There cannot be many financing tools which have had such a roller coaster ride over the last few years as the business of securitization in Asia: from the high hopes of the second half of 1994 through the depression of 1995 and the first half of 1996 and then the excitement of 1997 to the point that we are at now - trying to crystal-ball gaze as to where the opportunities are and in which countries. This article will review some of the major Asian jurisdictions where securitization has taken place to date, look at some (but by no means all) of the hurdles of those jurisdictions and, finally, give some thoughts on where the securitization business in Asia may go in 1998 and beyond.
Hong Kong
A review of securitization in Asia can start nowhere other than Hong Kong. For all practical purposes, Asian securitization began in Hong Kong in 1994 with the residential mortgage securitization for Bank of America. This was followed rapidly by other residential mortgage deals for Citibank, Cheung Kong and Standard Chartered Bank as well as a credit card transaction for Chase.Hong Kong is probably the most securitization-friendly jurisdiction in Asia. The legal system is based in general terms on English Law (with familiar concepts, eg, equitable/legal assignment) making it quite straight-forward to structure "true sale" transactions from a legal, regulatory and accounting perspective. The legal framework, in particular bankruptcy law, is well developed, with a mixture of legislation and case law. The regulatory environment is sophisticated, with a set of guidelines for regulatory off-balance sheet treatment for regulated institutions which largely follows the Bank of England model. Unlike virtually in every other Asian country, in Hong Kong there is no withholding tax on interest payments to a non-resident, making the securitization off-shore of interest-bearing receivables much simpler.
In addition to consumer receivables securitization, Hong Kong has also been the source of some more innovative structures such as that used in the Queens Funding and Pacific Palisades residential property transactions, and which was subsequently used for commercial property in the Sino transaction in March 1997.
As the number of transactions in Hong Kong has increased, rating agencies, monoline insurers and investors have become increasingly comfortable with Hong Kong. In particular, the main concerns on mortgage securitization such as assignability, stamp duty and the requirements of the Land Registry have been thought through on a number of occasions and closing such deals has become a relatively well-trodden path. The return to China of Hong Kong in July of last year seems to have made little difference, and during the second half of last year a large number of residential mortgage transactions was being documented, some of which closed prior to the currency problems. At the same time, we have seen the development of the Hong Kong Mortgage Corporation, which has recently begun to acquire its first pools of residential mortgages, although it is probably too early to say what effect this will have on mortgage securitization in Hong Kong.
THAILAND
Outside of Hong Kong, securitization really came alive in the autumn of 1996, partly with the closing in August of the Thai Cars auto receivables securitization for TISCO in Thailand. Entities which were regulated by the Bank of Thailand were previously prevented from securitizing their assets (and there was an absence of regulatory off-balance sheet guidelines) and the initial transactions in 1996, including Thai Cars, were carried out by unregulated companies.Putting a transaction together in Thailand proved to be a legally more complex matter than in Hong Kong. As a civil law system, Thai law is comparatively inflexible. It does not generally have the benefit of the common law concept of a trust. This, for example, causes the special purpose vehicle (the SPV) to run "commingling" risk if the debtors continue to pay into the originator's normal collection account: ie, payments in respect of the securitized receivables will be mixed up with other payments and, in the bankruptcy of the originator, the SPV will not be entitled to claim the payments belonging to it but instead will have a claim as an unsecured creditor. In addition, although the auto lease and hire purchase receivables in the Thai Cars deal were assignable as a matter of Thai law, it proved impossible to achieve a "true sale" due to the imposition of VAT on the purchase price of the receivables. VAT was also imposed on any servicing fee. It also proved impossible to structure the transaction without being liable for withholding tax on payment of interest off-shore.
