practice, however, whether securitisation transactions that do not fall within the purview of the ABS Act qualify as 'true sales' or 'true trusts' is nonetheless decided in substance by the true sale requirements set forth in the ABS Act.
In the case of a true sale, so long as the transfer is perfected against third parties and does not become the subject of fraudulent conveyance or avoidance by the court, the transferred assets would not be a part of the bankruptcy estate or assets of the originator in the event that the originator becomes the subject of an insolvency proceeding under the DRBA or a corporate restructuring proceeding under the CRPA. However, in the case of a secured loan, the transferred assets would be a part of the bankruptcy estate or assets of the originator if the originator becomes the subject of an insolvency proceeding under the DRBA or a corporate restructuring proceeding under the CRPA.
In the case of a true trust, so long as the entrustment is perfected against third parties and does not become the subject of fraudulent conveyance or avoidance by the court, the entrusted assets belong to the trustee and the beneficiary right would not be affected by the originator’s insolvency proceeding under the DRBA or corporate restructuring proceeding under the CRPA. In the case of a security-purpose trust, Korean court precedents have held that the trust assets are distinguished from the trustor's (originator) assets and, as such, the beneficiary’s rights will not be affected by the trustor’s rehabilitation proceedings even if such assets were entrusted for the purpose of securing the obligations of the trustor to the beneficiary, on the basis that legal title to the trust assets belongs to the trustee (a third party) and not the trustor as of the date on which the corporate reorganisation proceeding was commenced. However, this Korean court precedent does not extend to corporate restructuring proceedings under the CRPA.
In the case of a true sale or true trust, so long as the transfer is perfected against third parties and does not become the subject of fraudulent conveyance or avoidance by the court, the originator’s assets are not affected by the originator’s bankruptcy, rehabilitation or corporate restructuring proceedings. In the case of secured loans or security-purpose trusts, however, the originator’s assets may be affected by such proceedings in the following ways.
Secured loans are acknowledged as part of a creditor’s secured rehabilitation claims in rehabilitation proceedings, and are affected by the changes to such rights as part of the rehabilitation plan (reduction of debt, delay in payment, debt/equity conversion, etc). Similarly, secured loans are affected by the adjustments of debt in corporate restructuring proceedings as well (extension of maturity date, reduction of principal and interest, debt/equity conversion, etc).
In the case of bankruptcy proceedings, although all collateral assets belonging to the debtor at the time of bankruptcy belong to the bankruptcy estate, the holders of security in the collateral nonetheless enjoy pre-emptive rights to the collateral, which may be exercised as an action that is separate from the bankruptcy proceedings.
In the case of security-purpose trusts, trust beneficiary rights are not affected by bankruptcy or rehabilitation proceedings under the DRBA. However, they may be changed as part of an adjustment of debt in corporate restructuring proceedings under the CRPA (extension of maturity date, reduction of principal and interest, debt/equity conversion, etc).
In securitisation transactions, transaction parties normally obtain an opinion of counsel to support the bankruptcy remoteness of the transfer. In particular, the ABS Act requires that an opinion of counsel on the true sale be attached to all ABS plan applications.
The material conclusion of a bankruptcy remoteness opinion is that the transfer to the SPE of the securitised assets by the originator will not be characterised as an assignment by way of security in connection with a financing transaction, and that such securitised assets would not be a part of the bankruptcy estate or assets of the originator in the event that the originator becomes subject to an insolvency proceeding under the DRBA.
Although the qualifications may differ depending on the type of securitised asset and the transaction structure, the material qualifications of a bankruptcy remoteness opinion are as follows:
Payments or other acts (such as the granting of a security interest or the sale of assets) by the originator may be avoided by the insolvency official after commencement of the insolvency proceedings if they fall into one of the following four categories:
The Korean Supreme Court held, in a decision (28 March 2013, 2010Da63836) relating to the rehabilitation of an individual debtor where the debtor had provided certain future receivables as collateral by way of assignment (yangdo tambo) prior to entering into the rehabilitation proceeding, that future receivables that arise after the commencement of the rehabilitation proceeding shall not be included in the collateral. However, this is a decision on the security right of a creditor in a rehabilitation proceeding and is not likely to apply to a transaction where no such security right has been established over the concerned assets.
An SPE or trust should be utilised in Korea in order to insulate the transferred financial assets from the insolvency risks of the originator. The ABS Act specifically provides for establishment of an SPE as a securitisation vehicle (the 'ABS SPE'). An ABS SPE may be incorporated within or outside of Korea as a company engaged exclusively in the securitisation business.
The ABS Act provides that an ABS SPE incorporated in Korea shall be in the form of a limited liability company (yuhan hoesa), and that the ABS SPE may not establish a branch nor hire an employee. Under the ABS Act and Korean tax laws, various benefits in perfection procedures and tax benefits are granted to the ABS SPE. There are no specific requirements regarding the status of directors or equity holders. The servicing of the ABS SPE’s assets must be delegated to a qualified servicer, and the corporate and other administrative matters of the ABS SPE (other than matters that require equity holders’ resolutions, matters that fall within a director’s power to represent the company and matters that fall within the power of an internal auditor) must be delegated to a business trustee. Further, in order to protect the investors' interest, the ABS Act provides that a resolution of the equity holders of the ABS SPE which is contrary to the securitisation plan or which prejudices the rights of the holders of securities issued by the ABS SPE shall be null and void.
