WASHINGTON, Jan. 31 /PRNewswire/ -- The following was issued by The Bond
Market Association:
In a letter sent to House and Senate leadership, The Bond Market
Association reiterated its support for amendments to the federal Bankruptcy
Code that would create an objective safe harbor for certain securitization
transactions. The amendment would define circumstances in which assets
conveyed for purposes of certain securitizations are removed from the
transferor's bankruptcy estate. These amendments have been debated in
Congress for a number of years as part of broad bankruptcy reform legislation
and as part of a more limited financial insolvency bill.
The Association's letter is in response to a January 23 letter sent to
Congressional leadership by a group of law professors opposed to amending the
Bankruptcy Code in this fashion.
The Association believes the January 23 letter "offers an extremely
inaccurate and highly prejudicial view of the bankruptcy proposal, which would
increase legal certainty and predictability for legitimate mainstream asset
securitization transactions." The Association further asserts that the law
professors' letter "misapprehends and mischaracterizes" the motivations
underlying amendments to the bankruptcy code. More disturbing, the
professors' letter attempts to link the proposed bankruptcy code amendments,
and securitization activities generally, to financial disclosure issues raised
by the collapse of Enron -- an analysis that the Association believes are
specious and irresponsible, as explained in detail in the Association's
response.
We believe your readers would be interested in our views and comments to
the January 23 letter, and our position on why amendments to the federal
Bankruptcy Code, and the preservation of efficient securitization markets, are
important. The points below summarize the Association's principal views. As
set forth in greater detail in the enclosed letter, the Association:
-- Believes the application of securitization techniques has reduced the
cost and increased the availability of financing for individuals and
businesses. However, a degree of legal uncertainty regarding the
status of asset-backed securities (ABS) transactions in bankruptcy
hinders market efficiency. "This residual uncertainty contributes to
an unnecessary layer of cost and complexity in executing many
securitization transactions, which raises the overall cost and expense
of financing." The Association believes the safe harbor proposed in
the bill would address and resolve this problem for a specified, but
carefully limited, subset of all securitization transactions.
-- Is concerned that the January 23 letter fails to describe how the
proposed amendment would "institutionalize and encourage one of the
practices that led to Enron's failure and its harsh consequences."
The Association further points out that the January 23 letter is
unclear about how Enron's failure relates either to securitization
activities or the substantive provisions of the amendment.
-- Explains that securitization transactions structured as "true sales"
are designed to segregate and isolate assets transferred to a
securitization special purpose vehicle (SPV) to ensure that neither
the company nor its creditors will be able to assert any legal or
equitable claim on those assets in the event of the company's
bankruptcy. This is done not to conceal those assets, or disguise
their true ownership, as the professors' letter suggests, but to
achieve a necessary and fundamental securitization goal:
"It is precisely this feature of securitization that creates
substantial financing efficiencies and corresponding benefits, for the
wide range of companies that rely upon it," the Association's letter
states.
-- Disagrees that the proposed amendment would create an "unregulated"
safe harbor for asset securitization that would "facilitate the
undisclosed reallocation of risk," and further, disputes the assertion
that off-balance sheet accounting treatment of securitization
transactions "can mislead other creditors, investors, auditors and the
public," as described in the January 23 letter. The Association
stated that the proposed safe harbor would not affect existing
financial disclosure obligations with respect to securitization
activities at all, and that in fact, companies that engage in
securitization activities are already subject to extensive regulation
and disclosure requirements that result in the provision of extensive
information and data to investors, creditors and the general public.
I have attached a copy of the complete letter for your review, and would
be pleased to put you in touch with someone at the Association that could
explain our position more fully in conversation. You may call me, Myra
Dandridge, at 202-434-8421, mdandridge@bondmarkets.com. Thank you.
