25 April 2005
Over the past number of years, a combination of factors has prompted the growth in the use of Irish special purpose vehicles in cross-border securitisations, collateralised debt obligations (CDOs) and other structured finance transactions.
Principal among such factors is Ireland's favourable tax regime for structured finance vehicles (Section 110 of the Irish Taxes Consolidation Act 1997). This allows such vehicles (known as 'Section 110 companies') to achieve effective Irish tax neutrality while retaining access to Ireland's wide network of double tax treaties. The tax regime also permits investors in Section 110 companies to use flexible profit extraction techniques without any 'deemed distribution' tax concerns.
Section 110 companies can be debt or equity funded and Ireland has no thin capitalisation rules. A number of exemptions from withholding tax on interest payments are available to such vehicles, including a 'quoted eurobond' exemption for listed bearer notes.
Recent improvements in the legislative framework have exempted Section 110 companies from Irish VAT on certain services, most notably collateral management and corporate administration services. Helpfully, the Irish Revenue Commissioners are generally willing to provide rulings on the appropriate tax treatment of a transaction involving a Section 110 company where there is any doubt as to the applicability of the structured finance tax regime.
Other factors which have helped the growth of the cross-border structured finance business include Ireland's status as an Organisation for Economic Cooperation and Development country and European Union (EU) member state, the availability of a large pool of experienced service providers (legal, accounting and corporate administration), a common law based legal system, the fact that in general the activities of structured finance vehicles fall outside the ambit of regulated financial services, and the complementary listing business of the Irish Stock Exchange, which is now the European market's stock exchange of choice for asset-backed securities.
Wide variety of transactions
This combination of factors has led to vehicles used in a wide variety of transactions being located in Ireland. Such transactions now include commercial mortgage-backed securitisations, a range of CDOs including synthetic and cash-based, trade receivables securitisations, asset-backed commercial paper conduits, lease receivable-backed deals, catastrophe bonds and insurance-embedded value securitisations.
Hard evidence of the success of Ireland as a jurisdiction for locating debt issuing vehicles is manifested in a recent survey carried out by the International Financial Law Review, which showed that Ireland is now the most popular jurisdiction for the location of issuance platforms for European synthetic CDO transactions (the survey covered deals completed during 2004 and valued above $50m (£26.5m) or equivalent which were listed on a European stock exchange).
Irish covered bonds - a significant development
Another significant growth area has been the issue of Irish covered bonds (asset-covered securities). Covered bonds are issued by specially authorised restricted activity bank issuers which are secured by a statutory preference over a ring-fenced pool of assets. The asset pool may be comprised of residential or commercial mortgages, or public sector credits.
Unlike securitised debt, which is created and secured by an appropriate network of contractual relationships, the legal framework for covered bonds is typically contained in legislation, although this is not the case for UK 'structured covered bonds', which have been issued by a number of UK financial institutions without the benefit of a legislative framework, but rather relying on the UK's general strongly pro-secured creditor legal regime. It is generally a combination of a legislative foundation, the restricted activity bank status of the issuers, the bankruptcy isolated status of the asset pools on which the bonds are secured, and the low risk nature of those assets that allows covered bonds to achieve high credit ratings, thus making them a valuable funding tool for issuers.
While covered bonds have been a feature of the European capital markets for well over 200 years, it is only recently that they have ceased to be purely domestic instruments and found a wider global investor base. The emergence of a number of jumbo German pfandbriefe (a debt instrument) issues in the latter half of the 1990s showed that there was a global market for highly rated and liquid covered bonds. It is in this context that the introduction in 2001 of the Irish covered bond product should be viewed.
The legislative framework governing Irish covered bonds and creating the bondholders' statutory preference over the ring-fenced asset pools maintained by issuers is contained in the Asset Covered Securities Act 2001 (the ACS Act). The first operation of the ACS Act was in 2003, with the debut issues of Irish covered bonds by two public sector credit issuers, Depfa ACS Bank and WestLB Covered Bond Bank. Both issuers have continued to be regular visitors to the capital markets and last year were joined by Bank of Ireland Mortgage Bank as issuer of Ireland's first mortgage-covered bonds, with a e2bn (£1.36bn) debut issue. Approximately e28.5bn (£19.44bn) of Irish covered bonds have now been issued.
No markets, and certainly not the fast-paced international capital markets, stand still. The success of the Irish financial services industry in positioning Ireland among the leading jurisdictions for structured finance vehicles will be maintained only with continued product innovation and support from government and tax authorities. So far, the authorities have proved responsive to industry concerns and requests, with enhancements to the Section 110 tax regime in each of the 2003 and 2004 Finance Acts and a provision in the 2005 Finance Act designed to ensure that the EU requirement for certain entities to apply international financial reporting standards should not adversely impact the Irish tax position of Section 110 companies.
However, continuous innovation is vital if Ireland is to maintain its competitive position. Issues which will feature in new legislation this year include an overhaul of Irish securities laws to reflect the requirements of the EU Prospectus Directive. In addition, the Irish Stock Exchange has published new listing guidelines for asset-backed securities which will come into effect on 1 July 2005. On the tax side, further refinement is always possible - for example, the industry is keen to see an extension of the quoted eurobond withholding tax exemption to registered instruments.
Fergus Gillen is a partner in the banking and financial services group at McCann FitzGerald