Moreover, since securitisation transactions are premised on bankruptcy remoteness from the originator, the originator may not be involved in the establishment of the ABS SPE other than as a unitholder in the ABS SPE, nor exercise control over the SPE. The relevant transaction contracts typically include provisions minimising the risk relating to the commingling of the securitised assets and the originator’s own assets and also limited recourse and non-petition provisions.
Korean insolvency laws do not have provisions pursuant to which the insolvency official can consolidate the assets and liabilities of the purchaser with those of the seller during insolvency proceedings. Outside of insolvency proceedings, there are a few Supreme Court cases where the court has applied the doctrine of 'piercing the corporate veil' by denying the corporate existence of a subsidiary where the parent company had incorporated the subsidiary (usually a paper company) for the purpose of harming its creditors or circumventing any application of laws or regulations against the parent company. In such cases, the Supreme Court has held that the assets and liabilities of the subsidiary belonged to the parent company. Thus, unless the corporate existence of the purchaser is denied based on the doctrine established by the above Supreme Court precedents, the assets and the liabilities of the seller and the purchaser would not be consolidated involuntarily during insolvency proceedings.
Nonetheless, in order to minimise any risks of consolidation, the SPE should be established and managed by a third party rather than the originator or its affiliate.
For transactions involving trusts, a key conclusion of the opinion of counsel is that “upon entrustment of the securitised assets by the originator to the trustee pursuant to the relevant trust agreement and upon registration of the entrustment of the securitised assets to the trustee with the Financial Supervisory Commission (FSC), such securitised assets will constitute the trust assets and will not be a part of the bankruptcy estate or assets of the trustee in the event the trustee is in an insolvency proceeding under the DRBA, and such securitised assets would not be a part of the bankruptcy estate or assets of the originator in the event the originator is in an insolvency proceeding under DRBA.”
On the other hand, opinions of counsel are not usually given for the bankruptcy remoteness of an ABS SPE, since an ABS SPE may only be used for one particular securitisation transaction backed only by the securitised assets transferred to such ABS SPE (with the relevant securitisation plan being filed to the regulator).
It is not clear whether a Korean court would give effect to provisions in an SPE’s organisational documents prohibiting the directors of the SPE from taking specified actions (including commencing an insolvency proceeding) without the affirmative vote of an independent director. If such a provision is provided for in an SPE’s organisational documents (eg, articles of incorporation), it would be considered invalid.
In the case of certain unregistered securitisation transactions that are not carried out under the ABS Act, a pledge or collateral by way of transfer (yangdo tambo) on the shares of the SPE is provided for the benefit of the investors to prevent the SPE from acting against the interest of the investors in the shareholders’ or directors’ meetings. This is not required in the case of registered securitisation transactions under the ABS Act (although it is not uncommon for such security interest in shares to be granted in registered domestic securitisation transactions), since the ABS Act prohibits shareholders’ resolutions that are against the investors’ interests.
In order for the sale of financial assets to be perfected against any later purchasers of the same financial assets from the transferor, or to be effective against the debtor and a third party, the transferor must give notice of assignment to the debtor with a fixed-date stamp affixed thereon (which means, eg, a notice of assignment to the debtor by contents-certified mail via a post office in Korea), or the consent to such assignment with a fixed-date stamp affixed thereon must be obtained from the debtor. In the case of a securitisation transaction under the ABS Act, if the assignment of financial assets from the originator to an ABS SPE or a trustee is registered with the FSC as required by the ABS Act, the assignment shall be effective as against third parties (other than the debtors). If the sale of financial assets is perfected as above, the sale shall be protected against any subsequent purchasers without any additional or other formalities, notwithstanding that the subsequent purchasers have purchased such financial assets in good faith and have paid the purchase price.
According to the Private International Law of Korea (KPIL), the law of the country where the promissory note was endorsed will govern the method of assignment. If Korean law is applied, assignment of promissory notes would be perfected by endorsement and delivery of the promissory note, pursuant to the Bills Act.
Marketable Debt Securities
According to the KPIL, the laws of the country where a bearer bond is located would apply with respect to assignment of the bearer bond. In the case of a registered bond, it is generally understood that the governing law of such a bond will be applied with respect to its assignment. If Korean law is applied, a bearer bond may be transferred by delivery, and a registered bond may be transferred by delivery and completion of transfer registration in the bondholders’ registry. Bonds deposited at the Korea Securities Depository may be transferred through book entry.
Perfection of a trust is required in addition to the perfection of the transfer of assets explained above. With respect to any property right that can be registered, the fact that the property belongs to a trust may be contested against a third person by completing a registration thereof. With respect to any property right that cannot be registered, the fact that the property belongs to trust property may be contested against a third person upon indicating that such a property right belongs to the trust by means of management, etc, of the property right separately from other property, or by indicating this fact on certain books or registries (eg, register of shareholders, etc).
