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Treasury & Capital Markets
Breakthrough securitization deal in China to bolster ABS market
Structure opens up a new market for securitized assets
Christoph Kober and Derrick Hong 1 Jul 2016

A Chinese financial leasing company has put together a landmark deal that opens up an entirely new channel for corporates to securitize assets. It adds momentum to the burgeoning Chinese asset backed securities market, Asia’s largest.

The asset backed notes (ABNs) of International Far Eastern Leasing (IFEL), a subsidiary of Hong Kong-listed Far East Horizon Ltd (遠東宏信有限公司), are the first notes issued via a trust, similar to the existing securitization method available only to financial institutions regulated by China’s banking regulator.

“The ABN issued by IFEL is a landmark deal,” comments Jerome Cheng, senior vice president for the Structured Finance Group at Moody’s Investors Service. “The trust structure offers a better bankruptcy remoteness protection as the underlying assets were entrusted to the trust vehicle instead of being ring-fenced on the balance sheet. The ABN model is recommended by NAFMII (National Association of Financial Market Institutional Investors).”

IFEL securitized 2.055 billion yuan (US$307 million) worth of lease receivables, raising 2.068 billion yuan in the process. Although ABNs are not a novelty in the Chinese market, having been introduced in the market in 2012, none of the preceding transactions utilized a trust structure. Instead, the originator pledged receivables or revenues to the ABN holders. The instrument was therefore comparable to a secured loan, says Cheng, where certain assets are ring-fenced on the balance sheet of the issuer rather than entrusted to a bankruptcy-remote vehicle.

It is with respect to this fine detail that the IFEL transaction differs: not IFEL but a trust vehicle issued the notes and purchased the lease assets. It thus guarantees bankruptcy remoteness, similarly to the Credit Asset Securitization Scheme (CASS) that is open only to financial institutions.

The deal is expected to become a blueprint in the market, a third way of securitization. Indeed, a senior analyst at one of the banks involved in the deal confirms to The Asset that a second transaction with the same structure is already in the pipeline.

“Companies want to have access to more off balance sheet financing,” he reasons. “The way to get it off the balance sheet until now was the Asset Backed Specific Plan (ABSP) regulated by the CSRC. But we know that the best way to obtain off balance sheet financing is through the use of a trust because this practice is approved and supported by trust law. So I think more and more companies will adopt this model. The interest rate is also lower in the interbank market compared [to the ABSP model].”

Ping An Trust acted as the trustee for the IFEL deal, while China Development Bank (CDB) was mandated lead underwriter and bookrunner with China Bohai Bank acting as the joint underwriter. Shanghai Brilliance Credit Rating rated the two classes of notes open to investors, with AAA and AA respectively.

The evolving regulatory framework

Securitization of various receivables has been possible since at least 2003 in China’s onshore market, with the launch of the first official framework governing such transactions by the China Securities Regulatory Commission (CSRC). Securitizations using this early framework – the ABSP – was and continues to be open to non-financial institutions only. Unlike securitizations in more developed markets, however, no special purpose vehicle is used to issue debt and buy the assets from the loan originator. Instead, an appointed securities company acquires the assets from the originator.

Such a contract-based transfer may not qualify as a true sale in the eyes of many investors.

Ratings agencies and investors were thus hesitant to grant such structures the same status as ABS transactions in other markets. Moody’s analysts in 2014, for instance, pointed out that “some ambiguity exists over how the assets [in a ABSP structure] can be ring-fenced. In the event that the project manager [i.e. originator and servicer] goes bankrupt, creditors of the bankrupted [originator/servicer] may have a pari passu claim as the ABSP investors over the ABSP assets.”

Furthermore, as Eversheds lawyers Kingsley Ong and Aaron Liu point out, the ABSP is merely an Administrative Rule and thus ranks lower than State Laws, Legal Interpretations and Administrative Regulations in China’s complex hierarchy of sources of law.

A different regulatory framework addresses all these concerns, being a State Law and, more importantly, including a provision for the creation of a trust which guarantees bankruptcy remoteness. The Credit Asset Securitization Scheme (CASS), which was launched in 2005, ticks all the boxes of a proper securitization transaction for investors then: even if the originator or servicer of the assets (or, for that matter, the trustee) bankrupts, the entrusted assets will not form part of the estate that creditors to the bankrupt party are able to claim during an insolvency. Most securitization transactions in China — including recent auto-loan securitizations by the finance arms of BMW, Ford and VW—have thus been structured within the CASS framework, employing a trust entity that has the same function as SPVs in comparable transactions in other markets.

Except for those groups with CBRC-regulated finance companies (such as the aforementioned car manufacturers), corporates were unable to tap the burgeoning ABS market in a manner similar to their peers in the rest of the world.

The IFEL transaction is noteworthy for the fact that neither CSRC nor CBRC have direct regulatory authority over the ABN instrument, which instead is a concept introduced by NAFMII, an industry association that in turn is regulated by the PBoC. The three avenues of securitization – CASS, ABSP and “Trust ABN” (for lack of an established acronym) – are competing concepts by three different (quasi) regulators.

With respect to corporates, IFEL’s pioneering structure may displace the ABSP that the CSRC champions. As China Merchants Securities analysts Bin Bin Sun and Yue Zhou point out: “The range of acceptable underlying assets in ABN transaction is slightly more comprehensive [than ABSP allows]. Furthermore, the ‘ABN Guidance’ [by NAFMII] has no requirement that the account receivables securitized cannot exceed 40% of the net assets of the originator.”

Sun and Zhou expect that the official guidance by NAFMII will be amended following IFEL’s ABN transaction, incorporating the use of a trust, and that other issuers will embrace the new model.

Observers in unison echo the view that the IFEL transaction signifies wider progress in the Chinese securitization market. “The market is developing in China,” says Bo Jiang, head of the structured finance department at Shanghai Brilliance Credit Rating & Investors Service. “The underlying assets as well as the structures are more diversified.”

But Jiang also concedes that the market’s rapid proliferation potentially challenges some investors, whose expertise in securitized assets might lag. “Because of the growing complexity of the ABS products in the market, rating agencies should not be the only institutions charged with disclosing risks,” he urges. “More needs to be done to educate investors.”

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