securitization securitization | haidermotabnrcompanies (asset backed securitization) rules,...
Post on 25-Apr-2020
27 Views
Preview:
TRANSCRIPT
0
Securit izat ion | Ha idermotaBNR
PRACTICE AREAS
Banking & Finance
Capital Markets
Competition / Anti-trust
Corporate & Commercial
Dispute Resolution
Mergers & Acquisitions
Privatisation
Projects & Infrastructure
INDUSTRIES
Aviation
Electronic Commerce
Energy
Healthcare & Pharmaceuticals
Manufacturing
Natural Resources
Philanthropy & Not for Profit
Property & Real Estate
Technology, Media & Telecomm
Securitization 2004
1
Securit izat ion | Ha idermotaBNR
Dated: November 23, 2004
SECURITIZATION
A. SECURITIZATION STRUCTURE
This paper is intended to highlight certain issues relating to securitization in the context of the
Pakistani legal environment.
The term “securitization” encompasses a wide range of transactions. The renowned English jurist
of international finance, Philip Wood, contends that “securitisation is essentially a sophisticated
form of factoring or discounting of debts”. The classic model of securitization was adopted in the
Companies (Asset Backed Securitization) Rules, published by the SECP in 1999. On the basis of
this model, a typical securitization structure can be as follows:
-- The originator (i.e. the party wishing to raise finance) sells its present and/or future
receivables to a Special Purpose Vehicle (SPV) in return for a purchase price payable
immediately on sale. I will use the term sale and assignment interchangeably.
-- The SPV finances the purchase price of the receivables by issuing Term Finance
Certificates (TFC) or some other debt instrument. The SPV grants security to the
investors over the receivables to secure the borrowing. In case of a TFC offering, the
security is granted through the intermediation of a trustee.
-- The originator, as “servicer”, may continue to collect receivables on behalf of the SPV, in
return for which the SPV pays a servicing fee to the originator.
-- Any surplus income of the SPV after deducting the money required to repay the investors
is returned to the originator either as a service fee or through other methods of profit
extraction which I will discuss later.
-- The securitization transaction may involve a credit enhancer to ensure that the
receivables are sufficient to pay the investors on time. For example, a third party may
guarantee the obligations of the SPV.
B. ADVANTAGES OF SECURITIZATION
I am sure the other speakers will talk about the several financial and commercial advantages of a
securitization most notably relating to off balance sheet treatment. There are also various legal
impediments that can be overcome by securitization. I will mention three of them here. The first
is a regulatory obstacle: since the SPV does not fall within the regulatory ambit of the State Bank
the minimum debt to equity ratio requirement under the Prudential Regulations does not apply
where funding is provided by an SPV. Nevertheless, where investors in TFCs are banks in DFIs they
are required to comply with certain conditions set forth in a State Bank Circular issued in 2002.
These conditions include a minimum credit rating of “A” for the TFCs by an approved rating
agency as well as limits on banks’ total exposure towards the asset backed securities. The net
result is that banks and DFIs can structure a transaction whereby funding is provided to the
originator through the SPV without attracting Prudential Regulations IV and V. The State Bank is
placing reliance on the adequacy of rating of the debt instrument which I think is a step in the
right direction.
2
Securit izat ion | Ha idermotaBNR
The second legal hurdle that may be overcome through a securitization structure is a contractual
one: the originator may be party to one or more contracts which contain “negative covenants”
restricting the originator from creating any security interest over its receivables. A transaction
structured as a sale of receivables to the SPV can, in appropriate cases, overcome such negative
covenants. Indeed, the U.S. $ 250 Million International PTCL Securitization was not initially
structured as a true sale but when due diligence revealed that the Government had given
covenants to international institutions whereby it was restrained from creating security interest
over foreign receivables owed to public sector entities, the transaction was structured as a sale
of receivables. This is not an un-common use of a securitization structure in developed
economies.
Lastly, a securitisation structure can enable a private company (without converting itself into
a public company) to indirectly raise finances from the public, as TFCs are issued by the SPV
and not the originator.
C. LEGAL ISSUES
1. Assignment
Now I will try and analyse certain legal issues that arise in respect of this structure. Under
our laws, it is permissible for the originator to either sell the receivables or transfer the
receivables as security to the SPV. Both come within the meaning of assignment of
receivables: the former is an absolute assignment or true sale and the latter is an
assignment by way of security. Upon a valid assignment the SPV steps into the shoes of
the originator in respect of all rights of the originator against the debtor, that is, the
person who owes funds to the originator. I may also mention that an assignment of
receivables is a much superior form of security as compared to hypothecation of the
receivables because in the context of the assignment the lender step into the shoes of
the borrower at the time of creation of the security with respect to enforcing rights
against the debtors.
