Finance Practice Contributes Us Securitization Chapter In Legal 500 Guide – Commodities/Derivatives/Stock Exchanges

1. How active is the securitisation market in your
jurisdiction? What types of securitisations are typical in terms of
underlying assets and receivables?

The securitization market is currently very active in the United
States. According to data published by the Securities Industry and
Financial Markets Association (SIFMA), there were approximately
U.S. $4,335 billion in principal amount of securities issued in
securitization transactions during 2020 with more than ten trillion
dollars outstanding. The vast majority of the new issuances during
2020 ($3,980.1 billion) were mortgagerelated securities issued by
Freddie Mac, Fannie Mae and Ginnie Mae.

The remaining securitizations during 2020 were (i) nonagency
mortgage-backed ($135.4 billion), (ii) auto ($109.7 billion), (iii)
CDO/CLO ($33.6 billion), (iv) equipment ($18.0 billion), (v) credit
cards ($2.9 billion), (vi) student loans ($17.8 billion) and (vii)
other assets ($37.3 billion).

2. What assets can be securitised (and are there assets which
are prohibited from being securitised)?

As a point of departure, almost any asset generating a payment
stream can be securitized. The more diversified and constant the
cash flow, and the fewer regulatory restrictions and licensing
requirements imposed on the origination, ownership, security
interest and sale of the relevant underlying assets, the easier the
asset may lend itself to securitizations. However, there is
currently no asset-class where securitization is outright
prohibited.

As a general matter, there are more restrictions and licensing
requirements in the consumer finance space than in the commercial
lending space. Certain esoteric assets such as spectrum, some
intellectual property rights and government concessions may be
subject to limitations on ownership and restrictions on granting
and enforcing security interests. Such limitations
complicate securitizations of such assets, but typically will
not prevent their securitization through an appropriately
structured transaction.

Assets where the future cash flow may be impacted by the
operations of the servicer or originator also present additional
challenges in a securitization context. However, as long as the
future cash flows can be sufficiently isolated from the
servicer’s or originator’s operational risk such that the
securitization will have the ability to continue to perform despite
a bankruptcy of the servicer or originator, it is possible to
securitize the relevant assets. Examples of such transactions
include whole business securitizations, securitization of future
oil and gas payment streams and securitization of future use-based
payment rights.

3. What legislation governs securitisation in your
jurisdiction? Which types of transactions fall within the scope of
this legislation?

There are a number of different laws and regulations that
together govern key aspects of securitizations. These include (a)
the Bankruptcy Code, (b) the Uniform Commercial Code (the
“UCC“), (c) the Securities Act of 1933,
as amended (the “Securities Act“), (d)
the Securities Exchange Act of 1934, as Amended (the
“Exchange Act“), (e) the Investment
Company Act of 1940, as amended (the “Investment
Company Act“), and (f) where the sponsor or seller of
the relevant asset, derivatives counterparty or investor in a
securitization is a bank, the Federal Deposit Insurance Act (the
“FDIA“), the Volcker Rule and the
applicable bank capital regulations.

The Bankruptcy Code or other applicable insolvency regime, such
as receivership or conservation under the FDIA for banks, together
with the applicable state contract law, will inform requirements
for ensuring that the sale of the relevant assets to the
securitization SPV as well as the bankruptcy remoteness of the
securitization SPV from that of its affiliates, will
be respected in case of insolvency proceedings against the
relevant transferor or affiliate. Insolvency laws will also inform
the enforceability of contractual provisions that are triggered off
the bankruptcy or financial condition of a contract party, such as
“flip clauses” that were used to subordinate defaulting
derivatives counterparties but were found to be unenforceable, even
though many other rights under derivatives contracts were protected
in a counterparty bankruptcy.