Establishment of security interest by way of transfer (yangdo tambo) and security-purpose trusts requires the same perfection procedures as true sales. However, the perfection exemption under the ABS Act only applies to true sales, so does not apply to secured loans or security-purpose trusts.
In the case of secured loans, security interest over an asset (eg, pledge) requires perfection of the transfer against a third party. This is achieved in the same manner as in an asset transfer (ie, notice, consent, delivery, transfer of registration, etc).
If the transfer is not perfected against a third party, the transfer itself will remain valid and enforceable between the transferor and the transferee but not against such third party. Since the bankruptcy receiver or trustee is included in the category of third-party creditors, a true sale that does not comply with the requirements is not fully insulated from the insolvency risk of the transferor.
Entrustment can be used to insulate securitised assets from the bankruptcy risk of the originator. The securitised assets can be transferred or entrusted by the seller to a trustee, which issues trust beneficiary certificates to investors.
The originator entrusts its assets to a trust established with a licensed trust company, which will serve as a securitisation vehicle. The trust beneficiary certificates to be issued by the trustee are acquired by an ABS SPE established under the ABS Act, and this ABS SPE issues marketable fixed-income securities to the investors.
Under the Trust Act and Korean court precedents, upon the valid establishment of a trust (which will be effectuated by the entry into a trust agreement between the trustor and the trustee and the transfer by the trustor of assets to the trustee) and perfection of such a transfer, the assets so transferred to the trustee are legally owned by the trustee but are separate from the trustee’s own assets. The Korean Supreme Court has ruled that, once a trust is established under the Trust Act, the trust assets belong to the trustee and shall not be regarded as the assets of the trustor and, therefore, a creditor of the trustor may not attach the trust assets, unless such a creditor has acquired an interest (eg, security interest) over the assets entrusted prior to the entrustment.
Unless such rights or obligations arose before the establishment of the trust or as a result of performing trust business, trust assets may not be enforced upon, sold or disposed for reasons of exercising security rights or paying taxes.
According to Supreme Court precedents, beneficial interest in a trust should be treated as security interest provided by a third party (ie, a party other than the trustor) to a secured or unsecured rehabilitation claim holder and thus would not be affected by the rehabilitation plan. Once an asset is entrusted into a trust, it will not form part of the assets of the trustor (originator), even after the commencement of rehabilitation proceedings or bankruptcy proceedings against the trustor (originator). Therefore, exercising beneficial interest in the trust will not be affected by rehabilitation or insolvency proceedings against the trustor (originator).
In the case of adjustment of debt in corporate restructuring proceedings, beneficial interest in the case of true trust (ie, not a 'security-purpose trust') is not affected by the corporate restructuring plan, unlike beneficial interest in a 'security-purpose trust' (ie, a trust set up for the purpose of security interest) which may be affected.
It is common legal practice to obtain legal opinions for trust agreements.
The material conclusion of the opinion is that the entrustment to the trustee of the securitised assets by the originator will not be characterised as an assignment by way of security connected with a financing transaction, and such securitised assets would not be a part of the bankruptcy estate or assets of the originator or the trustee in the event that the originator or the trustee becomes subject to an insolvency proceeding under the DRBA.
Although the qualifications may differ depending on the type of securitised asset and the transaction structure, the key material qualifications of a bankruptcy remoteness opinion in a transaction that involves a trust are the same as the qualifications for the true sale opinion (see 1.1 Insolvency Laws, above).
When profits are earned on assets being transferred to an SPE, any such profits earned within the fiscal year in which the transfer took place are included as the originator’s taxable income, subject to corporate income tax.
Value-added tax (VAT) is imposed upon the supply of goods and services, and on the importation of goods, at a rate of 10%. Business entities are required to collect VAT from purchasers and pay it to the relevant tax office. Goods for exportation and services provided outside Korea are subject to zero-rate VAT. Since receivables are not considered goods or services for VAT purposes, a sale of receivables is not subject to VAT.
If a sale of receivables is a true sale, no stamp duty or other documentary taxes are imposed with respect to the sale agreement. If the sale of receivables is recognised not as a true sale but as a secured loan, and the purchaser (ie, the lender) or the seller (ie, the borrower) is a Korean financial institution, stamp duty must be paid for each original of the sale agreement executed in Korea.
The interest income paid by a Korean debtor will be subject to withholding taxes in the following cases:
In the last case, the amount of withholding tax may be reduced or exempted by the applicable tax treaty between Korea and the country of the payee’s registered head office.
Under the Korean corporate tax laws, however, interest income from loans for financial companies is exempt from withholding taxes; since an ABS SPE is categorised as a financial company, its interest income from loans is exempt from withholding taxes. However, any interest income from debt securities, such as certificates of deposit, banker’s acceptance of depository institutions and commercial paper, is subject to a withholding tax of 15.4% (including local income tax), or 27.5% (including local income tax) in the case of non-business income.
Interest income of foreign corporations or non-resident individuals will be subject to a withholding tax rate of 22%, which may vary subject to any applicable tax treaties.
