Article by Peter Cockhill and Michael Johns
The Cayman Islands
The use of offshore special purpose vehicles for structured finance transactions has long been established. The Cayman Islands enjoys a dominant role in this field and is recognised by leading institutions and arrangers as the leading offshore financial centre in the world. The financial services industry in the Cayman Islands is well developed with a concentration of experienced offshore professionals and service providers that is second to none, a stable political and economic environment and a legal system based on English common law. The following article summarises the principal characteristics of securitisation in the Cayman Islands and looks at some of the legal and business attractions of the jurisdiction.
What is Securitisation?
Broadly speaking, securitisation is a process by which illiquid assets, in the nature of cash flows, receivables and connected contract rights, are pooled and converted into marketable securities representing claims against the illiquid pool of assets. The marketable securities are then sold to third-party investors so that the income producing assets are effectively refinanced by newly raised debt in transferable form on a non or limited recourse basis. This debt is then serviced by the cash flow from the assets.
Securitisation transactions (which are a form of structured finance) come in many forms and structures. Securitisations may involve repackaging (i.e., where the security offered to investors has different characteristics to the underlying assets), credit enhancement or even (through the use of derivatives) credit risk transfer without the transfer of underlying assets (known as "Synthetic CLOs" – Collateralised Loan Obligations). Synthetic CLOs aside, there are a number of basic elements which are generally common to all securitisation transactions.
The original owner of the assets (the "Originator") sells the assets to be securitised to a special purpose vehicle ("SPV") usually established by an investment bank or other financial institution for the purpose of acquiring those assets. The SPV will be an "orphan" vehicle owned by a share trustee, usually a Cayman Islands trust company, which will hold the shares on trust for charitable purposes or for the purpose of the transaction itself under a STAR trust (see further below), the effect of which is that the SPV will not appear on the balance sheet of any party to the transaction.
The SPV raises funds to pay for the assets by the issue of securities (either debt instruments or equity or a combination of the two) which, for the purpose of this article, are referred to as "Notes". It is important that the asset pool acquired generates a stable and predictable cash flow because it is that cash flow that will service interest payment obligations under the Notes. The eventual redemption or sale proceeds of the underlying assets will be used by the SPV to repay the principal on the Notes upon maturity.
The SPV creates fixed and floating charges over the purchased assets and the accounts into which the receivables those assets generate is credited, and all of the SPV’s other property, undertaking and assets, to secure its obligation to repay the holders of the Notes. This security is granted in favour of a security trustee for the benefit of the investors/noteholders and the providers of any enhancement (usually a swap counterparty). As the SPV is a specifically formed shell company with no other assets, forms of enhancement are often provided to protect the SPV from various risks to which it might otherwise be exposed. Hedging (interest and exchange rate) will usually be required to deal with any potential mismatch between the cashflows generated by the underlying assets and the interest due from the SPV on the Notes.
The Originator will most often continue to service the assets and collect payments from debtors under those assets and deal with the day to day administration and enforcement of the securitised assets, pursuant to an administration agreement.
What are the benefits of securitisation?
(i) Improving balance sheets – the securitisation of an Originator’s assets removes those assets from the Originator’s balance sheet and the proceeds from the sale of the securitised assets are shown as cash, thereby improving capital adequacy ratios for financial institutions and reporting ratios, such as debt-to-equity ratios and return-on-assets ratios.
(ii) Low Cost – securitisation can be a cheaper and more flexible source of long-term financing than conventional bank lending, particularly for companies below investment grade. Securitisation is a capital market tool that enables cash flows to be isolated from the credit risk of the Originator. Once isolated, the cash flows used to back the Notes issued in the capital markets often have a higher rating than securities issued by the Originator.
(iii) Liquidity – by selling a portfolio of assets, an Originator is able to realise cash for those assets, providing it with additional liquidity. This liquidity can be used by the Originator to generate new business and/or reduce its existing borrowings.
(iv) Credit Risk – an Originator may wish to reduce his exposure to certain sectors, and by remaining servicer of the securitised assets, the Originator is able to maintain its existing relationships with its customers without having to bear their full credit risk.
(v) Investors – the ability to participate in securities issued by the SPV may give onshore investors who may be prohibited by their domestic laws and regulations from investing in certain types of assets the opportunity to do so.
