A Q&A guide to structured finance and securitisation law in Bermuda.
This Q&A provides an overview of, among others, the markets and legal regimes, issues relating to the SPV and the securities issued, transferring the receivables, dealing with security and risk, cash flow, ratings, tax issues, variations to the securitisation structure and reform proposals.
MARKET AND LEGAL REGIME
1. Please give a brief overview of the securitisation market in your jurisdiction. In particular:
- How developed is the market and what notable transactions and new structures have emerged recently?
- What impact have central bank programmes (if any) had on the securitisation market in your jurisdiction?
- Is securitisation particularly concentrated in certain industry sectors?
Bermuda is firmly established as one of the largest and most developed offshore jurisdictions for securitisation transactions. The overall issuance of securitised products has returned to pre-financial crisis levels, predominantly in the areas of existing well-established structures and asset classes, though new asset classes have recently been seen.
Bermuda has seen minimal impact from the 2014 announcement that the European Central Bank would purchase securitisation bonds through an ABS purchase programme.
The majority of Bermuda securitisations in the last decade have been concentrated in the following industry sectors:
- Aircraft and aircraft engines.
- Insurance and risk management.
- Shipping containers.
More recently, vessel securitisation structures have been domiciled in Bermuda. It is expected that further new asset classes will follow, as Bermuda consolidates its position among offshore jurisdictions for securitisations.
2. Is there a specific legislative regime within which securitisations in your jurisdiction are carried out? In particular:
- What are the main laws governing securitisations?
- What is the name of the regulatory authority charged with overseeing securitisation practices and participants in your jurisdiction?
There are currently no statutes specifically governing securitisation transactions in Bermuda, because Bermuda's existing common law and corporate law provide both appropriate legal structures and protections required for securitisations.
The principal transaction documents relating to securitisations in Bermuda are most frequently governed by the laws of New York or England and Wales.
Security over shares in a Bermuda special purpose vehicle (SPV) is often provided under a Bermuda law governed share charge.
The largest institutional purchasers of securities issued in a Bermuda securitisation are domiciled outside Bermuda. As such, Bermuda securitisations are typically governed by non-Bermuda legislation.
There is no regulatory authority in Bermuda tasked specifically with overseeing securitisation transactions, practices or transactions in Bermuda. A typical securitisation vehicle will not be a regulated entity for the purposes of the Bermuda Monetary Authority.
REASONS FOR DOING A SECURITISATION
3. What are the main reasons for doing a securitisation in your jurisdiction? How are the reasons for doing a securitisation in your jurisdiction affected by:
- Accounting practices in your jurisdiction, such as application of the International Financial Reporting Standards (IFRS)?
- National or supra-national rules concerning capital adequacy?
- Risk retention requirements?
- Implementation of the Basel III framework in your jurisdiction?
Bermuda securitisations exist essentially to transform an asset into a security, which can be sold to investors in the capital markets. In a basic securitisation transaction, an SPV is incorporated and is often owned by a purpose or charitable trust. The SPV then purchases an asset, which usually has some form of regular cash flow, and issues loan notes or preference shares to investors in the capital markets to finance the purchase. The repayment of principal and interest on the notes is then secured by the purchased asset and the accompanying cash flow.
See Question 4.
Capital adequacy rules / risk retention requirements / Basel III Implementation
There are no Bermuda capital adequacy rules, risk retention requirements or Basel III implementation considerations which apply to a typical securitisation entity established in Bermuda.
The development of the insurance-linked securities (ILS) market in Bermuda has particularly benefited from its position as the existing dominant insurance and reinsurance market, as well as the development in Bermuda of efficient special purpose insurer (SPI) legislation.
THE SPECIAL PURPOSE VEHICLE (SPV)
Establishing the SPV
4. How is an SPV established in your jurisdiction? Please explain:
- What form does the SPV usually take and how is it set up?
- What is the legal status of the SPV?
- How the SPV is usually owned?
- Are there any particular regulatory requirements that apply to the SPVs?
