While Taiwan is generally noted for its hi-tech industry and often hailed as a model for regional development, the island's financial sector has at times lagged behind its regional peers.
This is changing – fast. In recent years, Taiwan has focused relentlessly on catching up with its neighbours. Now, the growth of its securitization market – arguably the most significant development in its financial sector over the last three years – has set it up as one of the region's most sophisticated.
Since its first deal in 2003, the Taiwanese securitization market has grown rapidly: six issues were completed in 2003, rated by the three major rating agencies, and nine issues were completed last year.
The island's landmark securitization law is important for the region in another respect: it serves as a useful template for other civil law countries, such as Thailand and mainland China, which are trying to develop their own securitization markets.
Behind Taiwan's success in this market is its willingness to take up recommendations from the private sector, both foreign and domestic, to develop the market, in marked contrast, analysts note, to some of its peers. "Some other Asian economies, including mainland China, have been noticeably slower in responding to recommendations from banks and other financial services firms," says one financier.
Laying down the law
Partly in response to proposals from the finance industry, the Taiwanese authorities have expanded on the 2002 Financial Asset Securitization Law, with a Real Estate Securitization Law in 2003 and legal revisions to allow the securitization of asset-backed commercial paper early last year, notes Ben McCarthy, a senior director at Fitch.
The market is now calling for more efficient approvals systems for securitizations – a request to which Taiwanese regulators have again responded positively in recent months. Ramping up rate of approvals removes a major hurdle in Taiwan's bid to become a leading player in one of the most sophisticated segment of financial services.
"Previously, applications for publicly placed deals under the Financial Asset Securitization Law deal had to be filed with the Bureau of Monetary Affairs (BOMA) and then, following approval from BOMA, with the Securities and Futures Bureau (SFB)," says Clementine Kiang, associate director at Taiwan Ratings. Now, the approvals process has been combined with BOMA as the only contact window. To help speed up the approvals process, BOMA and SFB will review the documents concurrently.
Robin Chang, a lawyer at Lee and Li in Taipei, says that BOMA has also proposed to amend the regulations to allow a shelf registration mechanism, which would allow issuers more leeway in deciding when to issue. "At the moment securitizations must be issued within one month after approvals have been received by the regulators," says Chang. "During that period, the market and interest rate situation may not be optimal for the issuer." Chang says the shelf registration system would allow issuers to launch deals up to two or three years after the necessary approvals have been given.
As the market develops, new and more complex structured finance products are likely to emerge. On the one hand, this will demand a greater degree of investor education on the island, notes McCarthy. But Taiwan is fortunate in that its investor base is already highly developed, relative to many other Asian economies. "Taiwanese investors are being targeted on a large scale with innovative products like synthetic CDOs (collateralized debt obligations). We have also seen that Taiwanese investors are willing to move down the credit spectrum in search of yields."
The depth of Taiwan's investor base was highlighted by a recent deal, the Hung Tai Real Estate Asset Trust Securitization, which featured an unrated mezzanine tranche, sold to private investors. It is one of the few transactions in Taiwan to have included mezzanine paper. (Mezzanine finance is debt finance with equity characteristics, and usually features higher risk and higher yields.)
In the last six months, Taiwan's government has further enhanced its investor base by allowing insurance companies to invest in structured products, notes Hilary Tan, associate director at Fitch. This liberalization should provide a quick boost to the CDO market. "I would expect the market to double in size in 2005," says Vinod Aachi, managing director of the Asian Relative Value Group at Deutsche Bank. Analysts believe about five CDOs were issued into the retail market in Taiwan in 2004, with a further five or six deals arranged for the insurance market.
Tax relief
Another important feature of Taiwan's structured finance market, and one which sets it apart from some other Asian jurisdictions, is its light tax regime for investors. "The tax system in the financial markets is generous compared with other markets," says Richard Watanabe, a tax partner at PricewaterhouseCoopers. "Capital gains on securities and futures transactions are tax free and transaction tax is set at only 0.3%," he says. This light tax regime suggests one reason for Taiwan's well developed investor market.
However, faced with a persistent government budget deficit, Taiwan's National Tax Administration (NTA) and ministry of finance have sought to raise the level of tax paid by participants in the structured finance, and last year proposed increasing the rate of tax applied to the equity portion of securitizations from 6% to 20%. The existing 6% rate gives issuers considerable tax arbitrage possibilities. For instance, the two property companies behind the Hung Tai deal would normally have paid tax on rental income from the Hung Tai building at a rate of 20%. As they retain an equity interest in their securitization, they pay only 6% on interest income from the retained bonds.
While encouraging the investor market, Watanabe says, a tax light regime, once imposed, is difficult to reverse. "Taiwan's ministry of finance has proposed to increase tax rates before, but has faced tremendous opposition from the financial industry. Because the rest of the tax regime for investment products is light, the authorities would also find it hard to justify raising the rate of tax applied to securitization," he says.
For all its advances, Taiwan still has some way to go before it has established a world-class structured finance market. Both Fitch and Taiwan Ratings would like to see better data collection mechanisms to capture historical performance of assets. Additionally, for residential mortgaged-backed securitizations (RMBS), which are the most important asset class in many securitization markets, Chang says the government similarly needs to improve its systems for capturing and manipulating data.
"We would like to see a system for bulk registration of mortgages, as this would make RMBS much easier to do. But the ministry of the interior has said this won't happen until the computer systems in each land registry office are upgraded," adds Chang.
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"I would expect the market to double in size in 2005" – Vinod Aachi