22/7/2011

UNIVERSITY OF LAGOS SECURED CREDIT TRANSACTION SEMINAR PAPER ON

LEGAL ASPECTS OF SECURITISATION: A PRIMER

PRESENTED IN PARTIAL FULFILMENT OF THE LL.M 2010/2011 PROGRAMME

SPERVISING LECTURER: DR. ‘DAYO AMOKAYE

Delivered by OKONJI, Eche Paul and SOGUNRO, Ayodele Olorunfunmi

Table of Content

Section Page

INTRODUCTION

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1 UNDERSTANDING THE CONCEPT, NATURE AND CLASSICAL STRUCTURE OF A SECURITISED TRANSACTION

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2 ESSENTIAL ELEMENTS, LEGAL ASPECTS; PARTICIPANTS AND DOCUMENTATIONS IN A SECURITISED TRANSACTION

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3 THE NIGERIAN SECURITISATION BILL: A COMPARATIVE ANALYSIS 35

4 CONCLUSION 48

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INTRODUCTION

Since the 1970’s1, the conventional forms of finance, that is, straight debt or equity have been extended to new financing structures that diminished or even eradicate the distinction between the traditional securities that give a right to participation in a company and those that principally guarantee the right to a return of sums lent in addition to interest.

Corporate finance now accepts the regime of extensive and complex financial products in the realm of structured finance (which includes financing or capital raising arrangements schemed to refinance and hedge existing assets in the form of receivables) beyond the conventional forms of debt and equity with the ultimate aim of reducing the cost of capital.

One of such structures is securitisation. Securitisation allows huge amount of capital to be transferred at a pace which, currently, is far beyond the reach of the security laws (particularly regarding the understanding of the nature of the relationship between the parties and the regulation of same), thus creating the need for the law to catch up with the prevalent trend. The huge significance of such transactions in modern times and the incidence of their poor or failed regulations on the global economy has clearly revealed the need for legal scholars to understand, engage and participate in creating and regulating the unconventional rights and obligations connected with the relationships.

It is unarguable that securitisation is one of the currently prevalent forms of structured finance; and in view of the Nigerian Securitisation Bill 2009 and the recently enacted Asset Management Corporation of Nigeria Act, 2010 there is every indication that securitisation is the “next-big-thing” in the Nigerian high finance market.

The purpose of this paper is to demystify the concept of securitisation; we intend to clearly explain the commonly used terms in a securitisation transaction, analyse the nature and structure of a securitized transaction. as well as the interest of the participants and an analysis of the requisite documentation. This paper will also examine the Nigerian Securitisation Bill with a view to comparing it with the laws in other similar jurisdictions. Accordingly, the paper is divided into the sections discussed in the following paragraphs.

Section 1: Understanding the Concept, Nature and Classical Structure of a Securitised Transaction. We shall look into the nature of securitisation alongside similar concepts, justify its relevance, and create a picture of the structure of a securitisation transaction. The section should give the reader an initial understanding of the concept.

Section 2: Essential Elements, Legal Aspects, Participants and Documentations in a Securitised Transaction.

Section 3: Participants; Documentation and Legal Implications of a Securitised Transaction. In this section, we discuss the documents that are required and the instruments that have to

1 Wood, P., Law and Practice of International Finance (Sweet and Maxwell) University Edition. 2008 p. 459.

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be drawn up in respect of the transaction. We also discuss the regulatory and legal implications of the transaction, including registration, perfection and tax obligations.

Section 3: The Nigerian Securitisation Bill: A Comparative Analysis. Under this section, we take a look at the bill before the National Assembly and discuss the features of the bill via a comparison to similar legislation in another country.

Section 4: In the last segment, we shall put forward our conclusion and recommendation on the entire subject.

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SECTION 1

UNDERSTANDING THE CONCEPT, NATURE AND CLASSICAL STRUCTURE OF A SECURITISED TRANSACTION

1.1 INTRODUCTION

Securitisation is a complex idea even for experienced legal and accounting practitioners. Our aim in this chapter is to dissect in as straightforward a manner as possible the concept of a securitised transaction, its nature and the structure of a typical transaction. We begin by examining the definition of the term “securitisation”.

1.2 UNDERSTANDING THE NATURE OF SECURITISATION

Due to the complexity, flexibility and adaptability of securitisation, a definition of the concept has become quite difficult as no single definition can encompass all forms of securitised transactions. This is even more true as more and more adaptations, transactions and financial products are continuously being created by financial engineers and investment bankers within the ambit of the concept. Thus the legal paralysis that lurks naturally in the definition of any legal concept has its grips fastened securely on securitisation.

Again, the concept of securitisation is sometimes misunderstood or assumed to be synonymous with structured finance (which is a broader term incorporating securitisation, credit derivatives and other hybrids financial products). For example, Ajayi2 applied the concept of ‘structured financing’ solely to securitisation when he stated:

“Structured financing typically involves the transfer of an income-producing asset to a separately created entity. The separate entity is sometimes referred to as a special purpose vehicle “SPV”. The SPV finances the purchase by issuing securities backed by the asset. This process is called “securitization” because, in essence, the assets have been converted to securities … So, structured financing theoretically creates a bankruptcy/insolvency-remote SPV.”

Marques and Scheicher3 defined securitisation as:

“[T]he issuance of claims backed by a pool of default-risky instruments where the new claims frequently have varying exposures to the underlying pool of collateral.”

2 Olaniwun Ajayi: Legal Aspects of Finance in Emerging Markets (LexisNexis Butterworth: South Africa: 2005) p. 140, paragraph 8.5 3 David Marques-Ibanez and Martin Scheicher: Securitisation: Instruments and Implications (electronic copy available at: http://ssrn.com/abstract=1405882) page 2.

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A similarly simplified definition was offered by Ramsay4 as the process whereby assets with an income stream are pooled and converted into securities for trading in the capital market. Another definition that:

“Securitisation is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said debt as bonds, pass-through securities, or collateralized mortgage obligation (CMOs), to various investors.”5

Bartlam, Herrington & Sutcliffe6 defined securitisation as:

[T]he appropriation of defined or identifiable cash flows to or through an insolvency remote vehicle to secure publicly or privately offered securities, issued on the basis that recourse is limited to such cash flows and any related assets. They further explained that Securitisations are complex, high-value transactions involving numerous parties, extensive documentation and, usually, several jurisdictions7.

Jobst8 on his part defined Asset Securitization as that process and the result of converting a pool of designated financial assets into tradable liability and equity obligations as contingent claims backed by identifiable cash flows from the credit and payment performance of these asset exposures. He concludes that it was the quest for more efficient risk-adjusted and diversified refinancing tools that steered the financial industry towards large-scale loan securitization by means of collateral loan obligations (CLOs), which is an efficient structure of credit risk transfer.

These definitions all attempt to describe what securitisation entails. What does the term “securitisation” imply? The term is called securitisation because it is the transformation of an identifiable cash-flow into tradeable securities that can be sold in the securities market9. Philip Wood10 on his part, clearly described the process for this conversion when he said that in a classical securitisation transaction:

4 Ian M. Ramsay: Financial Innovation and Regulation: A Case for Securitisation, SSRN-ID 928795 171.5Wikipedia (2011). Securitization. Retrieved 11 May 2011 from Wikipedia: http://en.wikipedia.org/wiki/Securitization6 Martin Bartlam, Orrick Herrington & Sutcliffe: Securitisation: Overview, available as a Practice Note on Practical Law Company (PLC), page 27 ibid8 Infra note 17.9 It is re-emphasised that securities as used here is as defined in Section 567(1) of the Companies and Allied Matters Act (‘CAMA’) which defines securities as including shares, debentures, debenture stock, bonds, notes (other than promissory notes) and units under a unit trust scheme”.10 Philip R. Wood: The Law & Practice of International Finance Series: Project Finance, Securitisation, Subordinated Debt (Vol.5) 2nd Ed. (London) Thomson, Sweet & Maxwell, 2007, pg 111.

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“an owner of receivables (the originator or seller) sells receivables to a third (the purchaser or special purpose company or SPV). The purchaser borrows money to finance the purchase price and repays the borrowing out of the proceeds of the receivables bought by it….”

Through securitisation, debts are factored and discounted in a structured and sophisticated manner which allows for the availability of funds and the repayment of the debt obligations through the creation of an insolvency remote vehicle which is separate, distinct and independent of the Originator.

