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Prudential Standard APS 120

Funds Management and Securitisation

Objective and key requirements of this Prudential Standard

This Prudential Standard aims to ensure that authorised deposit-taking institutions adopt prudent practices to manage the risks arising out of their involvement in funds management and securitisation activities, and to ensure that appropriate capital is held against the risks involved.

Authority and application

1. This Prudential Standard, made under section 11AF of the Banking Act 1959 (the Act), applies to all authorised deposit-taking institutions (ADIs) authorised under the Act.
2. Guidance Notes AGN 120.1 Disclosure and Separation (AGN 120.1), AGN 120.2 Credit Enhancement (AGN 120.2), AGN 120.3 Purchase and Supply of Assets (including Securities Issued by Special Purpose Vehicles) (AGN 120.3), AGN 120.4 Liquidity, Underwriting and Lending Facilities (AGN 120.4) and AGN 120.5 Servicing, Managing and Treasury Dealings (AGN 120.5) form part of this Prudential Standard.
3. This Prudential Standard does not apply to foreign ADIs,[1] except for the provisions relating to disclosure and separation. In their conduct of funds management or securitisation activities in Australia, foreign ADIs should have regard to all the disclosure and separation requirements.

Overview

4. Funds management encompasses the provision of investment and related services for the management of investors’ funds. Securitisation involves the pooling of assets, or interests in assets, in a special purpose vehicle (SPV), which is funded by the issue of securities.

5. ADIs can incur financial, credit, operational and legal risks arising from the obligations associated with their funds management and securitisation activities. Involvement in these activities can also yield moral risk - the possibility that an ADI will feel a moral obligation or a commercial need to support a funds management or securitisation scheme, or the investors involved in such schemes, beyond any explicit legal obligation to do so.[2]

6. It is the responsibility of the Board and management of an ADI to put in place clear strategies and policies to govern an ADI’s involvement in funds management and securitisation activities. These should incorporate appropriate management systems to identify, measure and control risks, including liquidity risks and potential conflicts of interest, arising from the ADI’s involvement in these activities.

ADI’s involvement in funds management & securitisation activities

7. An ADI’s role in a funds management or securitisation scheme can range from the establishment and sponsorship of the whole scheme to the provision of a single facility or service to a scheme sponsored by independent parties. Regulatory treatment, including for capital and disclosure, will vary depending on the risks that the ADI has to bear.

8. Where the provision of facilities or services meet disclosure, separation and arm’s length criteria as listed in AGN 120.1, AGN 120.2, AGN 120.3, AGN 120.4 and AGN 120.5, they will be subject to capital requirements in accordance with Prudential Standard APS 112 Capital Adequacy: Credit Risk. Otherwise, an ADI may be required to hold capital, on a solo and consolidated group basis, against the full value of securities[3] issued by the SPV[4] with which it is involved.

9. Where the totality of an ADI’s involvement in funds management and securitisation suggests that the overall level and/or concentration of risks has become excessive relative to its capital, APRA may require the ADI to maintain a buffer above the minimum capital ratio. In extreme circumstances, where there is evidence of misleading investors or incorrect perception of ADI support, such that the additional risks would not be adequately addressed by holding additional capital, an ADI may be precluded from continuing to undertake funds management and securitisation activities.

10. This Prudential Standard and its associated Guidance Notes apply to all forms of funds management and securitisation activities undertaken by ADIs in both the retail and wholesale markets. It also covers securitisation arrangements where the exposures do not cross an ADI’s balance sheet. The provisions should also be considered in any asset sales undertaken by an ADI where the ADI provides support services or other facilities to the buyer.

11. An ADI should consult APRA in advance of undertaking any new funds management or securitisation schemes, except where the structure involved has been previously provided to APRA by the ADI.

Disclosure

12. A key feature of funds management and securitisation schemes is that the payment of earnings and the return of capital to investors hinge on the cash flows from the underlying assets in which their funds are invested. Investors are exposed to investment risk, which may not be clear when investors are dealing with an ADI. To eliminate confusion, an ADI’s involvement in such schemes should be accompanied by clear disclosure that the investment in the schemes does not represent deposit or other liabilities of the ADI involved. Any recourse to the ADI for repayment of principal and/or interest will require appropriate capital support.

Separation

13. To achieve separation, an ADI must deal with a SPV and/or its investors at arm’s length and on market terms and conditions. An ADI’s undertaking in any funds management or securitisation scheme should be stand-alone, with the extent of the ADI’s obligations set out in legal documentation. Where this does not occur, the ADI will need to hold capital against the full value of securities on issue.

Clean sale

14. An ADI will be relieved of the need to hold capital in support of assets sold to SPVs only where the sale of the assets is clean and final (refer AGN 120.3). An ADI may incur risks or returns in respect of the assets sold as a result of the ADI providing facilities covered by this Prudential Standard or the associated Guidance Notes. Should the ADI retain any obligation, risk or interest relating to the assets sold other than arising from such facilities, the assets must be treated as if they were still on the ADI’s balance sheet. In supplying assets to SPVs, ADIs should ensure that it will not lead to deterioration in the average quality of assets remaining on its balance sheet.