To be eligible for favourable tax rates under a tax treaty, the taxpayer must submit an application for the favourable tax rate to the withholding agent. If the withholding agent does not receive the application form or if the beneficial owner of the taxable income cannot be determined under the application document, the favourable rate will not apply. Nonetheless, a foreign taxpayer can apply for a corrective order within three years of the date of the withholding.
As a Korean resident, an ABS SPE established under the ABS Act is subject to Korean corporate income taxes at the regular rates set forth under the Corporation Tax Law (CTL). An offshore SPE may or may not itself be subject to Korean corporate income tax, depending on the applicable tax treaty, although its Korean branch, if any, should be regarded as a Korean resident and be subject to Korean corporate income taxes at the regular rates under the CTL.
Under the CTL, an ABS SPE established under the ABS Act is entitled to a deduction from corporate income tax if it distributes dividends to its shareholders in an amount that is no less than 90% of its distributable income in the relevant fiscal year, which is defined as net income (excluding valuation gain or loss on securities) plus retained earnings (or minus deficit) minus legal reserves to be set aside under the Korean Commercial Code. The dividend amount so distributed would be deductible from the ABS SPE’s taxable income for the purpose of calculating its corporate income taxes. However, SPEs that are not established in accordance with the ABS Act do not enjoy these tax benefits.
The payments of the interest and certain fees on the foreign currency-denominated offshore fixed income securities by the Korean entity to a non-Korean resident (excluding a permanent establishment of the non-Korean corporation) would not be subject to any withholding or deduction on account of any Korean taxes, by virtue of the Special Tax Treatment Control Law of Korea (STTCL).
With respect to fees exempt from Korean income tax pursuant to the STTCL, in the case of the issuance of foreign currency-denominated bonds, the tax authorities have ruled to the effect that the fees so exempt are limited to the gross underwriting spread (eg, underwriting fee, selling commission, etc) that is directly related to the issuance of such bonds.
Legal opinions other than true sale opinions attached to the securitisation plans are generally not obtained for domestic ABS transactions, barring a special request by the transaction parties to do so.
In the case of cross-border ABS transactions, legal opinions are obtained. The material conclusions of the opinions are that:
In general, Korean Generally Accepted Accounting Principles (Korean GAAP) will apply to the seller or the purchaser in Korea in the context of a securitisation. If the purchaser is an ABS SPE incorporated pursuant to the ABS Act, the Accounting Principles for Securitisation Companies will also apply. The Korean GAAP and, if relevant, the Accounting Principles for Securitisation Companies are generally applied for tax accounting purposes. If the seller is a listed company or a financial institution, the Korean International Financial Reporting Standards (K-IFRS) have been applied as Korean GAAP.
There are no particular legal issues on the accounting standards to be applied to securitisation transactions.
Legal practitioners do not get involved, and lawyers are not asked to give legal opinions.
In order to conduct securitisation transactions under the ABS Act, the securitisation plans and details of the transfer of the securitised assets must be registered with the FSC, and disclosed to the public on the Financial Supervisory Service (FSS) website. The FSS is the enforcement arm of the main financial regulator, the FSC.
The servicer and business administrator of ABS SPE established under the ABS Act must prepare and display the details and status of its securitisation plans, and allow any investors to view these materials.
Securitisation transactions that are not conducted under the ABS Act are not subject to any disclosure obligations other than reporting and disclosure requirement under the Financial Investment Services and Capital Markets Act (the 'Capital Markets Act') in relation to the securities offering in the case of public offerings. However, investors may review the materials related to the securitisation transaction at their request, and any credit ratings and the details of the credit evaluation received by rating agencies on the ABS must be disclosed on the Korea Financial Investment Association website, in accordance with the Capital Markets Act.
The asset-backed securitisation plan under the ABS Act shall include the following:
The asset transfer registration under the ABS Act shall include the following:
More details may be found on the FSS electronic disclosure system (http://dart.fss.or.kr/).
The principal regulators of disclosure of ABS transactions are the FSC and the FSS under the Capital Markets Act, as well as the ABS Act for securitisation transactions.
According to Article 39 of the ABS Act, any person who has falsely prepared an asset transfer registration or any servicer or business trustee who has falsely prepared a securitised asset list and related documents or has failed to make such documents available for public perusal shall be punished by imprisonment for no more than three years, or by a fine not exceeding KRW20 million.
Korea Ratings, a Korean credit rating agency, announced that, of all ABS transactions that received credit ratings in 2017, 73.1% of securitised transactions were not established under the ABS Act, and most of these transactions were issued as private placements rather than public offerings.
Official details on securitised transactions established under the ABS Act are announced annually by the FSS. In 2017, of the total amount of issued transactions of KRW57,599.9 billion, public offering accounted for 81.1%, or KRW46,721.5 billion.
The investors of private placements are mostly institutions that deal with loans. There are no disclosure requirements for the issuance of private placement securitisations, other than its securitisation plan under the ABS Act (if the issuance is done pursuant to the ABS Act), whereas a registration statement and also an annual report and semi-annual and quarterly reports need to be submitted to the FSS for public offerings, and must be made available to the public. Unlike private placements where most of the participants are sophisticated investors, private individuals participate in public offerings and accordingly there are more stringent standards and disclosure requirements for public offerings. Issuing securities in public offerings also entail disclosure requirements under the Capital Markets Act, and failure to abide by these requirements may result in criminal penalties as well as administrative fines.