The UCC contains, amongst others, provisions relating to
creation and perfection of security interests. The term
“security interest” does not only capture the interests
in personal property or fixtures that secure a payment or
performance obligation but also captures any interest of buyers of
account receivables, chattel paper, payment intangibles and
promissory notes. As such, if the transfer of such property is not
perfected in accordance with the UCC, the Securitization may end up
losing the purchased assets to creditors of the seller, even if the
transaction is otherwise respected as a true sale. The UCC also
contains important contractual override provisions that relate to
enforcement of waiver of defences language in commercial
transactions as well as hell or high water clauses in financing
leases that are often important for the ability to finance such
assets through a securitization.

The Investment Company Act requires any entity owning
“investment securities” having a value that exceeds 40%
of such entities’ total assets (exclusive of government
securities and cash items) to register as an investment company
absent an applicable exemption. “Investment Securities”
is a broad term that includes all securities and loans with some
limited exceptions and would typically capture financial assets
that are being securitized. The requirements and restrictions
applicable to registered investment companies are incompatible with
typical securitization structures. Consequently, it is important to
structure the securitisation transaction to fit within one of the
exemptions to having to register as an investment company. One
exemption that was promulgated for the purpose of capturing
securitisation transactions is set forth in Rule 3a-7 under the
Investment Company Act. A second exemption is Section 3(c)(5) which
may be available to a securitisation entity that is primarily
engaged in the business of (i) acquiring receivables and other
obligations representing all or part of the sales price of
merchandise, insurance and services or (ii) making loans to
manufacturers, wholesalers, retailers or prospective purchasers of
merchandise, insurance and services or (iii) acquiring mortgage and
other liens on and interests in real estate. A third exemption that
traditionally has been broadly used, but currently is more of a
fall-back is Section 3(c)(7) which exempts entities that restrict
their investors to “qualified purchasers” and that
do not publicly offer their securities. However, relying on the
3(c)(7) exemption may result in the securitization entity becoming
a “covered fund” under the Volcker Rule unless it
restricts its assets as required by the loan-only securitization
exemption under the Volcker Rule. As part of the 2020 amendments to
the Volcker Rule, this exemption was broadened to permit the loan
securitization vehicle to also own up to five percent of assets in
the form of certain debt securities that otherwise would be
prohibited, but not asset-backed securities or convertible debt
securities. Banks are subject to restrictions in their dealings
with covered funds, and banking entities are generally not
permitted to being sponsors or holding an “ownership
interest” in covered funds. Ownership interests includes any
equity or any instrument reflecting the equity performance of the
funds and until October 1, 2020, also captured any interest that
has the right to vote for replacement of the manager outside an
event of default or acceleration event, even if such right only
arises as a result of a manager replacement event. As such, since
the junior most tranches of a securitization reflect the equity
performance securitization and the senior most tranches typically
have the right to replace the manager in case of a manager
termination event, the net effect has been that U.S. banking
entities have be restricted from sponsoring or investing in
securitizations that are “covered funds”. However, on
October 1, 2020 a number of changes relating to covered fund
exemptions, the ability of banks to deal with covered funds and the
definition of ownership interest went into effect. Amongst others,
these amendments provide a “safe harbour” for certain
senior debt interest not to be deemed an ownership interest for
purposes of the Volcker Rule, and also clarifies that, subject to
certain conditions, participating in removal or replacement of a
manager due to events that trigger creditor rights also do not
amount to an “ownership interest”. These changes,
together with the amendments to the “loan-only”
securitization exemption below, will potentially have a significant
positive impact on the future development of CLOs, which
traditionally have been one of the principal securitization types
relying on the 3(c)(7) exemption under the Investment Company
Act.

