Securitisation in Ukraine: Alternative Approach
The global economy is currently on the path of a slow and painful recovery after the unprecedented financial crisis which has threatened global economic stability and triggered the collapse of the world’s most powerful financial institutions. It means that, sooner or later, the economy of Ukraine, still in the midst of the crisis, will certainly follow the global trend and will become an attractive target for investments as it was before the crisis. In this respect, now is the time to make huge efforts to introduce and promote the necessary legislative frameworks facilitating implementation of innovative financing techniques and products that will help the financial sector of Ukraine to recover.
Securitisation is one of those powerful tools helping financial institutions, companies and public entities to gain access to vitally important additional funding and increase their liquidity. It is not news that practical implementation of such a highly sophisticated financing technique as securitisation has always been very problematic in Ukraine, mainly due to the strict currency control regime. Nevertheless, two large “true sale” securitisations of mortgage and car loan portfolios were carried out by Privatbank in 2007-2008. Below we will briefly uncover the biggest challenges for securitisation in Ukraine, and will focus on an alternative securitisation structure which is the most suitable for Ukrainian realities.
Limitations and Pitfalls of Current Ukrainian Legislation
As already mentioned, the lack of explicit legislative grounds and archaic currency control rules are the main obstacles preventing a securitisation technique from being widely used in Ukraine. In this regard, the Decree of the Cabinet of Ministers of Ukraine On the System of Currency Regulation and Currency Control of 19 February 1993, No. 15-93 (the Decree) plays a key role. In particular, the Decree sets out that settlements in foreign currency between domestic and foreign companies are allowed only upon receipt of a special license except for certain transactions expressly envisaged by law. Thus, when structuring a securitisation transaction it is very important to identify specific exemptions allowing transfer of proceeds generated by the portfolio of assets abroad.
Another restriction concerns settlements between domestic and foreign companies in the hryvnya, the Ukrainian national currency. Such settlements are strictly forbidden without an individual license and, consequently, assignment of assets generating receivables in national currency to a non-resident entity is impossible. Furthermore, the Resolution No. 265 of the National Bank of Ukraine (the NBU) adopted on 30 April 2009 provides that foreign currency loans initially granted by a domestic bank to a resident-borrower and subsequently assigned to a non-resident entity are now expressly required to be registered with the NBU by the borrower-resident. As a result of such a registration formality, the most important precondition of a true sale securitisation — assignability of receivables — could not be attained. Therefore, the true sale securitisation technique which was used in the example with Privatbank cannot be implemented.
The foregoing illustrates that classic “true sale” securitisation per se seems to be unattainable in Ukraine. The same applies to synthetic securitisation, since domestic companies and financial institutions (including banks) are expressly prohibited from entering into all possible kinds of swaps and other derivative transactions. It might sound surprising, but notwithstanding all existing restrictions securitisation in Ukraine is feasible. The solution is lying in a “hybrid technique” combining instruments of a true sale securitisation, secured lending and financial derivatives.
Alternative Hybrid Securitisation
This structure — by far the most basic — involves a sale of receivables, notably a portfolio of consumer loans denominated in national currency, by the originator (usually a banking institution) to a special purpose vehicle (SPV). In this case, a purchaser is a specially-formed single-purpose company incorporated in Ukraine in the form of a non-banking financial institution (the operating SPV) whose shares are held by an independent foundation representing the interests of investors. The incorporation of a non-banking financial institution in Ukraine for the purpose of securitisation does not require obtaining any special licenses in the future and does not take a lot of time, effort or financial resources.
As a rule, assignment of receivables does not require the consent of originator’s consumers and may be performed through a sale-purchase (assignment) or factoring agreements. The parties to the assignment are only required to notify consumers. The main objective of the assignment is that the originator receives immediate refinancing and removes the portfolio of assets from its balance sheet, thereby improving its capital adequacy ratio. The most important point is to ensure that the underlying assignment (sale-purchase) agreement is prevented from being invalidated by a court and this could be attained by structuring the assignment taking into consideration all requirements and peculiarities of Ukrainian legislation. The assignment of receivables denominated in national currency between two residents of Ukraine does not come under the currency control restrictions mentioned earlier in this article.
The structure also contemplates that the operating SPV will authorise the originator as the “servicer” to exercise day-to-day management of the portfolio of assets and collect the receivables on behalf of the operating SPV.
Simultaneously, a second special purpose company (issuer SPV), incorporated in a favourable low or no tax jurisdiction, extends a secured loan in a foreign currency to the operating SPV with the purpose of financing the purchase of receivables from the originator. The loan is secured by all business assets of the operating SPV, including the receivables that will be purchased from the originator. In this respect Ukrainian legislation allows the pledging of a whole company as a separate object together with all its assets and liabilities. In practice, it means that the issuing SPV will be treated as a preferential creditor and will be entitled to satisfy its claims at the expense of all assets of the operating SPV ahead of all other possible creditors. However, it is important to note that a loan agreement between the issuing SPV and the operating SPV should comply with certain requirements of currency control rules (in particular, the interest rate cannot exceed certain limits set by the NBU) and should be registered with the NBU. The registration of the loan agreement usually takes up to 10 business days.
The issuing SPV’s loan is funded by the issue of asset-backed notes, which are themselves secured by the issuing SPV’s assets (being principally the receivables from the issuing SPV’s loan). Investors in securitisation notes have, in turn, recourse to the claims of the issuing SPV under the secured loan and, indirectly, through the issuing SPV’s security interest, to the operating SPV’s business assets.
The operating SPV will, in its turn, use the receivables from the puchased asset portfolio to repay the principal and the interest on the loan.
Ensuring that the issuing SPV will not become insolvent can be achieved by traditional instruments which are usually contemplated in a classic securitisation. However, the described hybrid structure cannot completely eliminate the risk of bankruptcy for an operating SPV, even though such a risk is highly mitigated through full financial control over the operating SPV. Moreover since the operating company will be newly-created with a very limited and special purpose, it will have no trading history and business itself and will, therefore, be free from any contingent liabilities. Therefore, the originator is insulated from the insolvency of the operating SPV, and investors are insulated from the insolvency of both the originator and the operating SPV.
The key feature of this hybrid securitisation is that potential investors are involved at every stage of the transaction and have full control over its implementation. The described technique can be used to securitize receivables from mortgage loans, car loans and other corporate or consumer loans as well as leasing or utilities payments and, even, whole businesses provided that all such receivables and assets are denominated in national currency. In this respect, the main downside for investors is exposure to the volatility of the national currency’s exchange rate. Nevertheless, such a risk can be partially mitigated at the level of the issuing SPV by using various credit enhancement instruments. For example, credit default swaps can be used, and at the level of the operating SPV by purchasing the assets portfolio with a discount and, therefore, forming a special reserve. The operating SPV and the originator may also enter into an agreement whereby the latter is obliged to buy back the deteriorating assets.
The basic model of a hybrid securitisation described in this article is very flexible and can be tailored and fine tuned depending on particular purposes and interests of investors or peculiarities of the originators’ business.