Funds Management and Securitisation

Objective and key requirements of this Prudential Standard

This Prudential Standard aims to ensure that authorised deposit-taking institutions adopt prudent practices to manage the risks arising out of their involvement in funds management and securitisation activities, and to ensure that appropriate capital is held against the risks involved.

Authority and application

1. This Prudential Standard, made under section 11AF of the Banking Act 1959 (the Act), applies to all authorised deposit-taking institutions (ADIs) authorised under the Act.
2. Guidance Notes AGN 120.1 Disclosure and Separation (AGN 120.1), AGN 120.2 Credit Enhancement (AGN 120.2), AGN 120.3 Purchase and Supply of Assets (including Securities Issued by Special Purpose Vehicles) (AGN 120.3), AGN 120.4 Liquidity, Underwriting and Lending Facilities (AGN 120.4) and AGN 120.5 Servicing, Managing and Treasury Dealings (AGN 120.5) form part of this Prudential Standard.
3. This Prudential Standard does not apply to foreign ADIs,[1] except for the provisions relating to disclosure and separation. In their conduct of funds management or securitisation activities in Australia, foreign ADIs should have regard to all the disclosure and separation requirements.

Overview

4. Funds management encompasses the provision of investment and related services for the management of investors’ funds. Securitisation involves the pooling of assets, or interests in assets, in a special purpose vehicle (SPV), which is funded by the issue of securities.

5. ADIs can incur financial, credit, operational and legal risks arising from the obligations associated with their funds management and securitisation activities. Involvement in these activities can also yield moral risk - the possibility that an ADI will feel a moral obligation or a commercial need to support a funds management or securitisation scheme, or the investors involved in such schemes, beyond any explicit legal obligation to do so.[2]

6. It is the responsibility of the Board and management of an ADI to put in place clear strategies and policies to govern an ADI’s involvement in funds management and securitisation activities. These should incorporate appropriate management systems to identify, measure and control risks, including liquidity risks and potential conflicts of interest, arising from the ADI’s involvement in these activities.

ADI’s involvement in funds management & securitisation activities

7. An ADI’s role in a funds management or securitisation scheme can range from the establishment and sponsorship of the whole scheme to the provision of a single facility or service to a scheme sponsored by independent parties. Regulatory treatment, including for capital and disclosure, will vary depending on the risks that the ADI has to bear.

8. Where the provision of facilities or services meet disclosure, separation and arm’s length criteria as listed in AGN 120.1, AGN 120.2, AGN 120.3, AGN 120.4 and AGN 120.5, they will be subject to capital requirements in accordance with Prudential Standard APS 112 Capital Adequacy: Credit Risk. Otherwise, an ADI may be required to hold capital, on a solo and consolidated group basis, against the full value of securities[3] issued by the SPV[4] with which it is involved.

9. Where the totality of an ADI’s involvement in funds management and securitisation suggests that the overall level and/or concentration of risks has become excessive relative to its capital, APRA may require the ADI to maintain a buffer above the minimum capital ratio. In extreme circumstances, where there is evidence of misleading investors or incorrect perception of ADI support, such that the additional risks would not be adequately addressed by holding additional capital, an ADI may be precluded from continuing to undertake funds management and securitisation activities.

10. This Prudential Standard and its associated Guidance Notes apply to all forms of funds management and securitisation activities undertaken by ADIs in both the retail and wholesale markets. It also covers securitisation arrangements where the exposures do not cross an ADI’s balance sheet. The provisions should also be considered in any asset sales undertaken by an ADI where the ADI provides support services or other facilities to the buyer.

11. An ADI should consult APRA in advance of undertaking any new funds management or securitisation schemes, except where the structure involved has been previously provided to APRA by the ADI.

Disclosure

12. A key feature of funds management and securitisation schemes is that the payment of earnings and the return of capital to investors hinge on the cash flows from the underlying assets in which their funds are invested. Investors are exposed to investment risk, which may not be clear when investors are dealing with an ADI. To eliminate confusion, an ADI’s involvement in such schemes should be accompanied by clear disclosure that the investment in the schemes does not represent deposit or other liabilities of the ADI involved. Any recourse to the ADI for repayment of principal and/or interest will require appropriate capital support.

Separation

13. To achieve separation, an ADI must deal with a SPV and/or its investors at arm’s length and on market terms and conditions. An ADI’s undertaking in any funds management or securitisation scheme should be stand-alone, with the extent of the ADI’s obligations set out in legal documentation. Where this does not occur, the ADI will need to hold capital against the full value of securities on issue.