The Securities Act governs the offer and sale of
‘securities’, which is broadly defined and includes notes,
stocks, bonds, debentures, investment contracts and any instrument
commonly known as a security. Absent an available registration
exemption, any offer and sale of securities has to be made pursuant
to a registered offering. The Exchange Act provides the SEC with
broad powers to regulate various market participants, prohibit
certain types of conduct in the market and require certain periodic
reporting. Registered offerings of asset- backed securities
are subject to the disclosure requirements set forth in Regulation
AB II as further detailed below and the Exchange Act imposes
periodic reporting requirements for securities sold in a registered
offering. The Exchange Act and rules promulgated thereunder also
imposes certain requirements applicable to all securitizations
including those issued in a private placement. Such generally
applicable requirements include risk retention as set forth in
Regulation RR, furnishing periodic reports of certain demands for
repurchases and replacement of assets to the SEC on Form ABS-15G,
and the furnishing to the SEC on Form ABS-15G the conclusions and
findings of third party due diligence providers at least five
business days prior to the first sale of the asset-backed
securities. The Exchange Act also imposes a requirement to post all
information provided to rating agencies hired to rate the
securitization transaction to a password protected website (a
so-called 17g-5 website) that may be accessed by to all Nationally
Rated Statistical Ratings Organizations
(“NRSROs“) at the same time such
information was provided to the rating agency.

The Bank Capital Rules contain specific risk weighted asset
rules for traditional and synthetic securitizations that will
potentially permit a bank to reduce its riskweighted assets through
selling off or synthetically transferring subordinated risk in a
securitization transaction, or, conversely, impose a higher RWA for
certain subordinated positions.

The FDIA also contains a safe harbour provision that allows for
greater certainty that a transfer of assets to a securitization
transaction will be respected by the FDIA acting as receiver or
conservator in case of a bank insolvency.

Finally, the Commodities Exchange Act was amended as part of the
Dodd-Frank Act to regulate “swaps” (i.e. derivatives)
other than “securities based swaps”. While synthetic
securitizations in many circumstances can be structured to fall
within the definition of “securities based swaps” such
that they are regulated by the SEC rather than the Commodities
Futures Exchange Commission (the
“CFTC“), certain typical derivatives
such as nth to default credit default swaps, interest rate swaps
and foreign currency swaps will likely fall within the definition
of swaps that are regulated by the CFTC. Any special purpose entity
that enters into such swaps will, absent an exemption from the
CFTC, be a “commodity pool” subject to additional
disclosure obligations and will potentially require the manager to
register and become subject to regulation as a commodity pool
operator, which are typically not well suited for securitization
structures. As such, any use of derivatives by any securitization
entity will typically be limited to transactions where
derivative is not regulated by the CFTC or where the CFTC has
provided an applicable exemption from the commodity pool
requirements.

4. Give a brief overview of the typical legal structures used
in your jurisdiction for securitisations and key parties
involved.

Securitisations in the U.S. involve, in their most basic form,
the issuance of securities by an SPV to investors, the proceeds of
which will be used by the SPV to purchase the underlying assets.
Income generated by those assets will be applied towards periodic
payments of interest and principal on the issued securities, and
the investors will typically benefit from a security interest in
the assets of the SPV granted to the indenture trustee for the
benefit of the noteholders. The transaction structure will also
typically include a servicer or manager who will act on behalf of
the issuer SPV. This structure is, for example, typically used in
open market CLOs.

Other structures for securitization include:

• A two-tiered securitization structure where one securitization
  SPV (typically in the form of a Delaware Statutory Trust) acts as
  issuer with an additional securitization SPV (typically in the form
  of a Delaware limited liability company) acts as depositor, i.e. an
  intermediate transferor that purchases the underlying assets in a
  true sale and transfers those assets to the issuer. The two SPVs
  are structured such that they are both bankruptcy remote from other
  affiliates, but not necessarily bankruptcy remote from each other.
  This structure facilitates the transfer of assets into and out of
  the securitization and is typically used in securitizations of
  consumer loans, auto loans and equipment leases amongst others.
  Other key parties include the originator of the underlying loans
  and the sponsor of the securitisation. The sponsor organizes and
  initiates a securitization transaction by selling or transferring
  the relevant assets directly or indirectly through a depositor to
  the issuing entity and typically also acts as the servicer for the
  transaction but could be another affiliate of the Depositor. In
  some of these securitizations a back-up servicer will also be
  identified and be part of the transaction from the get-go.




