Korea

Author: | Published: 10 Oct 2001
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Korean cross-border securitization has developed rapidly over the past 18 months. This article considers some of these recent developments including which originators can securitize their assets, the role of the Korean special purpose company, the transfer of assets, what constitutes a true sale, tax considerations, mortgage securitizations and recent legislation.

ELIGIBLE ORIGINATORS

The Korean Asset Backed Securitization Act of 1998 (the ABS Act) has significantly increased opportunities for securitization in Korea. However, not all companies in Korea may undertake securitization transactions under the ABS Act. Only certain government entities and financial institutions are eligible to act as originators in securitizations under the ABS Act, including:

  • Korea Asset Management Corporation (Kamco);
  • the Korea Development Bank;
  • the Export-Import Bank of Korea;
  • Industrial Bank of Korea;
  • banks established under the Banking Act;
  • insurance companies;
  • securities companies established under the Securities and Exchange Act and investment trust companies established under the Securities Investment Trust Business Act;
  • mutual savings and finance companies;
  • certain financial companies established under the Credit Specialization Financial Business Act;
  • Korea Land Corporation;
  • Korea Housing Corporation; and
  • the Manager and Administrator of the National Housing Fund.

In addition to those institutions listed above certain Korean and foreign corporations with a sufficiently high credit rating may be eligible as originators under the ABS Act if they obtain prior approval from the Financial Supervisory Commission of Korea (FSC). Companies which do not fall within the categories of eligible originator may still securitize their assets outside of the securitization regime of the ABS Act.

Even where the originator falls within one of the allowed categories, the FSC will require an approved securitization plan to be registered with it in relation to any proposed securitization under the ABS Act. The securitization plan must specify the type of assets to be securitized and the classes of asset-backed securities to be issued. In addition, the principal documents for the transaction must be translated into Korean and filed with the FSC and will be available for public inspection.

SPECIAL PURPOSE VEHICLES

The ABS Act provides for SPVs and trust companies incorporated pursuant to the ABS Act and foreign companies specializing in the business of asset securitization to purchase assets and issue notes in securitization transactions. Until the ABS Act came into effect the concept of a company incorporated for a specific purpose or transaction was not recognized under Korean law.

Korean companies do not have shares as such but have equity interests which are owned by equityholders. In both domestic and international securitizations the originator is often a minority equityholder in the SPV. The remaining equity interests are usually held by a third party which also provides the sole director for the SPV.

The SPV incorporated under the ABS Act must be a limited liability company under the Commercial Code of Korea. It is exempted from certain requirements otherwise applicable to limited liability companies incorporated under the Commercial Code. It is, however, subject to certain specific restrictions: it may have only one place of business in Korea and may not hire employees. Nor may it merge with other companies or change its corporate structure. The SPV is only allowed to engage in activities relating to securitization, including the purchase, administration, management, assignment and disposition of securitized assets.

Other than matters requiring equityholders' resolutions or matters which are within the powers of directors or auditors, the SPV is required to delegate its business affairs to the originator of the transaction or to a third party. Furthermore, servicing of the SPV's assets may only be delegated to a limited number of institutions including the originator, a licensed entity engaged in credit information business or such other entity specified in the ABS Act. The servicer is required to keep the securitization assets under its management (and any moneys received in connection with such assets) separate from its other assets so that, in the event of the servicer becoming insolvent, the securitization assets would not form part of the servicer's estate.

The ABS Act allows the SPV to purchase and securitize most types of assets (including real property) and, following an amendment last year, now allows the SPV to securitize assets owned by another SPV or trust company and securities backed by assets owned by another SPV or trust company.

The SPV may issue debt securities pursuant to the ABS Act. The issuing of foreign currency denominated securities to non-Korean entities is regulated by, amongst other things, the Foreign Exchange Transaction Law. Such securities which have a maturity of less than one year or have a maturity of in excess of one year but where 20% or more of their principal amount may be redeemed within one year of issue require the prior approval of the Ministry of Finance and Economy.