The combination of these factors led to the deal being structured as a loan to the originators by a Thai SPV secured by an assignment of the lease and hire purchase receivables, the Thai SPV financing itself by a loan from an off-shore SPV. In addition, the first assignment was made absolute by notice of the assignment being given to the underlying obligors, partly to avoid the commingling risk referred to above - not something which is always commercially acceptable. In addition to the usual hedging arrangements, a complicated Thai baht/Japanese yen/US dollar swap was put in place which created for the Thai SPV a liability to pay interest on its loan from the off-shore SPV in Japanese yen. Withholding tax was then payable by the Thai SPV on that Japanese yen interest stream.
Attempts were made on other transactions to try to develop true sale structures which did not have the VAT problem referred to above, but these met with little success. This may have limited the appeal of securitization in Thailand as the Thai SPV was only a secured creditor of the originator and the structure did not provide the originator with off-balance sheet treatment. In addition, because it involved the originator in the creation of security, it was more likely to have negative covenant problems for the originator than a "true sale" deal.
In the middle of last year, the Thai government passed a new Securitization Law which went some way towards alleviating or at least clarifying some of the concerns. In particular:
- It set up a structure for on-shore SPVs.
- It clarified that the business of the SPV was not a finance or credit foncier business, which would have required a licence.
- The SPV could charge interest in excess of 15% per annum.
- Originator bankruptcy risk was removed if the transfer of the receivables to the SPV satisfied certain conditions.
However, the VAT issue still remained, for certain assets and cross-border deals still had a withholding tax problem. Unfortunately, the economic and currency crisis halted work on most transactions (which consisted primarily of auto receivables and other consumer receivables) and to date the implications of the new law have not yet been fully explored.
INDONESIA
Closing the first cross-border securitization in Indonesia provided another milestone in the second half of 1996. Like Thailand, Indonesia has both regulated and unregulated companies, although there are as yet no regulatory or accounting off-balance sheet guidelines. Banks are also under more stringent rules with regard to customer confidentiality. The first transaction for PT Astra Sedaya Finance involved an unregulated finance company.In general, the Indonesian legal environment is friendly towards securitization. Receivables can be assigned in such a way that they would not be treated as part of the seller's estate if it becomes bankrupt. There is also no VAT on the sale price of the receivables - so true sale transactions can be achieved rather than relying on the Thai secured loan structure. Although Indonesia does not have the equitable/legal assignment distinction familiar to English lawyers, the consequences under Indonesian law of not giving notice of an assignment are essentially the same as under English law. Giving notice, however, is a more formal and complicated procedure in Indonesia than in some other jurisdictions. Most of the transactions which have closed to date have delayed the giving of notice until the occurrence of one of a series of trigger events. Indonesia also does not have the benefit of the common law concept of a trust. However, daily sweeps of the collection account, until such time as notice is given to the underlying obligors, minimizes the commingling risk.
An SPV acquiring receivables from an Indonesian company is not required to have any licence, and most Indonesian lawyers are comfortable that the sale of receivables to an off-shore SPV does not constitute a borrowing requiring government permission. This may still be an issue if any of the underlying obligors is an Indonesian company as opposed to an individual.
Two tax issues continued to prove problematic. As in Thailand, VAT is imposed on fees including any servicing fee, and therefore in most deals the excess spread in the transaction is paid to the originator as deferred purchase price. A more difficult structuring challenge involves the issue of withholding tax on interest payments off shore. There are currently no double tax treaties which could come to the rescue (the best was The Netherlands which could bring the rate down to 10%) and, because a true sale structure was being used, the introduction of yen, as in the Thai Cars deal, was not appropriate. The solution in most of the transactions was for the SPV, contemporaneously with the purchase of the receivables, to sell the future interest component to an Indonesian bank, which paid for the interest stream as and when it was collected.
Like Thailand, Indonesia also embarked on a plan to encourage securitization, particularly in the local market. BAPEPAM, the capital markets regulator, produced a set of proposals for the regulation of on-shore securitization including a mechanism for establishing on-shore SPV's using some form of mutual fund. It seems that for the moment current events have temporarily shifted the focus away from the BAPEPAM proposals. Indeed, as with Thailand, work has effectively stopped on most transactions which also consisted significantly of consumer receivables.