• a master trust structure, which involves setting up a master
  trust that can issue different series of securities with all
  such series being collateralised by a pro-rata interest in a
  common pool of assets. This structure is typically used in dealer
  floor plan securitizations. A further variant of this structure is
  used in credit card securitizations, where the receivables from
  credit card use are continually transferred to a master trust, and
  are purchased from there by securitization SPVs. As the relevant
  receivables repay, the Securitization SPV will then purchase new
  receivables from the Master Trust and the Master Trust will have
  funds available to purchase newly created receivables. The parties
  in these transactions are similar to the prior structure except
  that the master trust will take the place of the depositor.




• a synthetic securitization structure where the performance risk
  of the underlying asset is transferred to an SPV through a credit
  default swap or other derivative instrument. The issuer SPV will
  issue securities similar to other securitizations, but instead of
  using the proceeds to purchase the relevant securitized assets, the
  proceeds will instead be invested in permitted investments. The SPV
  will apply the income it receives from the derivatives and the
  other permitted investments to service its obligations under the
  issued notes and otherwise make required payments similar to a
  typical cash flow investment. If a payment is due by the
  securitization SPV under the derivative or other instrument that
  synthetically transfers the credit risk of the reference assets,
  the SPV will sell a portion of the Permitted Investments and use
  the proceeds to make sure payment. The key parties in these
  securitizations will be similar to the first securitization
  outlined above, but will in addition include one or more derivative
  counterparties that may or may not be the originators or owners of
  the underlying assets.

5. Which body is responsible for regulating securitisation in
your jurisdiction?

The SEC is the principal authority responsible for administering
and enforcing the Securities Act, the Exchange Act and the
Investment Company Act. The SEC possesses broad jurisdiction
throughout the U.S. and abroad. In addition, the Financial Industry
Regulatory Authority (FINRA), a self-regulatory organisation with
authority over broker-dealers, is also an important regulatory
player in the market. For example, Rule 461 of the Securities Act
requires a statement of no objection from FINRA before a
public offering becomes effective.

Other important regulators include the Department of the
Treasury, the Office of the Comptroller of the Currency (OCC), the
Board of Governors of the Federal Reserve System (the Federal
Reserve) and the FDIC (collectively the banking agencies) as well
as the Federal Housing Finance Agency and the Department of Housing
and Urban Development (collectively the housing agencies). The
banking agencies, the housing agencies and the SEC have jointly
issued the risk retention rules that apply to asset-backed
securities.

Separately, the FDIC has promulgated securitization safe harbour
rules that establishes securitization criteria where the FDIC, when
acting as receiver or conservator of an insured depositary
institution, will not exercise its power to repudiate contracts to
recover or reclaim financial assets transferred in connection with
securitization transactions.

Each state also has its own securities laws, referred to as
‘blue sky laws’, which may come into play as part of an
offering or enforcement. States will be pre-empted from regulating
securities transactions relating to “covered securities”
within the meaning of Section 18 of the Securities Act, and the
blue sky laws themselves usually include certain exemptions outside
the covered securities context. As such, the state blue sky laws
play less of a role in the registration or qualification
requirements in securitisation offerings, but the preemptions do
not override the anti-fraud provisions of states’ securities
laws and, therefore, blue sky laws may be applicable in enforcement
actions.

6. Are there regulatory or other limitations on the nature of
entities that may participate in a securitisation (either on the
sell side or the buy side)?

