Matthew Cahill of Sidley Austin, London, and Cathy Kaplan of Sidley Austin, New York, discuss the drastic changes that the structured finance market has undergone since the financial crisis.
In recent years, regulations such as the Alternative Investment Fund Managers Directive (AIFMD) and European Market Infrastructure Regulation (EMIR) have had a major impact on structured finance transactions and, subsequently, law firms specialising in the area. How have law firms adapted in response to the increasingly regulated nature of structured finance?
Matthew Cahill: Structured finance legal practices have changed significantly since the financial crisis, reflecting the reduction in the size of the structured finance market, the reduced role that banks now play in that market and increased regulation. Financial institutions arranging and originating structured finance transactions need greater legal assistance to ensure compliance with all the new regulations they are required to comply with, both in Europe (such as risk retention rules) and in the US (such as the Volcker Rule as well as risk retention rules). Law firms have strengthened their regulatory capabilities in response to the growing regulatory legal needs of clients. In addition, law firms that may previously have relied on financial institutions for much of their work now focus more heavily on hedge funds and other alternative finance providers, which operate in a less regulated environment.
Matthew Cahill: A push to develop solar and other renewable energy sources has driven a substantial pipeline of financings, with structured and securitisation exits becoming more popular. While the focus has been on renewable energy facilities in the UK, we are seeing, and predicting that we’ll confirm to see, an increase in English law structured financings and private placement securitisations of facilities in other European jurisdictions. Deal sizes are relatively modest at present, but still large enough to take advantage of securitisation techniques. Other sectors which have been particularly active are CLOs, RMBS, real estate finance and a growing new market in the financing of peer-to-peer lending platforms.
Matthew Cahill: One of the main challenges facing lawyers in the structured finance market is that the market is significantly smaller than it was in 2007. Some commentators have noted that the market is now approximately 20 per cent of the size it was in 2007. This means that there are fewer structured finance deals to go around. There are significantly less publicly UK placed structured finance deals and a lot more privately arranged transactions. Among the firms that still focus on structured finance, there would still appear to be sufficient work to keep competition at a healthy level. Other challenges facing lawyers are an ever increasing amount of regulation to keep on top of, lack of investors for certain asset classes due to unattractive capital charges, increased due diligence requirements and a continuing general hostility among some regulators towards securitisation.
Cathy Kaplan: The events of 2008 completely changed the market for lawyers practising in the structured finance area. The period from the late 1970s to 2008 was one of expansion and growth with the volume of deals increasing every year. In addition, there was constant innovation, every imaginable cash-flow stream or asset was securitised and each year the structures used became more and more complicated and layered. The global financial crisis brought all of this to a halt. The number of financings dropped dramatically. In addition, in the years following 2008, innovation stopped too because investors were afraid of investing in anything other than the most simple deal. In the face of the volume decreases, most firms with significant structured finance practices stopped adding new lawyers or let lawyers go and lawyers in the area opted out by retiring early or changing practice areas.
The market is now coming back and firms are once again busy and hiring. As a new generation of lawyers are doing the deals, there needs to be a sensitivity to the history, the reasons for structural developments and, most importantly, an awareness of what did not work in the past. There also needs to be a careful analysis of structures and how risk is actually distributed. Careful attention needs to be paid to the diligence aspects of the deals. In addition, in light of all the regulatory changes in the United States and in other countries, regulatory lawyers have become key players on structured finance teams.
The financial crisis caused many financial institutions to put in much stricter controls as to what deals are done and how they are structured. This has increased the responsibility of outside counsel to scrutinise the deals and work with internal counsel to be sure that there is a complete understanding of the deal and how it works, particularly in any meltdown scenario.
Matthew Cahill: As noted earlier, current levels of securitisation activity are significantly lower than they were in 2007/2008. While the first half of 2015 has been the slowest since 2009, there has been significant activity in the last two years in the CLO and RMBS markets. Purchases of ABS by the ECB are helping the growth of the securitisation market and some EU regulators are continuing to note publicly the important role that securitisation can play in a healthy functioning economy. Provided that the capital charges for holding securitised assets become more favourable, it is likely that we will see an increase in the level of securitisation activity in the years ahead both in the public and private placement markets.
Cathy Kaplan: Securitisation was developed as a way to bring additional liquidity to a number of areas, especially, in the United States, the mortgage market. Structured financings were the key drivers of liquidity in many countries. The 2008 global financial crisis was a liquidity crisis. As a reaction to excess growth, bad players and concerns about the markets, investors stepped back. The United States and other countries have now rewritten the laws governing financial instruments and markets. As these laws are being finalised, and market participants are adjusting to them, and as investors are becoming more comfortable, activity is increasing.
There is significant activity in all the areas that remained relatively active post 2008, such as auto loan securitisation and commercial mortgage securitisation, and a large increase in volume of residential mortgage securitisations. In addition, people are again considering securitisations of more esoteric assets.