JAPAN
Along with Hong Kong, Japan is the only other jurisdiction where any volume of deals has been closed although, as with other jurisdictions, structures need to be adopted to suit local laws and regulations. The enactment in 1993 of the Law Relating to the Regulation of Business Concerning Specified Claims (the so-called "MITI Law") provided for an alternative and simpler method of perfection designed to facilitate the securitization business in Japan. The MITI Law provided that transfers of certain types of assets may be perfected by public notice in a daily newspaper in lieu of individual notices required under Article 467 of the Civil Code. The notice must contain the date of the assignment, the name of the transferee and a general description of the receivables. This streamlined procedure applied only to the transfer of "specified claims" by eligible transferors to qualified assignees. Eligible transferors include certain leasing and credit card companies, but do not include banks and other institutions regulated by the Ministry of Finance. In addition to the public notice, the transferor and the transferee must jointly submit a plan of the assignment with MITI.Further developments took place in February 1996 when the Securities and Exchange Law of Japan (the SEL) was amended to permit public offerings of secured bonds and commercial paper issued within Japan.
In addition, securitization of a number of financial assets, eg, trade receivables and promissory notes originated by manufacturing companies, has been completed in Japan. Recently there has been an increase in the number of Japanese banks which have securitized their commercial loan portfolios - the so-called "CLO" deals.
The typical cross-border Japanese securitization structure involves the setting-up off shore (eg, in the Cayman Islands) of an SPV having its principal office in that country. The SPV then establishes a branch office in Japan. The branch office acquires the assets to be securitized from the Japanese originator and finances that purchase by means of a loan from the principal office of the SPV, which in turn finances the loan by the issue of securities. The reason for the introduction of a Japanese branch results from the Foreign Exchange and Foreign Trade Control Law of Japan (the Foreign Exchange Law) under which the sale of a receivable by a Japanese resident to a foreign resident requires the seller to obtain approval from the Ministry of Finance. However, the Japanese branch of the SPV is, for purposes of the Foreign Exchange Law, a Japanese resident and no approval is required. Changes enacted last year and due to come into force on April 1, 1998 will enable an originator to directly sell receivables off shore without obtaining such an approval. This should enhance the prospects for the securitization market in Japan.
KOREA
Securitization in Korea is at a much-less-advanced stage of development than in some other Asian jurisdictions. The transfer of receivables by a Korean resident to a non-resident (eg, a Cayman Islands SPV) requires the consent of the Ministry of Finance and Economy (MOFE), and historically that consent was not forthcoming. However, during 1997 it became clear that MOFE was prepared to look more favourably on such transactions. During the second half of 1997 a number of transactions were being worked on involving Korean merchant banks as sellers of equipment lease receivables (all US-dollar denominated) owed by Korean corporations. The equipment generally consisted of so-called "big ticket" equipment such as construction equipment and factory production lines. The receivables could be assigned without any real difficulty; however due to the legal characteristics of a lease, it was necessary that, to avoid the leases being subject to the risk of cancellation by a liquidator of the lessor, consent of the lessee was obtained or notice given. The notice mechanics were relatively formal, requiring, for example, notarization with a fixed-date stamp. This may not be a problem when there are only a few obligors but could give rise to difficulties if the pool contains a large number of obligors. In addition, in assigning the receivables it was necessary to also transfer title to some of the equipment which in some cases, eg, ships, is logistically difficult and raises legal liability issues for the SPV. Korean law also recognized trusts which could be helpful in avoiding commingling risk, an issue which is grappled with in every jurisdiction.Another problem familiar by now in Asian transactions, was the issue of withholding tax which is payable on interest payments to a non-resident. It was therefore necessary to look for a country with which Korea had a double tax treaty which would reduce the withholding tax rate to zero. Fortunately, Ireland satisfied the requirements and was also a jurisdiction with which rating agencies, investors and others were familiar.
