Questions on Securitisation and Plan, Technique to Answer Them

8/2/2019 Questions on Securitisation and Plan, Technique to Answer Them

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Yerzhan KZ

1. In order for a securitisation transaction to be successful, it is important that the transaction shouldpresent low levels of legal risk to the investors who hold the bonds issued by the special purpose ve-

hicle/issuer.

Explain how securitizations are structured to ensure this is achieved.

(expects us to write about... a little bit about originators bankruptcy risks in transfer; re-

characterisation; substantive consolidation, i.e. you have to make sure there is no connection withoriginator; credit enhancement and liquidity support (the instrument is very inflexible so it needs

flexibility which is provided by liquidity support); )

Plan:

- Identify the risks that need to be covered and then discuss them in detail- Securitization is about the financing of the underlying portfolio of assets and it is how you

achieve that.

Three parts

1. To make sure that assets effectively transferred to the SPV (talk about-methods of transfer,

- re-characterisation risk, (true sale is really is about a re-characterisation analysis)

- originatorsinsolvency related risks (undervalue, preference)- insolvency remoteness aspects (substantive consolidation issues))

2. The way in which noteholders are protected in relation to the performance/non-performanceof the assets (- liquidity issues,

- credit enhancement,

- prepayment risk (eligibility criteria in revolving assets structure))

3. How the noteholders are protected within the context of the T&Cs of the notes issue(-subordination: making sure it works,

-security: security trustee)

1) When there is no facts given, we dont need discuss positive/negatives aspects of smth. go straight to issues.

The most effective method of transfer is novation, it transfers rights and obligations providing for

clean break. Assignment if it is a full legal assignment, you cannot transfer obligations, if there is anon-notified assignment there are deficiencies: set-off, priority, good discharge to originator, no di-

rect claim (irrevocable P of A given by way of security, secured power of Attorney (s.4 Powers of

Attorney Act 1971)

Area of risk is a transfer by method of sub-participation (talk about double credit risks and why it isdouble, and then about security over underlying assets to mitigate the risk),

trust transfers, proceeds trust (identify the risks in terms of potential insolvency when the trust in

bankruptcy is not effectively required to enforce onerous liabilities, and whether the structure would

protect you by power of attorney given by way of security that are taken in order to enforce security

to make sure you can effectively bring claims or in the context of disclaiming onerous property (s.315 IA 1985) having some benefit which is structured within the deal that enables trust in bankruptcy

take the benefit out post-bankruptcy situation . so obligations are not onerous (unprofitable, unsala-

ble, not readily saleable or give rise to pay money or to another onerous obligations).

Explain how the issues are addressed.


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Yerzhan KZ

Talk about re-characterisation risk (transfer method that is used needs to be clear spelt out in thedocumentation so that we covering any risk of re-characterisation provided the documentation is

clear as a matter of English law.

Insolvency risk (transaction at an undervalue, preference, disclaiming onerous property)

Talk about substantive consolidation risk and that this risk is remote under English law but the

SPV should not have the US parent company

Talk about insolvency remoteness succinctly.

2)

Say what are the credit enhancement/ liquidity support

It is important to make the difference b/w the credit enhancement and liquidity support.

How credit enhancement maybe incorporated in the deal.

Talk about when liquidity facility shall be available to the SPV, how it addresses problems of the

inflexibility of the bonds and covers time mismatches b/w maturity of underlying assets and bonds.

Inflexibility of the instrument issued by the SPV is going to present a problem, that is the risk thatbondholders will not have a certainty that their principal and interest will be paid on time, this cov-

ered and addressed by liquidity support.

Liquidity needs to be available to the SPV at the time when it makes payment to the notehold-

ers (interest and principal) and more important the way it is structured needs to ensure that it

will not being used to cover credit losses/risk (say smth how you achieve that, how you try to en-

sure that it is really providing only liquidity support and not covering situations where could be loss-

es on underlying portfolio)

Losses are covered by credit enhancement and then go on about C/E: C/E needs to be structured in

a way that covers risks against credit deficiencies in that context. C/E needs to be available to covercredit losses in underlying portfolio. It typically provided in two ways: Over-collateralisation which

is given to the SPV on day one, if it is external credit enhancement it needs to be available for draw-

ing at the time when SPV is due to pay the bondholders and suffer the losses. The second type issubordinated capital raising structure (tranching of the bonds to several classes) which enhance credit

quality of the underlying assets

Another risk is that bondholders do not get what they bargained for in terms of maturity.

Two key issues:

- buying bonds backed by the collateral (enforcement of security)

- buying the bonds which will generate interest for a period of years (prepayment risk)

Talk about risk of prepayment and the ways the deal is structured so as to avoid a prepayment risk

A revolving structure whereby if the underlying assets perform too quickly, what to do with the

money. To avoid that prepayment risk is by enabling the SPV to buy more assets from the originator

to keep the deal going for the life of transaction.

The other risk is that the assets coming to the deal after day one may not be as good as the original

assets. If the quality is


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Yerzhan KZ

How do we protect to ensure the quality of the collateral that backs the notes noteholders are buyingis maintained. This can be addressed by the concept of eligibility criteria procuring that the quality of

the collateral will not diminish.

