SECURITISATION– THE FINANCIAL INSTRUMENT OF THE NEW MILLENINIUM

Samathri Kariyawasam, B.B.A. (Colombo) Attorney - at Law

Senior Legal Officer – DFCC Bank

1. INTRODUCTION What is Asset Securitisation?

Asset-backed securities are securities, which are based on pools of underlying assets. These assets are usually illiquid and private in nature. A securitisation occurs to make these assets available for investment to a much broader range of investors. The “pooling” of assets makes the securitisation large enough to be economical and to diversify the qualities of the underlying assets. A special purpose vehicle is set up which takes title to the assets and the cash flows are “passed through” to the investors in the form of an asset-backed security. The types of assets that can be “securities” range from residential mortgages to trade receivables. The asset-backed security usually qualifies for a top rating and enables the issuing company or bank to raise funds at a very attractive rate.

2. DEFINITION OF SECURITISATION

“A device of structured financing where an entity seeks to Pool together its interest in identifiable cash flows over time, transfer the same to investors either with or without the support of further collaterals and thereby achieve the purpose of financing”.

Vonord Kothari Securitisation, the Financial Instrument of the New Millennium

In simple Securitisation is a process of converting something, which is not a security in to a security. In a Asset Securitisation, a Financial claims or a claim against a third party are assigned or sold to a special entity called the Special Purpose Vehicle (SPV). The objective is to legally separate asset from the issuer. The SVP in turn issues one or more debt instruments, whose interest and principal payments are serviced from the cash flows arising out of the underlying Assets.

The security at the end of the process of securitisation is an Asset Back Security and this security is significantly different from a usual Capital Market instrument. A usual Capital Market instrument is an exposure in the Business of the issuer but an Asset Back security is simply an exposure in an Asset.

Company

Special Purpose Vehicle

Investor

Pool of Cash flows

Asset Backed Securities

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3. PARTIES INVOLVED IN SECURITISATION

a) Obligor The Debtor who has sums to pay to the Organization

b) Originator The Entity that initiates the process of securitisation by transforming its assets in to securities

c) Special Purpose Vehicle (SPV) A legal entity either created or existing which act as a transformation device holding the assets receivable transferred by the originator on behalf of the investor and issues securities. If an operating company holds assets, it might incur expenses, and or incur liabilities and might go bankrupt, but a special purpose vehicle is a legal entity with only the specific assets transferred by the Originator. This is what makes a special purpose vehicle Bankruptcy remote

ORGANIZATIONAL FORMS OF SPVS

1. Signal Purpose Company 2. Trust

d) Investor

1. Banks 2. Government agencies 3. Insurance Companies

4. BANKRUPTCY REMOTE SECURITISATION

The main goal of a company utilizing asset securitisation techniques is simple: to obtain access to low-cost capital that is otherwise unavailable through conventional means. The company desiring to effectuate a securitization must begin by identifying assets that generate a relatively predictable stream of payments. These assets are "receivables." The company seeking to securitise the receivables is known as the "originator." One of the primary goals of securitisation is to isolate the receivables from the group of assets held by the originator in the event of the originator's bankruptcy. In order to adequately shield the receivables from the originator's bankruptcy estate and from the reach of the originator generally, it is necessary to set up what is known as a special purpose vehicle ("SPV"). The SPV will purchase the receivables from the originator and issue securities backed by the receivables. It is important that the SPV purchase the assets in what bankruptcy law refers to as a "true sale." That means that the assets will not become a part of the originator's bankruptcy estate should the originator become the subject of a bankruptcy proceeding. Another way to shield the SPV from the originator is through the observance of all necessary formalities consistent with existing as a completely separate entity.

This should

prevent the bankruptcy court from substantively consolidating the assets and liabilities of the originator with that of the SPV. It is important to keep the SPV and its receivables out of the originator's bankruptcy estate,. Finally, the structure of the SPV should prevent it from engaging in any activities outside of its "special purpose." The SPV's only purpose should be to hold the assets that provide the basis for its securities. All of the procedures outlined above allow the SPV to achieve the status of "bankruptcy remote"-a rating company's indication of a reduced risk that the SPV will be strapped into a bankruptcy of the originator. The SPV's ability to attain the status of bankruptcy remote is a cornerstone of any securitisation as it allows the SPV to issue debt securities at a lower rate of interest than the originator.

