Repackaging programme
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The Law and Lore of Repackaging
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A secured medium term note programme created by an espievie captive to the demands of a broker/dealer and used to sell securitised structured products, par asset swaps, credit-linked notes and all that good stuff.
The best ever repackaging programme was Goldman Sachs International's “MaJoR” Multi-Jurisdiction Repackaging Programme[1] which, as its name suggests, was (and as far as I know, still is) as cool as Jon and Ponch.
You know, the ones from TV’s “CHiPs”[2]
When contemplating the legal contracts around a repackaging programme, it is well to remember: an espievie is like a zombie queen ant, prostrate in its Caribbean nest, immobile, pinned down and paralysed, while a small army of drones, agents, bots and pleasure-droids crawl over it, administering necessary opioids and analgesics so that the various investors, hedge counterparties and agents can do whatever it is they want to do to each other under a prophylactic cloak of non-responsibility. It is rather like swimming in wellingtons, we are told.
A quick word about limited recourse
Secured, limited recourse obligations are de rigueur for multi-issue repackaging SPVs. They save the cost of creating a whole new vehicle for each trade, and really only do by contract what establishing a brand new espievie each time would do through the exigencies of corporation law and the corporate veil. The point is to completely isolate each set of Noteholders from each other. This is a surprisingly narrow point, as we will see, so we should not get carried away for the formalities of security.
With secured, limited recourse obligations there is a quid pro quo: all creditors are known; they are yoked to the same ladder of priorities; they all have agreed to limit their claims to the liquidated value of the secured assets underlying the deal. In return, the espievie grants them a first-ranking security over those assets — mediated between them by the agreed priority structure — and this stopping any interloper happening by and getting its mitts on the espievie’s assets.
The key point to absorb here: this is not a material economic modification to the deal. The line it draws, it draws around all the assets underlying the deal: the underlying securities, cashflows deriving from them, the espievie’s rights against custodians and bankers holding them, and its rights against the swap counterparty — everything, tangible or otherwise, of financial value in the transaction is locked down and pledged to secured parties, and the intercreditor arrangements, too, are fully mapped out. This kind of limited recourse, in fact, doesn’t limit recourse: it maps practical recourse, exactly to the totality of assets that the issuer has available for the purpose: all it saves is the unnecessary process of bankrupting a shell company with nothing left in it in any case. Secured limited recourse is like a nomological machine; a model; it is a simplified account where everything works as it should do, there are no unforeseen contingencies, and all outcomes are planned.
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.
Over the years this secured, limited recourse technology has been refined and standardised, and now plays little part in the education of a modern-day structured finance lawyer, though, at his mother’s knee, he might once have been told fairy stories about what became of poor Fidgety Phillip when he carelessly put “extinction” rather than “no debt due” in a pricing supplement on his way home from school and burned to death.[3]
Limited recourse is a trickier proposition when you try it outside the laboratory in the real world. We discuss this in our voidable preference article.
A quick word about repacks and the Single Agreement
Okay, do not adjust the Single Agreement provision unless you are writing an ISDA Master Agreement for a repackaging vehicle issuing segregated, secured, limited recourse obligations. In that case you — and here I am supposing that “you” are the inhouse legal eagle at the arranging bank, or someone advising her — will have multiple ISDA Transactions nominally between the same two entities — your employer and the SPV — but economically being totally distinct, relating as they do to discrete ring-fenced “Series” issued by the SPV and you absolutely do not want these to form a single agreement with each other, or net, or do anything ostensibly desirable like that.
Each Transaction (or set of Transactions, if more than one Transaction}} attaches to a single Series) stands quite alone, should not be accelerated, cross-defaulted, DUSTed, closed out or heaven forbid netted, just because some other Transaction, relating to another series, has gone arriba.
Treat them as if each Series had its own distinct ISDA Master Agreement, completely isolated, air-gapped and insulated against misadventure occurring in other ISDA Master Agreements the SPV has entered with you relating to other Series.[4]
In point of fact, your best bet is a bit of “deemery”: the Transactions entered into for each new Series should be under a deemed separate ISDA Master Agreement, constituted specifically for the Series in question, on the standard terms set out in your repack programme. If you do this, then no amendment to the Single Agreement clause is necessary, since the way you have structured your ISDA, it is just a Single Agreement for the Series. Do not be surprised or alarmed if counterparts to the deal don’t buy this, or trust such deemery, and may wish to amend the Section 1(c) language as well. Try to resist this, but don’t die in a ditch about it.
EMIR “Hedging exemption”
The question may arise as to whether an SPV is a non-financial counterparty and, if it is, whether article 10.3 of EMIR means you don’t have to engage in all that tedious measuring of notionals to ensure you stay small enough to count as an NFC-. Here’s what the hedging exemption says:
3. In calculating the positions referred to in paragraph 1, the non-financial counterparty shall include all the OTC derivative contracts entered into by the non-financial counterparty or by other non-financial entities within the group to which the non-financial counterparty belongs, which are not objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of the non-financial counterparty or of that group.