In the case of domestic issuances, there is usually no separate opinion on compliance with the relevant rules other than a general legal opinion on the true sale. However, in cases where a particular securitisation transaction may have issues with the relevant laws, such as the Capital Markets Act, the ABS Act or the Trust Act, legal opinions may be issued by a legal practitioner on that particular issue.
In the case of cross-border ABS transactions, a general legal opinion on the legality, validity and binding nature of the transaction agreement is generally obtained (see 2.5 Obtaining Legal Opinion, above).
ABS SPEs that have issued asset-backed securities in public offerings are required to conduct periodic disclosure (annual report and semi-annual and quarterly reports, etc), the requirements of which are set out in the Capital Markets Act, the Enforcement Decree of the Capital Markets Act and the Regulations on the Issuance and Disclosure of Securities. Although not a legal requirement, the FSC recommends periodic (eg, monthly) supplementary filings with the FSC in respect of the future receivables that have come into existence since the previous filing, for the purpose of perfecting the assignment or the entrustment of such future receivables against third parties.
Securitisation transactions not established under the ABS Act will also be subject to a requirement of periodic disclosure (annual report and semi-annual and quarterly reports, etc) if the SPE issued securities in a public offering.
The FSC and FSS regulate and enforce these rules.
Fraudulent description or representation concerning a material fact in its annual report or semi-annual or quarterly reports, the omission of a material fact or the failure to submit a report altogether may be subject to imprisonment for no more than five years, or to a fine not exceeding KRW200 million imposed by the FSC under the Capital Markets Act.
The general activities of ratings agencies (RAs) are regulated under the Capital Markets Act, but there are no particular regulations relating to RAs' securitisation activities.
According to the Capital Markets Act, an RA and its executive officers and/or employees shall perform their duties fairly and faithfully from an independent stance, while conducting their credit assessment work. Moreover, an RA must clearly set forth and abide by its internal control standards for credit assessment as well as its credit assessment methods, and submit its credit rating reports to the FSC and the Korea Financial Investment Association.
The FSC regulates the RAs.
According to the Capital Markets Act, if an RA conducts credit assessments in violation of its established credit assessment methods, fails to prepare a credit rating report, fails to submit a report or submits a false report, the FSC may revoke the authorisation granted to it and may take actions such as suspending its business completely or partially for no more than six months, issuing an order to correct or discontinue the violation, issuing an order to provide public notice or disclosure of the fact that it has been subject to a measure due to its violation, etc. In such a case, the FSC may also issue a demand for dismissal, suspension of duties for no more than six months, warnings or reprimands, etc, against the executive officer of the RA.
According to the Banking Supervision Regulations, when a bank extends a line of credit to an ABS SPE (including the acquisition of the ABS issued by the ABS SPE), the credit exposure will be treated
The Enforcement Rules of the Banking Supervision Regulations set forth the calculation methods of a bank’s securitisation exposure, as well as the standards for reducing the credit risk in the transfer of credit exposure to an SPE through a synthetic securitisation transaction.
According to the Enforcement Rules of the Insurance Supervision Regulations, in calculating an insurance company’s 'standard amount of solvency margin' (one of the standards to calculate the 'solvency margin ratio', ie, the ratio obtained by dividing the amount of solvency margin by the standard amount of solvency margin), which is one of the indicators of the financial soundness of the insurance company, asset-backed securities are treated in the same manner as short-term bonds, commercial paper and beneficial interest certificates, in that risk exposure is calculated by transaction exposure multiplied by the interest rate sensitivity and interest rate fluctuation coefficient (0.9%).
Financial Investment Companies
According to the Enforcement Rules of the Financial Investment Business, in calculating a financial investment company’s 'gross risk', which is one of the indicators of a financial investment company’s financial soundness, the risk exposure of asset-backed securities is calculated by calculating the risk exposure on the basis of its remaining term and credit rating. If the financial investment company acquires asset-backed securities that are either not rated or have ratings lower than A2 or A and holds on to the asset-backed securities for more than one month, an amount equal to the principal amount outstanding of the asset-backed securities will be deducted from the company’s equity capital.
Specialised Credit Finance Companies
According to the Enforcement Rules of the Specialised Credit Financial Business, in calculating the company’s adjusted capital adequacy ratio against adjusted total assets, which is one of the criteria for management guidance in the adequacy of equity capital of a specialised credit finance company, only 10% (50% for credit card companies) of the securitised assets under the ABS Act with substantive credit risk (eg, obligation to replace assets, credit enhancement, etc) will be accounted for in the purpose of calculating the total assets.
The FSC and the FSS regulate the requirements.
According to the Banking Act, if the FSC finds that a bank is likely to seriously undermine its soundness in its management, it may request that the bank takes necessary measures to improve its business management, by taking actions such as increasing capital, restricting dividends, securing assets with high liquidity, and issuing and holding a certain amount of contingent bonds.
