WWL: Many have commented on the increasingly regulated nature of structured finance, due to requirements established by the Alternative Investment Fund Managers Directive and European Market Infrastructure Regulation, among others. What impact has this had on the practice area and does your practice encompass a higher proportion of regulatory advice than previously?
Dale Lum: Cross-border activity has increased in the past year. These transactions must comply with a variety of regulatory requirements (including disclosure and diligence) applicable to the sponsor and servicer. Practitioners must also focus on foreign laws – such as the European Prospectus Directive, Capital Requirements Regulation and Alternative Investment Fund Managers Directive – that could present practical restrictions on an issuer’s willingness to offer securities in the relevant jurisdiction. For example, non-US issuers may prefer to offer securities in Europe rather than globally, so that they need not deal with US 10b-5 liability and the attendant due diligence requirements. Additionally, since a global Rule 144A offering can be made to foreign investors who are “qualified institutional buyers”, a US issuer should weigh the costs associated with including a Regulation S option against whether this inclusion would result in additional investors.
Sven Brandt: Regulation has, for quite some time, been increasingly important for our structured finance practice. In the early years of structured finance in Germany, the only regulation to observe was the German regulator’s circular 4/97 of 19 March 1997. This generic circular governed the German structured finance market until the coming into force of the Basel II regulation. Since then and under the influence of the global financial crisis, regulation affecting the structured finance industry has increased dramatically and become an important part of legal practice.
Among other regulations, the Alternative Investment Fund Managers Directive (AIFMD) and European Market Infrastructure Regulation (EMIR) have had an impact on structured finance transactions and thus on our practice. Structured finance transactions mostly require the underlying cash flows to be swapped from fixed interest to floating coupons for the notes to be issued. Hence, when structuring respective hedge transactions, the requirements of EMIR must be observed. Although most issuers are special purpose entities and thus, non-financial counterparties under EMIR, they have to comply with the reporting requirements and risk-mitigation techniques of EMIR.
When structuring a transaction the AIFMD has to be considered from two perspectives. On the one hand the AIFMD sets out risk retention and due diligence requirements for investors which are broadly similar to those that apply under Article 405 CRR. On the other hand transactions should generally be structured in a way so that they do not qualify as alternative investment funds that would have to be regulated pursuant to the AIFMD. Interestingly, even investment fund managers look to structure their funds to meet the exemption requirements for securitisation transactions under the AIFMD to avoid the new regulation, which is difficult as the boundaries of such exemptions are not yet entirely clear.
WWL: While securitisation activity might not yet have reached pre-2008 levels, confidence is returning to the area and the practice is still viewed as an important financing tool in capital markets. Do you predict work in the field to increase in 2014, and what do you consider to be the main reasons for its growth?
Dale Lum: The US government has consistently stated that securitisation is an important element of financing and is necessary to maintain functioning capital markets, whether in the US, Europe or Asia. While the residential mortgage markets (where many of the issues originated) may never recover to pre-2008 levels, confidence in other assets, particularly consumer assets and quality commercial mortgages, has continued to grow; this is expected to continue. Investors are seeking both yield and asset quality. This past year, we have seen a huge increase in renewable and alternative energy asset structured financings. We also expect to see more securitisations in receivables generated by other technology companies, whose business models lend themselves to structured financings, and the use of structured financing techniques in mergers and acquisitions and hedge fund financings.
Sven Brandt: The recovery of the securitisation market is still highly fragile and dependent on the further development of the regulatory environment on one hand and the return of investor confidence on the other. While the message from the European Central Bank and the Bank of England in their joint letter is encouraging, there are still threads on the regulatory side that are likely to have an impact on investment decisions. Most importantly, the outcome of the delegated Act on the Liquidity Coverage Ratio, according to Article 426 CRR, will be decisive in determining whether investors will continue to invest in securitisation products. If the regulatory framework will not further penalise investments in securitisation products, the highly liquid markets and the relatively low interest levels are likely to support a further recovery of asset securitisation.
WWL: Sources have observed that today’s market demands more of lawyers in terms of innovation in the structuring of products and transactions. Is this something you would agree with, and have you noticed any other trends in the sector?
Dale Lum: As the structured finance markets continue to heal and grow, we are seeing increased interest in new assets, structures and technologies. Surprisingly few lawyers have experience working with different asset types, structures or environments (eg, securitisations involving mergers and acquisitions or hedge funds). Success in new or innovative transactions will, in part, be based upon the experience of the lawyers working on them. Structured financing lawyers with more experience are more easily able to navigate the associated challenges, including keeping costs down. These lawyers, particularly those whose transactions survived the market dislocations, have the confidence of the investment bankers, rating agencies and investors, and can adapt bits and pieces of structures from other successful transactions that they have worked on in the past in a cost-effective manner.
Sven Brandt: I would agree in that a different type of innovation is required compared to the situation before the financial crisis. While prior to the crisis innovation was important to bring new asset classes to the market, innovation must now focus on how to cope with regulatory developments and transparency requirements of investors. When structuring a transaction in the current environment, it is also important to reduce complexity as much as possible so that investors fully understand the product they are purchasing. A further type of innovation is required to deal with the aftermath of the financial crisis. There are still a substantial number of high-volume transactions that defaulted during the financial crises and are subject to restructuring. However, as these transactions have been structured in a growing market, default situations and how to deal with them have often not been considered sufficiently diligent. Accordingly, such shortcomings now have to be addressed innovatively by the lawyers restructuring such transactions.
WWL: In your jurisdiction, how would you describe the current legal market in the field and levels of competition among firms for structured finance-related work? How would you assess the presence of both multinational firms and boutiques in the field?
Dale Lum: While many lawyers claim that they are structured financing experts, few truly have a broad range of experience in multiple asset types representing issuers, underwriters (or initial purchasers), lenders and investors. The most successful lawyers have consistently remained busy throughout the market downturn and recovery and can more easily adapt to the ever-evolving markets. Given the interwoven nature of today’s transactions, having the resources of larger firms is beneficial, as advice involving seemingly unrelated topics such as ERISA, tax law, capital requirements, mergers and acquisitions and hedge fund requirements can be rendered quickly and cost-effectively. Although there is increased pricing pressure as firms, both large and small, attempt to “buy” work at times when they are not busy, employing low-cost providers does not lend itself well to new and innovative transactions or those that are important to a company.
Sven Brandt: The German legal market is highly competitive and competition is still increasing between international firms, while local firms and niche players do not seem to play much of a role any longer. The main reason for the competition is the lack of new transactions from German originators due to the availability of cheaper funding alternatives. The concentration of international firms is supported by the legal environment in Germany and particularly the difficult tax environment. As a result of a potential trade tax burden on transactions with assets other than bank loans, issuers must be established in other jurisdictions. Further, the swap transactions that are required for most structured finance transactions are to be documented on the basis of the ISDA documentation which is governed by either English of New York law. As a consequence, a German transaction easily involves advice for three or more jurisdictions which is difficult for a firm without the resources of an international network.