Data center construction is showing no signs of slowing down, and the Securities and Exchange Commission just gave a leading law firm regulatory guidance that is expected to reduce execution costs and increase structural flexibility for sponsors looking to the securitization market for financing options.
The guidance removes structural, compliance and cost barriers for certain operators who were used to doubling down on cautionary measures to ensure deal execution, according to Latham & Watkins sources. Market professionals expect greater access for the asset class.
Data center securitization sponsors, no longer have to comply with the 5% risk retention rule. This suggests notably greater cost savings, because data center securitization sponsors typically retain 30% of risk, according to Latham & Watkins.
Another benefit is that the securitizations are not expected to fall within the scope of Rule 192, prohibits an ABS participant from engaging in any transaction that would end up in a material conflict of interest with an investor in a covered securitization.
Lastly, 15Ga-1 and 15Ga-2 disclosure requirements will no longer apply to data center securitizations. The former required regular disclosures of repurchase activity related to breaches of representations and warranties, while 15Ga-2 required third-party due diligence reports at least five business days prior to the initial sale of the related securities.
What's in the Box
True enough, data center securitizations share characteristics with Exchange Act ABS and even offer investors opportunities similar to that of real estate investment companies, Latham & Watkins counsel explained in their original request to the SEC.
The difference between commercial mortgage-backed securities (CMBS), for instance, and data center ABS, is the latter includes the physical property and the essentials to running the data center—including power, fiber and cooling, plus land and customer contracts.
"With a CMBS, the mortgage is being securitized, so the mortgage itself is a self-liquidating asset," Rolaine Bancroft, counsel at Latham & Watkins who advises clients on structured finance, securities compliance, and capital markets strategies. "The analysis being 'what is in the box' for a data center securitization."
The SEC agreed with Latham & Watkins' counsel that securitizations backed by data centers fall outside the statutory definition of an asset-backed security under section 3(a)(79) of the Securities Exchange Act of 1934, according to the law firm.
Known as "Exchange Act ABS," the type of bonds in question are described as a fixed-income security with any type of self-liquidating financial asset—including a loan, lease or mortgage, secured or unsecured receivable—that allows the security holder to receive payments depending on cash flow from the asset," according to a Latham & Watkins client alert.
"Data center facilities and their supporting infrastructure are not 'financial assets'," the company said, because they are physical assets that continue to exist well beyond the maturity of the related securities. They do not convert to self-liquidating assets by the end of their terms, like leases or mortgages, the company added.
Also, data center securitizations directly fund a business operation, and the proceeds can be used for a variety of purposes. Exchange Act ABS are issued to fund the purchase of a pool of self-liquidating financial assets, according to Lathem & Watkins counsel.