Asset Securitisation: How Remote is Bankruptcy Remote? by Michele J.Cohn

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5. STRUCTURE OF SECURITISATION

When discussing the structure of securitisation it can be mainly categorised into Existing Asset Securitisation and Future Asset Securitisation. In an Existing Asset securitisation, the cash flow or the Asset exists. In a Future flow securitisation there is no existing claim, the claim with be created in future. An Exiting Asset Securitisation is a distinction between Mortgage backed securities and Asset back securities. The mortgaged backed securitisation is the securitisation of mortgage loans including commercial as well as residential loan mortgages. The Asset backed securitisation is securitisation of non – mortgage assets

6. SOME BASIC ATTRIBUTES OF ASSETS THAT CAN BE SECURITISED

� Assets should represent a cash flow Cash flow should be for a period of time Cash flow should be steady and easy to identify � Quality of the receivables

• Good record of past payment statistics

• Good collateral protection � Capacity to assign Securitisation is a transfer of a right to receive against a third party of the assignee. � Homogeneity of Assets Assets in one portfolio should be of similar features

7. BASIC PROCEES OF SECURITISATION

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8. LEGAL FRAMEWORK FOR SECURITISATION

It is important to ensure that the transfer of assets by the originator is a Legally Valid Transfer and such assets would stay clear of any claim of the originator his creditor, liquidator and serve for the benefit of the investor.

9. BASIC PRE-CONDITION FOR LEGAL TRANSFER OF RECEIVABLES

� The receivables must be existing at the time of the assignment. � The Receivables must be identifiable:

• Who is the obligator, whose debt is being transferred

• If the Obligor has several obligations to pay, which of these obligations are being transferred

� The whole of the Receivable should be assigned • “If there is a assignment of a receivable, then the whole of the receivable should be

assigned”. English Common Law Principles � It must be an assignment of a right and not a obligation

• Assignment of a right is possible

• Assignment of a Obligation is possible, only if the Person to whom the Obligation is owed given his consent to the Assignment. This principle is not applicable to securitisation as in securitisation there is no transfer of Obligation, but only a transfer of a right.

• If there is a right with the Originator, which is based on an Obligation of the Originator the right is not assigned unless the obligation has been satisfied

10. LEGAL ISSUES IN SRI LANKA LEASE SECURITISATION MARKET

According to Sec 24 of the Finance Leasing Act No. 56 of 2000 “Lessor may with written notice to the Lessee, transfer or assign all or any of the Lessor’s rights to any other Registered Establishment “. This was a stumbling block to the development of the Lease securitisation in Sri Lanka as Lessor notification was a cumbersome process and did not obviously serve the business interest of the Lessor or the Originator. Further this Act prevented any institution which deals in Leasing to be a registered Leasing entity with the Central bank of Sri Lanka if it is to carry out Securitisation on Finance Lease receivables. At present the market place is crowded with many Financial Institutions which are dominant players in the Leasing market and the existence of the above constraints restricted the growth of the Leasing Securitisation market. Several amendments were introduced by the Act No. 24 of 2005 which allowed Leasing receivables to be assigned to the Special Purpose Vehicle (SPV) or the Trust amounting to a ‘True Sale”. It is also important to note that as per the said amended Act No 24 of 2005 (Sec 24[4]), upon transfer of the right in a motor Vehicle within the meaning of the Motor Traffic Act to a SVP, the transferee (in securitisation the SVP) shall be deemed to be the absolute owner of the Motor Vehicle.

11. CONCLUTION

Securitisation-The Financial Instrument of the New Millennium is expected to capture the capital Market of the World. In Sri Lanka Securitisation has become a popular Financial Instrument but there are number of Legal, Taxation and Administrative impediments that presently hinder the potential growth in Securitisation market. Therefore for there to be Ideal Securitisation, the Legal system must provide for the establishment of securitisation vehicles with the necessary independent status and the powers to carry out their necessary operations. References 1. Vinod Kothari, Securitisation, The Financial Instrument of the New Millennium (2

nd edition)

2. Asset Securitisation: How Remote is bankruptcy Remote? by Michele J.Cohn