1. How active is the securitisation market in your jurisdiction? What types of securitisations are typical?
The securitization market is currently very active in the United States. According to data published by the Securities Industry and Financial Markets Association (SIFMA), there were approximately U.S. $4,335 billion in principal amount of securities issued in securitization transactions during 2020 with more than ten trillion dollars outstanding. The vast majority of the new issuances during 2020 ($3,980.1 billion) were mortgagerelated securities issued by Freddie Mac, Fannie Mae and Ginnie Mae.
The remaining securitizations during 2020 were (i) nonagency mortgage-backed ($135.4 billion), (ii) auto ($109.7 billion), (iii) CDO/CLO ($33.6 billion), (iv) equipment ($18.0 billion), (v) credit cards ($2.9 billion), (vi) student loans ($17.8 billion) and (vii) other assets ($37.3 billion).
2. What assets can be securitised (and are there assets which are prohibited from being securitised)?
As a point of departure, almost any asset generating a payment stream can be securitized. The more diversified and constant the cash flow, and the fewer regulatory restrictions and licensing requirements imposed on the origination, ownership, security interest and sale of the relevant underlying assets, the easier the asset may lend itself to securitizations. However, there is currently no asset-class where securitization is outright prohibited.
As a general matter, there are more restrictions and licensing requirements in the consumer finance space than in the commercial lending space. Certain esoteric assets such as spectrum, some intellectual property rights and government concessions may be subject to limitations on ownership and restrictions on granting and enforcing security interests. Such limitations complicate securitizations of such assets, but typically will not prevent their securitization through an appropriately structured transaction.
Assets where the future cash flow may be impacted by the operations of the servicer or originator also present additional challenges in a securitization context. However, as long as the future cash flows can be sufficiently isolated from the servicer's or originator's operational risk such that the securitization will have the ability to continue to perform despite a bankruptcy of the servicer or originator, it is possible to securitize the relevant assets. Examples of such transactions include whole business securitizations, securitization of future oil and gas payment streams and securitization of future use-based payment rights.
3. What legislation governs securitisation in your jurisdiction? What transactions fall within the scope of this legislation?
There are a number of different laws and regulations that together govern key aspects of securitizations. These include (a) the Bankruptcy Code, (b) the Uniform Commercial Code (the "UCC"), (c) the Securities Act of 1933, as amended (the "Securities Act"), (d) the Securities Exchange Act of 1934, as Amended (the "Exchange Act"), (e) the Investment Company Act of 1940, as amended (the "Investment Company Act"), and (f) where the sponsor or seller of the relevant asset, derivatives counterparty or investor in a securitization is a bank, the Federal Deposit Insurance Act (the "FDIA"), the Volcker Rule and the applicable bank capital regulations.
The Bankruptcy Code or other applicable insolvency regime, such as receivership or conservation under the FDIA for banks, together with the applicable state contract law, will inform requirements for ensuring that the sale of the relevant assets to the securitization SPV as well as the bankruptcy remoteness of the securitization SPV from that of its affiliates, will be respected in case of insolvency proceedings against the relevant transferor or affiliate. Insolvency laws will also inform the enforceability of contractual provisions that are triggered off the bankruptcy or financial condition of a contract party, such as "flip clauses" that were used to subordinate defaulting derivatives counterparties but were found to be unenforceable, even though many other rights under derivatives contracts were protected in a counterparty bankruptcy.
The UCC contains, amongst others, provisions relating to creation and perfection of security interests. The term "security interest" does not only capture the interests in personal property or fixtures that secure a payment or performance obligation but also captures any interest of buyers of account receivables, chattel paper, payment intangibles and promissory notes. As such, if the transfer of such property is not perfected in accordance with the UCC, the Securitization may end up losing the purchased assets to creditors of the seller, even if the transaction is otherwise respected as a true sale. The UCC also contains important contractual override provisions that relate to enforcement of waiver of defences language in commercial transactions as well as hell or high water clauses in financing leases that are often important for the ability to finance such assets through a securitization.