January 30, 2002
Senator Patrick Leahy
433 Russell Senate Office Building
United States Senate
Washington, D.C. 20510
Congressman F. James Sensenbrenner
2332 Rayburn House Office Building
United States House of Representatives
Washington, D.C. 20515
Dear Chairman Leahy and Chairman Sensenbrenner:
The Bond Market Association(1) is extremely concerned by a January 23rd
letter sent to you by a group of law professors opposed to the
asset-backed securitization provision contained in Section 912 of
H.R. 333. Their letter offers an extremely inaccurate and highly
prejudicial view of this legislative proposal, which would increase legal
certainty and predictability for legitimate, mainstream asset
securitization transactions. In so doing, the letter misapprehends and
mischaracterizes the motivations underlying this important amendment, its
practical application in the capital markets, and the beneficial
consequences that would flow from its adoption.
More disturbing, however, is the letter's attempt to cast aspersions on
long-established and widely accepted securitization techniques --
including structuring conveyances of assets as "true sales" at law,
segregating and isolating those assets in bankruptcy-remote, special
purpose vehicles, and accounting for these transactions as sales, or
partial sales (to the extent that consideration other than beneficial
interests in the transferred assets is received in exchange)-by obliquely
linking such activities to the collapse of Enron, and suggesting that
passage of the amendment will perpetuate similar financial calamities.
Although this tactic may serve the authors' goal -- unrelated to Enron --
of amplifying the alarm they wish to sound over this legislative
provision, it inappropriately and irresponsibly threatens the interests
of numerous constituencies that would benefit from passage of the
amendment, and from the continuation and enhancement of efficient
securitization markets -- including the very "companies, creditors,
stockholders and employees" on whose behalf the letter presumes to speak.
The multi-trillion dollar securitization market has played a significant
role in the growth of the American economy. Companies that use
securitization have been able to significantly reduce their cost of
funds, increase liquidity, and obtain greater and more diversified access
to the capital markets. The market efficiencies created through
securitization are passed on to both consumers and businesses, in the
form of lower interest rates for home mortgage loans, automobile, student
and home equity loans, credit card debt, and other extensions of credit.
Absent an efficient securitization market, the cost of obtaining this
credit would likely increase, as it would be more costly for lenders to
finance their activities.
When all of the facts are accurately presented and thoroughly considered,
we believe that Congress, companies that rely on securitization for
efficient funding and effective risk management, investors in securitized
instruments, financial market participants and the general public, will
conclude that this amendment to the federal Bankruptcy Code is based on
sound policy and should be adopted. It is part of a broader business
bankruptcy reform initiative that has been under consideration for the
past five years, and which has been previously endorsed by the major
federal financial regulatory bodies (represented collectively within the
President's Working Group on Financial Markets). All of the
business-related provisions contained in this bill, including Section 912
(which would provide a non-exclusive safe harbor setting forth objective
criteria under which certain securitization-related transfers by an
entity subject to the U.S. Bankruptcy Code will not be included within
the debtor's bankruptcy estate) have been afforded a full opportunity for
prior deliberation and debate. The concerns expressed in the January
23rd letter you received, however inflammatory their presentation, simply
do not withstand responsible analysis and careful scrutiny.
I. Securitization and the Benefits of Adopting a Limited "True Sale"
Safe Harbor under the U.S. Bankruptcy Code
Securitization generally describes a mechanism for creating securities
whose payments are principally derived from cash flows generated by a
discrete pool of underlying assets. By enabling otherwise illiquid
assets to be transformed into more liquid and marketable capital market
instruments, the application of securitization techniques has reduced the
cost and increased the availability of financing for individuals and
businesses. As a result, this important and beneficial market has
continued to grow and flourish, both in the United States and abroad.
However, as described in greater detail below, securitization activities
in the U.S. have to date been conducted in a legal environment that is
characterized by an undesirable degree of legal uncertainty --
specifically regarding the lines of demarcation between "true sales" and
secured financings of assets that are designated to support payments on
securitized instruments.