According to the Capital Markets Act, if a financial investment company fails to meet any of the applicable guidelines, the FSC may order the financial investment company to take the necessary measures to secure soundness in its business management, by taking actions such as increasing its capital and placing a restriction on the distribution of dividends.
According to the Insurance Business Act, where an insurance company is deemed likely to undermine the soundness of its management due to its failure to observe the necessary standards, the FSC may order the insurance company to increase its capital or funds, and take other necessary measures such as restricting its holding of stocks and assets with high risk, etc.
According to the Specialised Credit Finance Business Act, when a specialised credit finance company is noticeably apprehended to harm the soundness of its management, the FSC may demand that it takes the necessary measures to improve its management, by taking actions such as increase of capital, limitations on profit sharing, etc.
There are no special laws or regulations that apply to SPEs or the use of derivatives, and related actions are governed by the Capital Markets Act.
Regarding investor protection, the Capital Markets Act sets forth regulations regarding the principle of suitability, the principle of adequacy, the duty to explain and the prohibition on undue recommendation.
Moreover, the Capital Markets Act requires a registration statement to be submitted, as well as the aforementioned periodic reporting (annual report, semi-annual and quarterly reports, etc) in the case of public offerings.
There are no special investor protection laws or regulations specific to securitisation transactions.
The Capital Markets Act does not impose criminal penalties on violators of its principles and duties, but an investor may file a claim for damages against a financial investment company that is in violation of the Capital Markets Act.
Investment solicitors, on the other hand, are regulated by the FSC and the FSS so if an investment solicitor violates the principles and duties of the Capital Markets Act, the FSC may revoke its registration or suspend its business for up to six months.
The Enforcement Rules of the Banking Supervision Regulations require that gains on sales resulting from securitisation transactions are deducted from the common share capital, and the credit enhancement I/O strip (an interest-related portion of the assets on the balance sheet that is subordinated to other positions by absorbing the losses first) increases the risk-weighted value by 1,250%.
If a bank provides implicit support for a securitisation transaction, it must retain the amount of capital that it would be required to retain had all the exposures of the securitisation transactions not been securitised, and it must also announce the fact that it has provided such support and the impact this has had on its own capital.
In asset-backed securitisation transactions, corporations, trusts or a combination of the two are the principal variations used.
In the case of securitisation transactions under the ABS Act, an ABS SPE or a combination of a trust and an ABS SPE are frequently used.
In the case of securitisation transactions that are not carried out under the ABS Act, an SPE set up pursuant to the Commercial Code or a combination of a trust and such an SPE are frequently used.
Whether or not to do a deal under the ABS Act depends on the need to utilise the exemptions provided by the ABS Act or its guidelines. The regulator does not allow asset-backed loans to the ABS SPE or securitisation transactions backed by stock as underlying asset, so these deals are done outside the ABS Act. As discussed above (1.2 Special Purpose Entity), the ABS Act allows a simplified perfection process, so a deal with a large number of underlying obligors will be likely to use the ABS Act.
Whether to use corporations or a combination of trusts and corporations is decided by the type of asset and the structure of the securitisation transaction.
When the size of the assets is not determinable (eg, future receivables) or if a securitisation transaction has a revolving aspect, a combination of a trust and a corporation is frequently used.
When using corporations, whether to use a joint stock company (jusik hoesa) or a limited liability company (yuhan hoesa) is decided by the type of investment. ABS SPEs established as a limited liability company under the ABS Act may enjoy the exemptions under the ABS Act to issue bonds, but limited liability companies not established under the ABS Act may not enjoy these exemptions. Therefore, if an SPE not established under the ABS Act wishes to issue bonds, it should be a joint stock company.
Before the application of the K-IFRS, an originator could still enjoy off-balance sheet treatment even after acquiring shares in the SPE and acquiring the junior ABS issued by the SPE. After the application of the K-IFRS, however, the requirements for off-balance sheet treatment are followed more strictly.
In order to receive off-balance sheet treatment for securitisation transactions, the shares in the SPE and the junior ABS issued by the SPE should be sold to third parties.
The FSS is in charge of regulating and enforcing the K-IFRS.
Securitisation transactions employ a wide variety of credit enhancement tools in Korea. Frequently used forms of credit enhancement include subordination, letters of credit and credit default swaps.
Since the originator’s provision of credit enhancement to the SPE is, in effect, an undertaking of the credit risk of the securitised assets, the principal legal issue arising in connection with this credit enhancement is whether the transfer of the securitised assets qualifies as a true sale, and must be reviewed on a case-by-case basis depending on the transaction structure.
Government-sponsored companies that act as originators or sponsors in the securitisation market are the Korean Housing Finance Corporation (KHFC) and the Korea Credit Guarantee Fund (KCGF).
The principal business of the KHFC is to acquire residential mortgage loans from financial companies in order to issue mortgage-backed securities (MBS) and covered bonds with such loans as the underlying assets. MBS and covered bonds issued by the KHFC are governed by the KHFC Act.