Clean sale

14. An ADI will be relieved of the need to hold capital in support of assets sold to SPVs only where the sale of the assets is clean and final (refer AGN 120.3). An ADI may incur risks or returns in respect of the assets sold as a result of the ADI providing facilities covered by this Prudential Standard or the associated Guidance Notes. Should the ADI retain any obligation, risk or interest relating to the assets sold other than arising from such facilities, the assets must be treated as if they were still on the ADI’s balance sheet. In supplying assets to SPVs, ADIs should ensure that it will not lead to deterioration in the average quality of assets remaining on its balance sheet.

Objective and key requirements of this Prudential Standard

This Prudential Standard aims to ensure that authorised deposit-taking institutions adopt prudent practices to manage the risks arising out of their involvement in funds management and securitisation activities, and to ensure that appropriate capital is held against the risks involved.

Authority and application

1. This Prudential Standard, made under section 11AF of the Banking Act 1959 (the Act), applies to all authorised deposit-taking institutions (ADIs) authorised under the Act.
2. Guidance Notes AGN 120.1 Disclosure and Separation (AGN 120.1), AGN 120.2 Credit Enhancement (AGN 120.2), AGN 120.3 Purchase and Supply of Assets (including Securities Issued by Special Purpose Vehicles) (AGN 120.3), AGN 120.4 Liquidity, Underwriting and Lending Facilities (AGN 120.4) and AGN 120.5 Servicing, Managing and Treasury Dealings (AGN 120.5) form part of this Prudential Standard.
3. This Prudential Standard does not apply to foreign ADIs,[1] except for the provisions relating to disclosure and separation. In their conduct of funds management or securitisation activities in Australia, foreign ADIs should have regard to all the disclosure and separation requirements.

Overview

4. Funds management encompasses the provision of investment and related services for the management of investors’ funds. Securitisation involves the pooling of assets, or interests in assets, in a special purpose vehicle (SPV), which is funded by the issue of securities.

5. ADIs can incur financial, credit, operational and legal risks arising from the obligations associated with their funds management and securitisation activities. Involvement in these activities can also yield moral risk - the possibility that an ADI will feel a moral obligation or a commercial need to support a funds management or securitisation scheme, or the investors involved in such schemes, beyond any explicit legal obligation to do so.[2]

6. It is the responsibility of the Board and management of an ADI to put in place clear strategies and policies to govern an ADI’s involvement in funds management and securitisation activities. These should incorporate appropriate management systems to identify, measure and control risks, including liquidity risks and potential conflicts of interest, arising from the ADI’s involvement in these activities.

ADI’s involvement in funds management & securitisation activities

7. An ADI’s role in a funds management or securitisation scheme can range from the establishment and sponsorship of the whole scheme to the provision of a single facility or service to a scheme sponsored by independent parties. Regulatory treatment, including for capital and disclosure, will vary depending on the risks that the ADI has to bear.

8. Where the provision of facilities or services meet disclosure, separation and arm’s length criteria as listed in AGN 120.1, AGN 120.2, AGN 120.3, AGN 120.4 and AGN 120.5, they will be subject to capital requirements in accordance with Prudential Standard APS 112 Capital Adequacy: Credit Risk. Otherwise, an ADI may be required to hold capital, on a solo and consolidated group basis, against the full value of securities[3] issued by the SPV[4] with which it is involved.

9. Where the totality of an ADI’s involvement in funds management and securitisation suggests that the overall level and/or concentration of risks has become excessive relative to its capital, APRA may require the ADI to maintain a buffer above the minimum capital ratio. In extreme circumstances, where there is evidence of misleading investors or incorrect perception of ADI support, such that the additional risks would not be adequately addressed by holding additional capital, an ADI may be precluded from continuing to undertake funds management and securitisation activities.

10. This Prudential Standard and its associated Guidance Notes apply to all forms of funds management and securitisation activities undertaken by ADIs in both the retail and wholesale markets. It also covers securitisation arrangements where the exposures do not cross an ADI’s balance sheet. The provisions should also be considered in any asset sales undertaken by an ADI where the ADI provides support services or other facilities to the buyer.

11. An ADI should consult APRA in advance of undertaking any new funds management or securitisation schemes, except where the structure involved has been previously provided to APRA by the ADI.

Disclosure

12. A key feature of funds management and securitisation schemes is that the payment of earnings and the return of capital to investors hinge on the cash flows from the underlying assets in which their funds are invested. Investors are exposed to investment risk, which may not be clear when investors are dealing with an ADI. To eliminate confusion, an ADI’s involvement in such schemes should be accompanied by clear disclosure that the investment in the schemes does not represent deposit or other liabilities of the ADI involved. Any recourse to the ADI for repayment of principal and/or interest will require appropriate capital support.

Separation

13. To achieve separation, an ADI must deal with a SPV and/or its investors at arm’s length and on market terms and conditions. An ADI’s undertaking in any funds management or securitisation scheme should be stand-alone, with the extent of the ADI’s obligations set out in legal documentation. Where this does not occur, the ADI will need to hold capital against the full value of securities on issue.