The January 23rd letter correctly points out that "property that has been
sold is not part of the bankruptcy estate. Property that is collateral
for a loan remains property of the estate, albeit subject to the
creditor's lien." However, this simple statement masks the very legal
uncertainty that the proponents of Section 912 of the bill wish to
minimize through its adoption. The basic problem, which the letter fails
to mention, is that there is a lack of controlling judicial precedent by
which the precise contours of this distinction may reliably be defined
and applied in the securitization context. As a consequence, a central
goal and intended outcome of many forms of securitization -- the legal
isolation of a defined and segregated pool of assets from the originator
(or other current owner) of those assets -- is subject to an undesirable
degree of residual uncertainty.
This residual uncertainty contributes to an unnecessary layer of cost and
complexity in executing many securitization transactions, which raises
the overall cost and expense of funding securitized assets.
Unfortunately, the existence of this uncertainty cannot be overcome by
requiring transaction participants to conduct more detailed or
comprehensive legal analysis, as the root cause of the problem is the
lack of clarity in the application and interpretation of the law itself.
The safe harbor proposed in Section 912 would address and resolve this
problem for a specified, but carefully limited, subset of all
securitization transactions. These transactions would be required to
meet a number of objective conditions that collectively establish their
status as mainstream, bona fide capital markets transactions, and to
possess structural features that are common in other securitization
transactions that have routinely been determined to involve a "true sale"
of underlying assets.(2) The existence of these conditions, limitations
and structural features should effectively respond to any theoretical
concern that this safe harbor will be exploited to engage in sham
transactions or disguised financings with favored creditors.
II. Analysis of Arguments Presented to Oppose Adoption of the Safe
Harbor
The January 23rd letter asserts that the amendment in question "would
institutionalize and encourage one of the practices that has led to
Enron's failure and its harsh consequences." However, the letter fails
to describe exactly what this objectionable practice is, or how it
relates either to securitization activities generally or to the
substantive provisions of the amendment. This is not surprising, as all
of the facts concerning the types of financial activities in which Enron
may have engaged, and whether Enron and outside experts they engaged
properly observed various legal, regulatory, accounting and other duties
and responsibilities in connection with those activities, have not yet
emerged.
Notwithstanding this lack of information and specificity, the January
23rd letter is replete with dark references to opportunities for
companies to engage in "secret transactions" and "sham sales," and the
"massive loophole" that will be created by passage of this amendment.
However, these negative characterizations are not reserved solely for
securitization transactions that fall within the proposed safe harbor.
The letter also broadly alleges, without foundation or support, that
"asset securitizations will prevent many businesses from being
reorganized at all," and that "off-book transactions of asset
securitization can mislead other creditors, investors, auditors and the
public." If the authors of this letter genuinely believe their rhetoric,
then they fundamentally misconstrue the purpose and effect of the
proposed safe harbor, and the application and benefits of securitization
techniques generally.
The apparent bases for the concerns expressed in the January 23rd letter
regarding the proposed amendment fall within the following three main
categories:
1) The provision would enable lenders to engage in abusive,
non-substantive transactions that would inappropriately shield assets
from other potential creditors, including a bankruptcy trustee, in the
event of the lender's insolvency.
2) Asset securitization activities of the type contemplated by the
amendment allow companies to engage in financial activities, and incur
financial risks, that are undisclosed to and undiscoverable by the
companies' creditors, investors and other economic stakeholders.
3) Protections afforded by prohibitions on fraudulent conveyances --
which are part of the current federal Bankruptcy Code -- are
insufficient to prevent fraud in connection with securitization
transactions.
As discussed below, each of these assertions is based on faulty
reasoning.
A. Securitization as a Mechanism for "Shielding" Assets from Creditors
With respect to the concern expressed over the inappropriate "shielding"
of securitized assets from a company and its creditors, it is certainly
true that transactions structured as "true sales" are designed to
segregate and isolate assets transferred to a securitization special
purpose vehicle (SPV), to ensure that neither the company nor its
creditors will be able to assert any legal or equitable claim on those
assets in the event of the company's bankruptcy. This is done not to
conceal those assets, or disguise their true ownership, but to achieve a
fundamental securitization goal -- to create and issue securities whose
value depends exclusively on the value inherent in a pool of underlying
assets, rather than on the financial prospects and general claims-paying
ability of an operating company.