Although many securitisation transactions involve an SPV that is directly owned by a parent, often a transaction will require an orphan SPV, meaning that it is not part of the originator's corporate group. By selling the asset to the orphan SPV, the asset is removed from the originator's balance sheet.
When an orphan is required:
- The SPV is incorporated with all the shares issued to a trustee (typically based in Bermuda) pursuant to a special purpose trust or charitable trust.
- The SPV then issues securities, such as notes, to raise funds to purchase the asset pool from the originator.
- The asset pool is then ring-fenced by the grant of a security interest over the asset pool in favour of the indenture trustee.
- The income flow from the asset pool is used to pay the transaction fees, costs and interest to the note holders.
The shares of a Bermuda SPV are usually issued to a trustee under a special purpose trust. A purpose trust is a trust established to fulfil certain purposes rather than one for beneficiaries, while a charitable trust has a charity as the beneficiary. The main advantages of a Bermuda purpose trust over charitable trusts available in other jurisdictions are threefold:
- The purposes of the trust and, therefore, the duties of the trustees, can be clearly linked to the contemplated transactions, that is, to subscribe for shares of the SPV, retain those shares, and support the activities of the SPV in the transactions. The duties of the trustees of a charitable trust are to maximise the benefits for the charity or charitable purposes and, depending on the circumstances, a conflict of interest may arise.
- A charitable trust created primarily to facilitate a particular structure or transaction, so that the benefits to the charity are not maximised, may be exposed to a substance over form argument (that the trustees are really acting in the interests and for the benefit of those who benefit from the structure).
- Most offshore centres that follow English common law principles grant jurisdiction to the Attorney General (or some similar public official) to enforce charitable trusts that are not being properly administered for the benefit of the charity. While it is not known of any instance where the Attorney General has sought to enforce a charitable trust used in a commercial structure, the risk cannot be entirely discounted in a jurisdiction where such enforcement powers exist.
The advantage of a charitable trust over a purpose trust is mainly one of nexus. It could be argued in some circumstances that a trust appearing to be for a certain purpose or purposes is in fact a trust for the benefit of an ascertainable person. This might give rise to a tax liability in the home jurisdiction of that person.
There is English case law authority that, where the benefit to a person is so indirect, intangible, or otherwise framed that the person does not have standing to apply to court to enforce the trust, then the trust would be considered a purpose trust. If the benefit is not so indirect, the trust may not be considered a purpose trust.
The tax rules in the home jurisdiction may apply different tests to determine whether a taxable benefit arises, and those rules would need to be considered appropriately. A properly structured charitable trust from which distributions are made from a realistically set level of dividend paid by the SPV may, therefore, be preferable, as the charities would be the person deriving a benefit.
In the ILS context, the SPV is generally incorporated and licensed as an SPI. These are licensed insurers specifically regulated to give effect to their status as being fully-funded, where all insurance risk is backed by at least an equal value collateral or contingent funding, and involving sophisticated participants only.
5. Is the SPV usually established in your jurisdiction or offshore? If established offshore, in what jurisdiction(s) are SPVs usually established and why? Are there any particular circumstances when it is advantageous to establish the SPV in your jurisdiction?
All securitisation transactions domiciled in Bermuda will use an SPV incorporated in Bermuda.
6. What steps can be taken to make the SPV as insolvency remote as possible in your jurisdiction? In particular:
- Has the ability to achieve insolvency remoteness been eroded to any extent in recent years?
- Will the courts in your jurisdiction give effect to limited recourse and non-petition clauses?
When establishing the securitisation structure, it is important to ensure that the SPV is bankruptcy remote. Although the SPV can be established with very broad objects and powers, while the transactions are being negotiated, prior to the transactions being entered into, the company's objects and powers should be limited, to allow it to only enter into the specific transactions related to the securitisation. This is also necessary if the securities the SPV is issuing are to be rated by one of the rating agencies.
