Securitisation is a sophisticated financing mechanism that transforms illiquid assets into financial securities that can be traded on the markets. At the heart of this financial engineering is the securitisation vehicle (SPV), a dedicated structure whose role is not limited to the simple purchase of receivables. Its main purpose, as defined by law, is to expose itself to risks and then finance or hedge them. Understanding the different methods of exposure to securitisation risks is therefore essential to understand the flexibility and power of this tool. This technical article extends our analysis of legal framework for securitisation undertakings in FranceThe complexity of these arrangements requires detailed analysis, often carried out with the help of a specialist. The complexity of these arrangements requires a detailed analysis, often carried out with the support of a specialist. lawyer specialising in banking and finance law.
The principle of exposure to risk: a broader definition
The modern concept of securitisation has gone beyond its original framework, which confined it mainly to a transaction involving the sale of receivables financed by the issue of securities. The legislator has adopted a broader and more financial vision. The purpose of a securitisation undertaking is now defined as the ability to "expose itself to risks", even before considering how they are to be financed. This approach confirms the supremacy of financial logic over a purely legal vision. The securitisation undertaking is no longer simply a purchaser of assets, but an entity whose primary function is to bear a financial risk, whether it arises from receivables, insurance contracts, complex financial instruments or even guarantees. Article L. 214-175-1 of the French Monetary and Financial Code lists the various ways in which a TO may be exposed to these risks, creating a technically rich landscape.
Acquisition, subscription or holding of receivables: the classic method
The acquisition of receivables remains the historical and most common form of securitisation exposure. Although this option was originally reserved for credit institutions, the scope of eligible receivables has gradually been extended. Today, any company, regardless of its type, can sell its receivables to a securitisation vehicle. This development has opened up this financing technique well beyond the banking sector. The nature of securitisable receivables is also very broad. They may be bank receivables (mortgages, consumer loans), commercial receivables (customer invoices) or even public law receivables. Article D. 214-219 of the French Monetary and Financial Code stipulates that the OT may acquire receivables arising from a deed already concluded or to be concluded, even if the amount, due date or identity of the debtors have not yet been determined. This opens the way to the securitisation of future receivables, a particularly useful technique for securing expected income streams. Doubtful or disputed receivables are also eligible, enabling impaired assets to be removed from the seller's balance sheet.
Secondary holding of equity securities: a limited role
Unlike a traditional investment fund, the primary purpose of a securitisation vehicle is not to hold equity securities such as shares. Its involvement in this segment is strictly regulated and can only be a consequence of its main operations. The law authorises it to hold "equity securities received by conversion, exchange or redemption of debt securities or securities giving access to capital". In other words, if the OT holds a bond convertible into shares and the issuer exercises the conversion, the OT will become the owner of the corresponding shares. This is therefore not an active investment strategy, but a "secondary" holding, resulting from the natural evolution of the debt assets initially acquired. This limitation preserves the specific nature of the TOP, which is a financing and risk transfer vehicle and not a private equity player.
Business loans: an innovation in the face of the banking monopoly
As companies seek to diversify their sources of finance, the legislator has opened up a significant loophole in the banking monopoly by authorising certain investment funds to grant loans directly. These authorised vehicles include securitisation vehicles. This option, confirmed by the Order of 4 October 2017, enables them to position themselves not just as purchasers of existing receivables, but as creators of new debt. Initially, this possibility was linked to obtaining the European Long-Term Investment Fund (ELTIF) label. Although this label is now mainly reserved for specialised financing organisations (SFOs), the ability of EOs to grant loans remains. This development marks a major transformation in the role of securitisation, which is becoming a direct financing tool for the economy, complementing traditional banking channels.
Contracts constituting forward financial instruments: synthetic securitisation
Synthetic securitisation represents a more abstract and sophisticated form of risk exposure. In this arrangement, there is no transfer of ownership of the underlying assets (the receivables remain on the originator's balance sheet). Only the credit risk associated with these assets is transferred to the securitisation vehicle. This is done by entering into specific contracts known as forward financial instruments, particularly credit derivatives. The best-known mechanism is the Credit Default Swap (CDS). In practical terms, the TO acts as a protection seller: it receives a periodic premium from the originator and undertakes, in return, to compensate the originator in the event of a "credit event" (such as the default of a debtor) on the reference portfolio. The TO finances this protection by issuing securities whose remuneration and repayment are conditional on there being no losses on the portfolio. This technique makes it possible to avoid the sometimes cumbersome transfer of assets and is a powerful tool for risk management and hedging credit.
