Ireland: Client Newsletter Winter 2009 – Banking And Capital Markets

In this issue:-

• New Government Bank Guarantee Scheme – The ELG Scheme
• Recent Irish Developments In Relation To The FVC Regulation
• Recent Developments In Relation The National Asset Management Agency
• New Amendments To Rating Requirements For Asset-Backed Securities In Eurosystem Credit Operations
• Case Law Update: Conditional Priority Provisions Upheld By The UK Court Of Appeal

NEW GOVERNMENT BANK GUARANTEE SCHEME – THE ELG SCHEME

The current Credit Institutions (Financial Support) Scheme 2008 provides that the Minster for Finance of Ireland (the "Minister") will guarantee certain types of liabilities ("covered liabilities") of participating named institutions ("covered institutions") for the period 30th September, 2008 – 29th September, 2010 inclusive (the "CIFS Scheme"). Please see our other Banking & Capital Markets publications for further information.

Under the CIFS Scheme, if a covered institution defaults on a covered liability, the Minister would pay to the creditor, on demand, an amount equal to the unpaid covered liabilities. Once the guarantee expires after the 29th September, 2010, it will no longer be effective and no call can be made on the guarantee after that date. Accordingly, the Department of Finance has issued draft text of the proposed Credit Institutions (Eligible Liabilities Guarantee) Scheme 2009 (the "ELG Scheme") which is intended to be implemented under the Credit Institutions (Financial Support) Act, 2008 (the "Act") and to supersede the CIFS Scheme. In addition, a draft set of rules which will be applicable to participating institutions participating in the ELG Scheme are also in circulation. The ELG Scheme was given EU State Aid approval on 20th November, 2009. It is intended that the Scheme will be brought into law in the near future and that the Minister will issue a delegation order to appoint the National Treasury Management Agency as the scheme operator during the course of December.

The Guarantee

The ELG Scheme is intended to facilitate and permit credit institutions in Ireland to issue debt securities and take deposits with a maturity of post-September 2010 on a guaranteed basis.

The guarantee will be given by the Minister on an unconditional and irrevocable basis and will provide for timely payment of the "eligible liabilities" (see below). The Minister may, at his or her discretion and at the request of the relevant participating institution, limit the application of the guarantee given to that participating institution to certain types or categories of deposits.

Credit institutions will be eligible to join the ELG Scheme if they are "systemically important", solvent and have been specified or are already specified by the Minister under section 6(1) of the Credit Institutions (Financial Support) Act, 2008. The participating institutions can apply for a programme to be guaranteed or can apply on an issuance by issuance basis.

The guarantee will terminate at midnight on the date falling 5 years after the end of the "issuance period" (see below) unless extended at the discretion of the Minister in compliance with EU State Aid requirements.

Eligible Liabilities

The eligible liabilities under the new guarantee will include:-

• all deposits (to the extent not covered by deposit guarantee schemes in the State (other than the CIFS Scheme) or any other jurisdiction);
• senior unsecured certificates of deposit;
• senior unsecured commercial paper;
• other senior unsecured bonds and notes

In addition, a blanket guarantee will apply to all relevant deposits incurred or rolled-over by a participating institution from the time such participating institution avails of a guarantee under the ELG Scheme for the first time, regardless of type, nature or the identity of the depositor.

In respect of other eligible liabilities other than deposits, the participating institutions may apply to the Minister for such eligible institutions to be guaranteed by the Minister and an eligible liability guarantee certificate will be given in respect of same at the Minister's discretion. This may be done on a stand-alone basis for particular eligible liabilities or for all of the eligible liabilities issued under a programme. As such, the ELG Scheme will permit participating institutions to issue eligible liabilities on a non-guaranteed basis.

In addition, eligible liabilities under the ELG Scheme will have to satisfy certain eligibility criteria such as:-

• an eligible liability (including deposits) must not have a maturity in excess of 5 years;
• an eligible liability must be incurred during an "issuance window" from the commencement date of the ELG Scheme to 29th September, 2010 (i.e. the final date of the CIFS Scheme) subject to the approval of the EU Commission at 6 monthly intervals that the issuance window can remain open. The Minister may also amend the issuance period pursuant to the Act.