3)

Subordination is not just about enforcing rights as between bondholders and SPV, but about priority as between the

creditors themselves (bondholders, liquidity provider, trustee, service agent and etc) ... moreover bondholders may go

into insolvency and trustee in bankruptcy may try to challenge subordination clause to improve its cash flow for bank-

ruptcy estate for all unsecured creditors of the insolvent bondholder.

The risk of the SPV or noteholders going insolvent because according to s.107 Insolvency Act

(the companysproperty in a voluntary winding up shall on the winding up be applied in satisfaction-

of the companys liabilities pari passu)

The pari passu principle is about people elevating themselves above other creditors, if you subordi-

nate yourself you do not offend that principle. So securitisation transactions are structured in thatway. It is about contractual subordination.

Pari passu principal applies to unsecured creditors whereas secured creditors are at another level

Therefore, security may mitigate the risk of equal treatment of bondholders because pari passu prin-ciple does not apply to secured creditors.

Bondholders and all other parties are subordinating their claims in different classes, which is done

through contractual documentation; this structure shall work even in the insolvency proceedings.

It is critical to avoid pari passu principal, and not only in insolvency, i.e. pari passu treatment needsto be maintained in a pre-default scenario as well as in a post-default.

You can agree to subordinate yourself, but not elevate yourself among other creditors. (Re Maxwell

Communications)

Talk about the problem, i.e. identify what the problem is

Talk about structurally how the contract provides for different treatment subordinating (stepping

back, tracnhing)

Talk about how the structure reinforce that further by insuring that it is built-in in the security docu-ments.

Security structure protects against insolvency issues, without insolvency you dont have this issue.


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Yerzhan KZ

2. Securitisation transactions are fraught with legal complexity that arises primarily because of the

problems associated with transferring the assets from the Originator to the SPV Issuer in a manner

that will address the risk of Originator insolvency.

Discuss.

Originators insolvency risk and re-characterisation (you should discuss current position in law in

terms of re-characterisation risk, will give you a pass or distinction):

- Talking through true sale analysis, the law is complex is a good place to start

- talking through the three indicia that comes through Inglefield

- finishing where the law currently stands (WDA, Orion) (notwithstanding, provided the transaction

documentation is carefully drafted and it reflex parties intention

- adding that we have concerns about Brumark type of thinking in the context of charges (whether

the English court might apply as a consequence re-characterisation now more liberally in a sale v.

security structure (however, there is a line of reasoning that has been applied to security, where not-withstanding that level certainty of drafting, the court said there are certain features of security (in

this case question of control) which are so fundamental and if they are not present, the fact the par-

ties made clearthey wanted to create one form of security, the court held you cant have that. Thereis therefore a concern that that type of policy analysis may be applied to the true sale analysis. How-

ever, there are no any indicia identified using the Inglefield analysis that are so fundamental to the

sale which may be compared with a question of control in the Brumark case distinguishing fixed and

floating charge, and this is reinforced by Romer LJ judgment in Re George Inglefield and WDA v.

Export Finance Co. )

- reaching a conclusion that the concern is little and the court would not apply Brumark type to the

true sale analysis, there is no such indicia in a sale such as in a fixed charge.

Bankruptcy/insolvency related issues:

There is a risk if the originator goes into bankruptcy, i.e. insolvency legislation will provide grounds

upon which the trustee in bankruptcy can claw back the assets into originators insolvency estate.Implications of that the BH will end up as unsecured creditors in the originators bankruptcy estate

and that is a huge risk.

Having said that we need to go through the law:

- Talking about transactions at an undervalue in particular and preferences,

- identifying why they relevant in securitisation and

- then critically talking about how those legal complexity may apply

- showing you really understand the law in relation to transactions at an undervalue (insolvency at the

time transaction entered into, or as a consequence of the transaction within two years from the onsetof insolvency, connected counterparties, it is not at undervalue if it is entered into in a good faith in

order to carry on its business; )

- concluding that notwithstanding relatively complex legal issues here they are not or shouldnt be of

the concern because... you may say 2-3 sentences on profit extraction two ensure that transaction atan undervalue is not be triggered because it is not substantially less, what you are getting back super-

ficially may look less a lot on day one but if the asset perform through deferred consideration,

through trust structure whatever you use, the originator is getting full value potentially back and notlosing any substantial amounts.


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Yerzhan KZ

s.238 (5) IA 1986

The court shall not make an order under this section in respect of a transaction at an undervalue if it

is satisfied

(a) that the company which entered into the transaction did so in good faith andfor the purpose of

carrying on its business, and

(b) that at the time it did so there were reasonable grounds for believing that thetransaction would

benefit the company.

Preference (s.239 IA)

an individual gives a preferenceto a person if

(a) that person is one of the individuals creditors or a surety or guarantor for any of his debts or

other liabilities, and

(b) the individual does anything which has the effect of putting that person into a position which will

be better than the position he would have been in if that thing had not been done.

Disclaimer of onerous property (s.315 IA)

The following is onerous property for the purposes of this section, that is to say

(a) any unprofitable contract, and

(b) any other property comprised in the bankrupts estate which is unsaleable ornot readily saleable,or is such that it may give rise to a liability to pay moneyor perform any other onerous act.

Insolvency risks related with transfer of assets:

By way of novation is a clean sale

By way of silent assignment or sub-participation and the originator goes into bankruptcy e.g. we

have a double credit r.isk.

Talk about issues only through the methods if they present risk as a consequence of insolvency.


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Questions on Securitisation and Plan, Technique to Answer Them