As most European structured finance pros know, the U.K. has one of the better - if not the best - securitization-friendly insolvency legislative measures out there (see ASR 1/13/03). But continental Europe is another story. Here, market players have long been smoothing out the rough edges that add major kinks to securitization holder's claims.
As these continental countries, on an individual basis, continue stepping in the right direction, Europe-wide regulation dictated by the European Commission could threaten to turn the whole process upside down.
The biggest concern regarding the EC Insolvency regime is that it sets bankruptcy-proceeding principles based on where an enterprise's main interest of business is located. The criteria for establishing this location, however, is not 100% clear at the moment. Currently, this uncertainty seems to be much more relevant to securitization than the changes made to individual legislations, said Olivier Moura, a partner at law firm Simmons & Simmons.
In Spain, changes lead to possible delinkage
It's worth looking at the advances of insolvency regimes that both Spain and France are set to implement before the end of 2004.
In Spain, reformed insolvency legislation, which is expected to go into effect in September 2004, will provide rating agencies with a platform that permits triple-A ratings. Under the current insolvency framework, for example, Standard & Poor's allows for a maximum uplift of two notches from an issuers' counterparty credit rating.
The new legislation will specifically benefit the ratings on Spain's growing covered bond issues under the cedulas hipotecarias and cedulas territoriales issuing programs. The agency explained that the impending changes to the law will provide a scenario that enhances the priority claim of covered bondholders as long as the cashflow produced by the underlying loans accumulated after the issuer's insolvency is enough to meet the covered bond payments. Provided there is no cashflow mismatch, the new framework would provide mechanisms that ensure the timely access to the proceeds of the underlying loans.
Currently, the cedulas creditors rank behind certain employee salaries and certain claims of Spanish state and insurance companies, said analysts at Commerzbank Securities. However, the new legislation does not address the coverage of potential post-insolvency cashflow mismatches between underlying loans and covered bond payments. But the agency said that it was currently exploring with market participants an effective bridging mechanism for potential post-insolvency mismatches that would enable to the agency to delink the rating on these structures from their issuer's rating. "While the issuer is solvent, these maturity mismatches are easily handled by refinancing the maturing covered bonds with new issuance," explained analysts at S&P. "In the case of some European covered bonds, this may become impossible.
"That is why in all countries where S&P rates covered bonds on a delinked' basis, it must be satisfied that the relevant national legal and regulatory frameworks allow the cover pool to obtain third-party liquidity in the event of a bankruptcy of the originator, assuming asset cash flows are sufficient," S&P said in a report. The agency added that while the new framework does not provide any such solutions, the probability of a cashflow mismatch in the case of Spanish covered bonds is reduced by the excess earnings generated by the underlying assets relative to the low amount of covered bonds outstanding. (For more information on specific changes made to the Spanish law, see ASR 3/8/04.)
France turns a softer view on the creditor
Meanwhile, the French Minister of Finance presented a new text on insolvency proceedings on May 12, 2004, which will now go to Parliament. Sources familiar with the proceeding believe the new law is likely to be indemnified by the end of this year. "Its important to remember that the French law has remained the same since 1985, created by a socialist government whose priority was to save employment and not to back bondholders," said Simmons & Simmons' Moura.
The new law would bring the framework more in line with the U.S.-styled Chapter 11 protection and proceedings. Its aim is to enable directors of failing companies to seek help before the situation becomes hopeless. Once enacted, a chief executive will be able to work with creditors to seek a solution.
One feature of the current French insolvency regime is the power and involvement of commercial courts in pre-insolvency and formal-insolvency proceedings. The process is lengthy and further complicated by the fact that security may only be enforced by a judicial sale or a foreclosure order, directed and controlled by the courts.
The new draft aims to speed up the liquidation process and provide secured creditors with better access to securities. It is much more "creditor-friendly" in that it would allow the creditor to organize that transfer of assets well before an issuer becomes insolvent. Current insolvency proceedings allow creditors limited access to assets that can be seized.
Up until now, the country has received a low ranking from S&P, which in the past declared French bankruptcy legislation bondholder adverse.
"The bondholders have been forgotten in the current reform, even if the new proceedings call for discussions between bondholders and management as well as the [bank creditor] committees," said Moura. "The idea is to help companies solve difficulties before actually declaring insolvency. This safeguard proceeding allows management to stay in place. However, they must discuss with two new committees that include the bank creditors and the other creditors involved. During this stage, it is possible to sell assets without having to obtain an authorization from the judge."
The new draft also aims to speed up the liquidation process and provide secured creditors with better access to securities. Because securitization is based on a transfer of assets, the new draft will be much more creditor-friendly in that it will allow the creditor to organize that transfer of assets well before an issuer becomes insolvent.
Insolvencies in Europe
All told, Moura considers uncertainty in the Europe-wide proposed regulations a greater concern than most other developments involving individual countries.
He illustrated his point with the case of the Daisytek Co; a subgroup of a U.K.-headed corporation based in France. "The French company presented a case that demonstrated that the company, although headquartered in France, did not have the seat of this main interest in France and was primarily driven by U.K. interests," said Moura. Because the French location was meaningless, insolvency proceedings, under the new EC Regulation, had to be driven by U.K.-based Insolvency proceedings.
The decision was, nonetheless, challenged in France, and it brings to light the unpredictability the EC regulation introduces. At this point, a company could choose to move its main interest to be under a legislation deemed more sympathetic to the business. "There are several steps at stake that are not properly addressed by the EC regulation and vary jurisdictionally from country to country to country," said Moura. "This unpredictability could lead to a freeze or a slowdown of such operations as securitizations."
Separately, the Kreditschutz-yerband von 1870 (KSV), which monitors insolvencies in Europe, reported 5,600 firms declared insolvent in Austria in 2003 - the second-highest rate in Europe. Germany had the highest rate of insolvencies, while Spain reported one of the lowest rates. Insolvencies in Europe increased by 8% to 189,000.
There are concerns that bankruptcies will remain high, or even spike, as a result of companies seeking protection before regulations change (see ASR 5/3), said market sources.
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