In an asset securitization, a lender packages a pool of financial assets and sells them to a special purpose vehicle (SPV), which in turn issues asset-backed securities to investors. The proceeds received by the SPV are used to pay the lender for the pool of assets. Cash flows from the pool (principal and interest payments, proceeds from insurance claims, etc.) are used by the SPV to make principal and interest payments on the securities. This structure has been used with a wide variety of asset classes, including residential and commercial mortgages, credit card receivables, vehicle loans, equipment leases, and trade receivables.
Securitizations are well suited to asset pools that are:
- large enough to warrant the time, cost and complexity of a securitization;
- sufficiently diverse to avoid excessive volatility; and
- transferable, and otherwise unencumbered.
Lenders with suitable asset pools are attracted to the securitization structure because it provides an (often cheaper) alternative to traditional funding sources such as bank lending, corporate bonds, and equity issues. An effectively structured securitization can have the added benefit of legally insulating the lender from the assets concerned.
Securitizations involving assets with a strong collection history, or credit enhancements such as overcollateralization or a third party guarantee, can receive a high credit rating. This makes the securities issued by the SPV attractive for investors, who also derive comfort from the security over the underlying assets.
The legal issues involved in an asset securitization are numerous and complex. Counsel working in this area provide advice and assistance regarding deal structure, the perfection and assignment of security interests in the pool, public offering documentation, the enforcement of rights to realize on underlying collateral, and due diligence.
Asset securitization practice embraces advising stakeholders on structuring and implementing asset securitization transactions including structuring and financing special purpose vehicles; documenting the acquisition of assets and the issue of the appropriate securities; ensuring regulatory compliance; and advising rating agencies. Lawyers in this practice act for asset originators, dealers, trustees, agents, liquidity lenders, credit enhancers, rating agencies, and others.
CREDIT RATING AGENCIES
In March 2012, the Canadian Securities Administrators adopted National Instrument 25–101 Designated Rating Organizations and consequential amendments, which came into force on April 20, 2012. The Instrument mandates filing, disclosure, governance and other requirements applicable to DROs. Credit rating organizations who wish their ratings be used to satisfy securities law requirements will have to apply for recognition as DROs in compliance with the Instrument's requirements.
While there will be no change to CROs' exemption from the civil liability provisions of securities legislation, the consequential amendments impact the disclosure required in prospectuses and annual information forms.
Otherwise, the Instrument imposes requirements aimed at the independence and integrity of the rating process; requires DROs to have a board of director subject to certain composition and independence requirements; to establish and post on their websites a code of conduct that complies with the Instrument's requirements and, among other things, contains a description of the process that ensure the quality and integrity of ratings, deals with independence and conflicts of interests, and stipulates the DRO's responsibilities to the investing public and issuers'; to have a compliance officer whose compensation is not linked to the financial performance of the DRO and which must be determined in a manner that preserves his or her independence; and to keep and safe keep books and records in an accessible manner for seven years.
In April 2012, the CSA announced that DRS Limited; Fitch, Inc.; Moody's Canada Inc.; and Standard & Poor's Rating Services (Canada) had been approved as “designated ratings organizations.” In July 2012, the CSA published proposed amendments to various national instruments, policies and forms intended to implement the new designation and regulatory regime. The purpose of the amendments was to change the references to ”approved” credit organizations to “designated” rating organizations that are found in some Canadian securities rules, thereby providing for consistent terminology in this context.
SECURITIZED PRODUCT MARKET RULES
In April 2011, the CSA published proposals that would effectively transform the exempt market for securitized products into a quasi-public market. The proposals narrow the scope of eligible exempt investors, impose significant disclosure and continuing disclosure obligations and create certification requirements as part of a broader statutory civil liability scheme.
The CSA also published proposed enhancements to disclosure requirements for securitized products distributed by prospectus. The proposed continuous disclosure rules would require issuers to file a report after each payment date detailing the asset pool's performance, mandate timely disclosure of significant events, annual reports from servicers and disclosure of any significant instance of non-compliance with servicing standards. These requirements are consistent with international developments, such as new IOSCO and SEC rules.