It may be helpful at this point to provide an outline of the various steps involved in a Securitisation as follows11:

i. An Originator of receivables would decide to dispose off its receivables by sale;ii. A newly incorporated special purpose vehicle (known as the SPV, buyer or issuer)

would agree to buy the receivables and pay an outright purchase price;iii. Prior to the sale in ii above and before the transaction is consummated, the SPV

would issue securities to raise debt capital to finance the purchase of the receivables. This may be done through the issuance of bonds, notes to sophisticated investors or in rear occasions through a bank loan. In some cases, equity or hybrids may also be issued in several structured tranches;

iv. The receivables, and amounts received from the receivables, are used as security to secure the SPV's obligations to pay the investors’ principal, interest and any amounts due to other parties involved in the transaction such as insurance provider;

v. The security will generally consist of an assignment of, or a charge over, the receivables and any other relevant assets of the SPV, such as the benefit of an insurance policy;

vi. The security will be held by a security trustee under a trust established by the SPV in favour of the investors;

vii. The SPV authorises the originator as servicer to collect the receivables on behalf of the SPV which uses them to pay principal and interest to the investors in consideration for a service fee;

viii. The SPV is usually a thinly capitalised single-purpose company whose shares are held by someone other than the originator, typically a charitable trust, will hold its shares. This is so that the SPV is not treated as a subsidiary of the originator, would not be affected by the insolvency of the originator and does not need to have its balance sheet consolidated with the originator's balance sheet. The SPV in some cases may

11 See generally Wood (supra) and Martin Bartlam, Orrick Herrington & Sutcliffe pg 3.

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be registered in a low tax jurisdiction or a tax haven such as the British Virgin Island, Seychelles, Ireland, Jersey, Delaware, USA, the Netherlands or the Cayman Islands.

ix. In order to ensure that the receivables are sufficient to to repay the investors on time, there may various forms of Credit Enhancement may be taken. Examples include guarantee by a third party; a subordinated loan by a third party or a retention of the price until the notes are repaid.

x. The notes are often rated by a rating agency. The loan would usually attract a higher rating than a direct loan to the originator because the rating agency would only consider the receivables and not the credit worthiness of the originator.

xi. The SPV may pay any other interest not required for the repayment of th loan to the originator either as service fees, an higher rate of interest on the subordinated loan or by any other means as may be designed in the transaction structure.

In summary, what is achieved by the foregoing is that non-marketable assets (the receivables) are converted into marketable securities (the notes). The lenders can thus sell the notes which are secured on the receivables. The intended economic effect of the foregoing is that the originator raises money from investors on the security of the receivables and continues to retain any surplus on the receivables just as if it had granted a security interest over them.12

The main distinction between a security interest and a securitisation is that under a security interest, the secured creditor must return any surplus not needed to repayment of the secured loan to the debtor while in a securitisation, the originator transfers the risk in the non-payment of the receivables to the investors and removes the asset and the loan notes from its balance sheets. The loan is thus, not a liability of the originator but that of the SPV. In the case of a direct loan, to the originator, rather than the SPV, the originator would be liable to repay the notes if the secured assets were insufficient.

All that has been said so far can be graphically represented in the figure13 below as follows:

12 Wood Op.Cit page 11213 See Martin Bartlam, Orrick Herrington & Sutcliffe (supra) 3.

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Simply put, the originator/Seller sells receivables to a buyer (Purchaser/SPC/SPV/Issuer) which Buyer “borrows” money from third parties (Sophisticated Investors/Bank) to make the purchase price and for which the third parties are paid from the Receivables collected from the original Debtor. A Security Trustee may be appointed for the purpose of enforcing the security created pursuant to the transaction while an insurance company may be engaged for the purpose of credit enhancement.14

Securitization seeks to substitute capital market-based finance for credit finance by sponsoring financial relationships without the lending and deposit-taking aspects of conventional banking (disintermediation). In this wise, the issuer raises funds by issuing certificates of ownership as pledge against existing or future cash flows from an investment pool of financial assets. This done with the aim of increasing the issuer’s liquidity position without increasing the capital base or by selling these reference assets to a SPV, which subsequently issues debt to investors to fund the purchase. Aside from being a flexible and efficient source of funding, the off-balance sheet treatment of securitization also serves to:

14 See portion on credit enhancement below in page 12 below.

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I. reduce both economic cost of capital and regulatory minimum capital requirements as a balance sheet restructuring tool (regulatory and economic motive); and

II. diversify asset exposures (especially interest rate risk and currency risk).15

The generation of securitized cash flows from a diversified portfolio represents an effective method of redistributing asset risks to investors and broader capital markets (transformation and fragmentation of asset exposures). As opposed to ordinary debt, a securitized contingent claim on a promised portfolio performance affords investors at low transaction costs to quickly adjust their investment holdings due to changes in personal risk sensitivity, market sentiment and/or consumption preferences. Thus, Jobst surmised that securitization is a regulatory arbitrage tool: an efficient, flexible funding and capital management technique for companies16.

Securitization continues to readily register as an alternative and diversified market-based source for refinancing economic activity, by substituting capital market-based finance for credit finance and thus sponsoring financial relationships without the intermediation of banks. The off-balance sheet treatment of securitization also serves to diversify asset exposures (especially interest rate risk and currency risk), since the cash flow proceeds from the securitized asset portfolio are partitioned and restructured into several tranches with varying risk sensitivity. The generation of securitized cash flows also represents an effective method of redistributing asset risks to investors and broader capital markets. The implicit risk transfer of securitization does not only help issuers improve their capital management, but also allows issuers to benefit from enhanced liquidity and more cost efficient terms of high-credit quality finance without increasing their on-balance sheet liabilities or compromising the profit-generating capacity of assets.

1.3 ORIGINS OF SECURITISATION

There are two possible sources of the origins of Securitisation. The first is traceable to the nineteenth century practice of factoring and discounting of receivables. The practice was for companies to sell their trade receivables to factors or specialist factoring companies, either on the basis that the factor bore the risk of non-collection or on the basis that the seller guaranteed collectability. The practice of selling Bills of Exchange as was prevalent in continental Europe may be regarded as the second possible origin. This is otherwise known as “forfaiting”. In the words of Wood, “In Continental Europe it was common to sell trade bills of exchange – “forfaiting”17 – with or without recourse to the seller. The advantage of 15 Ibid Jobst, footnote 216 ibid17 Forfaiting is a trade finance concept and practice. It involves the purchase of receivables from exporters. The Forfaiter will assume all the risks involved with the receivables; which receivables are usually evidenced by such debt instruments as Bills of Exchange, Promissory Notes, Letters of Credit and Letters of Guarantee. Forfaiting converts these credit-based transactions into cash-yielding transactions. The difference between forfeiting and factoring is that, whilst factoring is a firm based transaction in which the Factor buys all the

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bills of exchange was that it was not necessary to give notice of a transfer to the debtor: this was (and still is) necessary in the case of ordinary contract receivables, mainly in Napoleonic countries and also Scandinavia, in order for the transfer to be valid on the insolvency of the seller.”18

Traditionally, securitisation was essentially a sophisticated form of factoring or discounting of debts. According to Andreas Jobst19, Securitization started when companies began exploring new sources of asset funding either through moving assets off their balance sheet or raising cash by borrowing against balance sheet assets (“liquifying”) without increasing the capital base (capital optimization) in order to reduce both economic cost of capital and regulatory minimum capital requirements.

Securitisation however long began in the United States of America (US) in the 1970s when the Federal Home Loan Mortgage Corporation (FHLMC, popularly known as ‘Freddie Mac) and Federal National Mortgage Association (FNMA, popularly known as ‘Fannie Mae’) acquired home mortgages from lending institutions, raising the finance for such acquisition through the issuance of securities that were backed by the pools of the home mortgages. The Government National Mortgage Association (GNMA, popularly known as ‘Ginnie Mae’) gave guarantees to such securities. Progressively, US Investment Banks set up in-house departments to deal with such Ginnie Mae papers.

The Bank of America was the first bank to securitise its own home loans in 1977 with the first non-home loan securitisation occurring in 1985. In March 1987, Sperry Corporation undertook what is today regarded as the first major securitization involving an engineered security whose cash flows were backed by the receivables on Sperry Corporation’s computer leasing program. Shortly after this, General Motors Acceptance Corporation (GMAC) indirectly issued securities supported by a pool of its car loans. GMAC created a Special Purpose Vehicle (SPV) to which it assigned a portfolio of its car loans. The SPV in turn issued securities representing claims on the interest and principal payments received on those loans. According to Kavanagh,20 “Since then, the population of assets underlying those structured transactions has diversified dramatically and now includes credit card receivables, corporate trade receivables, aircraft leases, stranded utility costs, plant projects, patents, and more.”21

In 1997, the Hong Kong Corporation (HKC) was set up by the Hong Kong Government to buy residential mortgages and to use mortgage-backed securities. Presently, the Bank can

receivables of the Firm, Forfaiting is a transaction based operation in which a Firm sells one of its receivables.18 Philip R. Wood: Project Finance, Securitisations, Subordinated Debt (Thomson Sweet & Maxwell: London: 2007) 11219 Andreas Jobst: ‘A Primer on Structured Finance’ Electronic copy available at: http://ssrn.com/abstract=832184)

20 Babara T. Kavanagh: ‘The Uses and Abuses of Structured Finance’ Policy Analysis No. 479, July 31, 2003 (CATO Project on Corporate Governance, Audit and Tax Reform).21 Ibid at p.3

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guarantee eligible mortgages and securitize mortgages by ‘on-sale’ to orphan Special Purpose Companies. The HKC is financed by public bond and a revolving credit-line from the Hong Kong Monetary Authority.

Currently, the United States has the largest securitisation market by volume while Europe follows its lead. The assests mostly securitized are home mortgage loans and consumer receivables in automobiles and credit cards. The concept and practice of securitisation has thus evolved into a specialized financial transaction type that generally involves the structuring of specified streams of receivables (generally mortgages and other credits) in a company’s books and selling them alongside their underlying security, if any, in the form of securities to investors.