Rating agencies will want to ensure the SPV is not able to carry on any business other than the securitisation. It is also important that the trustee, pursuant to the purpose trust, is not allowed to sell the shares, merge or amalgamate the SPV, continue the SPV into another jurisdiction or make any other structural changes to the SPV, such as amending its constitutional documents. If a purpose trust is used, these requirements can be set out in the purpose trust. If a charitable trust is used, the trustee can agree, pursuant to a separate agreement, that it will not change the structure of the SPV. Again, this is one of the advantages of using a purpose trust whereby everything can be set out in one document.
It is important to ensure that the SPV will not be petitioned into winding up (bankruptcy) and the trustee of the purpose trust will agree not to petition the SPV into bankruptcy. Further, the note holders, indenture trustee and other service providers will agree in the indenture and other transaction documents that they will not petition for the bankruptcy of the SPV. Also, the transaction documents will usually contain a provision for the extinguishment or diminishment of obligations if at any point the liabilities are greater than the assets, so that the liabilities will be extinguished or diminished to be less than the assets. This will ensure that the SPV is at all times solvent, and therefore cannot be petitioned into bankruptcy.
Ensuring the SPV is treated separately from the originator
7. Is there a risk that the courts can treat the assets of the SPV as those of the originator if the originator becomes subject to insolvency proceedings (substantive consolidation)? If so, can this be avoided or minimised?
Bermuda law has not developed a distinct body of law governing the relations between parent companies and their subsidiaries or between companies and other companies in which they have substantial shareholdings. Instead, the ordinary rules of Bermuda company law are generally applied to such companies, to transactions between them and to transactions by them, with other persons as though no special relationship existed. As a general rule, Bermuda law recognises the separate and distinct existence of a Bermuda company from its members and subsidiaries.
There is some judicial precedent for the courts to disregard the fundamental principle of separate legal existence of a company (lifting the corporate veil) in certain circumstances. However, each case is determined on its particular facts, and it is not possible to formulate any single rule as to when the corporate veil will be lifted. However, while there has been no comprehensive and definitive statement by the courts as to when the corporate veil will be lifted, the English courts (the decisions of which are highly persuasive in the Bermuda courts) have shown a general willingness to do so where a company is being used as a device for an illegal or improper purpose, such as when a company is interposed to deliberately evade or frustrate enforcement of an existing legal right.
It is the authors' view that, save in very limited exceptions, a Bermuda court, a liquidator appointed by a Bermuda court or the official receiver of Bermuda, have no power under Bermuda law to "consolidate" assets. That is, to treat a company that is not insolvent as part of one or more companies that are insolvent, and treat the assets of the solvent company as available to satisfy the obligations of an insolvent company or companies, to establish the claims of creditors against the group as a whole.
Bermuda securitisation transactions are typically structured to avoid the risk of the SPVs assets being treated as belonging to the originator, to another third party, or to a creditor or liquidator of a third party company, which has a claim on the assets. This aim is assisted by ensuring, among others, in the transaction agreements and in the SPVs constitutional documents that the SPV:
- Observes all corporate formalities necessary to remain a separate legal entity.
- Maintains its assets and liabilities separate and distinct from unrelated parties.
- Maintains separate records, books, accounts, financial statements and minutes.
- Conducts its business in its own name.
- Maintains an arm's-length relationship with its affiliates.
- Pays its own liabilities and obligations.
- Uses separate stationery, invoices and cheques.
- Holds itself out as a separate entity, and corrects any known misunderstanding regarding its status as a separate entity.
- Does not pay or become liable for any indebtedness of another party.
- Observes all corporate or other procedures required under applicable law and its constitutive documents.
Issuing the securities
8. What factors will determine whether to issue the SPV's securities publicly or privately?
Public offerings and private placements are the two main methods for issuing securities. A combination of the two can be used as part of the same transaction. Factors determining whether the SPVs securities are offered publicly or placed privately will be led by onshore considerations.
9. If the securities are publicly issued:
- Are the securities usually listed on a regulated exchange in your jurisdiction or in another jurisdiction?
- If in your jurisdiction, please identify the main documents required to make an application to list debt securities on the main regulated exchange in your jurisdiction. Are there any share capital requirements?
