The structured finance market in the APAC region continues to grow in recent years, particular in the number of new issuances and the use of different financial products in complex structuring. Cayman special purpose vehicles (SPVs) are one of the most utilised offshore vehicles in the Asian structured finance industry, which is well supported by established legal and regulatory regimes. This article introduces a key feature of securitisation and repackaging, which is the ring-fencing of assets and removing them from the bankruptcy risks of the originator/seller of the assets – often referred to as bankruptcy remoteness. Investors of structured notes can simply take on the credit risks of the underlying asset, and the seller can achieve off-balance sheet treatment of the underlying asset.
A Cayman SPV helps achieve bankruptcy remoteness via three key steps:
- separation of the SPV from the other parties;
- true sale of the underlying asset to the SPV; and
- inclusion of bankruptcy remote provisions in the transaction documents.
The first step to help achieve bankruptcy remoteness is the separation of the SPV from the seller and other transaction parties, such that there is no risk of consolidation between the SPV and the other transaction parties for accounting purposes. To achieve bankruptcy remoteness, the SPV and the underlying assets that it ultimately holds, must be placed beyond the reach of other transaction parties or their creditors. In the event that any other transaction parties become insolvent, there will be no risk of consolidation with other parties. Whilst the question of off-balance sheet treatment of the underlying assets and consolidation of the SPV would depend on specific accounting advice to be obtained on a case-by-case basis, generally speaking when assessing the accounting treatment of the SPV, there are two important factors to consider – the ownership structure and control of the board of directors.
The legal ownership of the SPV would be held by a share trustee, which is usually a corporate service provider in the Cayman Islands; the beneficial ownership of the SPV would be held on a trust arrangement, most commonly a charitable trust or in some cases a special purpose STAR trust established for the specific purpose to carry out the role as the sole shareholder of the SPV. Both achieve the same purpose of putting the ownership of the SPV in a trust structure beyond the reach of other transactional parties. Without an ultimate beneficial owner, this type of corporate entity is referred to as an “Orphan SPV”. The trustee wouldn’t be allowed to sell the shares, to amalgamate or migrate the SPV to another jurisdiction. They also wouldn’t be allowed to amend the constitutional documents or make any changes to the SPV generally. It is important to note that specialist legal and tax advice must be sought with regard to the terms of the trust. Any attempt to assert too much control over the SPV would ultimately undermine the fundamental concept of the trust arrangement. Similarly, neither the seller nor the investors can appoint directors to the board of the SPV without running the risk of consolidation. Independent professional directors would be appointed to the board of the Orphan SPV and they will operate the SPV in accordance with the terms of the transaction documents and subject to their fiduciary duties. Through this specific type of corporate structure, neither the seller nor the investors will have ownership or control of the SPV and the underlying assets, thereby avoiding any risk of consolidation.
The second step to achieve bankruptcy remoteness is the “true sale” of the underlying assets. Once the Orphan SPV has been set up, there must be a bona fide “true sale” of the underlying assets to the SPV. This means that the seller must transfer the asset to the SPV by way of a sale that removes the assets from the ownership of the seller, and that such a transfer would not be re-characterised as security or bailment, or any other type of transfer which would otherwise give the seller a right to take back the asset. As such, any transfer by way of security assignment or lease would not be appropriate. Ascertaining a true sale of the asset is important, particularly where the securitisation relates to assets involving a complex and large pool of receivables, or where the repackaging relates to bespoke non-liquid assets such as pre-IPO shares or closed-ended fund interests. We would, in such cases, need to ensure both on transfer from the seller to the SPV (and subsequently on enforcement of the security over the underlying assets where applicable) that any relevant restrictions to transfer are addressed and any relevant consents and waivers are obtained. This task will be undertaken by the legal advisers and the scope of review will depend on the underlying assets (sometimes a “true sale opinion” may be required).
The final step to achieving bankruptcy remoteness is the inclusion of bankruptcy remote provisions in the transaction documents. Bankruptcy remote provisions mainly come in the form of two provisions: limited recourse and non-petition. A limited recourse provision ensures that all counterparties to the transaction documents acknowledge and agree that the obligations of the SPV are limited to the assets acquired in respect of that transaction or series. Once exhausted, all outstanding obligations will be extinguished. A non-petition provision ensures that all counterparties to the transaction documents agree that they will not commence proceedings against the SPV. The transaction documents would also contain a provision for the extinguishment or diminishment of obligations in the event that liabilities of the SPV exceed its assets. This keeps the SPV solvent and would not be petitioned into bankruptcy.
Bankruptcy-remote structures have long been used in asset-backed securitisation and repackaging transactions, and provide the fundamentals in deploying strategies in reallocating risks. The Cayman Islands is a mature jurisdiction that has served as a hub for structured finance for many years. Appleby has significant experience in the structured finance sector representing issuers and underwriters in both public and private offerings of securities involving various asset classes. Appleby Global Services provides corporate administration, trustee and/or nominee directors and, together with our legal expertise, offer clients comprehensive legal and fiduciary services.
