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Speech by Ms. Tay Bee Bee, Director
Monetary Authority of Singapore Derivative FitchGlobal Structured
Credit Conference 14 May 2007, Pan Pacific Hotel Singapore
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Evolution of CDO
Market
Good afternoon, ladies
and gentlemen. I am Tay Bee Bee, from the Monetary Authority of
Singapore. I am head of the Debt Market and Treasury Division,
which is responsible for the strategic development of the debt
capital market in Singapore. I am therefore pleased to be invited
by Derivative Fitch to speak at today¡¯s Global Structured Credit
Conference, to share with you our observation and vision of the
development of structured credit products in Singapore.
According to Fitch,
structured finance issuance has outstripped corporate issuance for
the past 2 years. Notably, among the various securitized asset
classes, Collateralised Debt Obligations, or CDOs have registered
the fastest growth in recent years. In the last 5 years, CDO global
issuances have grown more than 6 fold to US$600 billion in 2006,
with the market doubling in the past year. Excitingly, the growth
trend in structured finance and CDOs are expected to continue in the
next few years.
Allow me to comment on
the growth of CDO market along two dimensions. CDO started out as a
domestic instrument in the US, sold to US investors in the 1990s. It
was later sold to European investors, which in turn generate demand
for European-based CDOs. US managers set up offices in Europe to
manage European CDOs. At the same time, as more CDO expertise and
technology were transferred to Europe, we saw the emergence of
European managers. Today, we are experiencing a similar phenomenon
in Asia. Asian investors are already strong buyers of both US and
European CDOs. In addition, we are seeing a small number of Asian
CDO managers issuing deals to international investors.
Another dimension to
examine the CDO growth story is in the underlying assets. The list
of the types of underlying assets backing CDOs has expanded to
include bank loans, emerging market debt, middle-market loans, REITs
and asset-backed securities. The development of liquid markets for
credit default swaps (CDSs) led to the appearance of synthetic CDOs,
which allowed players to gain exposure to credit risk without the
need to hold the underlying collateral. In other words, any asset
for which there is a regular cashflow or which a synthetic
instrument is used to create that cashflow can be put into a CDO.
Asian Structured
Credit Market
What does this portend
for the Asian markets? As I had mentioned earlier, we strongly
believe that Asia will follow the growth path of US and Europe, and
that we can expect to see more Asian-based CDOs and securitization
deals to surface in the near future.
In my view, there are at
least 3 sources of Asian assets, which are potentially large and
diverse enough to support CDO origination.
First, with strong
growth and rapid urbanization, Asia will need to undertake large
amounts of fixed investments over the next decade, particularly in
real estate and infrastructure development. An increasing
proportion of this will be securitized. Last year, over half of
Asia ex-Japan¡¯s cross-border securitization issuance was in
mortgage-backed securities, with a number of mega deals in excess of
US$1 billion each. This was fuelled by strong RMBS issuance in South
Korea as well as CMBS issuance in Singapore. While we can expect
more CMBS issuances out of Singapore, Standard and Poors also
anticipates that mortgage corporations in Thailand and Malaysia will
issue in the international capital markets to fund the demand for
housing finance in their markets.
In the arena of project
financing, project bonds are still relatively rare in Asia.
However, we believe this will certainly grow over time. Asian
countries are projected to invest as much as US$250 billion a year
over the next 5 years on infrastructure. With the strong support
rendered to the development of domestic bond markets in Asian
countries, we believe there will be an increasing role for debt
capital markets in infrastructure financing space.
Let me now touch on the
next source of underlying assets - leveraged loans.
There is a surge in
leveraged buyout activity in Asia. In 2006, LBOs in Asia hit a
record level of US$22 billion, more than double the level in 2005.
This year, with more private equity funds focusing on Asia, LBO
activities are expected to grow further. This can lay the
foundation for an active leveraged loan market, similar to those in
Europe and the US.
The third, and no least
important source of underlying assets, is SME loans.
There are a
significantly large number of small and medium sized borrowers in
Asia, which are often too small to be rated and to access the bond
market. However, securitization technologies now allow these loans
to be pooled together, and to be repackaged into rated tranches that
appeal to and could be sold to international investors. In
Singapore, we had launched the SME Access Loan Scheme to help Small
and Medium Enterprises (SME) gain greater access to the capital
markets by issuing bonds backed by SME loans. We have also seen
similar SME-linked CLOs issued in Malaysia.
While the prospects for
the Asian market look promising, the market is not without its
challenges. It is clear to market practitioners that there are a
host of issues that need to be addressed in many countries in the
region. These issues would need to be resolved if we were to see
explosive growth of structured finance in the region.
One key challenge is
that the market is fragmented: in terms of legal framework,
currencies, regulatory treatment as well as accounting standards.