1.4 COMMON CONCEPTS IN SECURITIZATION

1.4.1 Asset Backed Securities (“ABS”): securitization is also generally referred to as ABS and may be subdivided into the following divisions:

i. Collateralised Loan Obligations (“CLOs): this refers to the situation where the securities issued are backed by bank loans.

ii. Collateralised Bond Obligations: the receivables in backing the securities are bonds.

iii. Mortgage Backed Securities (“MBS”): the receivables in these instances are mortgages. It may be a Commercial Mortgage Backed Securities (“CMBS”) where the receivables are commercial mortgages or a Residential Mortgage Backed Securities (“RMBS”) where the receivables are residential mortgages.

iv. Collateralised Debt Obligations (“CDO”): this is a generic term used to describe securities backed by loans or bonds. It therefore comprises of both CLOs and CBOs.

1.4.2 Non-Performing Loans (“NPL”): this refers to defaulted bank loans.

i. Real Estate Investment Trust (“REIT”): these are trustees which hold title to pools of real estate properties and the investors have beneficial interest in the pool or the property company is treated as an investment company.

ii. Credit Enhancement: Credit enhancement is the use of various finance techniques to improve the creditworthiness of a security, as indicated by a credit rating. A security can be credit enhanced by reducing the probability of default by the issuer.

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iii. Credit Rating: the credit rating of a person is an indication of the person’s ability to repay its debt. In practice, a high credit rating will attract a low interest and vice versa. Some institutional investors such as the Pension Funds Administrators are not by law permitted to invest in any securities which are not of investment grade.

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SECTION 2

ESSENTIAL ELEMENTS, LEGAL ASPECTS, PARTICIPANTS AND DOCUMENTATIONS IN A SECURITISED TRANSACTION

2.1 ESSENTIAL ELEMENTS

Having discussed the general nature of a securitisation, we now turn towards a discussion of the elements that must be present for a feasible Securitisation.

2.1.1 Transferability

There must be possibility of a transfer of assets and accompanying receivables by the originator to the buyer without expense or formality or the consent of the debtors or a serious risk of the debtors set-off.

2.1.2 Sufficiency of Credit

It is essential that the sums derived from the receivables be sufficient to redeem the securities issued by the purchaser to finance the purchase price. In most instances, shortfalls, mismatches and possible defaults may be covered by various forms of credit enhancement.

2.1.3 True Sale

The element of true sale requires that the receivables be actually transferred to a third party other than the originator – this is basically to ensure that the insolvency of the assets of the purchaser are not traceable or attachable in the event of the insolvency of the originator. Usually, the structure involves setting up a single purpose SPV as mentioned above, whose shares would be held by a third party other than the originator usually an independent Charitable Trust (Trustee) or Foundation. The essence of the independent Charitable Trust (Trustee) or Foundation is to ensure that the SPV is by no means a subsidiary of the Originator of the transaction or subject to its control. The SPV, which is formed as a public company22, purchases the receivables from the Originator in a true sale transaction, with the objective being that the SPV should not be consolidated on the Balance Sheet of the Originator. Thus, the SPV and the investors therein are insulated from the insolvency of the Originator and vice versa

The implication of this transaction is that the SPV carries two essential risks. The first is the risk of the non-repayment of the receivables. Thus, where the receivables are not paid to the Originator, it owes no obligation to the SPV to repay the deposits made. The second is that the SPV is exposed to the insolvency risks of the Originator. This essentially is because

22 According to Philip R. Wood: Project Finance, Securitisations and Subordinated Debt (London, Sweet & Maxwell, 2007) 120, para. 6-015, the SPV is formed as a public company to in order that it may issue securities to the public (non-private securities)

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the receivables are neither the products of a fixed charge or trust in favour of the SPV. Thus, in the event of the insolvency of the Originator, the SPV can only recover the deposits made in respect of the receivables as a creditor since it has no rights over the receivables.

In very recent times, banks in developed jurisdictions have increasingly looked to reducing their traditional ‘on balance sheet’ borrowing and lending in favour of securitisation. This has had the result of reducing the typical risks (credit, liquidity, interest rate) which are features of traditional bank borrowing and lending activities. For example and as previously stated, banks in the United States have expanded their application of securitisation well beyond mortgage-backed securities that emerged in the 1970s/80s into frontiers that were hitherto unknown; thus all types of receivables can readily form the subject of a securitisation transaction.

Conversely, securitization remains of few application in less developed financial markets, with most of its application coming from emerging markets. Quite naturally, the attendant risks in these emerging markets, to wit, high political risk and their uncertain legal framework continues to remain a major bottleneck to the development of securitization and other major applications of structured finance in these climes. The legal regime for securitization in Nigeria will be considered in the next section. We shall thus consider the legal aspects on securitization.

2.2 LEGAL ASPECTS OF A SECURITISED TRANSACTION

Flowing from the essential elements already considered, the following key legal issues must be considered in structuring a securitised transaction23:

2.2.1 The Mode of Transferring the Receivables to the SPV

Transfers of receivables in a securitisation under English law may take the form of a novation; an assignment; or a declaration of trust. In some other instances, the economic interest in the underlying assets may be transferred by sub-participation or synthetic arrangements24.

Novation: The use of novation in securitisation is uncommon primarily because all the parties (including the debtors) would need to sign the novation agreement thus where the pool of receivables is large, this would be impracticable.25

Assignment: Outright Assignment is the most common and convenient method for transferring intangible assets, such as receivables. Under English law, it is possible to assign

23 24 Discussed below, p.15.25 Ibid

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not only current but also future intangible assets (but not obligations) with a minimum of administrative process.

The common law position above can be contrasted with the civil law jurisdictions where formal notice procedures as well as court processes are required in certain instances. Furthermore, only current assets can be assigned while future interests are not assignable. Some jurisdictions have enacted specific legislations permitting the securitisation of receivables. It must be noted however that some transaction structures may not be covered by the definitions set out in such legislations.

Under English law, section 136 of the Law of Property Act 1925 requires that for a transfer to be a legal assignment, the transfer must be:

i. An absolute assignment;

ii. The whole of the debt;

iii. In writing and signed by the assignor; and

iv. Notice of the transfer to be given to the debtor.

Any transfer not complying with all the foregoing requirements will take effect as an equitable assignment. Thus having regard to the large pool of debtors in a securitisation and the commercial interest of the originator, it may not be feasible to give notice to all the debtors in which case, the assignment may take effect in equity.

The legal effects of not serving notice on the debtors are:

i. The assignee (the SPV in a securitisation) will not be able to bring an action in its own name against a debtor.

ii. A subsequent secured creditor of the assignor (the originator) may gain priority over the assignee (the SPV) by being the first to serve notice on the debtor.

iii. Each debtor will be entitled to set up intervening claims against the assignor (originator), such as set-off in respect of mutual debts (between the debtor and the originator) arising before notice is served. The effect of an intervening claim may be that the SPV will receive less than anticipated.

iv. Payments made directly to the assignor (originator), but not passed on to the assignee (SPV), will reduce the debt due to the assignee (SPV) without the assignee receiving any benefit.

v. A security trustee holding security in respect of the receivables will have no direct claim against the debtors until notice has been served.

While these constitute risks to investors in a securitisation, the risks are usually heavily mitigated by:

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i. Restrictive covenants imposed on the originator in the receivables sale and purchase agreement (sale agreement) against creating subsequent security over the receivables.

ii. Warranties given by the originator, in the sale agreement, that there are no adverse interests or rights of set-off in the receivables.

iii. The instruction to debtors to pay receivables into a specific account.

iv. The security trustee's ability to serve notice quickly if there is concern that adverse interests have, or may, arise.26

Where notice must be given to the debtors, such notices must comply with the laws of the relevant jurisdiction or the mode specified in the contract pursuant to which the obligations arose. It must be however that English law is relatively flexible on the form and timing of notice and would generally requires that notice of the assignment (in any form) be given to the debtor27.

In order to have an enforceable securitisation, it is important for the lawyer to ensure that the relevant rules, formalities and procedures regarding notice of assignment in the requisite jurisdiction(s) are fully complied with.

Declaration of Trust: where the originator does not desire to novate or assign the interest in the receivables, the originator may constitute a trust of the specified receivables in favour of the SPV as beneficiary. The originator will act as settler and trustee of the trust assets. The SPV will obtain the beneficial interest in the receivables and in all rights arising from the receivables without having to complete a novation or assignment.

Sub-participation: A sub-participation involves a transfer of the economic interest in the receivables, but does not transfer any of the originator's rights, remedies or obligations against the debtors. The structure is an entirely separate back-to-back, non-recourse funding arrangement.

The SPV places funds with the originator (in a funded sub-participation) or promises to make good the originator in respect of losses suffered by the originator due to non-payment of the underlying receivables by the relevant debtor (in an unfunded risk participation). In return for the funding or payment covenant, the originator agrees to pass on payments received by the originator from the debtor in relation to the underlying receivables to the 26 See Martin Bartlam, Orrick Herrington & Sutcliffe (supra) 13 & 1427 This may be contrasted with the procedure in other jurisdictions. For example, French legislation requires a bailiff's notification or debtor's acceptance by acte authentique. In Italy, an assignment can be perfected against the originator, debtors and third party creditors of the debtors by publishing a notice in the Italian Official Gazette, if the assignee is: A bank authorised under the Consolidated Banking Act (CBA); or Not a bank and subject to Bank of Italy supervision on a consolidated basis (Article 65, CBA); or A financial institution enrolled in the special list set out in Article 107 of the CBA,

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SPV. The SPV therefore takes credit risk on both the originator and the underlying debtor in a sub-participation arrangement. The SPV may require a charge over the originator's claim against the debtor in respect of the underlying receivables and any amounts received by way of payment of such receivables.