- If a particular exchange (domestic or foreign) is usually chosen for listing the securities, please briefly summarise the main reasons for this.
Securities issued pursuant to the transactions described in this article are usually listed on onshore exchanges. A notable exception to this is in the ILS context which, when listed, are often listed on the Bermuda Stock Exchange.
In addition to accessing the main US market via the New York Stock Exchange, securities offered by Bermuda companies are often listed on the Bermuda Stock Exchange (BSX) and the Irish Stock Exchange (ISE). At the end of October 2016, the BSX accounted for over 75% of the global market capitalisation of ILS and, as such, is the principal exchange for ILS listings. The ISE is one of the leading exchanges for the listing of specialist debt securities, such as those issued by SPVs in ABS transactions.
Constituting the securities
10. If the trust concept is not recognised in your jurisdiction, what document constitutes the securities issued by the SPV and how are the rights in them held?
The trust concept is recognised in Bermuda.
TRANSFERRING THE RECEIVABLES
Classes of receivables
11. What classes of receivables are usually securitised in your jurisdiction? Are there any new asset classes to have emerged recently or that are expected to emerge in the foreseeable future?
Assets which are habitually securitised using a Bermuda structure are generally movable assets and include:
- Aircraft engines.
- Sea containers.
In addition, Bermuda is the principal offshore jurisdiction to domicile a range of ILS issuances, which use a Bermuda SPI as the issuer. The issuance of catastrophe bonds or similar insurance-related bond issuances are particularly common in Bermuda.
The authors anticipate the emergence of new structures involving larger ships and vessels, with ship owners and/or charters looking to access the capital markets.
Transferring receivables from the originator to the SPV
12. How are receivables usually transferred from the originator to the SPV? Is perfection of the transfer subject to giving notice of sale to the obligor or subject to any other steps?
The most common method of transferring receivables is by way of assignment (equitable or legal). The key requirements of a legal assignment are that it must be an absolute assignment of the chose in action and the assignment must be in writing, signed by the assignor and, to perfect the legal assignment, it must be notified in writing to the obligor.
Where the sale of a receivable falls short of these requirements it will take effect as an equitable assignment. Any subsequent assignment effected by the seller and notified to the obligor, before the date on which the original assignment is notified to the obligor, will take priority.
Alternative methods to transfer receivables include:
- A novation (which transfers the rights and obligations in respect of the receivables and requires written consent from each of the obligor, transferor and transferee).
- A declaration of trust over the receivables, or over the proceeds of the receivables (coupled with a power of attorney).
- A sub-participation (essentially a limited recourse loan to the seller in exchange for an economic interest in the receivables).
13. Are there any types of receivables that it is not possible or not practical to securitise in your jurisdiction (for example, future receivables)?
Bermuda permits the securitisation of any type of receivable, including future receivables.
14. How is any security attached to the receivables transferred to the SPV? What are the perfection requirements?
Security for a receivable can usually be assigned in the same manner as the receivable itself. As a matter of Bermuda law, a charge is not required to be registered in Bermuda to be valid. However, it may be desirable to ensure the priority in Bermuda of a charge that it be registered in the Register of Charges under the Bermuda Companies Act 1981 (Companies Act). On registration, to the extent that Bermuda law governs the priority of a charge, the charge will have priority in Bermuda over any unregistered charges, and over any subsequently registered charges, in respect of the assets which are the subject of the charge.
Prohibitions or restrictions on transfer
15. Are there any prohibitions or restrictions on transferring the receivables, for example, in relation to consumer data?
There are no prohibitions or restrictions on transferring the receivables.
Avoiding the transfer being re-characterised
16. Is there a risk that a transfer of title to the receivables will be re-characterised as a secured loan? If so:
- Can this risk be avoided or minimised?
- Are true sale legal opinions typically delivered in your jurisdiction or does it depend on the asset type and/or provenance of the securitised asset?
