Road Map for Developing an Online Platform to Trade Nonperforming Loans in Asia and the Pacific

A sharp increase in nonperforming loans (NPLs) could destabilize financial systems in Asia and the Pacific and compromise post-pandemic economic recovery. This report explains how trading distressed assets could help relieve pressure on banks to ensure they have the capacity to continue financial intermediation. It examines the feasibility of establishing an electronic marketplace to facilitate the trade of NPLs in the region. Designed to serve as a road map, it assesses the region’s demand and readiness for an NPL platform, details the benefits it could offer, and explains how it could ultimately help countries improve their financial stability.

• Previous crisis experiences have illustrated negative and persistent macrofinancial effects NPLs can have on the real economy, underlining the importance of swift resolution measures • A sharp increase in NPLs could destabilize regional financial systems and compromise post-pandemic economic recovery • A developed market for NPL trading can contribute toward a swift and effective NPL resolution • While the development and deepening of NPL markets was on the policy agenda prior to the COVID-19 pandemic, current economic and financial conditions underscore the relevance of swift resolution of banks' NPLs.
 Against this backdrop, this report seeks to examine the feasibility of establishing an NPL transaction platform for Asia and the Pacific region • IPAF CCM suggested an assessment of the readiness and feasibility of establishing an NPL trading platform in Asia • ADB prepared this feasibility study with assistance from a number of different parties • The study benefitted considerably from IPAF members' support.Interviews and surveys with numerous IPAF members were conducted and insights incorporated into report   Difference between net book value and the estimated bid price

As a result of the above, such markets typically see low transaction volumes and low prices, notwithstanding strong levels of supply and good investor appetite
Limited numbers of active investors -including as a result of high transaction costs which act as a barrier to new entrants (due diligence costs only recoverable for successful bidders -limits investors to those that can afford to absorb them and therefore excludes many small potential investors) High bid ask spreads -as a result of information asymmetries and poor data quality, and/or unrealistic pricing expectations Predominantly domestic market -restrictions on repatriation of profits/ownership of assets, etc. will limit foreign investors' appetite as will any regulatory or legal uncertainties e.g., around enforcement.Investors will require access to a range of different, independent service providers (e.g., servicers, valuers, legal advisers, appraisers, etc.) -the absence of an appropriate independent loan servicing infrastructure could be a further constraint

Limited information around market prices and volumes
A number of factors contribute to low prices and transaction volumes notwithstanding potentially good supply and demand.Common features of underdeveloped NPL markets include:

Servicer
• Depth of experienced servicing and restructuring skills is a key driver for recovery.Sufficient servicing capabilities are required to effectively rehabilitate debtors.
• Foreign buyers sometimes team up with trusted local servicers to manage NPLs post-transaction.
• A creditor-friendly legal regime for restructuring, enforcement and insolvency would improve recovery from distressed assets from an investor's perspective.
• Lengthy and complex enforcement processes in some markets create uncertainty, increase collection costs, and ultimately lead to a wider bid-ask spread for NPL sales.

Legal Enforcement Frameworks Advisor
• An advisory community with sufficient skills and resources to support transaction activity (e.g., valuations, due diligence, legal, etc.)

Seller
• A sizeable supply and a visible pipeline of future deals are critical in attracting investors.
• Sellers should commit to the transaction with realistic price expectations.The reluctance of banks to accept losses/restrictions on banks' ability to sell below par will discourage NPL transactions.

Buyer
• Participation of foreign investors in domestic NPL markets offers banks access to larger capital pools, which can absorb increased levels of bad debts.
• However, restrictions on buyers, especially foreign buyers, (e.g., limited ownership, restricted deal structure) create barriers to new entrants.

Regulator
• Clear and supportive frameworks for NPL transfer and investment are crucial to developing an efficient market.
• Some countries in Asia still lack policy guidance around resolution methods and loan sales.
Several factors need to be present to allow an active NPL market to develop.And no single global solution.Rather, countries have developed their own bespoke frameworks for dealing with rising NPL stock.
Illustrative NPL Transaction -Simplified Process The diagram below shows the typical NPL transaction process, from portfolio selection and process design, to information preparation, notification, due diligence, the auction process and completion.Some aspects of the process lend themselves more readily to being managed through an online platform (e.g., notification and bidding).
Step 1: The seller publishes notice on the auction.
Step 2 (offline): Bidders conduct site visit and due diligence.
Step 4: Bidders submit the bids.
Step 5: Confirm the winning bidder.
Source: Based on Taobao process. • Step 1 -The online notice typically includes: a basic description of the asset, any defects, key documentation, seller's reserve price, eligibility of the bidders, auction process, timeline, contact details of the seller, etc. • Step 2 -Based on the (non-confidential) information provided in the public notice, interested buyers proceed with due diligence which may be managed offline.All the information provided on the main auction page will be fully public and will not require a non-disclosure agreement ("NDA").• Step 3 -To participate in the auction, bidders may need to pay a deposit through the platform's online payment system which will be frozen until the end of the bidding process.• Step 4 -Once the deposit is paid, a bidder can submit their bid on the auction page.All bids submitted are live, anonymized and visible to other participants.

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Step 5 -The bidder with the highest bid wins the auction, and the system automatically generates a confirmation letter stating the winning bidder.Where the sale is by way of judicial auction (e.g., in PRC), the confirmation letter is published on the auction page, stating the name of the vendor, the buyer, and the transacted price thus, providing full transparency.For other (nonjudicial) auctions, including NPL sales by banks or AMCs, details will not be made fully public.• Step 6 -The buyer contacts the seller offline to execute the transaction documentation and complete the transfer.