(i) Set up
The SPV in a typical structured finance transaction is incorporated as a Cayman Islands exempted company under The Companies Law (2002 Revision). The incorporation process is very straightforward and the SPV can be set up within twenty-four hours. Government fees are payable upon registration of the Company, and at the beginning of each year thereafter, and are based on the authorised share capital of the Company. Most SPV’s are set up with an authorised share capital of US$50,000 or less to qualify for the minimum registration fee of US$574 (the maximum fee is US$1,722). The share capital of the SPV may be denominated in any currency and there are no minimum requirements in respect of issued or paid up capital. The SPV need only have one shareholder and one director, neither of whom need be resident in the Cayman Islands. The SPV must have a registered office in the Cayman Islands and it is necessary that a register of directors and officers (a copy of which must be filed with the Registrar of Companies in the Cayman Islands) and a register of mortgages and charges be held at the registered office. A register of shareholders must be maintained, but is not publicly available information and does not need to be held at the registered office.
In the case of a typical off-balance sheet SPV, the shares of the SPV are owned by a Cayman Islands trust company which will hold the shares on trust for charitable purposes and who will provide directors to the SPV. Alternatively, under Cayman Islands law, it is possible to establish a trust specifically for the purpose of ensuring the transaction is bankruptcy remote (a "STAR trust") under The Special Trust (Alternative Regime) Law 1997.
The SPV must be run as an independent entity to avoid the risk of a court piercing the corporate veil and treating it as an agent of the Originator. Furthermore, the directors of the SPV, as with English companies, must act in good faith and in the best interests of the SPV. This is achieved by the SPV charging a fee for entering into the transaction (corporate benefit issues are the same as in England) and by using a Cayman Islands trust company to provide independent directors.
(ii) Continuing Requirements
The continuing requirements for a Cayman Islands exempted company are minimal. An exempted company must file an annual return, together with the appropriate annual filing fee (described above) with the Registrar of Companies. The annual return simply confirms that the requirements of the Companies Law as far as they relate to exempted companies have been complied with and that the SPV has conducted its operations mainly outside the Cayman Islands.
(iii) Publicly Available Information
The only information which may be obtained by a member of the public from the Registrar of Companies in relation to an exempted company is the type of company it is (i.e. exempted) and the location of its registered office. The exempted company’s register of mortgages and charges may be inspected by any shareholder or creditor of the company.
The SPV is required by the Companies Law to keep books of account which give a true and correct view of its affairs. However, the SPV is not required to have its accounts audited nor do any accounts need to be filed with any Cayman Islands authority.
The enormous value of modern securitisation transactions make careful tax planning imperative.
The Cayman Islands is a tax-neutral jurisdiction and therefore does not impose any direct taxes on the SPV or the Noteholders or indirect taxes by way of withholdings on payments made by the SPV. This is supported by an undertaking given by the Cayman Islands Government that the exempted company will not be subject to any tax imposed by any new law enacted in the Cayman Islands for a period of at least twenty years from the date of the undertaking.
Stamp duty is only payable on instruments if such instruments are executed in or physically brought into the Cayman Islands. Stamp duty is charged at a nominal rate provided that the property over which the security is granted is not situated in the Cayman Islands (which is usually the case for all property secured except for the shares of the SPV). It is usual therefore that documents are executed by way of power of attorney outside the Cayman Islands.
Cayman Islands Service Providers
The financial services industry in the Cayman Islands has developed over many years and institutions and arrangers doing business in the Cayman Islands benefit from top quality professional service providers with extensive experience of structured finance transactions. Service providers are often used to provide the share trustee of the charitable or STAR trust and directors to the SPV and may also provide transfer agent and accounting agent services. Fully licensed subsidiaries of major international financial institutions, such as BNP Paribas, CIBC, Deutsche Bank and HSBC, are very experienced in structured finance transactions and the market for service providers is very competitive.
The service provider will typically enter into an administration agreement with the SPV pursuant to which it agrees to provide corporate services to the SPV. The fees of such administrators are competitive with other offshore jurisdictions. With the broad range of service providers available it is easy to ensure that the SPV is controlled and managed offshore by experienced personnel supported by first-rate legal advisers and all the major accounting firms.
The trust deed pursuant to which the share trustee agrees to hold the shares in the SPV will invariably prohibit the trustee from exercising its rights as a shareholder to wind-up the SPV during the life of the transaction. The service provider will also be concerned to ensure that the transaction is structured on a limited recourse basis so that the liability of the SPV is limited to the security provided and that in the event of a shortfall after that security has been realised, any further sums due from the SPV to any party shall be extinguished. The roles and concerns of each party are well rehearsed and understood so that finalising legal documentation can be done quickly and economically.
The Cayman Islands continues to be the offshore domicile of choice for structuring off balance sheet finance transactions and the outlook for securitisations and debt repackagings in the jurisdiction remains bright. The publication in July 2002 by Standard & Poor’s of the application of its criteria to Cayman Islands SPVs and the listing of several specialist debt securities programmes issued by such SPVs on the Cayman Islands Stock Exchange bears testimony to the jurisdiction’s enduring appeal.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.