Clean sale

14. An ADI will be relieved of the need to hold capital in support of assets sold to SPVs only where the sale of the assets is clean and final (refer AGN 120.3). An ADI may incur risks or returns in respect of the assets sold as a result of the ADI providing facilities covered by this Prudential Standard or the associated Guidance Notes. Should the ADI retain any obligation, risk or interest relating to the assets sold other than arising from such facilities, the assets must be treated as if they were still on the ADI’s balance sheet. In supplying assets to SPVs, ADIs should ensure that it will not lead to deterioration in the average quality of assets remaining on its balance sheet.

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Guidance Note AGN 120.1

Disclosure and Separation

1. Authorised deposit-taking institutions (ADIs) may develop a presence in funds management or securitisation schemes provided there is very clear disclosure and adequate separation. The ADI’s brand name may be used in marketing, provided there is adequate disclosure of the ADI’s role and responsibilities.

Disclosure

2. To safeguard against investor confusion, an ADI involved in funds management and securitisation activities should ensure that there is very clear and prominent disclosure to investors of the nature and limitations of the ADI’s obligations arising from the involvement. Documentation or marketing of funds management or securitisation schemes with which an ADI is involved should not give the impression that recourse to the ADI would extend beyond any specific undertakings to which the ADI has formally committed.

3. Investors should be clearly informed in writing that:

(a) their investments do not represent deposits or other liabilities of the ADI;

(b) their investments can be subject to investment risk, including possible delays in repayment and loss of income and principal invested; and

(c) the ADI does not in any way stand behind the capital value and/or performance of the securities issued, or assets held, by the special purpose vehicle (SPV) except to the extent permitted under Prudential Standard APS 120 Funds Management and Securitisation and as specified in the documentation provided to investors.

4. The above written disclosures should be conspicuously provided in any marketing document and in any paper or electronic document inviting investment.[5] Any proposal to modify the requirements set out above is to be agreed with APRA. An ADI should ensure that any marketing or promotion of a scheme with which it is associated does not give any impression contrary to the disclosure requirements.

5. Generally, disclosures in documents inviting investment should be included as a stand‑alone item on the inside front cover of the documents. Where this conflicts with other statutory or regulatory requirements, variations to the presentation of the disclosure should be agreed with APRA.

6. Investors should provide a signed acknowledgement indicating that they have read and understood the required disclosures. To ensure the validity of the acknowledgement, the signature should appear in close proximity to the disclosures to be acknowledged.

7. It is recognised that the issuance and trading of certain types of securities are sometimes undertaken in an electronic environment. While disclosure requirements should be capable of being satisfied in such circumstances, market arrangements may make it impractical to obtain the signed acknowledgements referred to above. In such circumstances, where securities are issued:

(a) in substantial parcels; and

(b) there is no application form or equivalent documentation completed by prospective investors,

a signed acknowledgement by investors will not be required.

8. Where an ADI has a limited ability to ensure the required level of disclosure (and signed acknowledgements), compliance with disclosure standards may be relaxed following consultation with APRA. This exemption will not be available where the ADI is the “sponsor”, “manager”, “trustee” or “responsible entity” of the scheme, or where the ADI permits the use of its name, badge, logo or any other identifier in the marketing of the scheme.

Badging

9. An ADI may allow its logo or trademark to be used in marketing investment products of third‑party institutions, including related entities, where:

(a) the “name” and/or “badge” of the other party providing the product features prominently in all advertising material, marketing documentation and documentation inviting investment or participation in a product;

(b) the respective roles of the two parties are explained clearly and prominently in any documentation inviting investment or participation in the product – including the extent to which each party is responsible for the safety and performance of the product; and

(c) the disclosure and acknowledgement requirements in paragraphs 3 and 6 are fully satisfied.

Separation of funds management and securitisation schemes

10. Funds management and securitisation schemes should stand clearly separate from any ADI involved in the schemes, and there should be clear limits governing the extent of that involvement. Any undertakings given by an ADI to a SPV and/or investors should be subject to the ADI’s usual approval and control processes. Such undertakings should be expressed clearly in the legal documentation of the scheme, and must be fixed as to time and amount.

11. An ADI should not:

(a) have any ownership or beneficial interest (except as provided for in paragraph 12) in a SPV;

(b) include the word “bank”, “building society”, “credit union”, “authorised deposit-taking institution”, or “ADI” in the name of the SPV; or

(c) have any of its directors, officers or employees on the board of a SPV unless the board is made up of at least four members. The ADI may be represented by one director in a board of four to six members and by no more than two directors in a board with seven or more members.

12. Requirements (a) and (c) in paragraph 11 do not apply to:

(a) an entity which is involved in the capacity of pure “trustee” or “custodian”;

(b) a life insurance company and its statutory funds regulated by APRA or equivalent regulatory authorities overseas;

(c) an “approved trustee” or “custodian” established under provisions of the Superannuation Industry (Supervision) Act 1993 or like legislation overseas;

(d) “common trust funds” established pursuant to legislation and complying with Australian Securities and Investments Commission Policy Statement 32; or

(e) a “responsible entity” established under the Managed Investments Act 1998, or similar entities established under like statutory provisions overseas.

