In the six years since the promulgation of the ABS Law in September 1998, the Korean securitization market has undergone various changes, resulting in an ongoing need to supplement and improve the regulatory regime for ABS. In 2004, regulatory authorities and market participants began to discuss avenues to improve asset-backed securitization and consider various means to supplement and reform the securitization process. The outcome of their efforts is the ABS Best Practice.

The following characteristics were also noticeable in 2004:

• More mortgage-backed securities were issued with mortgage loan claims as underlying assets.
• Securitized assets were diversified, such as the assets involving project financing and social overhead capital (SOC).
• The master trust scheme was introduced.

ABS Best Practice

To support the sound development of the ABS market and to better protect ABS investors, the ABS Best Practice was prepared as a set of self-regulated rules for market participants and became effective on May 1 2005.

The ABS Best Practice applies to the parties involved in the issuance, redemption, and public disclosure of asset-backed securities and management and operation of the securitized assets, including, among others, the arranger, servicer, transaction administrator (that is, business trustee), a commissioned company in respect of the bond offering, rating agency, accounting firm, legal counsel and originator. With respect to the originator, however, the ABS Best Practice applies only during the transfer of the securitization assets to the securitization vehicle.

The ABS Best Practice generally applies both to domestic and to cross-border ABS transactions whether they are structured as public offerings or private placements. If, however, the monitoring and supervision of the ABS special purpose companies (SPCs) are performed by a third party other than the servicer and the transaction administrator, then the transaction parties may decide not to apply the ABS Best Practice with respect to any matters deemed unnecessary.

Although the decision of whether or not to adopt the ABS Best Practice is left to the discretion of the transaction participants in principle, it is expected that the lead arranger will disclose in the ABS plan whether the ABS Best Practice has been adopted when issuing the asset-backed securities and that the rating agency will consider whether or not the ABS Best Practice has been adopted when rating the securities. It is expected that more detailed administrative guidance will be established, with flexibility, as the ABS Best Practice is applied to securitization transactions.

Among the various items, details of the ABS Best Practice are:

The roles of relevant transaction parties standardized and a detailed and clear scope of their duties and responsibilities set up

The ABS Best Practice requires each transaction participant to carry out its duties and responsibilities with the care of a good manager and prohibits provisions that unduly exculpate liabilities.

If the servicer or the transaction administrator delegates some of its duties to a third party, in principle, the servicer or the transaction administrator should be responsible for the third party's performance of the delegated duties as the principal obligor. Further, to prevent the commingling of assets, the servicer must deposit, or cause to be deposited, the cash collections from the securitization assets into the SPC's account without delay.

A detailed mechanism for checks and balances among transaction participants established

The transaction administrator's duty to monitor the servicer: The ABS Best Practice requires the servicer to report to the transaction administrator details of the servicing of the securitization assets. In this regard, details concerning the methods and contents of the report should be determined and disclosed in the ABS Plan and the transaction agreements. Sanctions for a servicer's failure to timely provide the servicing reports and the measure for enforcing the servicer's obligations to provide the servicing reports should be specified in the servicing agreement. Further, the transaction administrator is required to periodically review the possibility of an early amortization event occurring, based on the servicing reports and other available materials.

Checks by the independent auditor against the servicer and the transaction administrator: When conducting its audit of the ABS SPC that has issued asset-backed securities through a public offering, the independent auditor of the ABS SPC must verify whether the transaction administrator and/or the servicer is carrying out its duties and responsibilities according to the provisions and guidelines as prescribed under the relevant transaction agreements. If the independent auditor discovers cases of non-compliance it must reflect the details of non-compliance in the audit report.

In addition to the above, under the ABS Best Practice, the rating agency is required to consider: the status of servicing of the securitized assets; the compliance or non-compliance by the transaction parties with the terms and conditions of the transaction agreements; the change in the rating of any transaction party; and other relevant matters in the course of conducting scheduled or unscheduled rating evaluations.

Disclosure requirements strengthened

The ABS Best Practice requires that information concerning ABS transactions that securitize present and/or future receivable claims on a revolving basis be stated in the ABS plan. In this regard, when evaluating the underlying assets that are securitized, the transaction parties, in principle, should use objective evaluation data that is readily available. However, if a different evaluation method or standard is used (compared to that used by an independent agency or used by the originator) to securitize a similar type of asset within the past year, the reasons for using the different evaluation method and the contents of the difference should be disclosed.

Increase of mortgage-backed securities

Depending on the originator, a mortgage-backed securities (MBS) transaction can be executed in two ways in Korea. Korean financial institutions (for example, domestic commercial banks) may directly issue MBS with mortgage loans as the underlying assets both in the domestic market and in overseas markets pursuant to the ABS Law. Or they may sell certain qualified residential mortgage loans to the Korea Housing Finance Corporation (KHFC), which in turn securitizes the mortgage loans by issuing MBS pursuant to the Korea Housing Finance Corporation Law (the KHFC Law). The MBS volume issued by KHFC in the domestic market in 2004 was about W3 trillion ($3 billion), which constitutes 11.2% of the total securitization volume for 2004.

After the promulgation of the Mortgage-Backed Securities Law (the MBS Law) in January 1999, Korea Mortgage Corporation (KoMoCo) began issuing MBS in 2000. However, the total amount of MBS issued in the four years until 2003 was only W2.9 trillion. The factors that hampered the wide acceptance of securitization of mortgaged loans pursuant to the MBS Law, among others, were: the characteristics germane to the Korean housing financing market, such as home buyers' preference for capital gains, financial institutions' difficulty in securing long-term funding sources and the absence of a long-term index for interest rates; and KoMoCo's limited fundraising capability.