Synthetic structures: this involves the use of derivatives to replicate the economic position of a transfer of receivables or a sub-participation. In a synthetic structure, there is no transfer of the receivables to the SPV or sub-participation in respect of them. Instead, the SPV effectively buys an income stream calculated by reference to the underlying assets. As such, it is not necessary for the SPV to buy the income stream from someone who actually holds the underlying assets. The seller of the income stream only needs to be someone who will pay the amount of the income stream calculated by reference to the specified receivables or "reference assets".

2.2.2 Possible Challenges Associated With The Mode Of Transfer Or Any Prohibitions Thereto

The second legal issue which the lawyer must address is the possible Before using any form of transfer, it is important to consider the express terms of the receivables contracts or, where a pool of receivables is being transferred, a sufficiently representative sample.

Under English law, a party to an agreement may assign the benefit of that agreement to a third party without the consent of the other party, provided that the agreement expressly allows assignment or is silent on the matter and is not "personal". If the receivables contracts include a restriction or require consent, the agreement of the debtors is required.

2.2.3 Risk of Re-Characterisation

While the character of the transfer may seem straightforward, some of the other commercial requirements of the transaction may result in doubt being cast on the validity and effectiveness of the transfer. For instance, where the transaction has certain characteristics, such as the originator receiving a servicing fee calculated by reference to "profit" in the receivables pool and has a right to re-purchase receivables to end the securitisation, it could be argued that the transfer could be viewed as a loan with the granting of security rather than a sale. As the security interest would not have been registered, it would be void against third party creditors or a liquidator of the originator.

The English courts have however been reluctant to re-characterise a transaction expressed as a sale as something other than a sale, except where the transaction is clearly a sham. The questions a court will consider were set out in Re: George Inglefield28 and were considered

28 [1933] Ch.1

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and applied by the English Court of Appeal in Welsh Development Agency v Export Finance Co. Ltd29 and Orion Finance Limited v Crown Financial Management Ltd30 as follows:

i. Is the intention of the parties (as expressed by the language in the sale agreement) consistent with a transfer by way of sale, as opposed to an assignment by way of security?

ii. Is the transfer pursuant to the sale agreement in consideration of the payment of a purchase price or the provision of funds for a term certain31?

iii. Does the originator have the right to re-acquire any of the receivables sold by it by repaying the purchase price to the SPV?

iv. Does the SPV have any obligation to account to the originator for any profit made on any disposition by it of property acquired pursuant to the sale agreement?

v. In a trust situation, does the trust deed provide for the beneficiaries of the trust (the investors) to have a right of recourse against the originator if the trustee disposes of the receivables for an amount less than the price paid for them?

The courts have been clear that the failure of an agreement to reflect one or more of the features characteristic of a sale would not in itself result in the transfer being treated as something other than a sale. The courts will look at these characteristics in the context of the transaction as a whole.

It must be noted at this point that based on our knowledge of a secured credit transaction, there is a clear but thin line between the mode of transfer and a secured credit transaction and in structuring any securitisation, it is essential that this line is clearly drawn as to where the assignment amounts to a true sale and where a security interest is intended as the incidence of both transactions are clearly distinct.

Thus, the following features are essential in avoiding the transaction being re-characterised as a loan with security:

i. The sale agreement should express, as clearly as possible, that the transfer is a sale.

ii. The sale agreement should reflect the parties' separate identities and legal roles. The sale agreement should be on arms-length terms and include an appropriate purchase price.

iii. The seller should have no right of redemption whether legal or equitable and howsoever described or contained.

29 [1992] BC 27030 [1996] BCLC 7831 Italics mine

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iv. The sale agreement should clearly document the passing of ownership risk to the SPV.

v. The sale agreement should not provide post-transfer rights to the originator in respect of funds generated from transferred receivables.

2.2.4 Reversion of Transfer and Insolvency Remoteness of the SPV

Two key legal issues that must also be considered particularly in the light of the insolvency of the originator is the possibility of reversion of the transfer and the issue of the remoteness of the SPV to the originator so that in sequestrating the assets of the originator, the assets of the SPV are not attached.

Regarding the reversion of the transfer, it is essential to avoid or minimise the risk that the transaction (transfer of receivables) is unwound at some future date by the originator, or a liquidator or administrator of the originator. Generally, the possible grounds on which an administrator or liquidator may be entitled to claw back assets from the SPV are:

i. A transaction at an undervalue32

ii. A preference33

iii. An extortionate credit transaction34

iv. A fraudulent transfer35

It thus behoves on the transaction lawyers to ensure that the transfer is not undervalued, there is no fraudulent preference of creditors, the credit transaction is not perceived as extortion and that the transaction is devoid of fraud.

On the issue of insolvency remoteness of the SPV, it is expedient that as far as legally possible, the SPV is isolated from compulsory or voluntary insolvency proceedings of the originator. This is because some jurisdiction36. The steps that are taken to achieve "insolvency remoteness" and ensure that the SPV is treated separately from the originator are:

32 See section 238, Insolvency Act 1986 (UK), as amended by the Enterprise Act 2002 (1986 Act)).33 section 239, 1986 Insolvency Act.34 section 244, ibid.35 (section 234, 1986 Act).36For instance in the US, the concept of "substantive consolidation" allows the court to treat assets of an affiliate that is closely associated with a parent entity as if the assets were all held by the same entity (substantive consolidation). On bankruptcy of the parent, the assets of the affiliate will be available to meet the obligations of the parent. This may be contrasted with England where English law does not have the principle of substantive consolidation and English courts will generally be reluctant to lift the corporate veil in order to treat the assets of a separate legal entity as the assets of its parent. English law does, however, have the principle of shadow directorship, whereby the courts may treat the assets of an entity acting as a shadow director of another entity as assets available to meet the liabilities of that other entity.

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i. The SPV should be a distinct legal entity capable of holding assets and carrying on business and operating on a solvent basis, separately from the originator.

ii. Appointing directors (or a director,) independent of the originator whose vote is required to pass a board resolution relating to the SPV's insolvency. Such Directors of the SPV should be independent and be in a position to approve activities of the SPV, not simply rubber stamp the originator's decisions.

iii. Placing restrictions on the SPV that prevent it from incurring any liabilities outside those contemplated by the securitisation. The SPV should clearly hold itself out as doing business separately from the originator and its corporate authorisations through board meetings, or other requisite authorisations, should be properly documented and recorded.

iv. Including clauses in agreements between the SPV and third parties that prohibit the third parties from commencing insolvency procedures against the SPV.

v. Including limited recourse wording in all significant transaction documents that restricts a counterparty taking enforcement action in respect of the SPV's assets to those assets which the SPV actually holds and in respect of which the counterparty has security.

2.2.5 Creating Security

This, in our opinion, is the most essential element of a securitised transaction. It is of utmost importance that a security interest be created to ensure that the investors or providers of fund have recourse to some property in the event of default or failure of the SPV to pay back the principal sum or the agreed returns on investment. In a securitisation, it is important to analyse which property and rights should be used as security and to ensure the formalities for creating security are complied with37.

In a securitisation, it is essential for security interests to be created. The interest would usually take the following form:

i. Assignments of intangible rights of the SPV, including all rights in respect of the underlying transaction documents.

ii. Assignments of bank accounts and rights to receivables acquired from the originator.

iii. A fixed charge over all tangible assets of the SPV.

37 You may wish to recall the various forms of security interests and quasi security with which we are all familiar such as mortgage, charge, lien, pledge, hypothecation etc.

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iv. A floating charge over assets of the SPV not effectively assigned or charged under the assignment or fixed charge referred to above.

2.2.6 Determining the applicable law and Compliance with regulatory rules

It is the responsibility of the lawyers to determine the applicable laws to the transaction documents as well as ensure compliance with the formalities prescribed under the preferred law.

2.3 DOCUMENTATION AND PARTICIPANTS IN A SECURITISED TRANSACTION

Securitisation is usually complex involving many participants and huge documentations. This section attempts to briefly examine the documents necessary for a securitised transaction as well as the participants, their various roles and objectives.

2.3.1 Participants in a Securitised Transaction

The participants in a securitised transaction include the originator, the arranger, the investors, the security trustee, paying agents, an investment collateral manager, rating agencies, monoclines, swap counterparties, the SPV, Lawyers, accountants, and the servicers. In the following paragraphs, we shall consider the nature and role of the various participants.

i. The originator

The originator is responsible for creating or acquiring the receivables that are to be sold to the SPV for the securitisation. Originators are usually financial institutions (such as banks), large companies and commercial enterprises. In some cases, they may be specialist entities set up for securitisation.

ii. Arrangers

The Arrangers are responsible for determining the transaction structures to provide the maximum possible return available on the assets, the benefits of which may be shared between the originator, the investors and any other parties. The arranger also introduces the necessary counterparties to take on risks associated with the receivables that are required to be removed from the transaction as well as ensuring that the transaction comes to a closure. Issues to be put into consideration during structuring include structuring the risk profile of the receivables to create different tranches of securities; credit arbitrage; credit enhancement; liquidity support and devising how the originator can extract profit from the transfer of receivables.

