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Officials from the CA Sri Lanka overseas chapters

The government has pledged to bring the Securitization Act to parliament this year as part of the private sector development program agreed with the Asian Development Bank. The government has pledged to bring the Securitization Act to parliament this year as part of the private sector development program agreed with the Asian Development Bank. The ADB is also pushing to make securitized instruments publicly traded,
At the moment legal gray areas in structuring asset securitization deals have made some deals look risky.

The promise to bring the draft securitization bill to parliament is welcomed by players in the financial sector who want to strengthen legal framework surrounding securitization deals.

Industry players have been pushing for a Securitization Act, which will clear gray areas around asset securitization.

In a transaction, cash flow generating assets, such as motor leases, housing mortgages, or credit card receivables, are taken out of the balance sheet of the originator and ‘sold’ to a Special Purpose Vehicle or SPV.

In developed markets, 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 securitized 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.

“One of the reasons why you cannot transfer all the risks and rewards of the pool to the trust is legal snag. I would expect the securitization law would deal with this,” says Alistair Corera, Fitch Ratings

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.

As present laws stand, a lease or its cash flows can only be transferred to an approved institution.

“The law dose not recognize the concept of an SPV,” points out.

The whole process does not inspire confidence, though agencies such as Fitch ratings have rated such issues.

“The securitization that has been happening in Sri Lanka for while is, in the true sense of securitization, is transfer of assets to a pool. It is a transfer –is sold out- and you shouldn’t have any feature that claw it back to the company.”

“What happens in Sri Lanka is not really a set out. They pledge the assets to the trust if you securities against it but they also have a recourse to the entity,” explains Alistair Corera.

Recently lawyers were proposing a new technique borrowed from another developing country.

The technique known as a ‘Declaration of Trust’ separates a portion of the assets of a financial firm without actually taking it out of the balance sheet.

Neomal Gunewardene of the law firm Nithya Partners told a seminar of financial professionals recently that such techniques are widely used in India.

That way the originator can retain legal powers such as parate execution provisions, which allow firms such as banks to takeover the assets of defaulters.

A specially incorporated SPV would not have such powers.

But preserving such links can also leave room for creditors of the parent company to argue that the assets do not really belong to the SPV.

The same goes for promises to replace defaulting leases with new ones.

But the introduction of the bill would hopefully clear the legal gray areas in securitization transactions.

-LBR Newsdesk: LBOEmail@vanguardlanka.com

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