The Recent Changes in the French Securitization Regulatory Framework
By Jean-Norbert Pontier
On June 17, 2003, the French Parliament adopted the bill on financial security (Loi de Sécurité Financière) (the "Reform"). The Reform now provides more flexibility and liquidity to the French securitization market and clarifies the legal and regulatory framework for the French securitization vehicle known in French as "Fonds commun de Créances."
By way of background, a fonds commun de créances ("FCC") is a mutual debt fund with no separate legal identity, whose sole purpose is the acquisition of receivables and the issuance of units representative thereof. The FCC must be constituted jointly by a société de gestion ("Management Company") and a dépositaire ("Custodian") acting throughout the life of the FCC as, respectively, manager of its business and custodian of the FCC's assets.
The key changes introduced by the Reform are summarized below.
Before the Reform, only credit institutions with registered offices in France could assume the role of Custodian. All credit institutions licensed in France, or French branches of credit institutions having their registered offices within the European Economic Area ("EEA") or any institution authorized by the French minister of economy are now authorized to act as Custodian.
The Monetary and Financial Code authorizes the creation of FCCs with sub-divisions or "compartments." In brief, this consists of allocating the FCC's assets to the various compartments created. The acquisition of the assets in each compartment is financed by the proceeds of the corresponding units issued by the FCC, and the remuneration and redemption conditions of each unit are determined on the basis of the amount collected from the assets allocated to each respective compartment. Before the Reform, it was unclear whether third-party creditors would be prevented from making claims against the assets assigned to other compartments of an FCC, if the sums resulting from the liquidation of their compartment were insufficient to repay amounts due to them. The Reform expressly provides that each compartment, set up within an FCC, shall be considered "ring-fenced" from the others, thus limiting the recourse of third-party creditors and unit holders to the assets allocated to their compartment.
Applicable Law for Priorities
French conflict of law rules provide that the enforceability of any assignment of receivables against third parties (other than the assigned debtor) is governed by the law of the assigned debtor's place of incorporation. Pursuant to the Reform, transfers to an FCC shall be deemed automatic and enforceable against all third parties (including the assigned debtor) with no further formalities, whatever the law governing the transferred receivables and the law of the assigned debtor's residence.
Enforcement of the Related Security
The Monetary and Financial Code states that any security interest or guarantee attached to a receivable acquired by an FCC is automatically transferred with and at the same time as such receivable, without any formalities. However, as the sole purpose of an FCC is to own receivables as opposed to tangible assets, it was unclear whether the FCC could become the owner of secured assets upon foreclosure, particularly when the FCC was the beneficiary of a real property mortgage. The Reform now clearly states that an FCC has the capacity to take title to assets upon the enforcement of security interests.
The Reform has introduced the concept of a third-party beneficiary account (or locked-box account) so as to isolate cash collections received by the seller or the servicer, (and not yet transferred to the FCC) from the seller’s or servicer's receiver in the event of either bankruptcy. The FCC would then be entitled to claim any sum standing to the credit of such account notwithstanding the commencement of bankruptcy proceedings involving the seller or the servicer.
Issue of Debt Instruments
The Reform has widened the type of debt instruments that can be issued by an FCC.
Until the Reform, FCCs could only issue units and were not allowed to borrow money. The units of an FCC, representing co-ownership rights in a pool of receivables, are often not easily marketable under certain securities market regulations or due to investment restrictions for certain categories of investors, since such units are not characterized as debt instruments. As a result, a number of French securitization transactions have a two-step structure allowing the marketing of debt instruments issued by the two-step vehicle and backed by the units issued by the FCC. Under the Reform, FCCs now have the ability to issue debt instruments (titres de créance) such as bonds and short-term paper.
Use of Credit Derivatives
Until now, an FCC’s ability to use derivative instruments was restricted to transaction for hedging purposes only. The Reform enables FCCs to enter into credit derivatives subject to certain conditions which are to be specified in a forthcoming decree.
As a result, FCCs should be allowed to enter into synthetic securitization transactions in which, for example, the FCC will act as seller of protection in order to cover the exposure of a third party under credit default swaps.
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