Subject to certain exceptions, to perfect an assignment, strictly speaking, consent of
debtors is not required but it is strongly recommended when the same is practical. The
practicality generally depends on the number of debtors. Consents would be highly
impractical in the context of securitization of utility bills where the utility’s customers are
numerous. Consents should, however, be obtained where, for example, lease rentals for
large plants and equipment are assigned. In the latter case the debtors are likely to be
few and the amount of receivable of each such debtor quite significant.
Even where consent is not obtained, notice of the assignment to the debtors should,
however, be given. There are case laws under our Transfer of Property Act to suggest
that if notice of assignment to the debtor is given, then the debtor's obligation can only
be discharged if payment is made by the debtor to the assignee, that is, the SPV. In other
words, if the debtors pay the originator after the notice has been given, its obligations of
the debtor to the SPV would not be discharged.
2. Present vs. future flow securitization
3
Securit izat ion | Ha idermotaBNR
In the context of securitization, present receivables relate to receivables that have been
generated out of any service rendered or any contract entered into. The fact that a
payment under a certain contract is due several years from today does not mean that
the securitization relates to future flows. Future flows refer to receivables that have not
been generated at the time of securitization, for example, utility bills that may be owed
by customers. Here, generally stated, at a future date the utility will be used by a
customer, where after the utility company will bill the customer thus generating a
receivable. The Paktel securitization is an example of future flow transactions where the
receivables are generated when the customer makes the phone call in the future.
The distinction between existing and future flow receivables is critical to determine
whether and to what extent off balance sheet treatment will be permitted. I understand
from friends in the accounting profession that in terms of IAS32 and IAS39 off balance
sheet treatment in respect of receivables other than future flow is a well-established
subject to fulfilling requirements of the IAS. Future flow is more complicated because
there are no receivables on the books against which the purchase price received on the
sale of receivables can be adjusted on the asset side and therefore an entry has to be
made on the liability side of the balance sheet. I understand that there is a US Accounting
Guideline called EITF 88-18 in respect of treatment of future flow securitizations. If the
conditions of such guidelines are satisfied, then notwithstanding the recording of a
liability on the balance sheet such liability amount may be excluded for the purpose of
determining debt equity ratio of a company which effectively means that several of the
advantages of off balance sheet treatment is also available in the context of future flow
securitizations. I may mention that these guidelines are not only beyond my expertise
but, quite complicated, onerous and in my view somewhat unclear.
3. True Sale
The next issue that I would like to deal with is the concept of a true sale. Before I discuss
true sale, however, I want to deal with a popular misconception that securitization
necessarily involves a true sale. Instead of purchasing receivables, it is perfectly feasible
for an SPV to lend funds to the originator and have the receivables assigned to it by way
of security. The only circumstance where this is not possible is where the originator is a
bank/DFI. In this case, the State Bank Circular requires securitization to be by way of true
sale and lays down very stringent standards for such sale. This is so because sale of banks
assets impacts on the capital adequacy ratios, which I will discuss in the context of a very
brief discussion on mortgage securitizations later.
For entities other than banks/DFIs a loan structure through an SPV is an option. This
structure is advantageous for investors from a risk point of view. As with a true sale, the
SPV would be entitled to sue and recover directly from the debtors. In addition, it would
have full recourse against the originator for outstanding amounts in the event
receivables dry up. The structure is disadvantageous from the originator’s point of view
because the receivables will remain on its balance sheet.
4
Securit izat ion | Ha idermotaBNR
Getting back to true sale, determining whether or not an assignment of receivables is a
true sale is a complex question made more so by the absence of Pakistani law on point.
Broadly and loosely stated, generally recognized standards of true sale require that all
risks and rewards associated with the receivables be transferred in their entirety to the
SPV.
In the absence of Pakistani (or indeed Indian) law on point it is common for our courts to
fall back on English common law principles. These principles are liberal: provided the sale
is properly documented and is treated by the parties as such the courts will recognize the
transaction as a sale even if the buyer has limited recourse to the seller for unpaid
receivables and even if the seller has a right of repurchase. However, in view of the much
stricter accounting standards and the possibility that our courts may not follow English
law to the letter it may be advisable to adopt the accounting standards as a benchmark
for constructing a true sale, even if accounting objectives is not a key consideration in a
particular transaction.