13. An ADI, in its capacity as an authorised deposit-taking institution, should not act in any circumstances as a manager, trustee, responsible entity or any similar role. Any such involvement should be conducted through a stand-alone subsidiary or other associate that is not itself an ADI. Where an ADI’s subsidiary or associate acts in such a role, the ADI itself should ensure that a clear distinction exists between itself and the subsidiary or associate concerned.

Disclosure and Separation

1. Authorised deposit-taking institutions (ADIs) may develop a presence in funds management or securitisation schemes provided there is very clear disclosure and adequate separation. The ADI’s brand name may be used in marketing, provided there is adequate disclosure of the ADI’s role and responsibilities.

Badging

9. An ADI may allow its logo or trademark to be used in marketing investment products of third‑party institutions, including related entities, where:

(a) the “name” and/or “badge” of the other party providing the product features prominently in all advertising material, marketing documentation and documentation inviting investment or participation in a product;

(b) the respective roles of the two parties are explained clearly and prominently in any documentation inviting investment or participation in the product – including the extent to which each party is responsible for the safety and performance of the product; and

(c) the disclosure and acknowledgement requirements in paragraphs 3 and 6 are fully satisfied.

Separation of funds management and securitisation schemes

10. Funds management and securitisation schemes should stand clearly separate from any ADI involved in the schemes, and there should be clear limits governing the extent of that involvement. Any undertakings given by an ADI to a SPV and/or investors should be subject to the ADI’s usual approval and control processes. Such undertakings should be expressed clearly in the legal documentation of the scheme, and must be fixed as to time and amount.

11. An ADI should not:

(a) have any ownership or beneficial interest (except as provided for in paragraph 12) in a SPV;

(b) include the word “bank”, “building society”, “credit union”, “authorised deposit-taking institution”, or “ADI” in the name of the SPV; or

(c) have any of its directors, officers or employees on the board of a SPV unless the board is made up of at least four members. The ADI may be represented by one director in a board of four to six members and by no more than two directors in a board with seven or more members.

12. Requirements (a) and (c) in paragraph 11 do not apply to:

(a) an entity which is involved in the capacity of pure “trustee” or “custodian”;

(b) a life insurance company and its statutory funds regulated by APRA or equivalent regulatory authorities overseas;

(c) an “approved trustee” or “custodian” established under provisions of the Superannuation Industry (Supervision) Act 1993 or like legislation overseas;

(d) “common trust funds” established pursuant to legislation and complying with Australian Securities and Investments Commission Policy Statement 32; or

(e) a “responsible entity” established under the Managed Investments Act 1998, or similar entities established under like statutory provisions overseas.

13. An ADI, in its capacity as an authorised deposit-taking institution, should not act in any circumstances as a manager, trustee, responsible entity or any similar role. Any such involvement should be conducted through a stand-alone subsidiary or other associate that is not itself an ADI. Where an ADI’s subsidiary or associate acts in such a role, the ADI itself should ensure that a clear distinction exists between itself and the subsidiary or associate concerned.

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Guidance Note AGN 120.2

Credit Enhancement

1. An authorised deposit-taking institution (ADI) should hold capital against the credit risk incurred when it provides credit enhancement, explicit or implicit, to a special purpose vehicle (SPV) or its investors.
2. Credit enhancement facilities include all arrangements that could result in an ADI absorbing losses of a SPV, its investors, or any providers of liquidity and other facilities. Credit enhancement facilities may take the form of a first or a second loss facility. Such facilities may be provided to a SPV that is “sponsored” (i.e. created) by the ADI or by a third party.
3. An ADI providing credit enhancement facilities should ensure that:

(a) the extent of any undertaking provided to a SPV and/or its investors is expressly stated in a written agreement. There should be no recourse to the ADI beyond the specified contractual obligations;

(b) it is able to demonstrate that the facility is provided on an arm’s length basis, is subject to the ADI’s normal credit approval and review processes and is transacted on market terms and conditions (including price or fee);

(c) the facility is limited to a specified amount (i.e. a maximum dollar amount of the ADI’s commitment under the facility) and a specified time period (i.e. the earliest of when assets are redeemed, the securities are paid out, or the ADI’s obligations otherwise terminate). A fixed termination date need not be specified, provided the ADI has an unfettered discretion to withdraw from the commitment at any time following a reasonable period of notice. Withdrawal must not be conditional upon the appointment of an alternative facility provider. As a general rule, an ADI should be able to relinquish its role after giving 90 days notice;

(d) subject to reasonable qualifications, the SPV and/or investors have the express right to select an alternative party to provide the facility; and

(e) the facility is documented in a manner which clearly separates it from any other facility provided by the ADI. An ADI’s obligations under each facility should stand alone.

4. Where the above conditions are not satisfied, an ADI should hold capital against the full value of all securities issued by the SPV.