TRANSFER OF ASSETS AND TRUE SALE

Transfer of assets

The majority of domestic and international securitizations to date have been either lease or loan securitizations although there has been an increasing number of transactions involving other asset classes such as airline receivables, auto loans and credit cards and which now include future flow and revolving structures. Under general Korean law, to make the transfer of such assets enforceable against each obligor of the relevant lease or loan, notice to, or the consent of, each obligor would be required.

Under the ABS Act the transfer of the securitization assets must be registered with the FSC where the assets are transferred by the originator to the SPV (and also where the SPV creates a pledge over those assets). Such registration under the ABS Act operates to perfect the transfer of the assets against third parties. Any future purchase of assets by the SPV (for example in the case of a transaction with a revolving portfolio of assets) will require such purchase to be registered with the FSC, as will any permitted repurchase of securitized assets by the originator following a breach of representation relating to such assets.

True sale

The second key issue in relation to the transfer of the assets is that of true sale. The distinction between a transfer being a true sale as opposed to the creation of a security interest is of fundamental importance in the event of the liquidation of the transferor. Where the transfer of assets is deemed a true sale, the liquidator of the transferor has no claim on the transferred assets. Where, however, a transfer of assets is regarded, under Korean law, as being merely the creation of a security interest, the liquidator of the transferor may have a claim on the transferred assets.

Under the ABS Act, the transfer of assets will be treated as a true sale and not the creation of a mere security interest only if such transfer satisfies all of the following criteria:

  • the transfer is by way of a sale and purchase;
  • the transferee must have the right to the profits of, and the right to dispose of, the transferred assets, except that the transferor may have a right of first refusal when the transferee disposes of the assets;
  • the transferor does not have any right to demand the return of the transferred assets and the transferee does not have any right of reimbursement with respect to the consideration paid for the transferred assets; and
  • the transferee assumes all risks (a term which is not defined in the ABS Act) with respect to the transferred assets, except the transferor may bear such risks for a certain period of time or may provide warranties for defects in the transferred assets.

It is not yet certain how narrowly or broadly Korean courts will interpret the true sale criteria set out in the ABS Act in the context of securitization transactions.

SECURITY

The subject of taking security in Korea falls beyond the scope of this article. However, reference should be made to the Secured Bond Trust Act in so far as it affects securitization transactions where security is taken over assets located in Korea to secure notes or bonds issued by Korean SPVs. The Secured Bond Trust Act limits the type of security which may be granted and the types of assets which may be secured in connection with secured notes and bonds. In both the Kamco and the recent Hanareum Mutual Savings & Finance Corporation (HMSF, a wholly owned subsidiary of Korea Deposit Insurance Corporation) securitizations the Korean SPV pledged the securitization assets to a Cayman SPV as purchaser of the senior bond. The Cayman SPV in turn assigned such pledged rights to the trustee of the notes issued by the Cayman SPV to international investors.

To restrict the rights of the equityholders in connection with their equity interests in the Korean SPV during the term of the securitization, it is common for the equityholders to pledge their rights in and to the equity interests in the Korean SPV in its capacity as purchaser of the securitization assets. Such rights are then assigned by the Korean SPV to the Cayman SPV as security for the payment obligations owed by the Korean SPV in respect of the senior bond issued by it.

TAX CONSIDERATIONS

In general and unless exempted or reduced because of the application of double taxation treaties, Korean withholding tax of 27.5% will apply to interest or rental payments made by a Korean obligor to an offshore SPV. Withholding tax may be minimized if the offshore SPV is incorporated in a jurisdiction which benefits from a double taxation treaty with Korea, such as Ireland. This was the structure in the KDB Capital securitization of lease receivables last year. Withholding tax in respect of the securitization assets will not be payable if interest or rental payments are made by a Korean obligor to a Korean SPV incorporated under the ABS Act. Interest payments in respect of notes issued by a Korean SPV to non-resident investors will not be subject to Korean withholding tax in certain circumstances. Payments by a Korean SPV to Korean resident investors will, however, be subject to withholding tax. Accordingly, in transactions where there is a subordinated bond which is purchased by the originator, withholding tax will be payable by the holder of the subordinated bond, on the basis that it is a Korean entity. When such tax is payable depends on whether the subordinated bond is in bearer or registered form.