On the buy side, the type of entity that may participate in a
particular securitization will depend primarily on the offering,
the relevant ABS securities, and the applicable Investment Company
Act exemption. The Issuer may, for example, restrict pension plans
from investing in the securitization equity or in any
non-investment grade tranches in order to protect against the
securitization itself becoming subject restrictions applicable to
pension plan assets. On the other hand, there will typically be no
investor restrictions placed on the purchase of investment grade
debt securities issued in a registered offering. If the securities
are offered in a Rule 144A private placement, then investors will
normally be limited to “qualified institutional buyers”
which, as a general matter, are investors that own and invest on
a discretionary basis at least $100 million ($10 million in
case of dealers) in securities of unaffiliated entities. The
securitization may also offer securities in a private placement to
“accredited investors,” which would allow investments by
natural persons that individually or jointly with their spouse have
a net worth of at least $1 million or have earned at least $200,000
individually or $300,000 jointly with their spouse, for each of the
past two years with an expectation to make at least that amount in
the current year as well as entities that have total assets in
excess of $5 million or another enumerated group of institutions).
To the extent the securities are issued in in a foreign offering in
reliance on Regulation S, they may be purchased by investors that
satisfy the requirement of a “non-US Person”. The
definitions of “accredited investor” and “qualified
institutional buyer” were further expanded, effective December
8, 2020, to capture additional investors deemed to have sufficient
knowledge and expertise to participate in investment opportunities
that are not subject to the requirements and protections of a
registered offering.

In addition to the Securities Act investor restrictions outlined
above, there may be additional requirements imposed under the
applicable Investment Company Act exemption. As such, Section
3(c)(7) entities must generally limit their investors to
“qualified purchasers,” a term that as a rule of thumb
requires net investable asset of at least $5 million for
individuals and certain family companies, and at least $25 million
for other entities. Issuers relying on Rule 3a-7 must take care to
restrict investments in non-fixed income securities to qualified
institutional buyers, and investments in below investment grade
fixed income securities to institutional accredited investors or
qualified institutional buyers.

As noted above, banks are prohibited under the Volcker rule from
owning “ownership interests” in covered funds, which
could restrict them from investing in certain tranches of
securitizations that are deemed to be “covered funds” for
purposes of the Volcker Rule.

On the sell side, please refer to section 14 below for the
issuer. Depending on the asset class, there may be certain
licensing requirements on the servicer of the relevant underlying
asset and purchasers that act in a broker-dealer capacity,
including as initial purchaser in a 144A transaction or as an
underwriter in a registered offering, will be subject to a number
of requirements and obligations under the securities laws the same
as for any other securities offering.

7. Does your jurisdiction have a concept of “simple,
transparent and comparable” securitisations?

The United States has not implemented the “simple,
transparent and comparable” securitization concept as
such.

8. Does your jurisdiction distinguish between private and
public securitisations?

As noted above, US securities regulations distinguish between
registered offerings, also referred to as public offerings, and
offerings that are exempt from registration, often referred to as
private placements. The distinction matters in terms of
restrictions on the investors that may participate in the relevant
offering (as discussed in question 6 above), the amount and type of
disclosure, subsequent reporting requirements, as well as relevant
eligibility criteria and securitization structure. The liability
and applicable defences also vary between the two types of
offerings.

9. Are there registration, authorisation or other filing
requirements in relation to securitisations in your jurisdiction
(either in relation to participants or transactions
themselves)?

If the issuer or underwriter of any asset-backed security that
will be rated by a nationally recognized statistical rating agency
has obtained a third-party due diligence report for such security,
then they must furnish Form ABS 15G, containing the findings and
conclusions of such report, to the SEC by electronic filing at
least five business days prior to the first sale in the
offering.

Furthermore, the issuer or sponsor of any asset backed security
for which the underlying agreements contain a covenant to
repurchase or replace an underlying asset for breach of a
representation or warranty, must file Form ABS 15G, providing
details of the asset backed security and the relevant assets, at
the end of each calendar quarter in which a demand has been made
for such repurchase or replacement. If no demands for such
repurchase or replacement has been made during a calendar year,
then the issuer or sponsor must confirm this by filing Form ABS
15G.

Any public offering of asset-backed securities requires
compliance with detailed disclosure requirements and the filing of
a registration statement with the SEC. ABS offerings that qualify
for shelf registration must be filed on Form SF-3 and other
registered ABS offerings must be filed on Form SF-1.

Issuers of ABS securities offered and sold in a registered
offering will be required to make periodic filings of an annual
report on Form 10-K and any updates regarding current events on
Form 8-K as well as Issuer Distribution Reports on Form 10-D.

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