The basic idea in securitization is to create a security which is based on , or derived from the assets of the originator, such that the security is not a claim against the originator but a claim against such assets.
In other words, the originator securitizes (meaning converts into securities) his assets.
Obviously enough, this would necessitate a transfer of assets by the originator to the benefit of the investors.
The following are the key issues relating to transfer of assets:
To whom should the assets be transferred?
If the assets were to be transferred to a single person, say a single investor, such as in case of direct or discrete portfolio transfers, there is no problem transferring the assets directly to the investor or acquirer.
However, in most securitizations, the investors are many. Besides, the resulting security is going to be marketable: in other words, the investors will be a nebulous, uncertain group. Hence, it is necessary to bring in a conduit to hold the assets for the benefit of the investors. This conduit is called the special purpose vehicle. See more about the special purpose vehicle here. Note that in many cases the SPV may be much more than a simple conduit.
Is a tranfer of assets necessary?
In most securitization transactions, assets are transferred in favour of investors. However, in several securitizations, the assets might be pledged/ mortgaged or otherwise made available to the investors. Several securitizations are structured with a number of preceding SPVs, with transfer being involved at some stage followed by loans or hypothecation at the later stages.
The essential idea is to allow the investors a privileged, preponderant right over the assets being securitized: that is what will distinguish securitization from collateralised lending.
How should the assets be transferred?
The legal methodology of "transfer" of assets is achieved by a sale of the subject assets. If the asset is receivables, such transfer is often called assignment.
What are the methods of transfer?
Transfer of assets could be either by way of :
- novation, that is, alteration in the terms of the original contract with the obligor.
- participation, that is, creation of a right in favour of the transferee, in the proceeds of the assets.
- assignment, that is, full legal transfer.
Which of these methods should be followed?
To achieve full legal transfer, the proper method is assignment or sale.
What needs to be done to ensure a transfer or assignment?
This is the "true sale" question. That is, in order for the assignment to be regarded as a proper sale or legal transfer, it must comply with some conditions, which differ from jurisdiction to jurisdiction. See for details here.
What are the problems with assignment or sale?
As the assignment or sale is made, mostly, in respect of receivables, which is a right against a third party, the following legal problems may be faced, depending on the jurisdiction involved:
- notification to the obligors/ consent of the obligors
- stamp duty
Links:
Chapter on Legal Issues in Vinod Kothari's book.
CORPORATE LOAN SECURITIZATION: SELECTED LEGAL AND REGULATORY ISSUES by THOMAS W. ALBRECHT AND SARAH J. SMITH – this detailed research article gives a very thorough account of different methods of assignment – click here
For meaning of terms, see our Glossary.