For purposes of promoting the procurement of funds by mid-sized enterprises, the KCGF sponsors the pooling of bonds issued by mid-sized enterprises to conduct collateralised bond obligation (CBO) transactions. These transactions are referred to as 'primary CBOs' because the securitised assets are bonds issued in the primary market and are structured in a way that Korean banks with AAA ratings provide standby credit facilities and the KCGF provides guarantees to cover potential bank losses. These transactions are governed by the ABS Act and the KCGF Act.
The major investors in ABS are pension funds, insurance companies, banks, securities companies and other funds. These entities either invest directly or through trust funds.
There are no special rules governing these entities’ investment in securitisation transactions, and the general applicable rules for the relevant transaction will apply. However, when investing in a securitisation transaction through trust funds, a more stringent standard for private placements will be applied if the asset-backed securities issued are commercial paper.
Since bankruptcy remoteness is achieved through the transfer of the securitised assets to the SPE or the trustee, the documentation that sets forth provisions related to the bankruptcy remoteness is the sale and purchase agreement and the trust agreement. Since the originator acts as the servicer of the SPE in most ABS transactions, the servicing agreement has an effect on determining the bankruptcy remoteness as well.
The sale and purchase agreement or the trust agreement is prepared so as to ensure that:
The servicing agreement is prepared so as to ensure that the servicer (originator) does not have an arbitrary right to dispose of the securitised assets, that the monies received from the securitised assets are deposited directly to the SPE or the trust, and that the securitised assets are managed separately from the servicer’s own assets.
The principal warranties of the sale and purchase agreement and the trust agreement include the following:
These agreements also provide that any falsity regarding these warranties is a cause for termination or an event of default, as well as a valid cause for a damages claim.
Perfection against third parties is consummated immediately upon the transfer of assets, and perfection against underlying obligors is consummated in accordance with the relevant laws through notice or consent when the securitised assets are transferred. In the case of securitisation transactions of residential mortgage loans, auto loans or credit card receivables, the number of underlying obligors will easily be in the thousands, and perfecting the transfer of the underlying asset against each of the underlying obligors may not be practical. In practice, perfection against underlying obligors is triggered upon the occurrence of predetermined events, such as when the credit rating of the originator falls below a certain threshold or the SPE administrator believes it necessary for the protection of the ABS investors; in such cases, the administrator may demand that the originator carries out the perfection of the transfer. Failure to perform the perfection procedures by the originator will enable the administrator to perform the perfection procedures on the originator’s behalf. The administrator can obtain the necessary information from the originator in order to consummate the perfection, and the funds for the perfection are reserved with the SPE.
The principal covenants used in sale and purchase agreements and trust agreements are as follows:
These agreements also provide that the failure to abide by the above covenants is a cause for termination or a valid cause for a damages claim.
In general, the originator/seller will be allowed to service and manage the receivables transferred to the SPE. There is no general prohibition or legal requirement applicable to a third-party entity being appointed as the servicer of the receivables. Whether any licences will be required depends on the type of asset that has been transferred and who the servicer is. For example, unless the securitisation transaction is carried out pursuant to the ABS Act (in which case defaulted receivables can be serviced by a qualified servicer under the ABS Act, which includes the originator, without having obtained a collection business licence), a specific licence (ie, a collection business licence) is required for the servicing of defaulted receivables, including when the originator acts as servicer. Likewise, whether a particular type of entity may act as a servicer will require a review of the statutes and regulatory provisions applicable to that entity.
The principal defaults include events relating to the payment ability of the SPE and inability to make payment on interest and principle on the ABS issued with the cash inflow from the securitised assets. In transactions securitising future receivables or revolving-structure ABS transactions, causes of early amortisation events which can trigger mandatory redemption include the originator’s credit rating falling below a certain level or collection on the securitised assets falling below a certain level, but they do not constitute events of default.
The transaction documents impose certain requirements regarding the securitised assets, such as the valid existence of the underlying agreement of the securitised assets, the possession by the originator of rights on the securitised assets free and clear of any liens or claims by other parties, and the transferability of the securitised assets. If such requirements are not met, then the transferee (or trustee) may file a claim against the originator demanding that the warranty on the asset be enforced. This will nullify the sale and purchase agreement (or trust agreement), and the originator must return any funds received in connection with the securitised assets.
The originator generally also indemnifies the transferee (beneficiary) against any fraudulent or false representations or warranties made within the agreement.
The collections from the securitised assets by the business trustee are applied in the following order:
In addition, when there is excess cash in the SPE, the business trustee must deposit this cash in a bank at or above a designated credit rating or invest in treasury bonds, municipal bonds at or above a designated credit rating or corporate bonds or promissory notes at or above a designated credit rating.
Minimising the commingling risk is critical in securitisation transactions.
Since the originator usually performs the role of a servicer in securitised transactions in Korea there is risk of the securitised assets being commingled with the own assets of the servicer. If this is the case, there is a risk that the assets may not be protected in the case of an insolvency event of the originator, notwithstanding the validity of the original transfer as a true sale. Article 11 of the ABS Act states that the servicer shall manage the securitisation assets separately from its own assets (including the collections and other property rights received as a result of the administration, management, and disposition of such assets), and prepare and maintain separate books for the administration of the securitisation assets. Therefore, the servicing agreement sets forth clear obligations for the servicer to separate its own assets from the securitised assets, and any collections by the servicer on the securitised assets should be deposited directly into the accounts of the SPE or the trustee.