The Investment Company Act requires any entity owning "investment securities" having a value that exceeds 40% of such entities' total assets (exclusive of government securities and cash items) to register as an investment company absent an applicable exemption. "Investment Securities" is a broad term that includes all securities and loans with some limited exceptions and would typically capture financial assets that are being securitized. The requirements and restrictions applicable to registered investment companies are incompatible with typical securitization structures. Consequently, it is important to structure the securitisation transaction to fit within one of the exemptions to having to register as an investment company. One exemption that was promulgated for the purpose of capturing securitisation transactions is set forth in Rule 3a-7 under the Investment Company Act. A second exemption is Section 3(c)(5) which may be available to a securitisation entity that is primarily engaged in the business of (i) acquiring receivables and other obligations representing all or part of the sales price of merchandise, insurance and services or (ii) making loans to manufacturers, wholesalers, retailers or prospective purchasers of merchandise, insurance and services or (iii) acquiring mortgage and other liens on and interests in real estate. A third exemption that traditionally has been broadly used, but currently is more of a fall-back is Section 3(c)(7) which exempts entities that restrict their investors to "qualified purchasers" and that do not publicly offer their securities. However, relying on the 3(c)(7) exemption may result in the securitization entity becoming a "covered fund" under the Volcker Rule unless it restricts its assets as required by the loan-only securitization exemption under the Volcker Rule. As part of the 2020 amendments to the Volcker Rule, this exemption was broadened to permit the loan securitization vehicle to also own up to five percent of assets in the form of certain debt securities that otherwise would be prohibited, but not asset-backed securities or convertible debt securities. Banks are subject to restrictions in their dealings with covered funds, and banking entities are generally not permitted to being sponsors or holding an "ownership interest" in covered funds. Ownership interests includes any equity or any instrument reflecting the equity performance of the funds and until October 1, 2020, also captured any interest that has the right to vote for replacement of the manager outside an event of default or acceleration event, even if such right only arises as a result of a manager replacement event. As such, since the junior most tranches of a securitization reflect the equity performance securitization and the senior most tranches typically have the right to replace the manager in case of a manager termination event, the net effect has been that U.S. banking entities have be restricted from sponsoring or investing in securitizations that are "covered funds". However, on October 1, 2020 a number of changes relating to covered fund exemptions, the ability of banks to deal with covered funds and the definition of ownership interest went into effect. Amongst others, these amendments provide a "safe harbour" for certain senior debt interest not to be deemed an ownership interest for purposes of the Volcker Rule, and also clarifies that, subject to certain conditions, participating in removal or replacement of a manager due to events that trigger creditor rights also do not amount to an "ownership interest". These changes, together with the amendments to the "loan-only" securitization exemption below, will potentially have a significant positive impact on the future development of CLOs, which traditionally have been one of the principal securitization types relying on the 3(c)(7) exemption under the Investment Company Act.
The Securities Act governs the offer and sale of 'securities', which is broadly defined and includes notes, stocks, bonds, debentures, investment contracts and any instrument commonly known as a security. Absent an available registration exemption, any offer and sale of securities has to be made pursuant to a registered offering. The Exchange Act provides the SEC with broad powers to regulate various market participants, prohibit certain types of conduct in the market and require certain periodic reporting. Registered offerings of asset-backed securities are subject to the disclosure requirements set forth in Regulation AB II as further detailed below and the Exchange Act imposes periodic reporting requirements for securities sold in a registered offering. The Exchange Act and rules promulgated thereunder also imposes certain requirements applicable to all securitizations including those issued in a private placement. Such generally applicable requirements include risk retention as set forth in Regulation RR, furnishing periodic reports of certain demands for repurchases and replacement of assets to the SEC on Form ABS-15G, and the furnishing to the SEC on Form ABS-15G the conclusions and findings of third party due diligence providers at least five business days prior to the first sale of the asset-backed securities. The Exchange Act also imposes a requirement to post all information provided to rating agencies hired to rate the securitization transaction to a password protected website (a so-called 17g-5 website) that may be accessed by to all Nationally Rated Statistical Ratings Organizations ("NRSROs") at the same time such information was provided to the rating agency.
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Originally Published by The Legal 500.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