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iii. The Investors

The investors are the subscribers to the securities issued by the SPV with the objective of receiving interest as well as a capital repayment. The class of investors in a securitisation would include institutional investors, financial institutions, insurance companies, pension funds, hedge funds, corporations and high net worth individuals.

iv. Security Trustee

As stated earlier, a securitised transaction without a security interest over the underlying transaction is worthless. However, due to the fact that the securities would be issued to numerous investors, it would be impracticable to grant security to the various investors. Thus, a Trustee will be appointed to hold the benefit of covenants and rights in the securities on behalf of the investors. The trustee may also act as security trustee (to hold the benefit of the security on behalf of investors and other parties in the transaction whose interests are secured). A professional corporate trustee will usually take on the trustee role.

The trustee will be appointed by the issuer under a trust deed (or indenture in US transactions). The trust deed is the central document under which the securities are constituted and under which the terms and conditions of the issue will be set out. The Trustee will be appointed under a trust deed which will also contain a right for it to enforce the security as well as his overall duties, clearly defined roles and remuneration.

v. Paying Agent

The principal responsibility of a paying agent is to make payments of interest and principal on the securities as such amounts fall due. The paying agent will typically be a major bank. It is appointed by the SPV and its obligations and duties will be set out in the paying agency agreement.38 It may be necessary to appoint more than on paying agent particularly where investors are located in different jurisdictions. Where this is the case, the SPV may appoint a principal paying agent who will act as the main counterpart to the SPV in respect of the paying agency functions. The paying agent will be paid a fixed fee for services and will be indemnified for expenses incurred in the course of carrying out its duties.

vi. Servicer

The Servicer is responsible for ensuring the underlying receivables are continually collected and administered to the beneficiaries. The initial servicer will usually be the originator, or a company within the originator's group which would continue to deal with the receivables as it did before the securitisation, except that it will be appointed by, and will act as an agent of the SPV pursuant to a servicing agreement. Nothing however precludes the appointment of an independent party to perform the servicing role.

vii. Collateral Administrator38 Discussed at page below

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The collateral administrator is appointed by the SPV to act as its agent in relation to administration of the portfolio collateralising the securities. The duties of the collateral administrator will include the maintenance of a database detailing the content of the portfolio and using this database to: run performance tests; provide reports on the underlying assets; obtain valuations of the underlying assets; calculate payment and receipt requirements; open and administer the bank accounts and direct payments to be made in accordance with the transaction documents. The collateral administrator is usually an independent party (i.e not related to the other parties to the transaction) and is paid an agreed (fixed) fee but reimbursed for certain expenses incurred in carrying out its duties, including legal fees and payment fees.

viii. Swap Counterparty

The swap counterparty's role is to take on certain risks in the securitisation, such as the risks of interest rates changes and currency fluctuations in consideration for a fee. Swap counterparties are financial institutions specialised in assuming the risks in the swap documents.

ix. Monolines

Monolines39 are large specialist insurance institutions that provide insurance for financial exposures. The monoline will unconditionally and irrevocably agree to pay interest and principal in line with the original payment schedule for the securities issued to investors if the SPV defaults on its payment obligations. The objectives of monocline insurers is to minimise the risk inherent in the financial guarantees only either by accepting only investment grade risks; analysing the risk of default in any one transaction and only issuing policies where the risk is considered acceptable; or maintaining a diverse portfolio of underlying exposures.

x. Clearing systems

The clearing systems provide clearing and settlement services for securities. The most popular securities clearing systems in Europe are Euroclear, Bank SA/NV and Clearstream Banking, S.A. and the DTC.

xi. Rating agencies

Securities are usually rated and the ratings which the securities serves as an indicator as to whether the issuer (in the instant case, the SPV) has a strong or weak capacity to pay interest and principal. The three main rating agencies are Standard & Poors, Moody's Investor Services and Fitch Ratings40. In Nigeria, we have Agusto.

39 as opposed to multiline insurers − provide just one line of insurance e.g. financial "guaranty" insurance. They are generally licensed under New York state insurance law. The best known monolines are Ambac, MBIA, FGIC and FSA

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Each rating agency has its own scale of ratings which range from a very strong credit rating, where the rating agency considers that there is a very small statistical probability of default, to a very weak credit rating where the securities are already in default. In the case of Standard & Poors, for example, ratings range from AAA (extremely strong capacity to pay interest and repay principal) to D (securities in default). A security is said to be investment grade if it has a Stardard & Poors rating of BBB or above.

The rating is provided by the rating agencies consequent upon carrying out detailed statistical analysis on the probability of default and the effects of such default on the ability of the SPV to comply with its payment obligations in respect of the securities. The rating by usually includes draft or preliminary rating during the structuring of the transaction (known as a shadow rating), rating for the issuing the securities and ongoing ratings during the life of the securitisation.

The rating of the securities is at the heart of structuring a securitisation transaction. If securities need to be, say, AAA rated in order for them to be saleable, the arranger will need to structure the transaction to achieve this. This may involve various credit enhancement techniques. The higher the rating, the lower interest will be paid as the risks will be considered lower. In addition the credit rating extends the range of institutional investors to which the issue may be marketed.

xii. Accountants

The accountants may be required to provide confirmation of financial information in relation to the SPV, any guarantors or the receivables. The accountants will also be responsible for providing the audit report and financial statements of the SPV or, if the SPV is newly incorporated, a report on its position immediately following securitisation as well as the requisite financial due diligence and projections/analysis of various aspects of the underlying collateral.

xiii. Lawyers

The lawyers’ responsibilities here basically include advising on the legal and regulatory aspects of the structure; advising on the tax aspects of the structure; drafting and negotiating the legal documents; establishing the relevant legal entities; reviewing the corporate capacity and authority of each party; conduct of legal due diligence on the underlying assets; reviewing certain parts of the offering memorandum; opine on the enforceability of the transaction documents; and overall co-ordination of the documentary and legal aspects of the transaction as well as ensuring a seamless closure.

xiv. The SPV

40 Philip R. Wood: The Law & Practice of International Finance Series: Project Finance, Securitisation, Subordinated Debt (Vol.5) 2nd Ed. (London) Thomson, Sweet & Maxwell, 2007, pg 170.

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Traditionally, the SPV is a separate legal entity from any of the other participants in the securitisation and will be established specifically for the purpose of the securitisation. As earlier mentioned, it is common practice to locate the SPV in a tax haven ( i.e. low-tax or no-tax jurisdiction) such as Delaware, Mauritius, Seychelles, British Virgin Islands, Ireland, Jersey, the Netherlands or the Cayman Islands. The SPV will have no employees and will not conduct business other than that specifically provided for in the transaction documents. The main purpose for establishing the SPV is to be able to isolate the receivables that will be used to repay the securities from the credit risk of the originator.

2.3.2 Principal Transaction Documents in a Securitisation

The principal transaction documents required for a securitised transaction would include a offering memorandum, the trust deed, agency agreement(s), the subscription agreement, the servicing agreement, the sale agreement, the security agreement, investment or collateral management agreement, swap documents and legal opinions.

A brief discussion of the main contents of the above mentioned documents is presented below:

a. Offering memorandum

The offering memorandum (sometimes called an offering circular, prospectus or information memorandum) is the principal legal and regulatory disclosure document for the securitisation. This document sets out the terms and conditions of the securities, together with information about the SPV and, more importantly, the underlying collateral on which the securitisation is based.

The offering memorandum must comply with the legal requirements applicable to securities offerings in each jurisdiction in which the information is being made available, as well as in the jurisdiction in which the SPV is incorporated. In the EU if the offering memorandum constitutes an offer to the public, or is supporting an application for admission to listing and trading on a regulated securities market, the offering memorandum will constitute a prospectus and will be required to comply with the requirements as implemented into the applicable law of each relevant jurisdiction.

If the securities are listed, the offering memorandum and its contents must also comply with the listing rules of the relevant listing authority.

b. Trust deed

The trust deed is the main legal document in the transaction, as it is the legal instrument constituting the securities being offered. It sets out the SPV's covenant to pay the amounts referred to in the certificates representing the securities and covenants, representations and warranties given by the SPV for the benefit of the investors. The trust deed may also constitute the security created over the assets of the SPV. The trust deed sets out the

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relationship between the SPV and the trustee, including the trustee's powers of enforcement and rights to deal with assets compromising the security package.

The terms and conditions set out in the offering memorandum and the form of certificates representing the securities will be scheduled to the trust deed.

c. Paying agency agreement

The paying agency agreement is an administrative document establishing the mechanism for investors to present their securities or coupons for payment of principal and interest respectively, to exchange certificates that are damaged or claim replacement certificates if a certificate is lost and generally to

The subscription agreement is entered into between the SPV and the arranger and other managers of the issue on the signing date. It deals with the arrangements for the issue of the securities and their marketing. The managers agree to procure subscribers or themselves jointly and severally to subscribe for the securities on the closing date. The provisions include:

The agreement of the SPV to issue the securities in the form set out in the trust deed and to their listing and rating.

Representations and warranties by the SPV including those as to its legal status, the validity of its acts and the accuracy of the information in the offering memorandum.

Conditions precedent to be fulfilled prior to issue of the securities.

An indemnity by the SPV in respect of breaches of representations and warranties and conditions precedent or a force majeure event affecting the issue or marketing of the securities.