Liabilities Not Covered By The ELG Scheme

Specifically, dated subordinated debt (Lower Tier 2) and asset covered securities (i.e. covered bonds issued under the Irish Asset Covered Securities Acts 2001(as amended)) are not covered by the ELG Scheme. In addition, it seems that "senior unsecured debt" under the CIFS Scheme will be replaced with "other senior unsecured bonds and notes" which would appear to have a potentially narrower interpretation and limited application.

Dated subordinated debt (Lower Tier 2) and asset covered securities (i.e. covered bonds issued under the Asset Covered Securities Acts) and other forms of covered bonds issued by a covered institution before the commencement date of the ELG Scheme will continue to be guaranteed under the CIFS Scheme.

Interaction With The CIFS Scheme

All liabilities guaranteed under the CIFS Scheme as at the commencement date of the ELG Scheme (and in respect of a participating institution, as of the date it avails of the guarantee for the first time under the ELG Scheme) will remain unconditionally and irrevocably guaranteed by the Minister under and in accordance with the CIFS Scheme.

From the time that a participating institution avails of a guarantee for the first time under the ELG Scheme, only covered liabilities of that participating institution in existence or contracted for prior to that time will continue to be guaranteed under the CIFS Scheme and any liabilities incurred or contracted thereafter can only be guaranteed under the ELG Scheme.

Fees

It is expected that the ECB pricing recommendations on government guarantees for bank debt dated 20th October, 2008 will apply to liabilities guaranteed under the ELG Scheme.

RECENT IRISH DEVELOPMENTS IN RELATION TO THE FVC REGULATION

Reduced Reporting Requirements For Small Financial Vehicle Corporations

Further to our update in our Summer Newsletter, the Irish Central Bank & Financial Services Authority of Ireland ("Central Bank") has issued a further derogation under Regulation EC No. 24/2009 of the European Central Bank concerning statistics on the assets and liabilities of financial vehicle corporations ("FVCs") engaged in securitisation transactions (ECB/2008/30) (the "FVC Regulation").

Under the FVC Regulation, a national central bank may reduce the reporting for some FVCs so long as the sum of total assets/liabilities of the vehicles using the derogation is less than 5 per cent of the population's total assets/liabilities. The Central Bank have announced that they will allow reduced reporting for smaller FVCs whose total assets/liabilities are under €180 million. Therefore FVCs with balance sheets under this threshold (i.e. with assets or liabilities under this amount) will only need to supply total assets/liabilities and the list of securities with ISIN codes issued on a quarterly basis.

This derogation does not apply to FVCs which are initially beneath the threshold (e.g. during a ramping up or warehousing period) but then exceed it when they have fully taken up business. It should be noted that the derogation for reduced reporting requirements is at the Central Bank's discretion and, in some cases, full reporting may be necessary for some FVCs who are in fact below the threshold (e.g. those set up by euro-area banks to securitise mortgages).

The Central Bank has confirmed that the appropriateness of the threshold will be monitored and is subject to annual review.

Guidance Issued By The Central Bank In Relation To The Application Of The FVC Regulation

The Central Bank has also issued formal guidance to provide additional information on the scope of the FVC definition as well as instructions for completing the forms provided in order to streamline communications regarding FVCs with the Central Bank.

In terms of the scope of the definition of FVC, the Central Bank has issued a non-exhaustive list of typical entities and structures which fall within the meaning of a "financial vehicle corporation" under the FVC Regulation and have indicated that these examples should not be construed as being mutually exclusive as a number of features may apply to a particular vehicle:-

• securitisations in which an entity which purchases loans from an original lender financed by the issuance of debt securities, securitisation fund units, loans, other debt instrument or financial derivatives;
• securitisations in which the credit risk is transferred through the use of credit derivatives, or similar mechanism, to an entity which is financed by the issuance of debt securities, securitisation fund units, loans, other debt instrument or financial derivatives;
• entities set up for the purposes of "internal" securitisations by banks (for example to create eligible assets to use as collateral in refinancing operations with a central bank) in which the sponsor bank purchases the securities issued by the entity;
• an entity which is financed by a loan from its sponsor as part of preparatory measures related to a securitisation (e.g. warehousing of assets);
• an entity which issues securities and uses the proceeds to purchase loans in the secondary market as part of an active investment strategy, (e.g. a "managed" CLO);
• an entity which is used for the securitisation of assets other than loans, such as corporate bonds, sovereign debt, or future cash flows from trade receivables, tax receivables, whole-business securitisations etc;
• entities which form part of a securitisation transaction involving multiple vehicles are included, for example in a structure whereby an "issuing company" issues securities (or securitisation fund units, etc) and passes the proceeds as a loan to an "asset purchasing company" which holds the assets. One or both must register with the Central Bank if they are resident in Ireland. If, for example, the issuing company is resident in the US and the asset purchasing company is resident in Ireland, then the Irish-resident entity should register;
• an entity which issues securities to finance the purchase ("repackaging") of assets that have already been securitised;
• master trusts, which hold a pool of assets, often a changing or revolving portfolio of assets such as credit card debt, which is financed by a loan from an FVC which issues securities;
• conduits, which finance securitisations through issuance of commercial paper backed by assets (ABCP); and
• multi-issuance vehicles which contractually "ring-fence" a pool of assets to a particular issuance through limited recourse arrangements are included in the definition insofar as these activities are securitisations under the FVC Regulation. A multi-issuance vehicle is regarded as a single FVC for the purposes of registration on the list of FVCs and for reporting purposes.

