A recent paper released by Moody's Investors Service suggests that transactions could be structured without SPVs in certain jurisdictions.

The report asserts that there are circumstances in which the agency believes that a non-bankruptcy remote company (operating company) can issue asset-backed notes with a rating significantly higher than the company's own rating.

By placing a fixed security charge over the assets and a floating security charge to mitigate the risk of an administrative order, securitization transactions would be simplified and the need for a separate SPV (special purpose vehicle) would be eliminated, the report said. This would result, says Moody's, in lower legal costs, shorter execution time and greater ability to define credit events.

The two authors of the report, Ebo Coleman and Stephen Roughton-Smith, put forward the view that English insolvency law is particularly favorable to creditors and therefore it is legally possible to isolate the securitized assets within the originator.

This would apply in the following countries with insolvency legal systems: England & Wales, the Cayman Islands, Hong Kong, Singapore, Australia, Malaysia and Bermuda. Some of these jurisdictions may actually be better suited to the procedure than the United Kingdom, because they do not have statutory administration proceedings, or company voluntary arrangement proceedings for small companies.

"The key thing in a securitization is to ring-fence the assets, and then to have the ability to access the assets in the case of bankruptcy of the originator," said Roughton-Smith, a vice president and senior analyst at Moody's. "Whereas in the United States you have to sell them to another corporate entity, in the United Kingdom a physical transfer of the assets is just not necessary. So if all you need to do is to legally ring-fence that assets, why bother to sell them as well?"

The other author involved, Ebo Coleman, who is also a vice president and senior analyst at Moody's, added: "We are not in any way trying to stop people selling the assets to an SPV, but clearly what we are trying to say is why should people bother to sell them as well, if it is not necessary. We are not in the structuring business, but many issuers tell us that derivatives are great because there is no transfer of assets. We would be recreating the same benefits by using the structure, with the additional benefit that funds are raised."

Market response

Securitization is often referred to as a very cumbersome process. One of the advantages associated with the absence of the true sale would mean that the work associated with transferring assets, and the due diligence this involves, would be greatly reduced. For instance, the process of going though each asset and ascertaining whether it could be sold would be eliminated, resulting in securitization becoming more commoditized.

Securitization originators are commending Moody's for inviting debate on the subject, and see positive implications for the market. There is, however, general skepticism on the actual cost savings that would be achieved.

While some observers are commenting that there is nothing new in the paper and that essentially these techniques are already being used in the market, others see Moody's as reinforcing its faith in the English insolvency law.

"I think where the Moody's paper is interesting is that it reinforces the administrative receiver concept that underpins whole-business securitizations and opens the possibility of its application in other more traditional asset classes," said Philip Basil, head of securitization at the Royal Bank of Scotland. "Further, it implies that if the underlying asset quality is supportive, then some element of a whole-business style securitization should be able to reach a triple-A rating."

Iain Barbour, global head of structured finance research at Commerzbank Securities in London, is also positive. "I believe that this is very positive and will have wide implications for the securitization market; we have seen it working well in Continental Europe already, creating considerable cost savings: not perfecting transfer of title at close will save money.

"Cost savings will be limited as the underwriting and distribution costs will not be affected," he added.

Pie in the sky

Of the skeptics, some have implied that the cost savings being discussed are pie in the sky'. The only costs to be eliminated, they say, would be the ones relating to the SPV, and these are marginal overall in a securitization transaction.

Others commented that there was nothing new in this paper, which was essentially a re-hash of the secured loan structure with nothing revolutionary about it.

"This report is important in relation to the willingness of Moody's to re-appraise the necessity of established features of non-U.S. securitizations," said Kevin Ingram, partner at Clifford Chance. "However, I believe that it will have a limited impact on securitization in the United Kingdom outside of whole-business/operating company securitizations which are already using secured loan structures to a large extent."

Another lawyer explained: "From a lawyer's perspective we do not see this as a revolution. We are in favor of anything that would render the securitization process more efficient, but the legal analysis that I would conduct, for instance in an operating company securitization, would not change.

"Yes, the SPV would be eliminated, and this would streamline the process, but the same legal analysis to ensure that we had security would have to be undertaken."

Lee Rochford, head of Northern European asset finance at Credit Suisse First Boston, saw nothing new in the idea. "This is something which has been capable of being applied to structured bonds in the U.K. corporate sector for a very long time."

Applications

Many comments on the paper seemed to focus on whole-business securitizations. The two authors of the report, however, maintain that the applicability is wider and embraces other asset classes.

Coleman and Roughton-Smith assert that this structure could provide additional opportunities for the use of securitization techniques in corporate finance deals and bank balance sheet management. Corporates with low ratings could issue debt from their own balance sheet and, incorporating the right structural enhancements, could in theory elevate the ratings as high as Triple A.

According to Roughton-Smith, "A low-rated corporate, by applying a fixed and floating charge over its assets, could essentially issue higher rated bonds."

What Moody's suggests, however, may be difficult to achieve at present, given the Basel proposals. These indicate that banks will have to demonstrate a clean break to earn a reduction in their capital requirements, and therefore to assert that the transfer is legally robust - a true sale.

Moody's believes that representations are being made to the Basel committee regarding this specific point. "In the Basel proposals they set out a number of criteria to get off-balance sheet treatment, and they thought that there would always have to be a transfer to an SPV," says Roughton-Smith. "However, we believe that this is an issue which is being raised with the regulators by several market practitioners.

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