Enforcing security
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The Law and Lore of Repackaging
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Commercial legal eagles know a lot about taking security and granting security, but are usually well-clear of the blast radius by the time it comes to enforcing security. They will talk airily of enforcing security without necessarily having a good practical grasp of what it means.
In the world of repack, this is for the counterintuitive reason that it really doesn’t matter. One does not enforce security in a repack. To do so is to have admit you have failed in your one job.
Why it’s best not to be giddy about enforcing security in a repack
We shouldn’t get too hung up about the whys and wherefores of the security structure of a repackaging as long as it is there, it covers all the rights and assets it is meant to cover, and all necessary perfections and execution formalities are observed. For in a repackaging, the security just sits there and will almost certainly never be exercised.
All that tedious business about automatically releasing it to make payments, powers to appointing receivers, calling and collecting in, the trustee’s rights and obligations under the Law of Property Act 1925 and so on — look it is all good stuff; let your trustee lawyer have his day — but as long as it is there, none of it really matters.
Why? Because — unless you have negligently buggered up your ring-fencing and your Trustee has let you: both of these are quite hard to do — the SPV cannot go insolvent. Any repack redemption will be triggered by an external event: a non-payment on an underlying asset or by a failing counterparty or agent. None relate to the solvency or ability to meet its debts of the Issuer itself.
That being the case, once it exists, the security package will never actually do anything: any diminution in value to of the secured assets — will happen regardless of how strong the security is. The security is a formal belt and brace there to fully isolate from each other the noteholders of different series, and even that only matters only when the SPV is bankrupt. Which is, never.
The limited purpose of the security package in a repackaging is widely misunderstood – all it does is defend against unexpected holes in the ring-fencing.
This is why it is de rigueur to accelerate, liquidate and distribute the proceeds of a repackaged note without enforcement of the security.
Time of enforcement event
In the good old days, an “enforcement event” kicked in on upon any “mandatory early redemption event” — any event giving rise to an early unwind of the swap (a swap counterparty failure, asset default, tax event, credit event etc — it being understood, for reasons given above, that the trustee would be slow to kick into action and wouldn’t take steps precipitately (enforcing when the Notes could comfortably unwind according to their own terms).
It seems the global financial crisis changed all this, for the most counterintuitive of reasons: it became clear that the Trustee would not, ever, lift a finger to do anything, even when it was transparently necessary that it did so. Some trustees were criticised — not sued as far as we know, but at least glared at and shouted at by their clients and by their own SRMs, who had been shouted at by their clients, for being transparently useless when they could have been doing something.
The trustee community’s response to this was the classic buttocractic, timid, one you would expect from a bunch of useless, ticket-clipping rent-extracters: trustees began removing any discretion conferred upon them to be able to act to protect the Noteholder interests. This was designed to avoid uncomfortable scenarios where trustees would have a choice which, whatever the trustee does, it remains open to criticism from someone in hindsight.
Exercising this professional discretion is exactly what you hire a trustee to do.
Now trustees have few discretions, no obligation to act without satisfactory indemnification from Noteholders for any resulting claims or costs, and where possible the trustee will or will not act as a result of hard-edged rules. If it is legally obliged to do something, or not do something, it can’t be criticised for following instructions, however predictably moronic the outcome.
Enforcing the security is just such an uncomfortable discretion.
Now, of course, in most cases enforcing security is not required and would add little value, so the last thing you want to do is put a trustee on a rail so that it has to enforce security the moment there is a mandatory redemption event.
The market’s solution is the delay the enforcement event until there is a failure to perform any obligations required on a mandatory early redemption event. This seems a little lily-gilding given how “disinclined” the trustee would be to act, but — seeing as enforcement is such an improbable contingency — it would not hurt.