It is precisely this feature of securitization that creates substantial
financing efficiencies, and corresponding benefits, for the wide range of
companies that rely upon it. By legally isolating a discrete and defined
pool of assets as the principal source of payment on related securities,
a company can issue securities that carry a higher credit rating (and a
corresponding lower rate of interest) than the credit ratings assigned to
its general short- and long-term debt obligations.
In a related manner, the letter implies that the effect of conveying
assets to a securitization vehicle is to deprive the company and its
creditors in reorganization from the value inherent in those assets.
This view is also flawed in several critical respects.
First, it assumes that all securitization-related conveyances covered by
the amendment are in substance secured financings rather than true sales,
and therefore, that such assets should continue to be regarded as part of
the company's bankruptcy estate. Although the authors state that "not
every asset securitization is a disguised loan" the clear import of their
words suggests exactly the opposite. In a conclusory fashion, the letter
describes the operation of Section 912 as permitting "a debtor and one
favored creditor to engage in a secret transaction to remove valuable,
liquid assets from the corporate bankruptcy estate of a troubled borrower
and place them beyond the reach of the courts and other creditors"
[emphasis supplied].
By uniformly characterizing all securitization-related asset conveyances
under the amendment as either overt or disguised financings, the authors
apparently wish to retain the ability to argue that these assets should
remain subject to the powers of a bankruptcy trustee -- notwithstanding
the intentions expressed by the participants in structuring and executing
the conveyance as a sale, other objective indicia required by the safe
harbor to support this characterization, and the reasonable expectations
and reliance of investors and other third parties that the conveyance is,
in fact, a sale (which is vital in establishing and preserving the value
of the economic interests they hold, in the form of securities that
represent beneficial interests in underlying assets, rather than a
general corporate obligation).
Such a view stands in direct conflict with critically important and
far-reaching policy goals: the need to enforce the terms of commercial
agreements, to honor the express intentions and expectations of
transaction participants, and to maintain a stable, predictable and
reasonably certain legal environment within which financial and capital
markets activities may take place.
In this context, it defies logic that the January 23rd letter would cite
the LTV Corporation's pre-petition financing activities as support for
the assertion that asset securitization "will prevent many businesses
from being reorganized at all." In fact, for companies experiencing
financial distress, and even for companies that are operating under
bankruptcy protection, securitization often can be the only viable means
of accessing capital markets funding sources at reasonable cost. Lenders
may be unwilling to extend financing to a troubled entity at any cost,
but if the value embedded its assets can be isolated and transformed into
a security, the company may nevertheless be able, via securitization, to
efficiently fund its ongoing operations. Far from impeding the financial
viability of distressed companies, securitization techniques can and have
been used to help restore them to health.
These important benefits of securitization should not be threatened by
the prospect that properly structured "true sale" transactions will be
challenged or disregarded after-the-fact. This view was expressed by
over twenty organizations, including sellers and issuers of asset-backed
securities (among them, several integrated steel companies), pension fund
investors, financial market participants and financial industry trade
organizations in a joint friend-of-the-court brief filed in the LTV
bankruptcy litigation in February of last year.(3) That brief identified
and discussed in detail the grave market consequences that would flow
from a bankruptcy court decision allowing an insolvent company to
repudiate "true sale" securitization transactions in which it had
previously engaged-including the broad legal uncertainty that would
result from such a decision. Fortunately for the securitization industry
and for the many companies, employees, investors and others who rely on
this financing technique, this critical issue was resolved without being
litigated. In connection with LTV's successful efforts to obtain
debtor-in-possession financing, the company agreed to stipulate that its
prior securitization transactions were, in fact, "true sales."