First loss facility

5. A “first loss facility” provides a primary level of financial support to a SPV and/or its investors. The provider of the facility bears the bulk (or all) of the risk associated with the issued securities, or the assets held by the SPV.

6. A first loss credit enhancement also arises where an ADI provides an undertaking covering the payment of interest on assets held by a SPV and/or the payment of interest to investors (except where the undertaking is provided as part of a second loss facility covering the repayment of principal and accrued interest). This includes an undertaking to provide cover against reinvestment/ prepayment/ extension risk. Any undertaking to pay interest should specify the total dollar amount that the ADI can be required to pay as a result of its undertaking.

7. An ADI that provides a first loss facility should, for capital adequacy purposes, deduct the amount of the facility from its capital base. The deduction will be capped at the amount of capital the ADI would be required to hold against the full value of all securities issued by the SPV.[6]

Second loss facility

8. A “second loss facility” is a credit enhancement that provides a second tier of protection to a SPV and/or its investors.

9. A second loss facility should:

(a) be protected by a “substantial” first loss facility;[7]

(b) only be capable of being drawn after the first loss facility has been completely exhausted; and

(c) only cover losses beyond those covered by the first loss facility.[8]

10. APRA will review, in conjunction with an ADI which provides a second loss facility, the adequacy of any first loss protection. In reviewing first loss facilities with APRA, an ADI should provide details on:

(a) the class and quality of the assets held by the SPV;

(b) the history of default and loss rates on the assets;

(c) the output of any statistical or other models used by the ADI to assess expected losses on the assets;

(d) the types of activity permitted by the SPV and whether the risk underlying the credit enhancement extends beyond the assets held; and

(e) the quality of the parties providing the first loss facility, and the opinions provided by reputable third parties (e.g. ratings agencies) regarding the adequacy of the first loss protection.

11. Where an ADI provides only a second loss facility, the facility should be treated as a direct credit substitute for the purpose of Prudential Standard APS 112 Capital Adequacy: Credit Risk, with a 100 per cent credit conversion factor and a 100 per cent risk weight covering the amount of the facility.

12. Where a facility provided by an ADI substitutes for a first loss facility provided by another party upon that party’s default, the ADI’s facility should be treated as a first loss facility.

13. An ADI providing both a first and a second loss facility may treat the facilities as separate facilities, where:

(a) the facilities are separately documented and clearly function separately;

(b) the second loss facility meets the conditions in paragraph 9(a)-(c)[9]; and

(c) the second loss facility is made up of subordinated securities (or some form of marketable credit enhancement) which could be readily transferred by the ADI at any time.[10]

Otherwise, the combined facilities shall be treated as a first loss facility.

Credit Enhancement

1. An authorised deposit-taking institution (ADI) should hold capital against the credit risk incurred when it provides credit enhancement, explicit or implicit, to a special purpose vehicle (SPV) or its investors.
2. Credit enhancement facilities include all arrangements that could result in an ADI absorbing losses of a SPV, its investors, or any providers of liquidity and other facilities. Credit enhancement facilities may take the form of a first or a second loss facility. Such facilities may be provided to a SPV that is “sponsored” (i.e. created) by the ADI or by a third party.
3. An ADI providing credit enhancement facilities should ensure that:

(a) the extent of any undertaking provided to a SPV and/or its investors is expressly stated in a written agreement. There should be no recourse to the ADI beyond the specified contractual obligations;

(b) it is able to demonstrate that the facility is provided on an arm’s length basis, is subject to the ADI’s normal credit approval and review processes and is transacted on market terms and conditions (including price or fee);

(c) the facility is limited to a specified amount (i.e. a maximum dollar amount of the ADI’s commitment under the facility) and a specified time period (i.e. the earliest of when assets are redeemed, the securities are paid out, or the ADI’s obligations otherwise terminate). A fixed termination date need not be specified, provided the ADI has an unfettered discretion to withdraw from the commitment at any time following a reasonable period of notice. Withdrawal must not be conditional upon the appointment of an alternative facility provider. As a general rule, an ADI should be able to relinquish its role after giving 90 days notice;

(d) subject to reasonable qualifications, the SPV and/or investors have the express right to select an alternative party to provide the facility; and

(e) the facility is documented in a manner which clearly separates it from any other facility provided by the ADI. An ADI’s obligations under each facility should stand alone.

4. Where the above conditions are not satisfied, an ADI should hold capital against the full value of all securities issued by the SPV.

First loss facility

5. A “first loss facility” provides a primary level of financial support to a SPV and/or its investors. The provider of the facility bears the bulk (or all) of the risk associated with the issued securities, or the assets held by the SPV.

6. A first loss credit enhancement also arises where an ADI provides an undertaking covering the payment of interest on assets held by a SPV and/or the payment of interest to investors (except where the undertaking is provided as part of a second loss facility covering the repayment of principal and accrued interest). This includes an undertaking to provide cover against reinvestment/ prepayment/ extension risk. Any undertaking to pay interest should specify the total dollar amount that the ADI can be required to pay as a result of its undertaking.