Selling restrictions prohibiting the sale of the securities or distribution of offering material except in accordance with the applicable law in any jurisdiction. In the UK offers are normally restricted to being an exempt category of offer complying with section 86 of the Financial Securities and Markets Act 2000.

Provisions for issue and delivery of the securities against payment on closing.

d. Servicing agreement

The servicing agreement sets out the terms on which the initial servicer is to administer the underlying receivables, or other assets constituting the security, on an ongoing basis. The main administrative duty is the ongoing collection of amounts due by the debtors under the receivables contracts. The servicing agreement will set out procedures and actions to be taken by the servicer in relation to these receivables (including how to deal with late and

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defaulted receivables). It should also deal with the circumstances in which the initial servicer may have its role terminated.

e. Sale agreement

The sale agreement sets out the terms on which the SPV agrees to buy, and the originator agrees to sell, the receivables or other assets to which the securitisation relates. This agreement must be sufficient to effect a clean transfer of assets from the originator to the SPV. It will set out representations and warranties and the criteria that the receivables must satisfy before they fall to be transferred to the SPV. The sale agreement will also set out what recourse the SPV will have against the originator for breach of a representation and warranty, and that the originator must repurchase any receivable that does not meet the eligibility criteria at the same price as that for which the receivable was sold to the SPV.

vi. Security agreement

The security agreement will be entered into by the SPV and a security trustee acting on behalf of all the secured parties, including the investors. The security may be established as part of the original trust deed, using a supplemental deed or a separate security instrument. The precise form the instrument will take, and the nature of the security interest created, depend on the underlying assets.

vii. Investment or collateral management agreement

In transactions involving the active management of an underlying portfolio of receivables, such as an actively managed CDO, the SPV will appoint an investment manager to be responsible for acquiring, maintaining and selling underlying collateral for the benefit of the participants in the transaction. The investment manager will be required to comply with strict eligibility guidelines in respect of the assets that may form part of the asset portfolio and the agreement will set out the circumstances in which the manager may be replaced or the agreement terminated.

viii. Swap documents

The transaction structure may be cash based or synthetic.

In a cash transaction, it is likely that the SPV will be required to enter into swap documents to deal with interest rate risks, currency risks, basis risks, timing risks or otherwise to manage cash flow-based risks.

In a synthetic structure, the exposure to underlying reference assets will be established through a credit default swap or another form of credit derivative product. In either case, the documentation will generally involve ISDA standard documents.

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ix. Opinions

The arranger and the trustee will require opinions on:

1) Each party’s capacity and authority to enter into the transaction.

2) Whether the transaction documents have been duly executed and represent the legally binding and enforceable obligations of each party.

3) Whether requisite consents and authorities have been obtained and registrations made.

4) Whether all legal formalities for the transfer of the receivables have been satisfactorily complied with.

5) Whether security interests are effective.

6) Whether the choice of law provisions are effective.

In the case of an issue specific rating, the rating agency will require the above opinions to be addressed to it as well.

The law firm issuing an opinion will carry out due diligence before issuing the opinion. Depending on the scope of the opinion to be issued, the due diligence exercise should include:

1) A review of the constitutional documents to check that each relevant party has been constituted and has appropriate capacity and authority to enter into and perform the relevant transaction documents and to originate, hold and transfer the receivables.

2) Searches to confirm that:

a) no insolvency proceedings have been commenced in relation to the relevant parties; and

b) no security interests in relation to the receivables have been registered.

3) A review of the receivables contracts, or a sample of them, to check that they create legal obligations on the debtors and do not:

a) contain restrictions on their transfer;

b) require the debtors' consent for transfer;

c) require the SPV to give notice to the debtors following transfer; or

d) impose administrative fees or expenses relating to the transfer or consent to transfer.

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4) A review of the sale agreement and an analysis of whether it contains characteristics for a true sale rather than a secured loan.

5) A review of the transaction documents to consider whether they contain appropriate representations and warranties.

6) A review of the board resolutions and shareholder resolutions.

7) Checking that directors or officers' certificates have been provided and that they include any necessary declaration as to solvency.

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SECTION 3

THE NIGERIAN SECURITISATION BILL: A COMPARATIVE ANALYSIS

3.1 INTRODUCTION

It is inevitable that Nigerian legislation would catch up with trends in other parts of the world in respect to the structuring of specialised credit and financing transactions. The Nigerian Securitisation Bill (“NSB”) is an attempt of the legislature in this regard. In this chapter, we consider its scope and objectives and compare it to similar legislation in another developing country with a similar legal regime.

3.2 NATURE, SCOPE, OBJECTS & LIMITATIONS

The long title of the NSB states that it is “a Bill for an Act to provide for the regulatory framework for securitization”. The bill is comprised of Seven Parts containing a total of 21 sections spanning over such issues as Special Purpose Vehicles (SPVs), registration of asset-backed securities and security rights, assignments and transfer of security rights, Trustees and Servicer as well as offences and penalties under the Bill.

Section 2 of the NSB contains the objects of the Act which basically includes: the regulation of securitization transactions by providing modern and comprehensive legislative framework for the development of financing as a financing technique; the provision of a modern and comprehensive legislative framework for the development of securitization as a financing technique and investments in intangible financial assets generally; to ensure that the rules governing securitisation transactions promote the availability of capital and credit at more affordable rates by diversifying the capital market to enhance its development and widespread use; creation of certainty and predictability and to institutionalize international best practices in the risk management of securitisation transactions.

The Indian Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“Indian Securitisation Act”), which contains its objects in Section 42 may be regarded as more expansive in its provisions when compared to Section 2 of the NSB. The objects provided for includes: the regulation of securitisation and financial assets reconstruction companies, the mode and manner of the acquisition of rights and interests in financial assets, raising of funds by the issue of registered securities, notification of debtors (obligors), disputes resolution by compulsory conciliation or arbitration, enforcement of security interest, the central registry for the registration of all securitisation and asset reconstruction transactions, and offences and penalties. According to Padmanabhan Iyer,41

41 See Padmanabhan Iyer: ‘India: The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 – An Overview of the Provisions”’2003: sourced online at

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the twin objectives of debt recovery and the foreclosure of security aside from providing for the broad legal framework for asset securitisation and reconstruction appears to be the aim of the Indian Securitisation Act.

In comparison with the NSB, it would appear that the NSB is wider in scope than the Indian Securitisation Act. The basis for this assumption is that assets that may form objects of securitisation are not limited to receivables from banks or other financial institutions. However, and as noted by Pratap G. Subramanyam42, the Indian Securitisation Act extensively provides for such other ancillary matters as general assets reconstruction and enforcement of security interests, albeit limited to the assets of banks and other financial institutions.

The scope of the NSB, which must be read subject to its Section 4, extends to both assignments and subsequent assignments of receivables owed by debtors resident in Nigerian at the time of the contract that established the receivables.

By the provisions of Section 4, apart from saving the existing laws on the rights and obligations that accrue to parties on negotiable instruments, transactions made for personal, family or household purposes, the NSB, similar to Article 4 of the United Nations Convention on the Assignment of Receivables in International Trade,43 is intended not to apply to assignments made to or arising under or from:

a. an individual for his personal, family or household purposes;

b. transactions on a regulated exchange;

c. financial contracts governed by netting agreements except a receivable owed on the termination of all outstanding transactions;

d. inter-bank payment systems, agreement or clearance and settlement systems relating to securities or other financial assets or instruments;

e. transfer of security rights in sale, loan, holding of or agreement to repurchase securities or other financial assets or instruments held with an intermediary;

f. bank deposits; and

g. letters of credit or independent guarantees.

Section 31 of the Indian Securitisation Act is similar to Section 4 of the NSB. It provides for the instances or transactions in which the provisions of the Act would not apply. These transactions are:

http://www.mondaq.com/article.asp?articleid=22031 42 See Pratap G Subramanyam: Investment Banking – An Odyssey in High Finance (Tata McGraw-Hill Publishing Co. Ltd: New Delhi: 2005) page 72043 Resolution 56/81 adopted at the 85th Plenary Meeting of December 12, 2001

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a. liens on goods, money or security given by or under the Indian Contract Act, 1872; the Sale of Goods Act, 1930 or any other law for the time being in force;

b. pledges of movables within the meaning of section 172 of the Indian Contract Act, 1872;

c. security in any aircraft as defined in clause (1) of section 2 of the Aircraft Act, 1934;

d. security interest in any vessel as defined in clause (55) of section 3 of the Merchant Shipping Act, 1958;

e. conditional sales, hire-purchase or lease or any other contract in which no security interest has been created;

f. rights of unpaid sellers under section 47 of the Sale of Goods Act, 1930;

g. properties not liable to attachment (excluding the properties specifically charged with the debt recoverable under the Indian Securitisation Act) or sale under the first proviso to sub-section (1) of Section 60 of the Code of Civil Procedure, 1908;

h. security interest for securing repayment of any financial asset not exceeding one lakh rupees;

i. security interest created in agricultural land;

j. any case in which the amount due is less than twenty per cent of the principal amount and interest thereon

The NSB defines “securitization” as “the process by which assets are sold on a without recourse basis by the Originator to a Special Purpose Vehicle (SPV) and the issuance of ABS, which depend on the cash flow from the assets sold in accordance with the Scheme for their repayment, the SPV”;44. The Indian Securitisation Act on the other hand defines “securitisation” as an “acquisition of financial assets by any securitisation company or reconstruction company from any originator, whether by raising of funds by such securitisation company or reconstruction company from qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or otherwise”45

The Indian Securitisation Act also defines “asset reconstruction” as “acquisition by any securitisation company or reconstruction company of any right or interest of any bank or financial institution in any financial assistance for the purpose of realization of such financial assistance”46

44 See Section 5(23) of the NSB45 See Section 2(1)(z) of the Indian Securitisation Act46 See Section 2(1)(b) of the Indian Securitisation Act

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From an operational perspective, the NSB recognized the all-important role of SPVs as the appropriate securitization vehicles and thus made extensive provisions for their creation, regulation and dissolution. SPVs as used under the NSB will mean either a Special Purpose Corporation (SPC) or Special Purpose Trust (SPT). Whilst the SPC is described as a company created in accordance with the Companies and Allied Matters Act (CAMA) solely for the purpose of securitization and to which an Originator makes a true and absolute sale of assets, the SPT is described as a trust administered by an entity duly incorporated under the CAMA and need not be registered with the Securities and Exchange Commission to perform trust functions and created solely for the purpose of securitization and to which the Originator makes true and absolute sale of assets.

