One author has described asset securitisation as the process of raising funds through the issuance of marketable securities backed by future cash flow from income producing assets.

This involves:

(a) The sale of the receivables to a third party; and

(b) The issue of security by the purchaser of the receivables on the strength of the receivables.

Players

The players involved in a securitisation are generally:

(a) The originator or seller of the receivables, whose aim is to raise money from investors and continue to retain any profits from the receivables, but transfer the risk of non-payment of the receivables to the investors and remove the assets and the funding loan from its balance sheet;

(b) The purchaser, who will purchase the receivables from the originator, and is usually a specially-formed single purpose company independent of the seller ("SPV"). The SPV will generally be a public company formed in a tax-friendly jurisdiction.

(c) Investors, who provide the finance to the purchaser of the receivables to enable it to pay the purchase price, whether by way of a bond or note issue or a commercial paper issue.

(d) Administrator, who will be responsible for collecting the payments and arrears. The originator is often also the administrator so as to retain its relationship with its customers.

Theoretically, any kind of asset can be securitised. Generally however, securitisation is more suited to receivables where the documentation is basically the same for all debtors and the likelihood of collectability is good.

Advantages of Securitisation
For the originator or seller, the advantages of a securitisation are generally:

(a) Improved balance sheet - the originator is able to raise money without the loan appearing on its balance sheet and still keep the profits from sold receivables

(b) Capital raising - the seller is able to raise capital immediately, rather than having to wait for the receivables to be paid;

(c) Diversification of funding source - by virtue of the securitisation, the originator will often have access to wider sources of finance;

(d) More advantageous terms - the receivables by themselves being very often of better quality than the originator's assets generally, the originator may often be able to obtain better pricing or terms without the need for onerous covenants;

(e) Transfer of risk from the originator to investors.

Issues for structuring
For securitisation to be properly structured it requires a number of different issues to be carefully considered and addressed:

(a) Are there contractual prohibitions requiring the consent of the debtors?

(b) Are there issues of confidentiality?

(c) Should notice be given to the debtors? This notice would likely be required to render the assignment legal rather than merely equitable, this may, however, involve unwanted inconvenience and expense and possibly jeopardise the originator's relationship with its customer. If no notice is given, however, debtors could continue to acquire new set-offs and defences.

(d) Can the transaction be structured as a true sale of the receivables or will it be recharacterised as a loan such that the intended objectives of the securitisation are not achieved?

(e) Is the originator able to retain or receive the profit from any surplus interest from the receivables after the payment of interest to the investors and the other expenses of the SPV?

(f) Do the Securities Laws in the relevant jurisdictions create any difficulties for the offer and sale of securities of the SPV, which is often the means of raising the finances from the investors?

(g) Is the purchaser of the receivable at risk of being insolvent as a result of the transaction? It is the securities of the SPV which will be sold to raise the purchase price and, therefore, it is the credit risk of the SPV and of its principal asset, the receivables, which will be weighed and rated.

(h) Is the securitisation "bankruptcy remote" from the originator, so as to ensure that any insolvency of the originator will not damage the securitisation?

(i) Should a rating by a rating agency of the SPV or securitisation be sought? A rating is not a prerequisite for marketing and issue of the bonds but may broaden the potential investor base.

(j) Are any Capital Adequacy issues properly addressed by the securitisation structure proposed to be used?

(k) Have all tax implications for the transaction been fully considered and its impact assessed to determine feasibility.

Once all these issues have been thoroughly considered and assessed, the transaction can be properly structured so as to ensure that the seller achieves the advantages from the proposed securitisation, including the raising of capital upon more advantageous terms and the transfer of risk.

- Hilary Reid is a partner at Myers, Fletcher & Gordon and a member of the firm's commercial department, specialising in trust, banking and securities law.

Executive Class

Gardens with Gravel

Death to the Mullet!