In addition, they have confirmed that the definition does not, in principle, include the following:

• an entity which solely grants loans to third parties on its own account as part of an investment strategy – i.e. the entity is the "first" or "original" lender of the loans and, therefore, they have not been transferred to the entity from another lender. Where an entity which grants a loan to an FVC as part of a multi-vehicle securitisation structure the Central Bank has confirmed that it is still included in the definition;
• an entity which issues notes to investors and uses the proceeds to grant loans to its sponsor;
• a "dormant" vehicle has ceased to be an FVC for the purposes of the FVC Regulation and reporting requirements, and should be removed from the list of FVCs. This may be because the vehicle has matured, been redeemed, or was established with the intention of partaking in a securitisation, but such activities are no longer foreseeable; and
• entities ("option" companies) which are contracted to carry out certain activities in following a specified a trigger event, e.g. a downgrade or default, but is otherwise dormant. If, following the trigger event, the activities of the company fall under the definition of securitisation, then the company is an FVC from the point that the securitisation activity is foreseeable – i.e. it is not an FVC until after the occurrence of the trigger event.

RECENT DEVELOPMENTS IN RELATION TO THE NATIONAL ASSET MANAGEMENT AGENCY

The heavily debated National Asset Management Agency Bill, 2009, (the "NAMA Bill"), establishing NAMA, has been approved by Dáil Eireann (Irish parliament) and the Seanad (the Senate). The NAMA Bill was signed into law by President Mary McAleese on 22 November, 2009.The signing of the NAMA Bill will allow the banks participating in the scheme to approve their involvement in NAMA.

NEW AMENDMENTS TO RATING REQUIREMENTS FOR ASSET-BACKED SECURITIES IN EUROSYSTEM CREDIT OPERATIONS

The European Central Bank (ECB) has announced the tightening of the rules relating to certain asset backed securities which it accepts as collateral against its loans to credit institutions. From March 1, 2010, all asset backed securities issued as of that date will require at least two ratings from an accepted external credit assessment institution (ECAI) in order to be eligible as collateral. This amends the previous position where the ECB previously required one rating at the triple-A level.

In determining the eligibility of ABS as collateral, the ECB has confirmed that the Eurosystem will apply the 'second-best' rule, meaning that not only the best, but also the second-best-available rating must comply with the minimum threshold applicable to ABS.

As of 1 March 2011, the second-best rule and the requirement to have at least two ratings will be applied to all ABS, regardless of their date of issue.

Due to the grandfathering provisions applicable until 1 March 2011, the number of required rating opinions will differ depending on the date of issuance of the ABS transaction. The following table provides an overview of the applicable rating rules:

In the event that an ABS initially has only a rating from one rating agency, the second rating opinion that needs to be obtained is considered as a "rating at issuance". As can be seen in the table above, this second rating opinion at issuance must be at the AAA/Aaa level for ABS issued as of 1 March 2009 in order for the ABS transaction to remain eligible. For ABS issued before 1 March 2009, this second rating opinion at issuance should be equal to or higher than A-/A3/AL in order for the ABS transaction to remain eligible.

Furthermore, under the "General documentation on Eurosystem monetary policy instruments and procedures" (section 6.3.1), the Eurosystem reserves the right to determine whether an issue, issuer, debtor or guarantor fulfils its requirements for high credit standards on the basis of any information it may consider relevant, and may reject or limit the use of assets or apply supplementary haircuts if required to ensure adequate risk protection of the Eurosystem, in line with Article 18.1 of the Statute of the European System of Central Banks and of the European Central Bank.

