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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Originally Published by The Legal 500

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.