The Financial Services Commission (“FSC”) is promoting the enactment of a special law for the issuance of covered bonds. Covered bonds are essentially secured bonds issued with certain terms that provide enhanced protection for investors and are secured by assets such as residential mortgages, public sector loans and vessel financing, etc.

Although similar to other asset-backed securities in this regard, covered bonds go a step further in affording protection to investors by providing bondholders with dual recourse against the financial institution that issued the covered bonds. More specifically, in addition to providing bondholders with recourse against designated prime asset pools maintained by the issuing institutions, the bondholders may also exercise direct recourse against the issuing institution (and its general assets), since the issuing institution also bears the primary legal obligation for redemption of the bonds.

The FSC has recently taken steps to speed up the pace of the process required for the introduction of the proposed legislation. Such steps include the recent formation of a special task force composed of representatives from both the public and private sectors, which held its first meeting on June 21, 2012. The goal of the task force is to examine similar laws in other jurisdictions and consider essential details such as the procedures and effects of covered bond issuances. Pursuant to completing this process, the task force is expected to prepare a draft of the proposed legislation by the end of July 2012 and the FSC has targeted November 2012 for submission of the proposed legislation to the National Assembly.

Timed closely with the formation of the above-mentioned task force, the FSC promulgated the Model Standards for Bank Issuances of Priority Repayment Bonds (the “Model Standards”) with the objective of diversifying the means for banks to procure funds (as part of the comprehensive policy to bring about a “soft landing” of household debt) and increasing the availability of long-term, fixed-rate residential mortgages. Under the Model Standards, banks that have a BIS capital adequacy ratio of 10% or higher at the end of the preceding fiscal year, and/or securitization vehicles established by such banks, may use such assets as residential mortgages (that contain certain specified terms) and MBS issued by the Korea Housing Finance Corporation based on such residential mortgages in forming underlying asset pools (“cover pools”) for their covered bonds, provided that the cover pools are maintained with a surplus collateral level equal to at least 5% of the outstanding principal amount of the covered bonds issued.

The Model Standards also require issuers of covered bonds to make quarterly appraisals of the quality, etc. of the collateral contained in their cover pools and report the results to investors. In the event that any assets held in the cover pool do not meet certain minimum qualifications, such assets must be replaced with qualifying assets. (For more details, please see the related Model Standards report in LEE & KO’s Summer 2011 newsletter.)

Although the Model Standards have established a basic regulatory framework for covered bonds, the Model Standards alone are not regarded as sufficient to guarantee the administration of a fully effective dual-recourse protection framework for investors. As a result, there has been a continuing perception that the enactment of a special law concerning the issuance of covered bonds is a necessary step to activate the covered bond market and thereby promote such related objectives as reducing bank funding costs, promoting stability in long-term bank fund procurement and expanding the availability of long-term, fixed-rate loans, with such outcomes being expected to have positive effects with regard to structurally improving the household debt situation in the economy as a whole.