Seoul leads in covered bonds legislation South Korea is leading Asian peers in setting up a statutory framework for covered bonds, aiming to boost financial stability by opening a long-term funding avenue for banks. The bill, due to go before parliament next month, will set down rules for the issuance of covered bonds by financial institutions, the first such Asian legislation. Covered bonds typically carry lower interest rates than senior unsecured debt because of the security provided by ringfenced assets as collateral. In the event of default, investors have recourse to the cover pool and potentially to the issuer's other assets. "This is likely to start something that will sweep Asia," says Mark Austen, chief executive of the Asia Securities Industry & Financial Markets Association. He expects Singapore to introduce a similar law next year, while Japan, India, Malaysia and Indonesia are also moving towards legislation. The trend is driven partly by Basel III regulations calling for banks to seek more long-term, stable funding. In principle, covered bonds should enable banks to achieve this at lower costs than those of other long-term debt, and their popularity has been growing. The market is still expanding in Europe, where the products were pioneered, with covered bonds worth $335bn sold there last year. In May the US Securities and Exchange Commission authorised a $12bn covered loan issuance by Royal Bank of Canada , although Congress has made slow progress towards passing a legislative framework. Several Australian institutions have issued the instruments since Canberra introduced legislation in October last year. There has already been some issuance in South Korea. State-backed mortgage lender Korea Housing Finance Corporation has issued several covered bonds under dedicated legislation. But while other financial institutions can issue covered bonds by drawing up a bespoke structure for the issuance, only one has: Kookmin Bank sold $1bn worth of bonds backed by mortgage loans and credit card receivables in 2009. Bankers say the new law will reinvigorate the market. "There will be a broadening of the investor base once the legislative framework comes in," says Rob Londrigan, Asia-Pacific head of debt capital market bonds at Commerzbank. Insurers are quite keen on having a legislative framework; US investors are quite keen on it. The law aims to strengthen investors" peace of mind by stipulating that the value of the assets in the cover pool must be at least 105 per cent of the face value of the bond issuance. Domestic macroeconomic concerns help explain South Korea's relatively fast movement on this front. The country has one of the world's heaviest burdens of household debt, at more than 160 per cent of household income. Strict loan-to-value limits mean the country does not face a US subprime crisis-style meltdown, and the rate of debt accumulation has slowed significantly over the past year. But the consumer debt pile is putting serious pressure on household spending, which rose only 1 per cent in the third quarter of this year despite a 6.3 per cent increase in household incomes. Beyond the amount of the consumer debt, regulators are concerned by its structure: according to September data from the Bank of Korea, 83 per cent of household loans are floating-rate products, which the authorities consider a source of instability. They hope that opening a new means for banks to obtain long-term fixed-rate funding will make it easier for lenders to offer correspondingly stable products to customers. By law, banks must ensure that at least 30 per cent of their mortgage assets are fixed-rate and long-term loans by 2016. Seo Na-yeon, a deputy director of the banking division at the Financial Services Commission, the main financial regulator, says: "Covered bonds will allow banks to raise long-term funds, so we expect them to switch some short-term mortgages into longer-term loans." Some experts play down the likely impact of the law. "Interest rates won't be much lower" relative to senior unsecured debt, says Hwang Seiwoon, a research fellow at the Korea Capital Markets Institute. Korean banks are already considered financially sound, and that's reflected in the borrowing rate . . .[credit default swap] premiums are at record lows. One drawback of covered bonds is that they require the issuer to tie up assets that could otherwise be put to other uses. Moreover, Korean banks face no serious funding problems, and demand for credit from consumers and companies remains weak amid subdued economic growth, argues Michael Na, an analyst at Nomura. But Martin Berry, head of retail banking at Standard Chartered Korea, says covered bonds will be a good means for Korean banks to reduce interest rate risk as regulation forces them to increase the proportion of fixed-rate loans on their balance sheet. "It's attractive from the perspective of better managing the structural mismatch of long term assets and shorter term deposits," he says.