Transaction facilitation
• Acts as a marketplace for sellers looking to sell NPL stocks and for investors looking to buy as well as facilitating portfolio trades, the platform would allow the bundling of smaller portfolios together which might be of interest to specific buyers • Offers standardized, ready to use documentation (NDAs, sales and purchase agreements, etc.) to avoid lengthy contract negotiations • Existing in use platforms already include:  Q&A functionality and real-time updates for answers/documents uploaded  An auction platform (English Auction with binding public bids) with the ability to solicit nonbinding bids (market soundings), set reserve prices, etc.

Matching buyers and sellers and online auction
• In order to reduce transaction and search costs, the NPL platform would ensure data sharing and a high degree of data standardization.Completeness and other checks could be built in to enhance data quality as well as a range of data analytics tools.
• Unlikely to fully remove the need for additional due diligence but nevertheless fundamental to success.

Automated checks to provide a level of assurance on data quality/analytics
• Electronic database, regularly updated with detailed loan level data, including both financial information and other qualitative information (e.g., legal documentation, security documents, payment history, collateral appraisals, borrower correspondence, etc.)

Hosting of detailed loan portfolio information -financial and non-financial data
Portfolios visible to more potential investors and greater transparency Reduced bid ask spread, higher prices, faster resolution Below diagram is an example of what may be offered through an online trading platform.

NPL Transaction Platforms: Practical Issues
The report identifies nine practical issues that require consideration when rolling out an online NPL transaction platform. 15

Fee structures
Tax and currency exposures

Incentives for investors and creditors
Banking secrecy and data protection

International development organizations
The platform is established and owned by an international or regional development organization.This ownership type could help minimize both political and commercial conflicts of interests.

Public-private partnership
A balanced cooperation between the private sector and government in each participating country.
An option to consider may be an evolution of PPP, where the state plays a greater role during the initial stages of the platform development and exits the project once it is fully functioning.

Asset management companies
Considering their vast experience and that they may already have their own platforms, AMCs could also be an option for 3rd party disposals; as owners of NPLs, this could be perceived as creating a conflict of interest if transacting assets other than their own.

State ownership
The platform is jointly owned by the governments of participating nations either in equal shares to minimize potential conflicts around the leadership or undue influence, or according to the respective NPL market size in each country, or the level of investment.State involvement brings with it a risk of political interference.

Private ownership
A single or a group of independent private operators, experienced in running similar platforms (e.g., Alibaba and JD in PRC, DEBITOS in Europe) and without any state involvement.
Guidelines could be introduced to cover best practice execution.
How heavily should the platform be regulated?Contrast where the platform does not represent financial market infrastructure (and hence, may not need to be regulated) with the situation whereby the platform becomes a quasi monopoly.Also depends what services are offered. Level playing field-NPL markets and platforms should be regulated on a non-discriminatory basis, with the same standards and regulatory requirements applying to both foreign and domestic NPL investors.
 A level of minimum standards should be developed both in terms of NPL markets generally and online NPL platforms.
 Balanced protections for consumers-sustainable collection practices which protect consumers and borrowers and industry standards that do not restrict lenders' ability to efficiently work out NPLs.
 NPL markets and ecosystems are at different stages of readiness.As such, development of a regional platform may best be attempted by way of a phased approach.
 A network of platforms could be an option, with common standards in terms of best practice operation and information disclosure, cooperating with each other to maximize reach and the number of transactions.

Outline 1 .
Background: Road Map for Developing an Online Platform to Trade Nonperforming Loans in Asia and the Pacific 2. Practical Considerations in Developing an NPL Platform 3 AFG = Afghanistan; ARM = Armenia; AZE = Azerbaijan; BAN = Bangladesh; BRU = Brunei Darussalam; CAM = Cambodia; HKG = Hong Kong, China; IND = India; INO = Indonesia; IRR = internal rate of return; JPN = Japan; KAZ = Kazakhstan; KOR = Republic of Korea; KGZ = Kyrgyz Republic; MAL = Malaysia; MLD = Maldives; MON = Mongolia; NPV = net present value; PAK = Pakistan; PHI = Philippines; PRC = People's Republic of China; SIN = Singapore; SRI = Sri Lanka; TAJ = Tajikistan; THA = Thailand; UZB = Uzbekistan; VIE = Viet Nam.Notes: For Cambodia and Kazakhstan, only the total NPV loss is reported, without being separated into bank perspective and investor perspective.The bank lending rate data is not available in these countries.Source: Lee, Park, Park, and Rosenkranz (2021)

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Who should own the platform and what governance model should apply?How would that differ for a regional model?How would the differing stages of development of NPL trading ecosystems affect the choice?Countries' Readiness for an Online NPL Transaction Platform 20 • Methodology: We used a scoring system to evaluate readiness for and or benefit from the development of an online NPL transaction platform, considering:  Absolute and relative NPL levels  Experience of NPL trading (incl.if already use of online platforms)  Strength of legal frameworks • Findings: The PRC, Thailand, Republic of Korea and Indonesia may have a greater readiness for and/ or benefit most from such an initiative.• Kazakhstan and Viet Nam governments are actively exploring development of an online NPL platform Key Principles for the Development of NPL Markets and an Online Trading Platform 21 Harmonization-adoption of agreed international standards for NPL recognition and valuation methodologies.