An SPV which is incorporated in Korea or which has a permanent establishment in Korea will be subject to Korean tax. Accordingly an offshore SPV must take care to ensure that it is not engaged in business, directly or indirectly, through the management of assets in Korea which would result in it being deemed to have a permanent establishment in Korea and which would therefore make it liable to taxation in Korea. The two SPV structure employed in the HMSF transaction was used to ensure that the Cayman SPV was not deemed to have a permanent establishment in Korea, whilst the Korean SPV was able to pay interest without deduction of withholding tax to the Cayman SPV as a result of the exemption referred to above.

Certain additional tax benefits are available to securitizations under the ABS Act (and also the Mortgage-Backed Securitization Company Act, the MBS Act) including:

  • acquisition tax and registration tax are exempted in respect of real property purchased by an SPV on or prior to December 31 2001;
  • SPVs under the ABS Act and the MBS Act are not subject to value added tax in Korea;
  • if an SPV incorporated under the ABS Act distributes 90% or more of its distributable profit as dividends, the amount of such dividends will be deducted from its taxable income.

MORTGAGE SECURITIZATION

The MBS Act came into effect in April 1999 for the purpose of providing long-term financing for the construction of residential housing through the establishment of mortgage-backed securitization companies and the issuance of mortgage-backed securities.

A mortgage-backed securitization company under the MBS Act (an MBS Company) requires approval from the FSC and must:

  • be a joint stock company;
  • have paid-in-capital of not less than Won 25 billion; and
  • have a BIS ratio of not less than 8%.

Whilst an MBS Company does not fall within the ABS Act, the MBS Act does address many of the legal issues involved in a Korean securitization including registration of a securitization plan, true sale and perfection of title in the same way as the ABS Act.

In September 1999, Korea Mortgage Corporation (Komoco) was established under the MBS Act. Its principal equityholders consist of the Korean Ministry of Construction and Transportation, Housing & Commercial Bank, Kookmin Bank, Korea Exchange Bank, Samsung Life Insurance and the International Finance Corporation. Komoco's fourth mortgage-backed securitization closed on May 1 2001. As of yet there have been no cross-border Korean MBS transactions.

RECENT LEGISLATION

The Corporate Restructuring Promotion Act came into effect on September 15 2001. This Act applies to:

  • certain financial institutions (creditor financial institutions) which are creditors of a company;
  • which have provided credit (of a certain minimum amount) to that company; and
  • where such company may not be able to repay such indebtedness without financial support.

Under this Act, one of the options available to the principal creditor of such a company is to determine that the management of such company should be undertaken by its creditors, and this has two major consequences. First, the principal creditor is required to notify the FSC, whereupon the FSC may request the suspension of enforcement of the claims of third parties against the company (including enforcement of security against the company) before the first meeting of the committee of creditors. Secondly, the creditors of the company may then impose a suspension period of up to two months of the payment of indebtedness to creditors.

How does this affect an ABS transaction? A Presidential Decree in respect of this Act provides that an SPV established under the ABS Act may be included in the definition of creditor financial institution. If the SPV is deemed to be a creditor financial institution and if the sale of the securitization assets by the originator to the Korean SPV is categorized as providing credit for the purpose of the Act, the Korean SPV may be restricted in enforcing its rights against the originator – in ABS transactions, the principal claim a Korean SPV is likely to have against the originator is for enforcement of the originator's obligation to repurchase assets in the event of a breach of representation in respect of such assets. In addition, the Korean SPV may be restricted in enforcing its rights against corporate obligors in respect of the securitization assets. However, there is some uncertainty at the time of writing this article as to the precise scope of the Presidential Decree in the context of securitizations, and as to whether it applies to SPVs.


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