In determining whether a given transaction is a true sale or a charge, equity will look at the substance of the transaction and not merely at the form. While there is no exhaustive definition of a charge under Bermuda law, a charge by statutory definition includes any interest created in property by way of security (including any mortgage, assignment, pledge, lien or hypothecation). Further, under Bermuda law, a charge has three essential characteristics:
- The chargor is entitled, until it has been foreclosed, to have the charged property returned after paying to the chargee the money that has passed between them.
- If the chargee realises the charged property, for an amount in excess of that due to it (with interest and costs), it must account to the chargor for that excess.
- If the chargee realises the charged property, for an amount less than that due to it (with interest and costs), it is entitled to recover the difference from the chargor.
In general the relevant transaction documents are governed by the laws of a jurisdiction other than Bermuda, so the question whether the transaction possesses these particular characteristics will be determined under the laws of the applicable jurisdiction.
True sale legal opinions are typically delivered in relation to securitisations involving a Bermuda SPV.
Ensuring the transfer cannot be unwound if the originator becomes insolvent
17. Can the originator (or a liquidator or other insolvency officer of the originator) unwind the transaction at a later date? If yes, on what grounds can this be done and what is the timescale for doing so? Can this risk be avoided or minimised?
Assuming that the security documentation is effective, liquidators can only unwind a transaction and possibly get access to the security if the transaction can be said to fall within one of the transaction avoidance provisions under Bermuda law. Absent a case of outright fraud, transactions can only be avoided under statutory provisions in Bermuda legislation. The relevant provisions are under Part IVA of the Conveyancing Act 1983 and Section 237 of the Companies Act.
The Conveyancing Act permits a creditor to apply to set aside a transaction where the transaction was carried out with the dominant intention to place the asset beyond the reach of creditors and at an undervalue. Therefore, where a transaction is at arm's-length, at commercial value, and there is no intent to defraud creditors and no fraud, then it is unlikely that the transaction would be set aside, as a matter of Bermuda law. However, such a claim can only be made by an "eligible creditor", which is a person who is one of the following:
- Owed a debt by the transferor on or within two years after the transfer.
- On the date of the transfer is owed, a contingent liability by the transferor, where the contingency giving rise to the obligation has occurred.
- On the date of the action to set aside the transfer is owed, an obligation arising from a cause of action which occurred prior to or within two years after the date of the transfer.
There is a six-year limitation period on bringing such a claim. There is also a question as to whether such an action can be brought by a liquidator directly, as the statutory provision confers the right to apply to set aside such transactions on creditors. As a result a liquidator will typically bring such an action along with a creditor to avoid standing disputes.
Section 237 of the Companies Act permits a liquidator to apply to avoid a transaction that took place within six months prior to the presentation of a winding up petition, and the company is insolvent or unable to pay its debts and the transaction has been carried out with a view to giving the creditor a preference over others. This section does not affect the title of third parties who obtained title in good faith and for valuable consideration. Therefore, in most securitisation transactions, where the financing is obtained for valuable consideration, it will be difficult to set the transaction aside under this head.
A liquidator appointed by a Bermuda court has the right, in limited circumstances, to apply to court to disclaim a contract which he considers onerous on the company or which is unprofitable or unsaleable.
Bermuda law also creates causes of action where persons carry on business with intent to defraud creditors. If, during the course of the winding up of a company, it appears that the company has carried on its business with intent to defraud creditors (of itself or any other person) or for any fraudulent purpose, the court can order that any person who was knowingly a party to the carrying on of such business is personally liable for the debts or other liabilities of the company. Although this section does not provide for avoidance of the transaction itself, it is worth mentioning in this context.
Establishing the applicable law
18. Are choice of law clauses in contracts usually recognised and enforced in your jurisdiction? If yes, is a particular law usually chosen to govern the transaction documents? Are there any circumstances when local law will override a choice of law?
Choice of law clauses in contacts would be recognised, and given effect to, in any action brought before a court of competent jurisdiction in Bermuda, except for those laws:
- Which the court considers to be procedural in nature.
- Which are revenue or penal laws.
