Securitisation is a tool which transforms cashflows due to a company into immediate funding, which allows companies to diversify funding sources and tap sources of lower cost funding. The cashflow has to be relatively certain, measurable and steady over time so that a lender or investor can rely with confidence on this income stream to repay the funding obtained. As a result, receivables often take the form of financial assets such as loans, leases and hire purchase agreements, although other forms are also possible (such as supply invoices or royalties). Depending on an originator's funding needs, securitisations can be structured as: (i) forward flows where a lender pre-funds receivables for origination or: (ii) the purchase of an existing pool of assets. If a portfolio is expected to grow very quickly or the receivables are particularly well suited to be marketed to investors, a transaction can initially take the form of a warehouse intended to provide ramp-up funding with a view to carrying out a public take-out when the portfolio has reached critical mass.
Separate Collection Accounts
Securitisation financings are dependent on cashflows from the underlying securitised assets to repay investors. It is important to understand that receivables which have been securitised will no longer belong to the originator and the collections arising out of those receivables have been purchased by a newly established special purpose vehicle (SPV). Access to and isolation of these collections is key for the SPV to repay the funding made available by investors, and investors will require a trust or security over the accounts into which such collections are paid. The SPV can either be established as an entity outside the company’s group or can also (subject to certain structural mitigants such as ensuring the SPV is not VAT grouped and share pledges are obtained) be a newly incorporated subsidiary of the company.
Ideally, originators will ensure that the cashflows securitised are paid into separate collection accounts from the start so that securitised collections are not commingled with non-securitised funds and that transfer periods for collections are not too long. If setting up separate accounts is not possible or efficient, first ranking security will be granted over accounts into which collections belonging to both the originator and the SPV are paid, meaning there is a risk that collections belonging to the originator are used to repay investors. In addition, control by investors over mixed collection accounts could cause disruptions for the originator.
Whilst it is possible to request underlying debtors/obligors to change the account into which collections are paid, this is impractical and notifies underlying debtors of the existence of the securitisation structure, which originators often want to avoid. In consumer transactions, this process is easier thanks to direct debit bulk transfer mechanics which do not require any action by the consumers.
Many originators, particularly in the FinTech space, will rely on third party payment processors to manage the payment of collections by underlying debtors. While these payment processors provide an efficient way to track and obtain payment, investors will require certain protections to ensure that an originator cannot prevent the SPV from accessing collections in the future. In the UK and the EU, it is not possible currently to grant security over payment processor accounts. If the payment processor holds any cash due to the SPV, investors should be able to take control of the payment process in an enforcement scenario and direct the payment processor to take certain actions. Most payment processors are now familiar with securitisations but it is worth reviewing the contractual arrangements the originator already has in place with them. Ideally, the contract with the payment processor will be transferred to the SPV. Alternatively, the payment processor should enter into a side letter acknowledging the existence of the securitisation and agreeing to follow instructions provided by the investors in case of enforcement.
Assignability of Receivables
Originators should, together with their lawyers, review their template underlying agreements to ensure that there are no limitations on the assignment of rights arising under those agreements (i.e. the receivables). If a restriction on assignment exists in the template forms which have been used, the consequences of that will depend on the governing law of the underlying agreements and the applicable jurisdiction under private international law. We usually see three possible outcomes:
- Notification required by law: an assignment of receivables to the SPV is unenforceable without notifying the underlying debtors, whether the agreements contain any restrictions on assignment or not (e.g. Finland).
- Assignability limited: the restriction on assignment limits the enforceability of the assignment against the underlying debtors unless notice is given or consent from the underlying debtor is obtained, depending on the language of the restriction (e.g. England and Wales, and Spain).
- Restriction on assignment overridden: Some jurisdictions have statutory overrides in place. These are beneficial as they mean that the restriction on assignment will not be effective, subject to the satisfaction of certain conditions (e.g. France and Germany).
In the cases where notification is required by law or assignability may be limited, some form of notice would need to be given to debtors (possibly in the next invoice or specifically as part of the sale). If active acknowledgement or agreement to the transfer is required from the debtor, specific formalities may need to be observed. Originators should rely on local counsel to advise them on how best to notify or obtain consent in these scenarios.
Failure to correctly identify restrictions on assignment and their impact could lead to a lengthy due diligence process and increase legal costs. Ultimately, depending on the jurisdiction, the originator may have to seek consent from each individual underlying debtor in order to proceed with the transaction. The assignability of receivables is a fundamental component of a securitisation, and investors will not be willing to proceed with the structure without a clean due diligence report and comfort that the receivables will be validly assigned to the SPV so that they are no longer assets of the originator on any future insolvency of the originator.