Moreover, in case an accounting opinion is required on true sale, the lawyer’s job on
giving a true sale opinion becomes easy as the accounting standards are more defined
and much stricter.
One final point on true sale. The true sale standard set forth in State Bank Circular where
banks/DFIs act as originators is relevant from the point of view of satisfying State Bank’s
regulations. It is not relevant for determining whether a transaction is otherwise a true
sale. Thus, if the originator is not a bank or DFI, the true sale standard set forth in the
circular need not be followed.
4. Stamp Duty
Stamp duty payable on an assignment deed is considerable and would be a major
stumbling block for securitization were it not for the option of equitable assignments
which are permissible in the province of Punjab. This is a complex legal issue but let me
briefly touch upon the same.
5. Mortgage Securitization
The mode of equitable assignment to avoid stamp duty is, however, not
available in my view in the context of securitization of mortgages of immovable
properties. Under the Registration Act, any instrument which purports or operates to
create, declare, assign, limit or extinguish any right, title or interest in immovable
property requires compulsory registration, which is not the case in respect of movable
properties and debts.
The mortgage securitization can be structured where the title to the mortgaged
property remains with the originator and the interest in the receivables is transferred. In
our view, even such transfer of interest will require compulsory registration. Thus, the
problem can be effectively cured by an issuance of SRO waiving or reducing the
applicable stamp duty and registration fees. Such SRO should include all kinds of
properties as we would be more comfortable with the proper legal assignment as
opposed to equitable assignments.
5
Securit izat ion | Ha idermotaBNR
Assuming the stamp duty and registration issues can be managed, I would very
briefly state that in case of a mortgage securitization, given our laws, the title to the
mortgaged property would remain with the originator and the originator would hold the
same as agent for the SPV. The purchased receivables in our case would not only include
payments of principal and mark-up under the loan agreement but also proceeds received
by the originator upon the sale of the mortgaged property in case of a foreclosure which
recover will need to be made as the agent of the SPV.
As I have already mentioned that sale by banks and DFIs of its mortgaged
receivables must satisfy a tough true sale test as contained in the State Bank Circular.
Effectively there should be no recourse whatsoever on the originator. While I appreciate
that this standard has been included as sale of these assets affects capital adequacy
ratios, consideration may be given to permitting recourse under a couple of
circumstances; first if the seller bank has fundamentally breached a warranty in reliance
of which the mortgaged receivables were acquired by an SPV, for example, if the Seller
has warranted that the debtor has made all principal and mark-up payments till date on
time, and at later transpires that the same warranty was not accurate the SPV may
require recourse against the originator. Second, the originator will need to play an
agency role to service the receivables and to enforce the mortgage on behalf of the SPV.
The argument of some recourse against the originator is even stronger in this case where
the originator fails to discharge such agency obligations. This, however, is a policy
decision that needs to be made.
The structure of a lease securitization is quite similar to a mortgage securitization
except that in this case the issue of registration fees and stamp duty can be addressed
through an equitable assignment. Because of time constraints I will not dwell on lease
securitizations any further.
6. The SPV
I would also like to make a few observations on the SPV itself. In terms of the
Securitization Rules, an SPV (which is required to register with the SECP) may either be a
trust or a public limited company with a paid-up capital of not less than one hundred
thousand rupees. Ownership of the originator and the SPV may not be connected in any
way. In terms of the State Bank Circular referred to earlier, bank/DFIs participating in a
securitization transaction cannot own any share capital in the SPV either.
The SPV, after paying its obligations to the investors and its administrative costs, should
be in a position to return the balance remaining to the originator in terms of a profit
extraction formula. An example of such a formula is the service fee referred to earlier.
The originator continues to collect the purchased receivables on behalf of the SPV, and
in return is paid a service fee by the SPV. However, in developing the formula for e.g.
determining the service fee care needs to be taken to ensure that the transaction does
not lose its true sale character. This is so because in a true sale, the purchaser, i.e. the
SPV, would retain the residual interest after paying the investors. If all residual amounts
are returned to the originator, then it could be considered a mortgage redemption.