To overcome these limitations and to promote MBS, the Korean government promulgated the KHFC Law in December 2003, which enhances the credibility and fundraising capability of the MBS issuer and simplifies the issuance process. Upon its establishment in March 2004, KHFC acquired from KoMoCo the business concerning securitization of mortgage loans to effectively securitize mortgage loans.

Under the KHFC Law, KHFC may engage in the following loan securitization business:

• issuance of mortgage-backed bonds (MBB) up to 50 times the amount of paid-in-capital, using residential mortgage loans purchased from financial institutions as underlying assets;
• issuance of MBS using residential mortgage loans purchased from financial institutions as underlying assets; and
• issuance of student loan securities using student loans purchased from financial institutions as underlying assets.

Under the KHFC Law, to constitute the underlying assets of MBS and MBB issued by KHFC, loan proceeds from the residential mortgage loans must be used to acquire or construct residential house or to make repayment of outstanding borrowings for the same purpose, and the term of the loans must at least 10 years.

As differentiated from securitization under the ABS Law and the MBS Law, the KHFC Law allows KHFC to buy and hold residential mortgage loans for the purpose of securitizing them in the future. As a result, KHFC can control the timing of issuing MBS in consideration of financial market conditions.

Tables 1 and 2 outline the transaction structures for the KHFC's issuance of MBS and MBB.

Master trust

A master trust permits the issuance of multiple series of trust certificates from one single trust to the ABS SPC that is incorporated at the time of the initial closing as well as to other ABS SPCs that will be newly incorporated from time to time as the new assets are added to the trust. A master trust allows each series of such trust certificates to share the credit risks and cash flows from one large pool of trust assets. Under the master trust structure, a single master ABS plan would be filed with the FSC at the initial closing, and additional assets may be conveyed into the master trust from time to time by filing an amendment to the master ABS plan (with the incorporation of a new SPC).

In May 2004, LG Card Co Ltd completed, for the first time in Korea, a credit card receivable ABS transaction using a master trust structure and, subsequently, five additional tranches of securities were issued from the master trust in 2004. In October 2004, Hyundai Card Co Ltd set up another master trust with credit card receivables as its underlying assets.

Using the master trust structure has the advantages over the standalone trust structure:

• simplification of securitization process and cost saving, as it is no longer necessary to separately establish independent trusts when each series is issued;
• integrated management of the large pool of securitized assets; and
• a shorter controlled amortization period reducing the burden of idle money.

Considering these advantages, it is expected that there will be an increase in ABS transactions using a master trust structure.

Diversification of underlying assets for ABS

In 2004 there was an increase in securitization for loan receivables secured by land taken out to finance initial funding needs in connection with real estate development projects to build residential apartments, commercial buildings and residential-commercial complexes to a total of W1.6 trillion, as compared with W700 billion in 2003. The asset-backed securities issued under the project-financing scheme are generally short term in nature and are issued in the domestic market based on the credit of the construction company in the project to acquire land or satisfy other early stage funding requirements. As such, the amount for each issuance is generally modest.

There has also been an increasing trend in issuances of asset-backed securities whereby the underlying assets consist of future cash flow arising from toll concession rights, airport facility use rights, subway operation rights and other rights connected with state-owned companies.

Securitization transactions outside the ABS Law

Various types of securitization transactions in the Korean market use structures outside the ABS Law, such as asset-backed loans and asset-backed commercial paper programmes. However, these transactions might not qualify for benefits granted to ABS SPCs incorporated under the ABS Law, such as the exceptions for perfection requirements with respect to the transfer of the securitization assets and the related mortgages and pledges and certain tax benefits. With respect to the true sale and bankruptcy remoteness of these transactions, parties generally resort to the true sale requirements under the ABS Law.

Author biographies

Min Han Kim & Chang Min Han, a member of Kim & Chang, studied at Seoul National University (LLB 1981), the Judicial Research and Training Institute of the Supreme Court of Korea (1983) and Cornell Law School (LLM 1992). Throughout his career, he has focused on finance transactions, particularly those of a banking, project finance, asset-backed securitization and other structured finance nature. He has also advised with respect to Korean insolvency laws and purchase of non-performing loans and real estate assets by foreign investors. He is a member of the Korean and New York Bar associations. Seon Jee Lee Kim & Chang Seon Jee Lee has been a member of Kim & Chang since 1999. As a securities lawyer, her expertise is in structured bonds, particularly in asset-backed securities. She has been involved in a number of securitization transactions, both domestic and cross-border, with various types of underlying assets and advises on licensing and finance regulation. Recently, Seon Jee Lee co-authored an article entitled, "Asset-Backed Securitization Transaction and the legal problems thereto," published by the Center for Financial Law of Seoul National University (2004). Prior to joining Kim & Chang, Seon Jee Lee worked for the Bank of Korea in areas of bank supervision and financial dispute resolution. She received her LLB from Seoul National University, studied at the Judicial Research and Training Institute of the Supreme Court of Korea, and is a member of the Korean Bar Association. Jung Wook Kim Kim & Chang Jung Wook Kim is a foreign legal consultant in the Corporate Finance & Banking group of Kim & Chang where he is primarily involved in various international capital markets transactions, structured finance transactions and has worked on various 144A private placements of securities issued by Korean companies and cross border asset-backed securitization transactions. He has also participated in the Korean Won-denominated bond issuance by a foreign issuer (aka Arirang Bonds), the first of its kind issued by a non-Korean related foreign private issuer that was sold to Korean investors. Jung Wook Kim received his undergraduate degree in Business Administration from Korea University and subsequently obtained his JD at the National Law Center at George Washington University. He has since practised as an associate at Akin Gump Strauss Hauer & Feld, LLP before joining Kim & Chang in 2001. Mr Kim is a member of the New York State Bar.