The dearth of news in a market still recovering from the distractions of the Olympic Games was broken by positive developments on three fronts: the abandonment of tax legislation that had threatened to force an expensive restructuring on many securitisation programs, a rating confirmation and improved outlook for the local subsidiary of a U.S. mortgage insurer, and the unveiling of a pioneering subprime home-loan financing vehicle.

Not the most dramatic of events, perhaps, but they pointed respectively to an increasingly productive dialogue between the tax authorities and the financial markets (not always evident in the past), a relief to some of the gloomier prognoses made from time to time about the lenders' mortgage insurance sector, and growing comfort on the part of both the ratings agencies and investors with subprime transactions.

This last point is significant, as the largely untapped non-conforming market in Australia is estimated to be worth A$20 billion.

Tax Reform

Australia is in the midst of a far-reaching tax reform program, part of which involves a review of how companies and trusts are taxed.

This aspect of the program had originally proposed a unified-entity regime in which, broadly speaking, companies and trusts would have been taxed on the same basis: in other words, trust income would have been taxed at the entity level, rather than in the hands of the trust beneficiaries.

This obviously had adverse implications for securitisation trust structures. Draft legislation just released, however, shows that the proposals have been diluted, apparently in response to lobbying by industry groups, the Australian Securitisation Forum, and individual firms.

Instead of affecting all trusts, the proposals apply only non-fixed or discretionary trusts capable of varying their income and capital distribution arrangements.

The move has been widely welcomed by the industry, but a key issue remains - that of ensuring securitisation trust structures do not fall into the category of discretionary trusts.

Fixed Vs. Non-Fixed Trusts

According to lawyers involved in negotiations with the Australian Taxation Office and Commonwealth Treasury, the legislation's proposal to use the existing definition of a fixed trust (as defined in the trust loss provisions of the core tax legislation, the Income Tax Assessment Act 1936) causes potential problems.

In a note to clients, law firm Clayton Utz said many trusts regarded as fixed would technically fail to qualify as such. Any element of discretion or scope for participation by beneficiaries otherwise than in accordance with their unit entitlement may taint the character of the trust.

"A trust, although ostensibly fixed, which has any characteristics of a non-fixed trust...will be regarded as a non-fixed trust for tax purposes," said the firm.

For example, a securitisation trust which had one beneficiary with a residual interest in the income and capital of the trust was likely to be a fixed trust. This was likely to hold true where the beneficial interest was divided into a capital unit and an income unit, to enable the further securitisation of the trust's excess income.

Unless both units conferred a vested and indefeasible interest in the entirety of the income and capital, however, the trust would become non-fixed. The firm listed a number of other issues relevant to a securitisation trust's tax status, including:

An interest in a unit trust would not be taken to be defeasible simply because units in the trust could be issued or redeemed, but such units would have to be issued or redeemed for a price which represented the net asset value of the trust.

Where a beneficiary's vested interest could be taken away by exercise of a power of a trustee or any other person, the interest would not be a fixed entitlement. In particular, for a securitisation trust, this means that it will be necessary to review the power to amend its trust deed and, if necessary, to limit its scope, the firm said.

In the case of a trustee having power, in pursuit of the trust deed, to accumulate income, the accumulation would not prevent the trust beneficiary from being treated as having a vested and indefeasible interest in the income or capital. However, each unit holder must retain their interest in the share of the accumulated income or capital as represented by their unit holding.

A lawyer at another firm, who had been directly involved in consultations with the ATO and Treasury, described the draft legislation as a "step in the right direction," and said he had been pleasantly surprised by the constructive and positive attitude of the government departments which, traditionally, do not amend draft legislation to accommodate taxpayers' views without a fight.

Clayton Utz stressed the need for market participants to review their securitisation trust deeds before the legislation became effective next July, to determine whether the trusts are fixed or non-fixed and, if the latter, restructure accordingly.

Rating Agency Updates

Moody's Investors Service confirmed the A1 insurance financial strength rating of PMI Mortgage Insurance Ltd, in line with similar action it took on the US parent company; and Standard & Poor's confirmed the AAA rating on senior notes issued by Liberty Funding Pty Ltd., a vehicle that securitises subprime home loans originated by a small Melbourne-based financier, Liberty Financial.

Liberty Funding, which entered the market a year ago with a $100 million transaction, stunned investors earlier this year with the disclosure of late repayments of up to 17.5% of its pool. This has settled down to around 13%, and investors - most of whom are unfamiliar with subprime assets - have taken comfort from S&P's view that the "level of delinquencies is within the rating expectation."

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