CASE LAW UPDATE: CONDITIONAL PRIORITY PROVISIONS UPHELD BY THE UK COURT OF APPEAL

Conditional priority provisions, which apply to many structured finance and securitisation transactions, were recently upheld by the UK Court of Appeal as being valid and enforceable: see The Perpetual Trustee Co Ltd, Belmont Park Investments PTY LTD v BNY Corporate Trustee Services Limited, Lehman Brothers Special Financing Inc [2009] EWCA Civ 1160. The appeal was considered with Butters and others v BBC Worldwide Ltd and others [2009] EWHC 1954 (Ch) as both cases concerned the "anti-deprivation" principle and, in both cases, the appeals were dismissed.

While the judgement is not binding in Ireland, it is a welcome development in an area where there has been a dearth of Irish case law.

Background

The initial High Court case related to a multi-issuer secured obligation programme referred to as the 'Dante Programme' which was established by Lehman Brothers International (Europe) ("LBIE") in 2002 in order to, in effect, provide a form of credit insurance in respect of loans or other obligations owed to LBIE or another company in the Lehman Brothers Group by debtors or "reference entities". The claimants were, or represented, the noteholders in respect of issues made under the Programme by three issuers, namely Saphir Finance plc (an Irish public limited company), Zircon Finance Ltd and Beryl Finance Ltd (each established in the Cayman Islands). The first defendant was BNY Corporate Trustee Services ("BONY"), the trustee for each of the relevant issues and chargee in respect of the charges granted by the issuers. The second defendant was Lehman Brothers Special Financing Inc ("LBSF"), the counterparty under the swap pursuant to which LBSF paid the issuer the amounts due by the issuer to the noteholders in exchange for the sums equal to the yield on the government bonds or other secure investments purchased by the issuer with the proceeds of the notes.

Although the claim was initially brought against BONY as trustee of the notes, LBSF intervened and elected to join the proceedings to argue that the relevant provisions are unenforceable, both under English law and pursuant to certain provisions of the US Bankruptcy Code. The proceedings were brought by Perpetual as the holder of certain credit-linked notes (the "Notes") issued as part of the "Dante" Note Programme sponsored by LBSF and its affiliates. BONY maintained a neutral stance throughout the proceedings.

The action concerns a variety of issues, including whether BONY should be prevented from applying "Noteholder Priority" in relation to the distribution of the proceeds of the Collateral over which it was directed to enforce security following an acceleration of the Notes held by Perpetual. The documents (which were governed by English law) provided for a reversal of the priority of payments to allow Perpetual (as holder of the Notes) to be paid ahead of LBSF (as Swap Counterparty) if there was an Event of Default in relation to LBSF under the Swap Agreement. An Event of Default under the Swap Agreement had occurred as a result of the Chapter 11 Bankruptcy filings of LBSF and its parent company in the United States and other events.

LBSF maintained at first instance that provisions of the U.S. Bankruptcy Code (the so-called "ipso facto" rule) and, in the alternative, provisions of English law, operated to make the reversal of the priority of payments ineffectual as a matter of law. LBSF appealed the High Court's decision that the reversal of the priority of payments was not ineffectual under English law under the so-called "anti-deprivation principle."

Appeal

The Court of Appeal unanimously upheld the English High Court's decision at first instance, confirming that provisions in contracts governed by English law that subordinate the rights or beneficial entitlements of the swap counterparty on an insolvency or other default will not generally be prohibited by English law. The Master of the Rolls, Lord Neuberger, commented that LBSF's prior ranking right to the proceeds of the collateral under the documents was always contingent, and given that LBSF had never unconditionally owned a prior ranking right, it could not be said to have been "deprived" of such a right contrary to the English law anti-deprivation principle.

LBSF has applied for permission to appeal to the newly formed English Supreme Court and the Court of Appeal's decision on whether to grant such permission is expected shortly.

Also at issue in the proceedings is whether the English Court will permit the application of foreign insolvency laws (by virtue of an application under the Cross Border Insolvency Regulations 2006 ("CBIR")) to invalidate these subordination provisions. That issue was not the subject of the hearing before the Court of Appeal, having been adjourned by the English High Court to permit an appropriate application for recognition and assistance under the CBIR to be made by LBSF.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.