- The application of which would be inconsistent with public policy, as such term is interpreted under the laws of Bermuda.
English law and New York law are the most common laws seen in securitisation transactions using a Bermuda structure. Bermuda law is often preferred in respect of share security to be granted over the shares of a Bermuda SPV, as the shares are considered to be Bermuda property.
SECURITY AND RISK
19. Please briefly list the main types of security that can be taken over the various assets of the SPV in your jurisdiction, and the requirements to perfect such security.
Bermuda law will recognise the following principal types of security created by an SPV:
- Mortgages involving the transfer of title to an asset by way of security for particular obligations, on the condition that it will be re-transferred when the secured obligations are discharged.
- Fixed or floating charges under which obligations are secured by granting security over assets.
- Pledges by delivery of possession of an asset by way of security.
- Liens, being the right of retention of an asset until discharge of an obligation owed by the owner of that asset.
It is not necessary or desirable to ensure the enforceability in Bermuda of a charge that it be registered in any register kept by, or filed with, any governmental authority or regulatory body in Bermuda. However, it may be desirable to ensure the priority in Bermuda of a charge that it be registered in the Register of Charges under the Companies Act. On registration, to the extent that Bermuda law governs the priority of a charge, the charge will have priority in Bermuda over any unregistered charges, and over any subsequently registered charges, in respect of the assets which are the subject of the charge.
20. How is the security granted by the SPV held for the investors? If the trust concept is recognised, are there any particular requirements for setting up a trust (for example, the security trustee providing some form of consideration)? Are foreign trusts recognised in your jurisdiction?
Security granted by a Bermuda SPV is typically granted in favour of a trustee under a non-Bermuda trust, created under a trust indenture for the benefit of investors.
21. What methods of credit enhancement are commonly used in your jurisdiction? Are there any variations or specific issues that apply to the credit enhancement techniques set out in the Guide to a standard securitisation (Guide)?
Methods of credit enhancement in Bermuda are consistent with those applied in other principal jurisdictions. They can include subordinated tranches of security, letters of credit, third party guarantees, cash reserves, insurance and over-collateralisation.
Risk management and liquidity support
22. What methods of liquidity support or cash reservation are commonly used in your jurisdiction? Are there any variations or specific issues that apply to the provision of liquidity support as set out in the Guide?
Methods of liquidity support in Bermuda are consistent with those applied in other principal jurisdictions. Most typically, lines of credit will be made available to the SPV issuer by a lender.
Distribution of funds
23. Please explain any variations to the cash flow index accompanying Diagram 9 of the Guide that apply in your jurisdiction. In particular, will the courts in your jurisdiction give effect to "flip clauses" (that is, clauses that allow for termination payments to swap counterparties who are in default under the swap agreement, to be paid further down the cash flow waterfall than would otherwise have been the case)?
Other than those agreed between the parties or required by rating agencies, Diagram 9 of the Guide reflects cash flows for a typical Bermuda securitisation, except that swap agreements do not always form part of Bermuda securitisation transactions.
24. What methods of profit extraction are commonly used in your jurisdiction? Are there any variations or specific issues that apply to the profit extraction techniques set out in the Guide?
All of the methods of profit extraction specified in the Guide are competent in Bermuda, and will be determined by the nature of the assets, the type and tax treatment of credit enhancement and the requirements of rating agencies.
THE ROLE OF THE RATING AGENCIES
25. What is the sovereign rating of your jurisdiction? What factors impact on this and are there any specific factors in your jurisdiction that affect the rating of the securities issued by the SPV (for example, legal certainty or political issues)? How are such risks usually managed?
As of the time of writing, Bermuda's sovereign credit rating was affirmed at A+ by Standard & Poor's Rating Services and A2 by Moody's.
26. What tax issues arise in securitisations in your jurisdiction? In particular:
- What transfer taxes may apply to the transfer of the receivables? Please give the applicable tax rates and explain how transfer taxes are usually dealt with.
- Is withholding tax payable in certain circumstances? Please give the applicable tax rates and explain how withholding taxes are usually dealt with.