Second, the January 23rd letter ignores the fact that when a company --
whether experiencing financial difficulty or not -- elects to securitize
assets in a true sale structure, it does not forfeit or deprive its
creditors of their value. In exchange for the assets it conveys to a
securitization SPV, the company will receive cash, securities, or some
combination of both. The cash is typically raised from third-party
institutional investors, who purchase asset-backed securities issued by
the SPV. The basic point is that the underlying value inherent in
securitized assets has not disappeared. This form in which this value is
held and disclosed by a company has simply been converted -- it is now
represented in the form of cash, securities or both, rather than in the
original form of financial or other assets, which the company no longer
owns.
B. Securitization Disclosures and Risk Transparency
The January 23rd letter also argues that an "unregulated" safe harbor for
asset securitization would "facilitate the undisclosed reallocation of
risk," and further, that off-balance sheet accounting treatment of
securitization transactions "can mislead other creditors, investors,
auditors and the public." The proposed safe harbor would not amend
existing financial disclosure obligations with respect to securitization
activities, so any concerns the authors of the letter may have in this
area must already be presumed to exist.
In fact, companies that engage in securitization activities are subject
to extensive regulation and disclosure requirements that result in the
provision of extensive information and data to investors, creditors and
the general public. If a securitization transaction is issued in the
public markets by a non-exempt issuer, that transaction must be
registered with the Securities and Exchange Commission (SEC), and all
material information relating to the offering must be disclosed in a
prospectus that is delivered to investors, filed with the SEC and thereby
available to the general public. If the transaction is issued pursuant
to one of several private offering exemptions available under the federal
securities laws, the private investors (typically, large and
sophisticated institutions) solicited for that offering will also
typically be provided with disclosure documents setting forth the
material terms and conditions of the transaction, and afforded an
extensive opportunity to conduct their own inquiries and analysis prior
to investing. In either case, these disclosures are fully subject to the
antifraud provisions of the federal securities laws.
In addition to the securities registration and disclosure requirements
set forth above, any material risks associated with a public company's
involvement in securitization transactions are required to be disclosed
in its financial statements, which are also disclosed to the public.
Similarly, although a private company's financial statements are not
likely to be disclosed to the general public, that company's creditors
will have access to this information.
The types of risks that are disclosed may include, for example, those
that arise from any lending obligations or other economic recourse a
company may have to a securitization SPV (for example, a liquidity
commitment or guarantee). Other financial statement disclosures
promulgated by the Financial Accounting Standards Board require reporting
companies to detail risks associated with their retention of securities
issued by a securitization SPV that it established. For example, a
transferor must disclose, for all securitizations accounted for as sales
during the relevant period, a description of the transferor's continuing
involvement with the transferred assets, including but not limited to
asset servicing activities, recourse arrangements, restrictions on
retained interests, and any gain or loss that is booked in connection
with the sale. Moreover, depending upon the type of asset involved,
securitizers may either be required by law, or elect as a precaution, to
file public financing statements under the Uniform Commercial Code to
make an asset sale effective against third parties, including bankruptcy
trustees. In each case, creditors, investors and other market
participants receive notice of assets that have been encumbered through
asset securitization activities, and the material financial risks
associated with those activities.
Apart from securitization disclosures required by regulation, it is worth
noting that ratings assigned to securitization transactions -- which are
required under the safe harbor and are typically widely publicized --
constitute an important means through which investors, creditors and the
general public can receive both notice and detailed, independent analysis
of a company's securitization activities.
Finally, as noted above, the letter asserts that off-balance sheet
accounting treatment of securitization transactions may be misleading.
However, in circumstances in which a transferor relinquishes actual
control over transferred assets and no longer bears the economic risks
and rewards incident to their ownership, it would in fact be misleading
to continue to reflect those assets on the transferor's balance sheet.
Disclosing the presence of such assets in the financial statements of the
transferor would inappropriately suggest that those assets continue to be
available to satisfy creditors' claims and other general obligations of
the company. Of course, the cash proceeds of the securitization, along
with any beneficial interests retained or acquired by the company in
connection with the transaction, would be required to be properly
reflected on its balance sheet.