The Indian Securitisation Act makes no specific provision for SPVs but in the stead provided for ‘securitisation or reconstruction companies.’ These companies are required to obtain a certificate of registration from the Indian Reserve Bank before commencing or carrying on any form of securitisation or reconstruction business. These companies are also expected to have a minimum capital base of two core rupees or such other amount not exceeding fifteen percent of the total financial assets acquired or to be acquired by it, subject however to the overriding directives of the Indian Reserve Bank.47

In the light of the uncertainties and limitations surrounding the forms of companies created under CAMA and their inappropriateness for certain forms of transaction, it is opined that the approach taken by the Indian Securitisation Act is preferable. The limitations referred to herein includes: the inability of a private company to issue securities to the public, the strict regulations and high disclosure requirements to which public companies are subjected; the inability of Incorporated Trustees to carry on business; the long procedure for incorporating a company limited by guarantee and its inability to do business for the purpose of distribution of profits as well as the lack of legal capacity on a business name. It has been severally agreed that there is a dearth in the current forms of corporate persons and this scarcity will soon be felt by practitioners while attempting to structure securitisation transactions.

An SPV under the NSB would have powers to undertake all the following aspects of the securitisation business, to wit: accept the sale or transfer of assets; issue and offer asset-backed securities to investors; undertake either by itself or through any person, create any indebtedness or encumbrances to defray administrative or other necessary expenses; pay out or invest its funds as approved by the Securities and Exchange Commission (“SEC”); and generally undertake the activities contained in the authorised scheme of securitisation either by itself or through any person or entity.48

The SPV enjoys tax emption on amounts distributed to the holders of its asset-backed securities. Further where assets are sold or transferred to an SPV that is structured as a trust

47 See generally Section 4 of the Indian Securitisation Act48 See generally, Section 8 of the NSB in this regard

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(SPT), such sale or transfer is to be exempted from Value-Added Tax (VAT), Capital Gains Tax and Stamp Duties “or any other taxes imposed in lieu thereof”. This exemption will also apply to the original issuance of asset-backed securities and other securities related to the securitization transaction, for example, the originator’s equity, originator purchased subordinated debt instruments and related credit enhancements.49

The Indian Securitisation Act established a securitisation or reconstruction company similar to the Asset Management Corporation of Nigeria (AMCON), with unrestricted power to acquire the financial assets of any bank or financial institution either by issuing a debenture, bond or any other security in the nature of a debenture to the bank or other financial institution; or by entering into an agreement with such bank or other financial institution on mutually acceptable terms for the transfer of the financial assets to be acquired. Upon such acquisition, the securitisation or reconstruction company assumes the full rights and obligations of the bank or other financial institution and specifically, the securitisation or reconstruction company shall be with the power to enforce or act upon all contracts that relates to the acquired financial asset.50

The NSB requires an SPV to be dissolved and its approved asset-backed securities terminated, cancelled or withdrawn where it fails to accept the transfer of assets or issue asset-backed securities to qualified institutional investors within 6 months from the date of the approval of the securitisation scheme, unless the Commission extends the period within which it is to do so. Also, where a minimum two-third of the holders of its asset-backed securities make a resolution to the effect of its dissolution and obtain SEC’s approval, the SPV shall become dissolved. The Indian Securitisation Act did not use the terminology “dissolution” but rather provides for the instances where the certificate of registration of a securitisation or reconstruction company can be cancelled. These instances include where such company:

a. ceases to carry on securitisation or assets reconstruction business;

b. ceases to receive or hold any investment from a qualified institutional buyer;

c. fails to comply with any of the conditions under which the certificate of registration was granted

d. fails to satisfy the initial inspection and further inspection requirements of the Reserve Bank as enumerated in Sections 3(3)(a) – (g) and 4(1)(e)(i) – (iv) of the Indian Securitisation Act

3.3 THE ESSENTIAL ELEMENTS: CONCEPTS OF “TRUE SALE” AND “EFFECTIVE ASSIGNMENTS”

49 See generally, Sections 16,17 and 18 of the NSB 50 See generally Section 5 of the Indian Securitisation Act

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For the purpose of certainty of what will constitute a transfer of assets by true sale or assignment to an SPV, the NSB has expressly provided the characteristics of each of these modes of the transfer of assets. By Section 9 of the Bill, to constitute a true sale, the following characteristics must be present:

a. the assets must be transferred either by way of a sale, assignment or exchange on a without recourse basis to the originator;

b. the assets to be sold must be isolated and put beyond the reach and effective control of the originator and its creditors;

c. the transferee must have the right to pledge, mortgage or exchange the sold assets and shall have the rights to the profits and earnings from the disposition of the assets;

d. the transferee shall undertake the risks associated with the assets, provided however that the transferor shall not be excluded from providing the usual representations and warranties in respect of the asset;

e. the transferor shall be without right to recover the assets and the transferee shall not be entitled to reimbursement of the price or other considerations paid for the assets51

In relation to assignments, the Bill makes it lawful to assign or transfer receivables notwithstanding any agreement to the contrary between a debtor and the present assignor or transferor and same restriction will be invalid in the case of further assignment or transfer of the receivables. The effect of this provision does not however absolve the assignor or transferor of liability to the debtor, save that the debtor cannot void the assignment or transfer of the receivable to the assignee or transferee even where the transferee had knowledge of the agreement between the debtor and the transferor. These provisions are aimed to legislatively negate the consent requirement where a true sale, assignment or transfer of receivables is made for the purposes of securitisation.52

The ‘no consent’ requirement under the NSB appears slightly different from the discretionary provision in Section 6 of the Indian Securitisation Act which provides that the bank or other financial institution (the assignor) “may, if it considers appropriate, give a notice of acquisition of financial assets by any securitisation company or reconstruction company, to the concerned obligor and any other concerned person and to the concerned registering authority (including Registrar of Companies) in whose jurisdiction the mortgage, charge, hypothecation, assignment or other interest created on the financial assets have been registered.”53In the absence of any provision to such effect in the NSB, it still remains

51 See generally Section 9 of the NSB52 See Section 11 and 12 of the NSB53 Section 6 (1) of the Indian Securitisation Act

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the law in Nigeria that proper notification be made at the Nigerian Corporate Affairs Commission (CAC) in the event of a change in the particulars of a charged asset of a company, such that the assignor (in practice, it is the responsibility of the assignee) must, in the manner of the Indian Securitisation Act give the due notification to the CAC.54

Any property, either personal or real, that secures such receivable shall also be assigned or transferred without the execution of new assignment or transfer documents. Where however any existing law that regulates the transfer of the particular property requires the execution of new instrument of transfer, the assignor shall be statutorily obliged to execute such instrument.55

Further, the NSB intends to make lawful the assignment of more than one receivable in one transaction, provided that each receivable constituting the assignment is described separately and each can, at the time of the assignment, or in the case of future receivables, each can at the time of the conclusion of contract, be identified as the receivables to which the assignment relates. This effectively establishes a test of specific description and identification to validate the assignment of a pool of receivables.56

3.4 REGULATION AND SUPERVISION

As may be noted from the supervisory duties accorded to it in the foregoing paragraphs, SEC is proposed to be the major regulatory authority of securitisation transactions in Nigeria. 57

This position ma``y be juxtaposed with the provisions of the Indian Securitisation Act58 which provides for two different supervisory authorities. The first being the Indian Reserve Bank which is given the powers to, where it is satisfied that such powers should be exercised in the public interest or to prevent affairs being conducted in a manner detrimental to both the interest of investors and the securitisation or reconstruction company, determine policy and issue directions on the affairs any of such companies in matters relating to income recognition, accounting standards, provisions for bad and doubtful debts, capital adequacy based on risks weights for assets and the deployment of funds. Secondly, the Indian Securitisation Act has given the Indian Central Government the power to, by notification, set up a Central Registry for the purposes of the registration of securitisation and reconstruction of financial assets transactions as well as transactions that create security interests under the Act. The Central Registry is to have a Central Registrar who shall maintain a Central Register for entering of all transactions relating to securitisation, reconstruction and the creation of security interests. The information in the Central Register 54 See generally Section 197 of the Companies and Allied Matters Act, 1990 (compiled as Cap. C20, Laws of the Federation of Nigeria, 2004) (CAMA) 55 See particularly Section 12(1) of the NSB56 See Section 10 of the NSB57 Although under Section 6(2) of the NSB, it is not made mandatory for Special Purpose Trusts to be registered with SEC, their scheme of securitisation will however still require SEC approval.58 See Sections 12, 12(A) and 20 thereof

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can likewise be kept in electronic form. To ensure administrative efficiency, the Central Registry can maintain branch offices in such places as the Indian Central Government may think fit.