Insurance risk transfer: an alternative to reinsurance
The flexibility of securitisation means that it can be applied to risks other than simply credit risk. The transfer of insurance risks is a notable example. This technique, enshrined in European law and transposed in France, offers insurance and reinsurance companies an alternative to the traditional reinsurance market. The principle involves transferring the risks associated with specific, often catastrophic, events (storms, earthquakes, etc.) to a securitisation vehicle. The securitisation body finances this risk-taking by issuing financial securities, often called "catastrophe bonds" or "cat bonds", to investors. The return on these securities is generally high, but their repayment is conditional on the insured event not occurring. If the loss does occur, the investors' capital is used to compensate the insurance company. The creation of such an undertaking or sub-fund is subject to authorisation from the Autorité de contrôle prudentiel et de résolution (ACPR), which guarantees strict supervision of these operations.
Provision of guarantees or sureties: a form of synthetic securitisation
Exposure to the risks of the TO may also result from the granting of guarantees or the creation of collateral in favour of an originator. This is another form of synthetic securitisation in which the assets are not sold. Typically, the securitisation vehicle guarantees the losses that could affect a portfolio of receivables held by a bank, up to a certain amount. To secure its commitment, the securitisation vehicle provides a financial guarantee, often in the form of a cash collateral (a blocked deposit of money). This cash collateral is financed by issuing bonds to investors. The income from the bond, which is used to remunerate the investors, comes from the premiums paid by the bank in return for the protection and an indemnity for the immobilisation of the funds. In the event of losses on the portfolio, the cash collateral is called in, and the losses are passed on in the repayment due to bondholders. This is an effective credit enhancement and transfer of risk.
Risk or cash sub-participation: a new way of financing
Sub-participation is a technique that originated in banking practice, particularly in the context of syndicated loans where several banks jointly finance the same transaction. The Ordinance of 2017 explicitly opened up this possibility to securitisation undertakings. In this arrangement, the TO acts as a "sub-participant". It provides a bank (the "participant") with the funds it needs to lend to a company. In return, the TO shares part of the credit risk with the bank, according to contractually defined terms. For the TO, this is an indirect way of gaining exposure to a company's credit risk, without having to grant a loan directly or buy an existing loan. This mechanism opens the way to innovative and collaborative financing arrangements between securitisation organisations and the traditional banking sector.
Whole business" securitisation: capturing all the revenues of a business
Whole business securitisation is a large-scale financing operation that is not based on a specific portfolio of receivables, but on all the future income streams generated by a business activity. This complex arrangement generally takes place in several stages. First, the company transfers the revenue-generating strategic assets (brands, patents, operating property, etc.) to a special purpose company. Next, this dedicated company obtains a massive bank loan, secured by all these assets and future revenues. Finally, the receivables from this loan are sold to a securitisation company, which finances their acquisition by issuing securities on the market. The aim is to back a large amount of financing with the overall earnings capacity of a branch of activity, thereby raising much larger amounts than would be possible with traditional securitisation.
Financing and hedging of risks by the organisation: counterparties to exposure
Once the securitisation undertaking has exposed itself to risks using one of the methods described, it must finance or hedge these risks in full. This is the second part of its corporate purpose. To achieve this, the legislator offers a range of different tools. The most traditional means is the issue of financial securities: units for a fonds commun de titrisation (FCT), shares for a société de titrisation (ST), or debt securities (bonds, negotiable debt securities) for both forms. The proceeds from the subscription of these securities by investors enable the TO to finance the acquisition of assets or to provide the necessary guarantees. The TO may also borrow directly from credit institutions. Lastly, it can hedge the risks to which it is exposed by purchasing protection itself, for example by entering into forward financial instruments for hedging purposes or by being the beneficiary of guarantees or collateral.
solent avocats' expertise in structuring securitisation transactions
The diversity of ways in which risk is exposed demonstrates the extraordinary versatility of securitisation. From the simple transfer of commercial invoices to the hedging of insurance risks, the granting of loans or the conclusion of credit derivatives, this tool can be adapted to a multitude of situations to meet very specific financing or balance sheet management needs. However, each arrangement presents its own legal and regulatory challenges, which must be mastered to ensure the security of the transaction. The drafting of the organisation's constituent documents, the structuring of financial flows and compliance with a constantly evolving legal framework all require specialised expertise.
Structuring a securitisation transaction is a complex process that cannot be improvised. To secure your financing and guarantee the legal soundness of your arrangement, the assistance of a expert lawyer in banking and financial law is an essential step. Our firm is at your disposal to analyse your needs and help you implement the most appropriate solution.
Sources
- Monetary and Financial Code
- Commercial code
- Regulation (EU) No 2017/2402 of the European Parliament and of the Council of 12 December 2017 creating a general framework for securitisation
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