The currency and economic crisis coupled with the downgrading of Korea by the rating agencies has effectively brought work on these transactions to a halt.
THE PHILIPPINES
Only one transaction has featured prominently, namely the securitization by Philippine Airlines in 1996 of their US dollar ticket receivables originated through Visa, MasterCard, American Express and Diners Club. However, generally, the Philippine legal environment is friendly towards securitization. Receivables can be assigned and a true sale can be achieved to remove the bankruptcy risk of the seller. Indeed, securitization was contemplated some time ago and a securitization law passed to facilitate on-shore transactions using a form of master trust. It has, however, been little used. There are also some regulatory issues to be resolved. In addition to a lack of regulatory and accounting off-balance sheet guidelines, banks wishing to sell assets require Central Bank approval. Taxes again provide some problems. There is stamp duty (rising to 1%) on the assignment of certain types of assets, eg, mortgages and, of course, the familiar problems of withholding tax on interest payments off shore.PRC
No review of securitization in Asia would be complete without a discussion of the PRC. The size of the country and its economy make it an obvious candidate for securitization, certainly over time. There have already been some attempts to securitize PRC cashflows but the graveyard is full of failed deals. The most recent transaction to close involved the securitization of US dollar receivables owed by non-PRC companies but where PRC law governed the assignment of the receivables. This sort of transaction may be the trend in the immediate future. The issue is complicated further by the uncertain and still developing nature of Chinese law which, like most other Asian legal systems, is having to apply relatively undeveloped local laws to financial structures which tend to have been engineered in comparatively sophisticated legal environments such as the United States.However, in general terms, it is possible to achieve a legal true sale of receivables under PRC law although no equitable/legal assignment distinction exists and it is generally believed that to achieve a true sale the specific consent of the obligor must be obtained. This may prove logistically difficult where the pool size is very large. A major issue when considering any PRC securitization is, of course, the question of what, if any, PRC approvals are required. This may require the interpretation of complicated and sometimes ambiguous regulations. We do nevertheless expect to see increased activity in the PRC in the coming years.
THE FUTURE?
The economic and currency crisis in a number of Asian countries, combined with the downgradings of local and foreign currency debt has, at the time of writing, severely slowed down or brought to a halt work on a large number of transactions. The immediate problems seem to be:- Given that most of the transactions involved the issuance of US dollar securities (usually rated and guaranteed by a monoline insurer), some local currency/US dollar swaps are too expensive or simply impossible to execute.
- The deteriorating financial condition of a number of companies gives rise to greater caution when structuring transactions. In particular:
- Will the seller continue to service the receivables and what is the value of the seller recourse?
- In a future flow/revolving deal, will the seller be able to continue to generate receivables?
- What is happening to the level of arrears/default - are debtors taking longer to pay?
- The greater risk of liquidation generates the spectre of a legal challenge to the true sale or at least the possibility of the cashflow to the SPV being interrupted or delayed (with the increased likelihood of a draw under any surety bond issued by a monoline insurer).
- The risk of political interference in the legal process.
There are no easy answers to these issues. However, where do we go from here? Two trends have already appeared. First, there is the increased search for hard currency cashflows, particularly US dollars. These cashflows remove the need for currency swaps and the receivables are often owed by entities outside of the jurisdiction of the seller thus reducing the legal and political risk of that jurisdiction. Second, there is the search for new markets. In addition to the PRC, which to date has been comparatively undamaged by events, countries such as Malaysia, Singapore, and Taiwan are of interest. There are, of course, issues in all places. Malaysia, for example: has exchange-control legislation which could prove problematic, requires Bank Negara approval for any regulated institution to securitize assets, and has the familiar problems of stamp duty and withholding tax. There is also an increasing number of CLO and other transactions from Japan, where securitization activity has not really slowed down.
We are also seeing the quest for new assets to securitize, often involving so-called "future flows", including toll revenues, utility receivables, export receivables and receivables generated from projects.