Much as SEC is set up by law59 to be the apex regulatory authority for the Nigerian Capital Market to ensure investors’ protection, a fair, efficient, transparent market and the reduction systemic risks,60 its oversight functions are essentially directed at public companies and their securities,61 ensuring that the regulation of private company securities are more often than not outside its regulatory radar. Thus where as it is sought under the Bill, the SEC is to regulate securitisation transactions generally, it may then be assumed that securitisation transactions may have been unwittingly taken outside the scope of private companies to structure, or better still, that such transactions are anticipated to be public transactions and not such as can be privately traded.

3.4 OTHER ASPECTS OF THE INDIAN SECURITISATION ACT

Two aspects of the Indian Securitisation Act worth discussing are the provisions of its Section 11 and those of Part 3 of the Act, consisting of Sections 13 to 19.

Section 11 of the Indian Securitisation Act provides for the compulsory resolution by conciliation or arbitration of disputes between or among banks or financial institutions and securitisation or reconstruction companies and qualified institutional buyers. Such disputes which must be disputes that relate to securitisation or reconstruction or the non-payment of any amount due (inclusive of interests) are to be resolved by conciliation or arbitration process and procedure as provided by the Indian Arbitration and Conciliation Act, 1996.

Section 11 dispenses with the need for a Conciliation or Arbitration Agreement between the parties as by its operations, it is to be deemed that the parties have consented in writing to resolve their disputes by conciliation or arbitration. Such an overreaching statutory provision as this may only be appreciated in light of Section 35 which makes the provision of the Indian Securitisation Act override the provision of other laws. According to Section 35, the provisions of the Indian Securitisation Act is to have effect, notwithstanding any inconsistent provision of any other law or instrument for the time being in force.

Part 3 of the Act, comprising of Sections 13 to 19 generally provides for the enforcement of security interests. The revolutionary impacts of these provisions on debt recovery and the enforcement of security interests may have informed Padmanabhan Iyer’s62 conclusion that

59 See the Investments and Securities Act, 2007 No. 29 (“ISA”) 60 See long title to the ISA61 See for example Section 13(c) & (d) of the ISA62 See Padmanabhan Iyer: ‘India: The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 – An Overview of the Provisions’ 2003: sourced online at http://www.mondaq.com/article.asp?articleid=22031

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the twin objectives of debt recovery and the foreclosure of security aside from providing for the broad legal framework for asset securitisation and reconstruction appears to be the aim of the Indian Securitisation Act. These provisions empower secured lenders to attach and sell collateral security or other security interests to recover their loans, all without the intervention of the judicial process. Quite rationally, the Indian Securitisation Act has since been the subject of major disputes in Court with increased advocacy that the powers of a secured creditor under the Act should be whittled down, or at best, made subject to the judicial process.63

Specifically and by the provisions of Section 13(1), a secured creditor can legally and validly enforce his security interest without the intervention of the courts or the judicial system, provided however that such enforcement is in accordance with the express provisions of the Indian Securitisation Act. It is worth noting that Section 13(1) employed the use of the discretionary word “may” as it is not mandatory that all secured creditors disregard the judicial process in the enforcement of their security interests. This position of Indian Law may be juxtaposed with what is obtainable under Nigerian Law, particularly with regards to what in law is regarded as “self-help”. It is worthy of note that Nigerian law does not expressly prohibit self-help, for example, where a deed of mortgage contains a mortgagees power of sale in the event of default by the mortgagor in a consecutive three months period; however, the law as at today is that such self-help unless can be executed peaceably, should not be resorted to. Thus where a mortgagee who intends to exercise a power of sale meets with a debtor’s resistance, the only option left to him is to approach the Court for an order to enable him execute his right. The apt conclusion on this point of law is that, in civil society, only through the machinery of the judicial process can one seek to apply force in the enforcement of his right and in any event, the enforcement of his right remains not within his remit, but within the powers of the appropriate authorities established for such purposes, for example, the Sheriffs of Court, the Police, the Civil Defence Corps.

While subsection (4) of Section 13 of the Indian Securitisation Act provides for the rights of a secured creditor in the process of enforcement of his security interest, Section 13(2) and (3) states the criteria that must be fulfilled by the secured creditor before exercising his right of enforcement. By Section 13(2)(3) & (3A), it is mandatory that the following must be established:

a. there must have been default in the repayment of the secured debt;

b. the secured creditor has classified the debtor’s account as non-performing;

c. the secured creditor has by notice in writing required the debtor to discharge its liabilities in full within 60 (sixty) days from the date of the notice;

63 See Pratap G Subramanyam: Investment Banking – An Odyssey in High Finance (Tata McGraw-Hill Publishing Co. Ltd: New Delhi: 2005) page 720

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d. the notice shall give details of the amount payable and the security intended to be enforced by the secured creditor in the event of non-payment;

e. where on receipt of the notice, the debtor makes any representation or objection, the secured creditor shall consider such;

f. where the secured creditor finds the representation or objection untenable, he shall, within one week of receipt of the debtors representation or objection, communicate his non-acceptance and the reasons for such to the debtor.

It is worthy of note that by the proviso to Section 13(3A), such reasons communicated by the secured creditor under step (f) above cannot confer any right on the debtor to refer an application to the Debts Recovery Tribunal or other judicial forum.

The measures which a secured creditor may make recourse to for the recovery of the secured debt include:

a. taking possession of the collateral security including the debtor’s right of alienation;

b. take over the management of the debtor’s business including his right of alienation of same; provided however that the secured creditor may only lease, assign or sell the business where it was a substantial part of the business that was so held as security; and also, where the management of the business is severable, the secured creditor shall only take over the management of that aspect of the business that is related to the security.

c. appoint a manager to manage the security which is now in the secured creditor’s possession;

d. by notice in writing, require any person who purchased the security from the debtor, to pay to the secured creditor any sum that becomes due to the debtor as will be enough to satisfy the debt; such payment when made, shall be deemed a valid payment to the debtor.

Any of these measures can be taken singly or together; and with regards to the power of taking possession and selling or otherwise transferring the collateral security, the secured creditor may write to the Chief Metropolitan Magistrate or the District Magistrate of the jurisdiction where the security is situated, to take possession of the security alongside the documents relating thereto. Upon taking possession, whether by use of force or not, he shall transfer such security and its documents to the secured creditor and no action so taken by the Chief Metropolitan Magistrate or the District Magistrate shall be called into question before any court or any other authority.64 Further, the costs, charges and expenses properly 64 Section 14 of the Indian Securitisation Act

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incurred by a secured creditor in the process of an action against a debtor, shall be recoverable from such debtor. However, worth noting is that the power of a secured creditor to sell or transfer the security becomes abated, where before the date fixed for the sale or transfer, the debtor discharges his debt obligations alongside all the costs, charges and expenses incurred by the secured creditor.65

These powers of a secured creditor may however not be exercisable freely in instances where more than one secured creditor financed a particular security. In such instances no secured creditor will be entitled to exercise any of the rights stated above unless the exercise of any right by any secured creditor is agreed upon by secured creditors who have an aggregate three-fourths of the outstanding value of the debt (that is, the principal, interest and any other dues payable by the debtor to the secured creditor); and whatever decision reached shall be binding on all the affected secured creditors.

SECTION 4

CONCLUSION

It has long been established that credit is the fuel that essentially propel the wheel of commerce and with the provision of credit comes the risk of insolvency. Furthermore, it is undoubted that modern commercial transactions carry a higher volume of intangible assets comprising of receivables which are collectible over time. Commercial players and financial engineers have thus device means for not only financing projects but of also collateralizing the receivables from such transactions for the purpose of cashing out and financing other projects. What is therefore evident at this point is that all securitization carry with it the risk that the obligors who are to pay the underlying receivables may default. It is thus essential 65 See Section 13(8) of the Indian Securitisation Act

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for all securitized assets should carry with it an underlying security interest which would be enforced by the security trustee on behalf of the investors.

Nigeria as a nation with huge potentials is also desirous of advancing its laws particularly in the aspect of financing with a view to ensuring that there is funds for boosting other sectors of the economy as a robust financial sector would guarantee, provide room and promote a prospective economy. Whilst the NSB is commended as a step in the right direction, more deliberate efforts should still be directed towards promoting an enabling environment for structured finance to thrive in Nigeria. These efforts range from the passage of the bill, to the development of the insurance sector for the purpose of providing credit enhancement, to the reform of our security laws, the development and capacity building in the aspects of trust, corporate finance and asset management. The university curricular ought to change to prepare lawyers for the challenges of our time thus avoiding the dearth of capacity and ensuring that the structures for the transactions are well considered and all risks sufficiently mitigated. A standardized rating system with globally acceptable standard should also be developed and the securities market further diversified.

Our corporate laws may also be reviewed for the purpose of expanding the forms of corporate vehicles that are recognized as well as clearly delineating the quantum of disclosure requirements and corporate governance that is expected of them.

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