6
Securit izat ion | Ha idermotaBNR
7. Bankruptcy remote
Another issue which arises in the context of a true sale securitization is whether the
securitization is “bankruptcy remote” i.e. whether in the event of the originator’s
bankruptcy its creditors would have any claim on the receivables sold to the SPV. In our
view, a purchaser for due consideration (of the receivables) would be entitled to have his
interests in the purchased property of the insolvent to be dealt with at least as favourably
as the interests of a secured creditor holding security interest over such property. Under
Pakistani law, it is well established that a secured creditor can effectively stand outside
bankruptcy if it so desires or may submit to bankruptcy to prove its debt. The Supreme
Court of Pakistan has held that a secured creditor is at liberty to realise his security in any
manner he likes. This would suggest that securitization transaction in Pakistan can be
structured as being bankruptcy remote.
However, applying certain principles of English common law, a problem could arise in
respect of receivables that have not been generated at the time a liquidator is appointed.
The security may not catch receivables if the liquidator of the bankrupt must earn the
receivables to bring them into existence by rendering services. The rationale for the
same is that upon bankruptcy it would not be fair to unsecured creditors to deplete the
assets of the bankrupt for the advantage of a secured creditor.
D. TFC OFFERING
The final part of the securitization process is an offering by the SPV of redeemable capital such as
TFCs. I think most of you are familiar with the way TFC offerings in Pakistan are being structured
and, therefore, it is one part of the securitization transaction which is not novel from the Pakistani
perspective. Under our company laws, redeemable capital such as TFCs may be offered directly
to the public.
E. CROSS BORDER SECURITIZATION
Before I conclude, I may just mention a point on cross border securitizations where the
government is the obligor.
An export receivables securitization and/or a worker remittance securitization can be structured
where Pakistan risk is minimized thereby substantially improving the rating resulting in cheaper
source of funds. PTCL’s international securitization was given an investment grade rating even
though the relevant rating at the time for Pakistan credit was three or four notches below
investment grade.
In conclusion, I would like to say that legal and regulatory obstacles in my view are not the reasons
handicapping the growth of securitization as a financing tool. We should look to financial and commercial
considerations to determine why securitizations in Pakistan have not flourished. Even in the context of
mortgage securitization where registration and stamp duty are a problem, I think that if there is burning
desire to develop this market from a commercial angle, solutions can be found.
7
Securit izat ion | Ha idermotaBNR
Author(s)
If you would like further information on any issue raised in this note please contact:
Khozem A. Haidermota HaiderMotaBNR
Senior Partner,
khozem@hmcobnr.com
+92 (021) 111-520-000
www.hmcobnr.com
INSIGHT January 1, 2018
OIL & GAS INDUSTRY
OVERVIEW
©2017 HAIDERMOTABNR & CO Karachi Office: D-79, Block 5, Clifton, Karachi 75600, Pakistan Telephone: + 92 21 111 520 000 | 35879097 Internet: www.haidermotabnr.com All rights reserved This work is a product of the staff of HaidemotaBNR & Co. HaidermotaBNR & Co does not guarantee the accuracy of the data included in the enclosed and the same should not be relied upon as legal advice. Rights and Permissions This work is available under the Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) http://creativecommons.org/licenses/by/3.0/igo. Under the Creative Commons Attribution license, you are free to copy, distribute, transmit, and adapt this work, including, for commercial purposes, under the following conditions: Attribution— please cite the work as follows: HaidermotaBNR & Co. 2017. “Oil & Gas Sector – An Overview”. Karachi. License: Creative Commons Attribution CC BY 3.0 IGO Translations— If you create a translation of this work, please add the following disclaimer along with the attribution: ‘This translation was not created by HaidermotaBNR & Co and should not be considered an authorized translation. HaidermotaBNR & Co shall not be liable for any content or error in this translation.’ Adaptations— If you create an adaptation of this work, please add the following disclaimer along with the attribution: This is an adaptation of an original work by HaidermotaBNR & Co. Views and opinions expressed in the adaptation are the sole responsibility of the author or authors of the adaptation and are not endorsed by HaidermotaBNR & Co. Third-party content— HaidermotaBNR & Co does not necessarily own each component of the content contained within the work.
HaidermotaBNR & Co therefore does not warrant that the use of any third-party-owned individual component or part contained in the work
will not infringe on the rights of those third parties. The risk of claims resulting from such infringement rests solely with you. If you wish to
re-use a component of the work, it is your responsibility to determine whether permission is needed for that re-use and to obtain permission
from the copyright owner. Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and
licenses should be addressed by email to e-mail: hmco@hmcobnr.com.
www.hmcobnr.com
top related