This complicates the process of managing CDOs with underlying assets
across various Asian countries.
Each of these limbs also
poses its own fundamental challenge, for instance, the legal
environment. Financial engineering innovations such as the CDO
technology can only modify cash flow and risk structures. What it
cannot do is to change the legal environment of the underlying
assets. If I can illustrate with an example; English law allows the
originator to transfer the underlying assets to the SPV by assigning
its rights against the underlying debtor to the SPV. However, the
laws in some Asian countries are still not clear as to which
transfer methods are legally binding, for both domestic and
cross-border transfers. The governments in the region recognize this
fundamental requirement and are making concerted efforts in
improving and harmonizing their respective legal frameworks.
There is also a lack of
technical expertise and understanding of the Asian market by
domestic and international players. However, the various players are
taking action to mitigate these risks. Domestic institutions are
building up knowledge in the securitization space. Rating agencies
are collecting longer data series on default rates and correlation
numbers in Asian credits in order for them to better assess the
structure of each deal. International players are also setting up
offices in Asia to better understand this region. I think it is only
a matter of time before the securitization market in Asia will truly
take off.
Implications for
Singapore
As the Asian market
grows, we can expect to see the risks and challenges faced by the US
and European markets replicated here.
What can the authorities
do to mitigate these risks? Singapore¡¯s approach is to ensure that
our regulatory framework remains appropriate and robust in
addressing these market developments. For example, we have issued
banking guidelines with respect to securitization and credit
derivatives and we are constantly reviewing the framework to take
into account new instruments and financial innovations.
Financial institutions
also need to raise their risk management capabilities and oversight
to deal with such new instruments. Hiring the right people will be
important, and the MAS is committed to developing the talent pool
within the industry. I will touch on this in more details later.
Our approach has served
us well. Over the last 3 years, Singapore managers originated more
investment CDOs than any other country in Asia ex-Japan, with an
estimated S$6 billion of CDOs in 2006. In addition, from managing
predominantly US-based deals, Singapore managers are now looking at
increasing the Asian content in their deals. A number of
international CDO managers have also set up shop in here, with the
view to manage Asian-based CDOs.
Now, allow me to take a
moment to highlight some of the progress we have made in the
regulatory regime in Singapore, to keep pace with the market
development and growth in structured finance products.
In Asia, Singapore has
been pro-active in providing clarity and certainty on the treatment
of CDOs into our regulatory regime. Banks have been allowed to
invest in all tranches of CDOs, while insurance companies have been
permitted to invest in the equity tranches of CDOs since January
2006.
Also, MAS has updated
and amended the banking rules on securitization in September 2005.
As an illustration of the amendments, synthetic arbitrage
transactions are now clearly excluded from the scope of those
rules. Previously, banks acting as originators or managers in
securitisations had to seek MAS¡¯ prior approval for these
transactions. With the amendments, they need only notify MAS after
the transaction. Banks have welcomed these and other changes to the
rules.
Allowing financial
institutions to invest in CDOs is, of course, only a first step in
facilitating participation in this new asset class. Another issue
is the amount of regulatory capital that banks and other financial
institutions are required to hold against the credit exposures they
have acquired.
In this respect, MAS has
also taken steps to refine the calibration of regulatory capital
required for CDO investments. This was done through recent
amendment to MAS Notice 628 to banks. Previously all CDO
investments, regardless of rating, were deducted in full from
capital. With the amendment, tranches rated BBB- and above are risk
weighted at 100%. The treatment is closer to the risk weights under
proposed Basel II standardized approach, which applies a 20% risk
weight for investments rated AA- and above. However, even with this
adjustment, we are still more stringent than Basel II standards for
rated tranches for the time being.
Manpower
Training
Lastly, I would like to
share with you our thoughts on manpower and training. The
availability of skilled professionals for structured finance is
crucial and the MAS is committed to developing the talent pool for
the industry. First, we have put in place a Financial Training
Scheme. This scheme provides co-funding for short-term courses or
attachments for risk management professionals.
Last year, we also
launched the Finance Scholarship Program. The aim of this program
is to help groom a critical mass of specialists in targeted fields,
such as financial engineering and risk management. The scheme
provides scholarships for the pursuit of higher degrees at
top-ranked universities in these fields globally, as well as in
Singapore.
These efforts are
complemented by efforts undertaken to provide suitable training
program for CDO professionals. An example is the Certificate in
Financial Engineering, launched by The Risk Management Institute, in
collaboration with the UC Berkeley.
In conclusion, Asia is
entering a very interesting phase in the development of the
structured credit market for the region. We strongly believe in
this vision and are committed to building Singapore as a centre for
structured finance activities. We welcome you to be a part of this
exciting growth and development.
Thank you.
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Source:
www.mas.gov.sg Media Release
14 May 2007
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Growth of structured finance
products in Singapore
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