18 September 2006
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After a slow start European emerging market securitisation is beginning to pick up pace. Russia saw a number of securitisations in the first half of this year and other economies, such as Kazakhstan, Bulgaria and other Eastern European countries, are evolving their fledgling securitisation markets.
Development of securitisation across European emerging markets, and the speed with which securitisation technology has been transferred into those markets, can be put down to a number of factors, the most important of which would include:
- rapid growth in consumer and mortgage lending in those markets;
- significant developments in the legal and regulatory environment affecting those markets; and
- the increasing knowledge base of local participants, particularly banks and regulators.
Governments appear to have recognised the value of effective capital markets and are working together with legal communities to develop the legal infrastructure to provide greater confidence in the legal entities and structures that are at the centre of the securitisation process.
Despite advances in law and jurisprudence, the development of an active and liquid securitisation market will take time due to a lack of judicial precedent, regulatory interpretation of new structures and historical data and the upfront cost of pioneering deals. The market is, however, beginning to develop and practitioners are becoming more comfortable with the outlook for these emerging financial markets.
Excess liquidity and a low-default environment has inevitably led to tight credit spreads and a low-yield environment for traditional structured credit. The result is that investors and structurers are looking at alternative sources for yield-enhancing assets. It may be that the Eastern European emerging markets are set to benefit from this factor. Russia in particular, as the largest Eastern European emerging market, is certainly under the spotlight for new asset securitisation opportunities.
Russia has provided a good source for secured deals for many years. Financial innovation in the form of securitisation, however, only really got started in 2004. It is now beginning to accelerate in 2006 as factors such as the near doubling of consumer lending in 2005 compared with 2004 (still only accounting for around 5 per cent of Russia's gross domestic profit (GDP)) and an explosion in mortgage lending (up 600 per cent on 2003's levels, but still less than 1 per cent of GDP) are beginning to take effect.
If President Putin hits the target for one-third of Russians to own their own homes by 2010, then the effects for the home mortgage market are likely to be staggering. Since July this year Russia's sovereign debt has benefited from investment-grade ratings from all major rating agencies. This is all helping to entice Russia's banks to look to opportunities in the emerging securitisation market. Banks and consumer finance lenders grow much quicker than their deposit bases, and sourcing domestic finance is limited due to a relatively underdeveloped pension and investment fund sector. Asset-backed securitisations are seen as a financing tool to manage not only this mismatch, but also to diversify the investor and product base, obtain longer-term financing, provide capital more cost-efficiently and help with regulatory capital relief.
The legal system in Russia is, however, at a relatively early stage of development, and securitisation structures that under the common law system rely on fairly complex principles of jurisprudence have not yet been tested in the Russian courts. This does not preclude securitisations, but creates uncertainty as to how Russian courts will interpret concepts such as bankruptcy remoteness, true sale, limited recourse special purpose vehicles (SPVs) and tax neutrality.
A designated securitisation law would certainly help to codify concepts relevant to securitisation, creating more legal certainty in a judicial system that often takes a formalistic approach, but the lack of a designated law is not in itself preventing the development of an effective Russian securitisation market.
Reliance is currently placed on legal opinions from leading law firms on the likely interpretation of existing laws by the Russian courts. While continued #+ continuedthis may have somewhat slowed down the development of the securitisation market, it has not proved to be a barrier to Russian securitisation.
Indeed, the market is now moving on from offshore structures involving the securitisation of offshore, non-rouble-denominated assets to provide for onshore, rouble-denominated assets incorporating innovative structuring to compensate for perceived weaknesses in the legal certainty of such structures. These include: special tranches to absorb losses from commingling; short-term rolling foreign exchange and interest rate hedging to deal with rouble-denominated assets; international payment facilities to cut down the risk of a block on transferring money out of Russia; mezzanine tranches bought by organisations, such as the International Finance Corporation, to overcome the sovereign ceiling on ratings; storage of personal obligor details with a third party to overcome data protection issues; and the transfer of assets by way of assignment at undiscounted prices to mitigate challenges of true sale in the insolvency of the originator.
Participants, including the rating agencies, are becoming more comfortable with the Russian true sale analysis. This may be in part an evolution of the legal analysis, but it also reflects the increasing policy awareness for encouraging the development of an effective securitisation market for the benefit of Russia's financial system.
The only existing securitisation-specific legislation is the 'MBS Law'. The MBS Law sets out criteria for a form of covered bond, providing a securitisation framework of sorts. It introduces the concept of an SPV that may only be used in mortgage securitisations, expressly provides for transfer of collateral to the mortgage agent by sale, segregation thereof for bankruptcy purposes and tranching of issuances. Recent changes to the MBS Law aim to provide clarity on securitisation of principal and interest-only and clarify existing tranching provisions. While still not a fully fledged securitisation code for onshore securitisations, the general consensus seems to be that, with the MBS Law, things are moving in the right direction.
In spite of these weaknesses in the legal framework, it is likely that Russian banks and other consumer finance lenders will, for some time to come, look to the international financial markets to satisfy funding requirements. Local capital markets are not developed sufficiently, particularly on the domestic investor front, to generate sufficient demand for such funding requirements.
In time an increasingly active rouble-denominated corporate bond market will be important in creating an onshore, rouble-denominated securitisation market. Changes in securities legislation to permit domestic issues of asset-backed securities can only help to deepen and strengthen that market and, in addition, the abolition of currency controls (with ancillary changes becoming effective on 1 January 2007) will aid Russian banks in satisfying their funding requirements. Recent transactions, such as the $69m (£36.62m) residential mortgage-backed security by CityMortgage's, showed that investors have discounted convertibility risk given Russia's investment grade rating and its high level of currency reserves.
These changes are all encouraging signs to the markets that the Russian authorities are committed to establishing a proper and efficient capital market. n
Martin Bartlam is head of the London office and Karin Artmann is an associate, both at Orrick Herrington & Sutcliffe