7. An ADI that provides a first loss facility should, for capital adequacy purposes, deduct the amount of the facility from its capital base. The deduction will be capped at the amount of capital the ADI would be required to hold against the full value of all securities issued by the SPV.[6]

Second loss facility

8. A “second loss facility” is a credit enhancement that provides a second tier of protection to a SPV and/or its investors.

9. A second loss facility should:

(a) be protected by a “substantial” first loss facility;[7]

(b) only be capable of being drawn after the first loss facility has been completely exhausted; and

(c) only cover losses beyond those covered by the first loss facility.[8]

10. APRA will review, in conjunction with an ADI which provides a second loss facility, the adequacy of any first loss protection. In reviewing first loss facilities with APRA, an ADI should provide details on:

(a) the class and quality of the assets held by the SPV;

(b) the history of default and loss rates on the assets;

(c) the output of any statistical or other models used by the ADI to assess expected losses on the assets;

(d) the types of activity permitted by the SPV and whether the risk underlying the credit enhancement extends beyond the assets held; and

(e) the quality of the parties providing the first loss facility, and the opinions provided by reputable third parties (e.g. ratings agencies) regarding the adequacy of the first loss protection.

11. Where an ADI provides only a second loss facility, the facility should be treated as a direct credit substitute for the purpose of Prudential Standard APS 112 Capital Adequacy: Credit Risk, with a 100 per cent credit conversion factor and a 100 per cent risk weight covering the amount of the facility.

12. Where a facility provided by an ADI substitutes for a first loss facility provided by another party upon that party’s default, the ADI’s facility should be treated as a first loss facility.

13. An ADI providing both a first and a second loss facility may treat the facilities as separate facilities, where:

(a) the facilities are separately documented and clearly function separately;

(b) the second loss facility meets the conditions in paragraph 9(a)-(c)[9]; and

(c) the second loss facility is made up of subordinated securities (or some form of marketable credit enhancement) which could be readily transferred by the ADI at any time.[10]

Otherwise, the combined facilities shall be treated as a first loss facility.

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Guidance Note AGN 120.3

Purchase and Supply of Assets (including Securities Issued by Special Purpose Vehicles)

1. This Guidance Note details the “clean sale” requirements when an authorised deposit-taking institution (ADI) sells assets to special purpose vehicles (SPVs) or third parties. It also covers an ADI’s involvement in funds management or securitisation schemes, via:

(d) “spread accounts” and similar arrangements;

(e) the supply of revolving facilities to a SPV;

(f) the purchase of assets from a SPV; and

(g) the purchase of securities issued by a SPV.

2. All references to a “credit enhancement” should be read in conjunction with Guidance Note AGN 120.2 Credit Enhancement (AGN 120.2).

“Clean sale” supply of assets

3. An ADI will be required to hold capital against the value of any assets sold to a SPV or third party unless the transfer of the assets constitutes a “clean sale”. A “clean sale” will occur where the following conditions are addressed:

(a) the ADI retains no beneficial interest in the assets transferred;

(b) the ADI retains, in relation to the assets sold, no obligation, risk or return other than arising out of facilities covered by Prudential Standard APS 120 Funds Management and Securitisation;

(c) the SPV or third party has no formal recourse to the ADI for costs, expenses or losses resulting from the transfer of the assets except where such losses arise from breach of any service agreement, or other representations or warranties made to the SPV or third party;

(d) where the ADI transfers an undrawn commitment to lend, the transfer is effected by novation or assignment, and accompanied by a formal acknowledgement of the transfer by the borrower/debtor;

(e) the ADI receives a fixed amount of consideration for the assets no later than at the time of the transfer of the assets;

(f) the ADI is under no obligation to repurchase any part of the assets except where the obligation arises as a result of representations or warranties made by the ADI; and

(g) the document of transfer specifies that, if cashflows relating to an asset are re-scheduled or re-negotiated, the purchaser/SPV will be subject to the re-scheduled or re-negotiated terms.

4. The ADI should provide confirmation from appropriately qualified internal or external legal advisers that any obligations, risks or rewards relating to the assets subject to sale will be transferred.

5. Where an ADI is under an obligation to:

(a) substitute other assets for assets held by a SPV or third party except pursuant to any representations or warranties made; or under a revolving structure to replace performing assets which have been paid out in part or full; or to replace defaulting assets which have been repaid through recovery; or

(b) provide additional assets to a SPV to maintain a “coverage ratio” of collateral to issued securities except as permitted under a revolving structure,

the obligation should be regarded as a credit enhancement.

6. Where an ADI transfers assets to a SPV or third party at below-book value (e.g. pursuant to an over-collateralisation agreement or by sale at a discounted price), the amount short of book value should be considered as a first loss credit enhancement unless it is written off in the ADI’s profit and loss (and capital) accounts.