The enforcement regime for securitisation is generally considered to be quite effective. Korea is perceived as having one of the most robust securitisation markets in the world, in large part due to the trust and confidence that the market and particularly investors have placed on the Korean court system and enforcement regime; this has been the case throughout the history of securitisation in Korea. The ABS Act provides a stable and convenient platform for securitisation transactions, enforcing the effectiveness of the enforcement regime.
The SPE, as the issuer, purchases the securitised assets and issues asset-backed securities, insulating the securitised assets from the insolvency risk of the originator. It is also responsible for the obligation to make repayments on the asset-backed securities from the funds collected from the securitised assets. SPEs are paper companies established for specific securitisation transactions.
Generally, the originator becomes the sponsor of the securitisation transaction and considers various factors, such as the status of its assets. Once a decision is made to do a deal, it sets the eligibility criteria for the transferred assets and selects the assets that meet such eligibility criteria.
In the case of arbitrage transactions such as collateralised debt obligations (CDOs), a securities company becomes the sponsor and conducts searches on the target assets and designs the overall transaction.
Types of businesses that become sponsors are diverse and may include government-sponsored companies, credit finance companies and regular corporations.
Underwriters and placement agents are in charge of designing a suitable securitisation structure, considering various factors such as liquidity of funds, the characteristics of the asset and the type of investors. They also decide which issuance terms for the securities are most suitable for the securitisation structure.
They assist investors in making reasonable investment decisions, from the ABS plan registration stage. They ensure that all necessary registrations, applications and submissions are made correctly and in a timely manner, and that the investment risk and the investors’ concerns are correctly reflected. Finally, they subscribe the issued securities and distribute them in the market.
Management of the securitised assets is delegated to the servicers by the SPE. Servicers maintain the necessary manpower and organise a system to ensure effective management of the assets. They provide the necessary information pertaining to the assets to the arranger, administrator and credit rating agency. They may be inspected by the administrator or an outside auditor, to ensure that they are fulfilling their role in good faith. In order to reduce commingling risk, servicers must clearly distinguish the securitised assets from their own assets, and make sure that the collections from the securitised assets are deposited directly to the SPE or the trustee without going through the servicer.
Investors acquire the ABS, and thus become the actual bearers of risk of the securitised assets, for which they receive consideration in the form of interest or dividends. Investors do not typically bear any responsibility other than making payments for the securities. Major players include pension funds, insurance companies, banks, securities companies and other funds.
Since an SPE is a paper company, it entrusts its everyday operations to a business trustee, who manages the SPE’s funds and pays taxes, fees expenses, principal and interest.
An administrator may establish a standard set of guidelines on the entrusted work to achieve effective business operations. The administrator reviews the asset reports and other materials prepared by the servicer and determines whether the securitised assets are performing in accordance with the securitisation plan and the soundness of the assets; it also conducts inspections of the assets, reviews insolvency risks and early termination risks, and retains the relevant materials as evidence.
In Korea, synthetic securitisation may not be established under the ABS Act, but synthetic securitisation transactions are prevalent in non-ABS Act deals. There is a significant synthetic securitisation market in Korea.
Most synthetic securitisations are those in which a securities company is the originator or sponsor as an SPE.
Since it involves structured products, synthetic securitisation is regulated and monitored by the FSC and the FSS.
Synthetic securitisation is regulated by the Capital Markets Act. Since synthetic securitisation is not allowed under the ABS Act, it is not regulated by the ABS Act.
Since derivative-linked securities in which the principal repayment is not guaranteed may only be issued by certain licensed financial investment companies, SPEs may not issue derivative-linked securities. Therefore, SPEs issue fixed-income securities, which enable investors to indirectly assume the risk of the securitised assets and relevant derivative transactions.
If the terms of the credit derivative contract between a financial institution and the SPE meet certain credit risk reduction conditions set forth in relevant regulations applicable to the financial institution, the underlying assets may be excluded from the weighted risk assets of the finance company, which allows for regulatory capital relief.
The typical securitised assets for securitisation transactions under the ABS Act are residential mortgage loans, trade receivables, auto loans/leases, credit cards and project finance loans. For those securitisation transactions not established under the ABS Act, the main assets are CDOs and project finance loans.
Regardless of the type of asset, for transactions with a defined cash flow, the originator transfers the securitised assets to the SPE and the SPE issues asset-backed securities based on those assets. On the other hand, for revolving transactions or when cash flow is unpredictable, a trust-SPE structure is utilised, in which the originator entrusts the securitised assets to a trust and designates the SPE as the trust’s investor interest-holder, and the SPE issues asset-backed securities based on the investor interest. In the case of KHFC MBS, the KHFC receives residential mortgage loans from finance companies and entrusts the loans to issue beneficiary certificates, for which the KHFC provides a payment guarantee.
Securitisation transactions established under the ABS Act are regulated by the ABS Act, and the KHFC MBS is regulated and monitored by the KHFC Act. Transactions not established under the ABS Act are regulated by the Capital Markets Act.