- Are there any other tax issues that apply to securitisations in your jurisdiction?
- Does your jurisdiction's government have an inter-governmental agreement in place with the US in relation to FATCA compliance, and will this benefit locally-domiciled SPVs?
At the present time, there is no Bermuda income or profits tax, withholding tax, capital gains tax, capital transfer tax, estate duty or inheritance tax payable by a Bermuda issuer SPV established as an exempted company, or by holders of notes pursuant to a securitisation.
Bermuda exempted companies obtain an assurance from the Minister of Finance of Bermuda under the Exempted Undertakings Tax Protection Act, 1966 that, if any legislation is enacted in Bermuda imposing any tax computed on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, such tax will not, until 31 March 2035, be applicable to the SPV or to any of its operations, shares, debentures or other obligations, except insofar as such tax applies to persons ordinarily resident in Bermuda or payable by the SPV in respect of real property owned or leased by it in Bermuda.
RECENT DEVELOPMENTS AFFECTING SECURITISATIONS
27. Please give brief details of any legal developments in your jurisdiction (arising from case law, statute or otherwise) that have had, or are likely to have, a significant impact on securitisation practices, structures or participants.
The authors are not aware of any legal developments in Bermuda which are likely to have a significant impact on securitisation transactions in Bermuda.
OTHER SECURITISATION STRUCTURES
28. What other structures, including synthetic securitisations, are sometimes used in your jurisdiction?
While synthetic securitisations are available in Bermuda, the majority of transactions in the ABS securitisation sectors are established as conventional transparent structures.
In insurance securitisations there are two common forms of transactions: a catastrophe bond transaction and a transformation transaction.
In a catastrophe bond transaction, a reinsurance company looking for retrocessional cover will enter into a retrocession agreement with an SPV and pay a premium to the SPV. The SPV then issues limited recourse loan notes to investors, usually in an amount that, when added to the premium received by the SPV, equals the aggregate exposure under the contract.
Accordingly, the SPV becomes the perfect insurance company from the point of view of the insured, as it has assets equal to 100% of its maximum liabilities, and therefore there is no credit risk to the insured. There is no credit risk to the insured because the loan notes are limited recourse, and the investors in the loan notes agree that the SPV's obligation to repay is diminished by the amount that the SPI company is required to pay to the underlying insured.
In a special purpose transformation transaction, an SPV can be used to transform a single financial guarantee insurance contract into a credit default swap, and thereby permit a financial institution to assume the credit default risk. Alternatively, an SPV can be used to enable a primary purchaser of insurance to access reinsurers on a bankruptcy remote basis.
29. Please summarise any reform proposals and state whether they are likely to come into force and, if so, when. For example, what structuring trends do you foresee and will they be driven mainly by regulatory changes, risk management, new credit rating methodology, economic necessity, tax or other factors?
There are currently no Bermuda law reform proposals which would impact securitisation transactions in Bermuda.
Originators, sponsors and investors in Bermuda securitisation transactions are typically based outside Bermuda. The terms of the UK leaving the EU have yet to be drawn up and the nature of the UK's relationship with the EU post-Brexit has yet to be agreed. Accordingly, it remains too early in the process to know for certain what the impact will be and what the UK market will look like post-Brexit.
Nonetheless, the authors do not anticipate Brexit will impact securitisation transactions domiciled in Bermuda.
30. Has the nature and extent of global, regional and domestic reforms had a positive or negative affect on revitalising securitisation in your jurisdiction?
The period immediately following the start of the financial crisis in 2006, through its peak in 2008, and in the subsequent two years, saw a dramatic reduction in the number of securitisation transactions offshore, generally, and Bermuda was no exception. This can, in some part, be attributed to the legal reforms instituted as a response to the crisis, but is more likely a reflection of a lack of confidence in global liquidity markets. Bermuda was quick to recover in 2010, remaining active as a securitisation domicile since, with minimal disruption attributable to global legal reforms.
This article was originally published in Practical Law, January 2017.
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.