More on future flow securitisation
Securitisation of future flows is one of the most exciting areas of application of securitization, particularly from emerging market countries. A number of Latin American, African and emerging market originators have future flows securitisation to be attractive as a device for off-shore funding.
Mexico was the first country to securitize future flows – the transaction goes back to securitisation by Teléfonos de México S.A. de C.V. of telephone receivables in 1987.
The distinguishing feature of future flows securitisation is the fact that the asset being transferred by the originator is not an existing claim against existing obligors, but a future claim against future obligors. In other words, the claims are yet to be created, against obligors who are yet to be identified. Examples can be: export receivables (normally crude exports), future royalties, hotel revenues, sports receivables, etc.
Most of the future flow securitisations are by originators from emerging markets, whose offshore borrowing abilities are stymied by the sovereign rating of the country where the originator is stationed. For example, if a Brazilian originator having export revenues were to raise offshore money, the international rating of the originator is capped at the rating of the country, even though the domestic rating of the originator may be a AAA. In other words, such an originator will either be not able to source cross-border funding at all (from investors who as a matter of policy do not invest in below-investment grade securities) or would have to pay a very high cost.
Future flow securitisation essentially aims at piercing the rating of the sovereign and having a security of the originator rated above the rating of the sovereign. If, in the example above, the originator is an exporter, say exporting oil to US buyers, and if he securitises the oil exports such that the receivables are trapped and deposited in an account in New York, which is assigned to the SPV, the investors would:
- not be subject to exchange risk, as the receivables are in foreign exchange
- not be subject to sovereign risk as the receivables have been assigned by way of a true sale outside the country of the originator.
The only right the sovereign has is the right of redirecting the exports, which can always be rated.
Motivations in future flow securitisation:
An originator in a future flow securitisation would look essentially at two motivations:
- does it allow the originator to borrow more than under traditional funding methods;
- does it allow the originator to borrow at lesser cost than under traditional funding methods.
There is no certain answer to either of these two questions, but the economics of any future flow deal should be tested on the above. It is possible that a future flow securitisation may allow the originator to borrow more, since, while a typical traditional lender looks at the assets on the balance sheet (say, receivables which have fallen due), a future flow investor looks at receivables which are not on the balance sheet.
A future flow transaction may even allow the originator to borrow at lesser costs, for reasons discussed above, particularly in case of cross border financing.
Risks in Future flows
While future flows securitisations try to minimise the risk hinging on the sovereign, they do not minimise the following risks:
Performance risk: Every future flow securitisation is subject to performance risk, that is, the risk of the originator continuing to be in business, produce, and, as in the example above, export.
While this risk cannot be avoided, a future flow transaction must certainly put in two mitigants:
- The receivables in question must be such which arise out of an existing framework, and with a minimal performance by the originator, the framework can result into receivables. An ideal common place example can be: we have the cow, but we have not milked it ! The idea is – as long as we have the cow, it may be milked, whether by the originator or someone else. But if the originator has neither the cow nor the milk, he is really talking about securitisation of dreams. Let us apply this to real life situations – say securitisation of a crude mineral. The originator owns the framework, say the mine, and all he has to do is to extract the mineral and export it. This is a fit candidate for future flow securitisation. But think of exports of steel by an integrated steel plant – there is too much of performance risk there. Such cases, where the originator has to create something and then export it, are not fit cases for securitisation. There have been securitisation of such revenues as well – but there have also been cases of default – such as the Mexican steel maker Ahmsa.
- The receivables in question must sufficiently over-collateralise the investor's outflow, so that in an apprehended event of default, an early amortisation trigger may save the transaction. Early amortisation triggers have saved certain transactions during the Asian currency crisis.
Bankruptcy risk: Future flows securitisations cannot be bankruptcy remote, as existing asset securtisations can be. This is easy to appreciate as at any point of time, the assets in existence, that is the receivables that have been created, are not enough to liquidate the investors' claims.
Refer to an analysis and my comments here, for more on bankruptcy risk in future flow securitisations.
Legal issues in future flow securitization
Though most future flows are designed as "true sales" of future receivables, there are two major legal problems that need to be answered:
- In many countries, a future receivables is an unidentifiable debt that does not exist today, and therefore, cannot be assigned. Existence or identifiability of a receivable is required for assignment. For more details on this, refer to my comments relating to Italian securitization law here.
- It is strongly advised that the investors' rights over the receivables are further enhanced by a security interest on the framework from which the receivables arise, for example, the mine from which the minerals will be extracted, or the aircraft from which aviation revenues will be generated etc.
The law relating to future flows securitisation is not clear in most of the countries where future flow securitisations have taken place. In no country so far, the test of "true sale" in a future flow securitisation has been tried in Courts. Therefore, it is still a gray area in law and investors better take precautions.
The model assignment law suggested by UNCITRAL seeks to permits future receivables assignment as well – see here for text of the UNCITRAL law.
Accounting for future flow securitisation:
The amount received in a future flow securitisation should never be put off the balance sheet upfront, as there is no existing asset that has been transferred. The amount raised should be shown as a liability.
FAS 140/ IAS 39 apply only to transfer of financial asset, and an asset is an existing right to receive, not a future right. Hence, transfer of a future flow cannot result into an off-balance sheet funding.
Other methods of mitigating sovereign risk:
Political risk insurance – several bodies have started political risk insurance for debt offers from emering markets, thus competing directly with future flow securitisations. See our news item here.
Making use of preferred creditor status: By involving some international agencies as a conduit, so that the sovereign will not disrupt transactions with a preferred creditor. See for example, in case of a Turkish lease securitisation – click here for the news report.
Do you have any comments, questions or contribution? Please do feel free to write to me.