As with their counterparts in other areas of structured finance, emerging market players have been mulling over the question of where exactly their deals fit in the new regulatory landscapes of Western Europe and the U.S.

Notwithstanding the cut-and-dried cases, such as a straight RMBS and CDOs - which on the cross-border front have become exceedingly rare at any rate - there are a number of asset classes among cross-border issuers that do not come with easy-to-follow instructions for regulators or those who have to translate the rules.

To be sure, emerging markets were not on the minds of regulators when they devised these rules. But the changes may yet prove to have an impact on certain asset classes and will arguably become more relevant as local regulators across the globe either adopt the practices of Western Europe and the U.S. or players apply those regulations to local markets regardless of any moves by local regulators.

"EM issuers have generally been oblivious to all this because they have never had to worry about it in the past, not being public issuers," said Emil Arca, a partner at Hogan Lovells.

But he added that there are regulatory areas where EM issuers are either already covered or may be covered in the future: "[For instance] 17g-5 (see box) can apply to private deals if the rating agency involved thinks it meets the definition of a structured finance transaction; provisions in Dodd-Frank on reps and warranties reviews and asset review findings may apply to foreign issuers; and the SEC's initial draft of proposed Reg AB II, which has been back-burnered to deal with Dodd-Frank, proposed that it apply to private deals using 144A as a resale exemption or Reg D as the initial placement exemption."

The Curious Case of Future Flows

One area that typifies this unclear state of affairs for emerging market issuers is future flows, the securitization of future receivables related to certain business lines. While this sector has included world-class exporters such as Petroleo Brasileiro in its ranks, it has in recent history been dominated by banks backing their deals with diversified payment rights (DPRs), from countries such as Brazil, Turkey, and Peru. DPRs typically are tied to flows from such activities as exports, worker remittances and foreign direct investment, among others.

"It appears the whole regulation was not addressed toward types of deals like future flows; it was more addressed toward deals like CDOs, RMBS or ABS transactions," said Stefan Bund, a managing director at WestLB who oversees future flow deals.

Future flows have traditionally been covered by many of the same people who are involved in more traditional asset-backeds.

"Everybody has to make his own decision whether a future flow is a securitization or not," Bund said. "Historically, future flows were put into the securitization camp simply because it was rated by the rating agencies out of their securitization teams and the arrangers were from their securitization teams."

To be sure, this asset class, if it can be called that, always had a hybrid quality. This has been thrown into relief by the application of Rule17g-5 in the U.S. As it has worked out in practice so far, Fitch Ratings and Standard & Poor's have not applied the rule to future flows, while Moody's Investors Service has.

This, sources said, could be a harbinger of future discrepancies in how regulations are applied to emerging market asset classes.

Somewhat akin to Moody's application of the structured finance, or "sf," suffix to future flow deals - another area in which it differs from its peers - the agency determined that future flows fall under the rubric of structured finance for the purposes of 17g-5.

A spokesman for the agency said that those deals that had an "sf" suffix would be subject to 17g-5.

In a release from last December, Moody's updated the market on its criteria for assigning "sf" to a transaction. This criteria, in broad terms, included deals with the following characteristics: payments that depend upon the performance of an exposure or pool of exposures; the existence of a special-purpose entity and whether economic interests are transferred to such special-purpose entity; the instruments are not obligations of, or have full or substantially full recourse to, the originator/sponsor; and the presence of securitization tranching.

It was unclear how many of these principles a deal would have to fulfill in order to be considered a structured finance deal, and a query about this to Moody's was not answered as of press time. While future flows would arguably fit one or two of these criteria, they do not fit all. The agency does, however, make it clear that its definition of a structured finance instrument may not conform to those of other market participants. The definitions could change in the future as well, according to a Moody's spokesman.

Fitch, which has rated future flow deals since December without considering them under the umbrella of 17g-5, sees future flow deals as outside the spirit of this rule primarily because they are typically credit linked to the underlying corporate or financial institution and are usually not treated as off-balance sheet funding, said Managing Director Greg Kabance. "These deals are corporate hybrids primarily designed to protect investors from sovereign risk," he added. "That's not what traditional securitization is supposed to be about."

While not explicitly addressing future flows, in a FAQ on 17g-5 Standard & Poor's said that, in most cases, the three criteria that would make a transaction subject to the rule were the following: a special-purpose entity and a pool of assets that back the issued securities; a special-purpose entity and tranching; or a special-purpose entity and one or more assets in the pool of assets that back the issued securities, if such assets were previously issued in another transaction covered under 17g-5. A spokesman for the agency said that if a deal met these guidelines, then it would likely be covered by 17g-5. It was unclear whether a deal fulfilling only one of the principles would be placed under the rule.

While future flows typically do involve a special-purpose entity trapping the flows, they do not usually include tranching. Many larger DPR transactions, such as a €300 million ($445 million) one from Turkey's DenizBank settled in the last week of April, have multiple series but they tend to be pari passu in seniority.

WestLB's Bund said a number of aspects of future flows should make them exempt from any rules governing structured finance transactions. "Quite a few, if not the majority of future flow transactions, are structured as to give recourse to the originator," he said, pointing out that, for instance, some future deals have been structured using a loan structure where ultimately the originator has to make the payment to the investors. "Even though you use the future flows going through the structure, if these payments are not sufficient, simply by the nature of the loan structure, the originator would have to pay."