Application of Fraudulent Conveyance Law
Finally, the January 23rd letter asserts that fraudulent conveyance
law -- which generally allows bankruptcy trustees to avoid transfers made
"with actual intent to hinder, delay or defraud any entity to which the
debtor was or became ... indebted" -- affords insufficient protection
against a secured loan transaction disguised as a sale for purposes of
helping lenders escape the bankruptcy laws. The letter suggests that "if
the federal law says that asset securitization, regardless of deliberate
intent, is legally permissible, then any protection offered by fraudulent
conveyance law would be overridden."
These assertions reflect both faulty reasoning and a direct misreading of
the language of the proposed amendment. The safe harbor does not by its
terms render asset securitization "legally permissible," it simply
defines specific circumstances in which assets transferred in connection
with securitization transactions will not be included in a company's
bankruptcy estate. By itself, the existence of this provision does not
operate to override other provisions in the Bankruptcy Code regarding the
power to avoid fraudulent conveyances. In fact, language accompanying
the proposed amendment clearly states that the safe harbor does not
supersede a trustee's power to avoid fraudulent conveyances, including
transfers avoidable under Section 548(a)(1)(A) of the Code where the
debtor acts "with actual intent to hinder, delay or defraud," as well as
transfers avoidable under Section 548(a)(1)(B) of the Code, which
requires no "deliberate intent" at all.
Conclusion
While the January 23rd letter attempts to exploit the Enron bankruptcy to
suggest that similar accounting and financial disclosure problems will
surface if this amendment is adopted, the arguments attacking asset
securitization activities and the operation of the proposed safe harbor
are specious. The House and Senate have each passed the asset-backed
securities provision on three previous occasions. This proposal is the
product of careful deliberation, and includes a number of suggestions
received from regulators and financial market participants alike, to
ensure an appropriately balanced provision that includes sufficient
"anti-abuse" safeguards, while recognizing and responding to the need for
greater legal certainty and predictability in the securitization markets.
The prompt adoption of this provision will promote efficient capital
markets and the interests of the many constituencies those markets serve.
Sincerely,
/s/ John R. Vogt
John R. Vogt
Executive Vice President
(1) The Bond Market Association represents securities firms and banks
that underwrite, distribute and trade fixed income securities
domestically and internationally. Its members are responsible for the
vast majority of primary market distribution, and secondary market
trading, of all types of residential and commercial mortgage-backed
securities and non-mortgage asset-backed securities. More information
concerning the Association may be obtained from our website at
http://www.bondmarkets.com
(2) Contrary to the assertion in the January 23rd letter, the proposed
safe harbor and corresponding exclusion of assets from a company's
bankruptcy estate cannot be achieved solely by characterizing a
"loan" as a "sale," or by obtaining an investment-grade credit rating
for securities supported by assets that are sold. Among other
conditions, the safe harbor is available only for securitization-
related transfers (a) of eligible financial assets, as specifically
defined therein; (b) to an eligible entity, also as specifically
defined therein, but which in all cases must be engaged exclusively
in the business of acquiring and transferring eligible assets to an
issuer of securities, the payments on which are supported by those
eligible assets; (c) where the transferor, in a written agreement,
specifically represents that the assets were conveyed with the
express intention of removing them from its bankruptcy estate; and
(d) where the assets are used to support payments on securities, at
least one class of which were rated investment grade by a nationally
recognized securities rating organization upon issuance.
(3) See "Memorandum of Securitization Amici Curiae in Opposition to
Emergency Motion for Order Granting Interim and Final Authority to
Use Cash Collateral," dated February 20, 2001 (available on The Bond
Market Association's website at http://www.bondmarkets.com).
SOURCE The Bond Market Association
 back to top
Related links:
http://www.bondmarkets.com
CONTACT:
Myra Dandridge of The Bond Market
Association, +1-202-434-8421, mdandridge@bondmarkets.com
|