Notification to Underlying Debtors
Most jurisdictions require that for an assignment of receivables to be valid against the underlying debtors it must be notified to them. Underlying debtors will also be able to discharge their debt to the assignor (i.e. the originator) until they have been notified of the assignment. Finally, unless notified, most jurisdictions would require the originator to be joined in any enforcement proceedings by the SPV against underlying debtors for payment of the receivables so long as notification has not taken place. In theory this means that investors would be incentivised to notify any assignment of receivables as quickly as possible. In practice however, there are a number of reasons why originators and investors may agree to delay notification until the occurrence of certain triggers.
In most structures, the originator will also act as servicer on the basis that it has existing relationships with the underlying debtors and relevant systems in place to monitor payment of collections. Investors will be keen to cause as little disturbance as possible to the collection process and originators will want to maintain customer relationships. As such, it is common to see notification to obligors triggered by the occurrence of certain events, such as the insolvency of the originator or breach of certain financial covenants such as tangible net worth or the availability of unrestricted cash. Typically, the originator will be required to grant a power of attorney at closing of the transaction to enable the SPV to achieve this in the future.
Finally, as flagged above, it is worth noting that, in some jurisdictions, assignment to the SPV is not valid until notice has actually been given. In those situations, investors would not accept notification being delayed by more than a few days after closing.
Due Diligence
In addition to checking the assignment, restrictions as discussed above, early due diligence of other matters is essential in ensuring that information in the prospectus is accurate, complete and not misleading, and to verify whether other matters could impact the viability of the securitisation and should be considered when structuring the deal. These include:
- Validity of the underlying assets: The receivable should be valid under its applicable governing law. It is important to check that the originator had and maintains the necessary licences and approvals to enter into the receivables agreement.
- Confidentiality and data protection: Due diligence is required to ascertain whether there are any restrictions on the disclosure of information about the underlying obligor.Consent from underlying obligors may be needed, although under the laws of most jurisdictions, an underlying obligor would need to show loss before being able to claim for breach of confidentiality
- Maturity and pre-payments: The expected maturity of the underlying assets and whether the underlying debtor has any early repayment rights (and if so at what rate) may need to be taken into account as structuring considerations.
- Set off: Any contract under which the underlying obligor can set off payments due from the originator against payments due by it to the originator should be excluded from the structure as it indirectly creates additional exposures to the originator. If the entire portfolio contains set off rights, structural features such as set-off reserves can be put in place to mitigate the risk to lenders.
- Regulatory developments: We see an increasing focus by regulators on consumer and small and medium-sized entities protection, particularly with the cost-of-living crisis, rise of buy-now-pay-later products and consumer duty requirements which should be borne in mind in the initial due diligence.
Nature of Receivables
Receivables come in many shapes and sizes, which can have structural impacts on the transaction. If the originator retains ownership of the underlying asset financed by a receivable, as is the case with leases, elements such as maintenance costs, residual value of the underlying assets, depreciation and security over the underlying assets should be considered as part of the structuring phase. In particular, investors and lenders are likely to want recourse to assets that have a strong second-hand market, such as cars. The same holds true for loans benefitting from security over the underlying assets, such as mortgages. Leases and other types of receivables may also constitute VAT taxable supplies and the originator will remain liable to the tax authorities for these taxes, regardless of assignment to the SPV. From a cashflow perspective, originators should ensure that they retain access to any VAT payable by customers so that they are able to remit this to the relevant tax authorities when due.
Originators should also discuss with their lenders or arrangers whether the asset class they are looking to finance has an established track record in the markets. Coming up with new and innovative structures is very rewarding but can be a lengthy and expensive process which could prove particularly unnerving for first time originators. Applying a tested market standard approach is key to ensure a smooth and efficient process. If a particular asset class has not yet been brought to market in the originator's country, it may be helpful to look at other jurisdictions – for example, the US have a large number of public solar asset securitisations, whereas Europe is still waiting for the first public transaction to be brought to market (although we are aware – and have worked on, a number of solar asset warehouses).
Finally, originators should ensure that they have sufficient performance history for the receivables they intend to securitise. These usually include default and delinquency ratios, but other performance metrics may be required by lenders, investors and rating agencies as well. Whilst it helps to draw analogies with other transactions in the market using similar asset classes, most lenders and investors will be reluctant to finance receivables which do not have over three years of performance history.
