Legal experts are proposing a new technique to carry out securities transactions, more easily, cutting costs and legal uncertainties

Officials from the CA Sri Lanka overseas chapters

Sri Lanka’s financial market players are looking for ways to carry out securitisation transactions, to cut costs and legal uncertainties. Sri Lanka’s financial market players are looking for ways to carry out securitisation transactions, to cut costs and legal uncertainties. The latest proposal is a legal techniques knows a Declaration of Trust, where a group of identified assets are separated from a the parent entity.

“It’s used rather extensively in India, and some local firms are now looking at introducing it here as well,” says Neomal Goonewardena, Partner, Nithya Partners – a legal firm, addressing participants of a seminar organised by the Chartered Financial Analysts Sri Lanka Chapter.

Industry players have been pushing for a Securitisation Act which will clear grey areas around asset securitization.

In a transaction transaction, cashflow generating assets, (leases, housing mortgages, or credit card receivables) are taken out of the balance sheet of the originator and ‘sold’ to a special purpose vehicle SPV. The SPV is usually a limited company.

The assets of the SPV are supposed to be ‘bankruptcy remote’ or separated from the fortunes of the parent company.

This allows the securitised instrument issued by the SPV to have a higher credit rating than the originating company.

But in Sri Lanka a ‘true sale’ does not usually take place and the leases or other assets are assigned to a trust.

There is also an ‘agreement to mortgage’ which is supposed to executed at the first hint of trouble at the parent company, so that the creditors of the parent company cannot claw back the assets in the trust.

Issuers rely on the Trust Ordinance, the Registration of Document Ordinance and the Mortgage Act.

The whole process does not inspire confidence, and the costs of registering each transaction is also high explains Dinesh Warusuvitharana, Assistant Vice President, Fitch Ratings Lanka.

Industry players were pushing a Securitisation Act, to clear-up the grey areas in such transactions, but the draft bill has got bogged down in bureaucracy.

“The only way to clear the legal air, is to bring in the Securitisation Act,” says Ajith Fernando, CEO of Capital Alliance Holdings, who has been involved in securitisation transactions for almost a decade.

Central Bank’s two-year old proposed amendment to the Leasing Act talks about transferring all rights to the SPV.

Though it looks good on paper, the proposal carries some practical difficulties.

“It’s not going to work,” opines Goonewardena.

The SPV has little or no experiences in recovering the assets. At the moment even the in the case of motor leases, the originator has to step in and recover the money.

This can be particularly difficult in the case of housing mortgages, where the SPV would not have parate execution a legal right to recovery given to some banks, which is almost impossible for defaulters to block legally.

When it comes to auto leases, Sri Lankan leasing companies rely on security firms and ‘seizers’ to forcibly take away vehicles using strong arm tactics.

Goonewardena says perhaps a specialised recovery company could emerge to add some dignity to the process.

His view is shared by Vajira Kulatilake, CEO NDB Investment Bank who says that perhaps some enterprising Sri Lankan should think of starting an alternative service firm to meet such needs.

What are
Asset-Backed Securities?

Asset-backed securities, called ABS, are bonds or notes backed by financial
assets. Typically these assets consist of receivables other than mortgage
loans, such as credit card receivables, auto loans, manufactured-housing
contracts and home-equity loans.

ABS differ from
most other kinds of bonds in that their creditworthiness (which is at the
triple-A level for more than 90% of outstanding issues) derives from sources
other than the paying ability of the originator of the underlying assets.

institutions that originate loans—including banks, credit card providers,
auto finance companies and consumer finance companies—turn their loans into
marketable securities through a process known as securitisation.
The loan originators are commonly referred to as the issuers of ABS, but in
fact they are the sponsors, not the direct issuers, of these securities.

These financial
institutions sell pools of loans to a special-purpose vehicle (SPV), whose
sole function is to buy such assets in order to securitise them. The SPV,
which is usually a corporation, then sells them to a trust.

The trust
repackages the loans as interest-bearing securities and actually issues
them. The “true sale” of the loans by the sponsor to the SPV provides
“bankruptcy remoteness,” insulating the trust from the sponsor. The
securities, which are sold to investors by the investment banks that
underwrite them, are “credit-enhanced” with one or more forms of extra
protection—whether internal, external or both.

True sale
An actual sale, as distinct from a secured borrowing, which means that
assets transferred to an SPV are not expected to be consolidated with those
of the sponsor in the event of the sponsor’s bankruptcy. Rating agencies
usually require what is called a true-sale opinion from a law firm before
the securities can receive a rating higher than that of the sponsor.

Special-purpose vehicle (SPV)
A bankruptcy-remote entity set up to insulate the issuer of ABS (the
trust) from the sponsor, or originator, of the assets. Also called
special-purpose corporation (SPC).

-LBO Newsdesk:

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