Repackaging SPVs
Now this seems squarely to capture the derivative activity of a limited recourse repackaging SPV, which is entering derivatives to pass the cashflow of an asset, and receiving a cashflow to pay down a note. Even if you muff up the structuring, the “limited recourse” nature of an SPV forces a careful observer to the conclusion that an SPV who transacts derivatives in this way is “objectively measurably reducing risks directly relating it its commercial activity” — it is eliminating them in point of fact — and given the underlying security structure of such a deal (where the SPV secures its rights to the asset whose cashflow it is manufacturing in favour of the dealer to whom it is manufacturing that income stream) requiring the SPV to also post collateral as a credit mitigant makes no sense at all. There is no credit risk. The asset is the perfect delta-one hedge.
Nevertheless, this must have seemed too easy for some of the more curmudgeonly compliance professionals on the continent, and at the time of the EMIR refit the question arose as to whether this would cover SPVs (such as repackaging vehicles whose principal activity is to deal in financial instruments). The ESMA Q&A[5] posed, on page 28, this question:
Can non-financial counterparties (NFCs) whose core activity is to buy, sell or own financial instruments, benefit from the hedging exemption when using OTC derivative contracts to hedge certain risks, for example risks arising from the potential indirect impact on the value of assets the NFC buys, sells or owns resulting from the fluctuations of interest rates, inflation rates, foreign exchange rates or credit risk?
And came forth the answer, on page 30:
Yes. The hedging exemption set out in Article 10(3) EMIR applies to all non-financial counterparties, irrespective of what their core activity is. The list of financial counterparties in Article 2(8) EMIR is a closed list. It does not allow for the treatment of non-financial counterparties as financial counterparties for certain EMIR provisions, such as Article 10(3). That provision itself does not distinguish which non-financial counterparty is allowed to use the hedging exemption depending on that counterparty’s specific activity.
AIFs
Though, trick for the young players — an AIF is a form of financial counterparty, so does not qualify for the hedging exemption.
“Securitisation special purpose entity”
There is a bit of a reverse rabbithole here, but to see that a repackaging SPV is out of scope for AIFMD you start with the concept of “securitisation” as defined in ECB/2013/40 as follows:
“Securitisation” means a transaction or scheme whereby an entity that is separate from the originator or insurance or reinsurance undertaking and is created for or serves the purpose of the transaction or scheme issues financing instruments to investors, and one or more of the following takes place:
- (a) an asset or pool of assets, or part thereof, is transferred to an entity that is separate from the originator and is created for or serves the purpose of the transaction or scheme, either by the transfer of legal title or beneficial interest of those assets from the originator or through sub-participation;
- (b) the credit risk of an asset or pool of assets, or part thereof, is transferred through the use of credit derivatives, guarantees or any similar mechanism to the investors in the financing instruments issued by an entity that is separate from the originator and is created for or serves the purpose of the transaction or scheme;
- (c) insurance risks are transferred from an insurance or reinsurance undertaking to a separate entity that is created for or serves the purpose of the transaction or scheme, whereby the entity fully funds its exposure to such risks through the issuance of financing instruments, and the repayment rights of the investors in those financing instruments are subordinated to the reinsurance obligations of the entity;
Where such financing instruments are issued, they do not represent the payment obligations of the originator, or insurance or reinsurance undertaking;
Key is the expression “financing instrument”, which is defined nearby as “debt securities, other debt instruments, securitisation fund units, and/or financial derivatives” — that is do say, indebtedness, not equity ownership.
Right. Now over to the AIFMD, where we see, in Article 3, that the directive does not apply to “securitisation special purpose entities”, being entities whose sole purpose is to carry on securitisations within the meaning of [the securitisation regulations of ECB/2013/40] and other activities which are appropriate to accomplish that purpose”.
In other words, debt securities, properly called, are out of scope.
There is probably another way they could have got to the same place — by categorising “collective investment undertakings” as those conferring equity participations or ownership interests in the asset portfolio owned by the the SPV, rather than debt interests — although one can rather blur that line with minimal capital return total return notes (nominal: 100. Guaranteed repayment amount (subject ~ cough ~ to limited recourse) if that is your bag.
See also
- Voidable preferences
- Limited recourse generally
- What this all means for the Single Agreement
References
- ↑ Patent applied for!
- ↑ Youngsters: Let me Google that for you.
- ↑ Come to think of it he may have forgotten to file a Slavenburg.
- ↑ Except as regards “Bankruptcy” of the SPV, but if you have structured your vehicle correctly, it won’t be able to go bankrupt. And in any case the same bankruptcy event would be an independent Event of Default occurring under each discrete Master Agreement.
- ↑ Which you can find here.