New tricks

The Irish structured finance regime continues to embrace innovation, says Nollaig Murphy

Ireland is now the leading European onshore jurisdiction for special-purpose vehicles (SPVs), with in excess of an estimated 2,000 incorporations a year, more than double that of two years ago.

This is notwithstanding the return by banks to UK SPV issuers of mainstream asset-backed securities (ABS), residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) and whole business deals. So what has continued to drive the Irish structured finance market?

Twelve months ago, a large part of the new growth could be partly attributed to Ireland’s popularity as a collateralised debt obligation (CDO) location, in particular managed CDOs and CDO tranchelets, which were both very hot areas in the market at the time. The Irish legislature had previously introduced a blanket VAT exemption for investment management services provided to Irish structured bond issuers, representing a saving of 21 per cent on what would normally be relatively substantial fees.

However, this area is not the only driver behind the growth. Ireland is displaying all of the signs of being a matured structured finance market by attracting and fostering increased innovation in the types of originators and structures using the Irish regime.

Asset class diversity has also been highly prevalent. In addition to international capital using innovative structures to access the leveraged loan market and build secondary debt portfolios, Ireland has also seen: international banks raising tier 1 and tier 2 regulatory capital in advance of Basle II; US insurance companies creating and expanding European investment platforms and completing insurance proceeds deals; hedge funds driving their increasingly diverse asset portfolios; and a variety of niche European issuers ranging from Portugal to Russia using Ireland to hit the market.

Referrals of business are now coming from international clients who know that the structured finance experience in Ireland is mature and that challenging transactions can be successfully structured based on the pre-existing technology and knowhow founded on the vanilla and volume transactions of the past five years.

Arrangers are also aware of the cooperation between the legislature, civil service and professional advisers that has characterised this regime. In addition to finance SPVs within the funds and structured finance world sensibly being carved out of increased EU accounting obligations for normal corporates, the Irish legislature also recently responded promptly to industry requests that, for non-retail offers, structured finance vehicles need not be plcs – thereby reducing the share capital requirement for such issuers from ?40,000 (£27,900) to around ?1,000 (£697).

Rather like the CDO legislation mentioned previously, such a legislative move has led to an increase in business as in addition to now being a lower capitalised vehicle, such Irish issuers have never had a requirement to retain a minimum profit or ‘turn’ unlike some rival jurisdictions in Europe.

A classic case of this innovation was the recent Channel Capital CDPC transaction. Channel Capital, an Irish Section 110 vehicle, is the first credit derivative product company (CDPC) to be established in Europe. CDPCs are highly rated (triple-A) investment companies which sell protection through credit defaults swaps to take credit risk to gain return on capital.

However, they are not ordinarily exposed to mark-to-market movements from a capital adequacy perspective to the same extent as other market participants, as they are designed as continuation vehicles. As a result, they are not required to become forced sellers in a downturn; use proprietary models and strong capital to absorb credit-linked losses; and are usually not structured to rely solely on short-term funding, which provides certainty and assists capital modelling.

Channel Capital will initially sell protection on highly rated portfolio tranches of corporate, sovereign and supra-national credit risk. Using a multiple tranche capital structure was possible within the Irish Section 110 model and the challenging rating issues normally encountered by CDPCs were adequately met by the Irish corporate structure put in place for the transaction. Of no small assistance in this was the level of familiarity that the rating agencies have with Irish vehicles and Irish insolvency law principles, due to the high volume of rated transactions over recent years. With rating agencies indicating that a number of CDPCs are in various stages of discussions, along with the alternative funding structure they offer, it would seem that more of these transactions may be structured through Ireland.

Innovation has not only centred on diverse asset classes or types of issuer, however. The debt and equity worlds have been increasingly merging and hybrid product offerings have boomed for commercial banks and investment houses. We have also seen the use and combining of debt and actual funds technology to meet investor requirements. Most of the main investment banks now have highly active UCITS III (Undertakings for Collective Investment in Transferable Securities) platforms in place using the latest Irish fund technology and incorporating many debt concepts.

A relatively new development is the effective combination and integration of debt Section 110 technology with Ireland’s qualifying investor fund (QIF) regime, creating a bridge between debt market yields and the equity investment community. This was achieved to noteworthy effect in the recent Diamond III transaction.

SVG Diamond III is an Irish QIF that, through a collateralised fund obligation of private equity funds, raised ?700m (£487.93m). The structure incorporates drawable equity and re-investment and over-commitment strategies. This is the third transaction in a series, but unlike its predecessors, while SVG Diamond III is also a leveraged vehicle actively managed for enhanced returns, the debt, which represents 60 per cent of the total capital structure, is no longer provided by rated bonds, but rather by a revolving credit facility that allows for enhanced cash management and ramp-up flexibility without interest carry.

This debt and security package was innovative in terms of fitting within the overall debt and funds structure and, combined with the investment strategies for the vehicle, and it being the first such fund to be launched as an onshore European fund, ensured that overall the transaction was highly novel in the international sphere. From an Irish perspective, it innovatively combined the new Irish QIF funds technology (demonstrating the cost and timing efficiencies of regulatory self-certification by experienced funds advisors) with the Irish section 110 regime by interposing a securitisation vehicle in a QIF structure to maximise flexibility on underlying asset purchases and disposals, creating a leveraged, onshore private equity fund.

Although recent events have led to a hiatus in certain sectors of the market, the variety and depth of the Irish transactional portfolio in structured finance bodes well for future growth of the industry. Rather like the Celtic Tiger, the prognosis is healthy and steady as she goes.

Nollaig Murphy is a partner at A&L Goodbody