In addition, Bund argues that the risk transfers and the uneven allocation of risks and rewards that regulators are particularly concerned about when it comes to structured deals are non-issues for future flows. "In future flow deals, it's unthinkable to have a scenario where the flows dry up and the originator wouldn't get into serious trouble," he added. "They get into trouble because the majority of flows go back to the originator."

Beyond 17g-5, which, after all, is not deemed by most to be a high-impact regulation, the notion that future flows bear a strong resemblance to a proper securitization opens the door to other rules, sources said.

"The issue we face now is that if you classify it as a securitization, then you have to apply risk retention rules or European capital requirement directives, [and then] you have reporting standards, like on the granularity of the portfolio or other information that typically isn't applicable to future flows," said a market source familiar with the sector.

Bund said that, in the most recent future flow deals, issues such as risk retention are actually covered. "The documents are drafted such that if an investor or regulator were to take the position that the future flow transaction is a securitization, risk retention rules are addressed by particular means stated in the documentation," he added.

Deals Off the Regulatory Radar

Outside the future flows sector, cross-border emerging market players will have to navigate 17g-5 and other, weightier regulations as well. The consensus is that many if not most of the transactions we're likely to see in the proximate future - infrastructure, future flows and other deals attached to the operating risk of a single company - are unlikely to fall under the structured finance rubric for regulatory purposes.

Recent infrastructure deals linked to government risk in Peru, for instance, are outside the purview of these rules, according to Gianluca Bacchiocchi, a partner at DLA Piper. "Rules related to risk retention haven't affected payment right-backed project bonds," Bacchiocchi said.

These transactions, which to date have been supported by either direct government payment obligations or contingent guarantees for the construction of specified infrastructure projects, have recently been sold as Reg S-only transactions, with flowback into the U.S. pursuant to Rule 144A after initial issuance.

The most recent deal of this kind was a bond funding the construction of the Taboada wastewater treatment plant in Peru. The deal amounted to PEN942 million ($333 million) and consisted of three tranches with maturities ranging from 18 years to 22 years. The issuer was an SPV incorporated in the Cayman Islands for the purpose of purchasing without recourse certain payment rights from project sponsor PTAR Taboada as it completes construction milestones. These payment rights are irrevocable and unconditional payment obligations of Sedapal, the government-owned water utility company of the cities of Lima and Callao, and are vested upon the issuance of certificates that measure the progress of construction. Sedapal's payment obligations are supported by an assignment of all of Sedapal's water consumer receivables paid through Peruvian banks to a local trust. Most importantly, however, is that the payment rights are also guaranteed by Peru's Ministry of Housing, Construction and Sanitation, Bacchiocchi said, adding that the risk at the end of the day is akin to a Peruvian sovereign pass-through obligation.

"What we're dealing with here is a true sale of payment rights that are supported by the Peruvian government," Bacchiocchi said. "So we analyze completely separate from the sponsors themselves what is being generated and what is being purchased."

He added that, while a deal of this nature is more structured than traditional project finance, the fact that the receivables have not yet been created in the deal and depend on certain milestones being completed makes them a different animal from the structured finance deals regulators are targeting.

Bacchiocchi said that, in these types of transactions, having to comply with the collateral data disclosure potentially required by some rules would be impossible. "There is no receivable data because nothing has been generated yet," he said. "What people do is look at the sovereign - in this case, Peru - and ask: what is their debt rating?"

Other kinds of emerging market transactions inspire less confidence that they will remain outside the ken of structured finance regulators. And certainly if the more traditional ABS/MBS cross-border market returns from Latin America and other corners of the emerging markets - players may recall the time when cross-border Russian RMBS brimmed with promise - then issuers will need to comply.

For those that may be subject to the risk retention rules being proposed under Section 15G in the Dodd-Frank bill, an exemption is attached for non-U.S. issuers. But the qualification is very narrow, according to Laurence Pettit, a partner at Kramer Levin. "It would mean making sure that no more than 10% of your offering goes into the U.S.," he said. "Otherwise you have to structure a 5% retention as would any U.S. issuer subject to the rule."

Local Markets: Are They Next?

Many emerging market players are gritting their teeth over the possibility that their deals will have to meet requirements that essentially address problems endemic to transactions in the U.S. and Western Europe.

But in the largest markets for structured finance, local regulators are likely to adopt at least some of these new rules, sources said.

Indeed, some players are already applying new overseas rules to domestic deals. Moody's, for instance, applies 17g-5 to its national scale transactions that fall under what it considers structured finance.

Sources hope that when emerging market governments themselves begin to adopt these rules they will pick the most effective ones from Europe and the U.S.

"Our view is that local markets will adopt best practices in the leading markets," said Fitch's Kabance. He said that about 90% of Fitch's business in Latin American structured finance is in local markets. "And most of those countries haven't come up with regulations yet. The local deals will get covered at some point."

Rule 17g-5

Rule 17g-5 was adopted as part of the Credit Rating Agency Reform Act of 2006. It compels SEC-registered credit rating agencies or nationally recognized statistical rating organizations (NRSROs) to comply with certain limitations and procedures. These requirements were implemented to mitigate perceived conflicts of interest.

This particular ruling requires NRSROs paid to rate a structured finance product to get from the deal's arranger - in this case, the issuer, sponsor or underwriter-an agreement to post to a password-protected Web site all information provided in connection with the product's rating or any subsequent surveillance.

The data should be made accessible to the other NRSROs that were not hired to rate the security. The SEC put off the application of this rule for deals issued by non-U.S. persons that did not target U.S. investors until December 2 of last year.

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