The handful of future flow securitizations, particularly diversified payment rights (DPR) securitizations, originated in Russia over the years have all been done as secured loan structures, typically by an offshore SPV issuing notes backed by a secured loan made to the originator.
However, a pending proposed overhaul of the Russian Civil Code includes provisions for the assignment of future assets and should therefore provide for future flow deals to be executed on more conventional lines.
Among the Russian banks using loan structures for their DPR deals are Alfa Bank and MDM, which issued in the days before the global financial crisis, and ZAO Raiffeisenbank Moscow, which only last month placed the first Russian DPR transaction since 2007. The reason for such structure is that, to date in Russia, the ability of an entity to sell a future asset has been unclear at best, and not a topic on which law firms could provide a favorable legal opinion. In the absence of such clarity, secured loan structures have been used, although offering memoranda for such transactions may also include risk factors about a possible lack of recognition of New York-governed pledges over DPRs.
Future flow transactions backed by DPRs have been originated on a true sale basis from banks in Brazil, Costa Rica, El Salvador, Guatemala, Honduras, Jamaica, Kazakhstan, Mexico, Panama, Peru and Turkey. By their nature, future flow deals - as opposed to transactions backed by fixed or revolving pools of existing assets - are all ultimately linked to the originator, since the originator must generate future assets to make payments on the notes. Nonetheless, the true sale structure is widely viewed as according three advantages over a pledge structure:
1. A stronger creditor's rights position.
Although in some jurisdictions the rights of a secured creditor and those of a buyer may be similar, in many others the rights of the latter are superior. This is especially true in the United States, where DPR transactions usually have significant jurisdictional contacts and which therefore may be the location of court proceedings involving disputes or bankruptcy proceedings. These contacts include being the country where the originating bank receives DPR payments, the location of the transaction accounts with the indenture trustee, the location of many sending banks, the governing law of most of the provisions of the transaction documents (other than the sale itself) and the contractually chosen dispute-resolution forum. If the originating bank is subject to Bankruptcy Code jurisdiction in the United States, among the several potential adverse consequences of bankruptcy proceedings is the imposition of the automatic stay on creditors, including secured creditors. The U.S. Bankruptcy Code provides for jurisdiction over all foreign banks with any property in the U.S. - apart from those engaged in certain core banking activities through a licensed branch or agency.
2. Lesser likelihood of violating negative pledge clauses.
Of course, the wording of any existing financing document by the originating bank has to be examined carefully as to its scope (e.g., type of assignments covered, whether it applies to private as well as public debt, asset types covered and exceptions). However, as a general matter, it is not unusual for unsecured debt offerings to restrict future collateral pledges while exempting sales of less than substantially all assets.
3. A stronger diversion risk position.
Investors and other counterparties in DPR transactions usually feel they are better equipped to argue that attempted sovereign interference in a DPR structure is impermissible for assets held abroad if the orphan SPV is the owner of the assets than if the SPV were only the holder of a security interest in assets held by the bank headquartered in the interfering sovereign's jurisdiction.
The value of the sale structure was illustrated in perhaps the one true stress case for a DPR transaction, that of Alliance Bank in Kazakhstan several years ago. Its lengthy plan of reorganization filed and approved by a special financial court in Almaty in a brief paragraph exempted two categories of obligations from the substantial haircuts imposed on its other creditors, including international lenders and bondholders: (i) ordinary trade payables (obviously necessary to keep the bank in operation) and (ii) its DPR program (described in the plan as a true sale transaction to a Jersey SPV issuer). The Kazakh court order approving the plan was subsequently recognized by insolvency courts in London and New York as a "foreign main proceeding" and the program paid down all existing DPR notes in full, based on a partially accelerated early amortization cash sharing formula, as provided for in the DPR program indenture. The international court orders were especially important for the correspondent banks and the indenture trustee to know that they could keep making and applying cash payments as they did prior to the commencement of insolvency proceedings.
On April 3, 2012, then Russian President Dmitry Medvedev proposed revolutionary changes to all parts of the Russian Civil Code to the State Duma - Russia's lower legislative house. These changes have been actively discussed for almost four years. Many of the changes are understood to be inspired by concepts of the Anglo-Saxon law system, which is a significant change, as existing Russian legislation is based on the continental law system. The changes - almost 500 pages long - affect all parts of the Civil Code, bringing new concepts to corporate, real estate and intellectual property law. Of most immediate interest for this discussion is the draft law, which specifically provides the rules on the assignment and pledge of the rights that will arise in the future. An English translation of the applicable provisions is as follows:
Article 388.1. Assignment of the rights that will arise in the future
1. Rights that a party will have in the future may be assigned if the assignment is exercised on the basis of a transaction between parties that are both involved in business activities. The assignment agreement must clearly define such future rights, including rights that will arise from future contracts, so that they can be identified at the moment when they are created or when they are transferred to an assignee.
2. Unless otherwise provided in the law, future rights are transferred to an assignee at the moment they arise. The parties to an assignment agreement may agree that future rights will be transferred later.
The draft law passed a first reading, and a second reading is expected at the time this article went to press. If it is approved, most of the provisions will come into force on September 1, 2012. It goes without saying, however, that the draft law may be changed before it is approved by the State Duma in the third reading. Moreover, addressing the issue of future assignability will not singlehandedly resolve all issues relating to future flow transactions originating in Russia, including how clearly the future rights need to be identified and what the general inherent political risks are in doing highly structured cross-border transactions. Still, it appears to eliminate a major issue in executing such transactions using more familiar structures that rating agencies, investors and financial guarantors have found superior in other jurisdictions.
Russian DPR Structure Vs. Typical DPR Structure
The simplified diagram below illustrates the differences between the typical Russian future flow transaction executed as a loan to the originating bank and one done on the true sale structure used elsewhere.
A key to the numbered steps:
(1) Loan structure: a pledge by the bank of all of its rights, title and interest in, to and under the diversified payment rights (DPRs) to the SPC. Sale structure: a sale of the DPRs.
(2) In both cases: issuance of the notes by the SPC for which the investors will pay the applicable purchase price, in the loan structure secured by the loan to the bank, which is secured by the DPRs, in the sale structure secured by the DPRs owned by the SPC directly.
(3) The gross proceeds of the notes will be used to make a loan to the bank in the loan structure, and to pay the cash purchase price of the DPRs in the sale structure (the remaining purchase price in the sale structure being a subordinated note or certificate issued by the SPC to the bank representing the right to deferred payments over time equal to the amount of overcollateralization in the structure).
* SPC Jurisdiction: in non-Russian transactions, the offshore SPC has typically been in the Cayman Islands (with a few exceptions in Jersey or the Bahamas). Russian transactions typically use Luxemburg SPCs, although Cyprus SPCs could also achieve the tax objectives in Russian transactions structured as loans.