Incorporation of the SPV
Originators and their lenders or arrangers should discuss the best jurisdiction of incorporation for the SPV. Key considerations will include taxation, special legal regimes (such as securitisation specific corporate forms), the quality of corporate service providers and whether or not the SPV needs to issue securities to the public (in the case of public transactions). Whilst most SPVs will be orphan entities, the SPV will be incorporated at the request of the originator and the originator will be responsible for this workstream, with the help of its lawyers and the corporate services provider. We recommend that originators start this process early, as know-your-customer (KYC) checks can be lengthy and potentially delay the transaction. Crucially, an SPV cannot have its own bank accounts until the account bank's KYC process is complete. The earlier KYC is started, the likelier it is the transaction can close on time.
Regulatory Compliance
Most jurisdictions will have rules governing securitisations and it is important for originators to understand the laws to which they will be subject. In the EU, Regulation (EU) 2017/2402 (the EU Securitisation Regulation) provides harmonised rules across all members states. Post-Brexit, the UK on-shored the EU Securitisation Regulation (the UK Securitisation Regulation) but, subject to a commencement order the UK Securitisation Regulation will be replaced on 1 November 2024 by the Securitisation Regulations 2024 (as amended) and rules of the Financial Conduct Authority and Prudential Regulation Authority (collectively the New UK Securitisation Regulations). The UK Securitisation Regulation applies to all originators and SPVs based in the UK. Both the UK Securitisation Regulation, the New UK Securitisation Regulations and the EU Securitisation Regulation (together, the Securitisation Regulations) contain important obligations on originators regarding transparency, origination procedures and risk retention. The Securitisation Regulations also require investors to ensure that these obligations are complied with by originators.
In terms of transparency, originators should be aware that they will be required to produce at least quarterly reports (and monthly reports, in the case of transactions financed by asset backed commercial paper conduits) setting out the performance of securitised receivables (on an individual and portfolio level). Other reports may be required subject to the occurrence of certain events in relation to the securitisation. These reports should be prepared in line with specific templates published by the relevant regulators and made available to investors and regulators. It is therefore important that the originator's systems are attuned to these requirements. In the case of private securitisations, the originator is also responsible for a one-off transaction summary, usually prepared by the originator's lawyers. Compliance with these requirements can be time-consuming and originators should consider dedicated personnel to keep track of them. Updates to originators' IT systems may be required to cater for the production of these reports and several specialist companies can assist to automate these processes.
To ensure an alignment of interest between the originator and the investors, the originator is also required to retain, on a material net economic basis, at least 5% of the securitised exposures. This is usually achieved by way of a subordinated loan or note held by the originator. The risk retention obligation applies during the life of the securitisation. In addition, originators should ensure that they apply the same sound and well-defined criteria for credit-granting to securitised receivables as they apply to non-securitised exposures. Compliance with these two criteria should be confirmed by the originator in its reports to the investors and the regulator.
The rules set out in the Securitisation Regulations are complex, subject to change and supplemented by further laws, guidelines and standards adopted by regulators. Whilst the majority of requirements in the Securitisation Regulations are broadly aligned, there are also some areas of divergence which need to be considered. Failure to comply with these rules can, in certain circumstances, lead to criminal sanctions so it is important for originators to seek legal advice on how to adequately comply with their statutory obligations.
Conclusion
Securitisation offers originators a valuable financial strategy to diversify funding sources, manage risk and optimise capital structure. It is an effective tool to turn illiquid assets into immediate funding and should be a strong candidate for companies with long-term steady cashflows. However, originators must be aware of the key considerations outlined above to make the most of their securitisation structures. By understanding and addressing these points effectively, originators can navigate the complexities of securitisations, mitigate risks, and unlock the full potential of this financial tool. As the financial landscape continues to evolve, securitisations will remain a pivotal instrument for originators seeking to achieve their strategic objectives. With over 15 offices around Europe and a globally recognised securitisation practice, Hogan Lovells is well positioned to assist originators across jurisdictions considering securitisations as part of their funding sources.
This note is for guidance only and should not be relied on as legal advice in relation to a particular transaction or situation. Please contact your normal contact at Hogan Lovells if you require assistance or advice in connection with any of the above.
Authored by Julian Craughan, David Palmer, Steven Minke, and Jane Griffiths.