Spread accounts and similar arrangements

7. Where an ADI sells its assets to a SPV, it may be entitled to surplus income or payments generated by the securitisation scheme. Such arrangements may take the form of a residual interest, excess servicing income, a spread account or similar arrangement.

8. The transfer of assets under such arrangements should be considered a clean sale where:

(a) the ADI makes no payment to the SPV in exchange for an income stream, unless the payment is written off in the ADI’s profit and loss (and capital) accounts;

(b) the ADI has no right, and is under no obligation as a result of its entitlement to receive fees or other income, to repurchase any non-performing assets, or otherwise cover losses on assets or losses of investors;

(c) the ADI is under no obligation to return any fees or income once received; and

(d) the ADI does not recognise, for profit and loss (and capital) purposes, such fees or income until irrevocably received.

9. Where an ADI provides funds to establish a spread, reserve or similar account, those amounts should be treated as a first loss credit enhancement unless the funds are written off in the ADI’s profit and loss (and capital) accounts. The funds should be treated as a first loss credit enhancement until such time as the funds are irrevocably repaid to the ADI. Where the future earning capacity of any “excess spread” is recognised as an asset, it need not be included in credit risk assets for capital adequacy purposes provided the ADI deducts the amount of the asset from its capital.

10. Where an ADI contributes to the start-up costs of a funds management or securitisation scheme, the amounts involved need not be treated as a credit enhancement provided:

(a) the funds contributed are not intended to protect investors against loss;

(b) the funds involved represent a one-off commitment;

(c) the amounts involved are strictly limited and are in line with normal market expenses for similar schemes;

(d) there is no direct repayment of the contributions or direct fee earned for contributing to the start-up costs; and

(e) the contribution of funds is not linked to the provision of any specific facilities by the ADI.

Revolving facilities

11. An ADI may sell the receivables arising from a revolving finance facility to a SPV and retain an interest in those receivables. The sale of these revolving credit receivables can be considered a clean sale where:

(a) the rights and obligations of the ADI and investors are clearly specified at the commencement of the securitisation scheme;

(b) the distribution of the principal and other cashflows during the run-down period is clearly stated at the commencement of the program;

(c) the distribution of:

(i) interest flows during the on-going or revolving period;

(ii) all expenses; and

(iii) the principal and other cashflows during the run-down or repayment/amortising period of the securitisation scheme,

accord with the interests of the ADI and investors in the receivables;[11]

(d) the ADI shares in any losses or liquidity shortfalls associated with receivables on a pro rata basis, not exceeding the proportion of its interest in receivables held by the SPV;

(e) any discount rate on the sale to a SPV of additional receivables provided by an ADI during the revolving period, is fixed at the commencement of the securitisation scheme;[12]

(f) the ADI does not provide additional receivables, or cashflows from other receivables, to maintain a given cashflow or a coverage ratio once the amortisation period has commenced;

(g) the selection of receivables does not systematically favour investors, and the receivables transferred are chosen from a random selection of eligible revolving facilities;[13]

(h) the scheme provides for the amortising period to commence on a stipulated date (subject to the occurrence of any specified early amortisation date);[14]

(i) following the commencement of the amortising period, the ADI retains the right to cancel (without notice) any undrawn limits on revolving facilities whose receivables have been sold to the SPV. This is not required where the ADI holds capital against the undrawn facilities through the “revolving” and “amortising” periods in accordance with normal capital adequacy requirements;

(j) the ADI is able to demonstrate that the payment of principal on outstanding receivables held by the SPV will be sufficient to ensure repayment of the ADI and investors over the amortising period;

(k) any provision for early amortisation of assets held by a SPV cannot be precipitated by regulatory action affecting the seller of the assets;

(l) the effect of early or rapid amortisation events (if any) on the ADI’s capital and liquidity management has been considered by the ADI; and

(m) the ADI is under no obligation to:

(i) repurchase outstanding balances in a default situation;

(ii) alter the amortisation period except upon the occurrence of any specified early amortisation events; and

(iii) alter the principal allocation percentage which stipulates the share that investors would bear in any losses incurred by the SPV.

12. Where a securitisation scheme includes provision for early or rapid amortisation events, the potential effect of these events should be considered by an ADI in its capital and liquidity management plans. APRA may wish to review with the ADI such provisions and their potential impact in determining the treatment to be accorded the sale of securitised receivables by the ADI for capital adequacy and liquidity reporting purposes.

Representations and warranties

13. An ADI that provides facilities and services, or supplies assets, to a SPV, may make representations and warranties concerning those functions or assets. The ADI will not be required to hold capital against such representations and warranties where the following conditions are met:

(a) any representation or warranty is provided only by way of a formal written agreement, and the ADI is able to demonstrate that it accords with market practice (unless otherwise approved by APRA);

(b) the ADI undertakes appropriate due diligence before providing or accepting any representation or warranty;

(c) the representation or warranty refers to an existing state of facts that is capable of being verified by the ADI at the time the services are contracted or the assets are sold; and

(d) the representation or warranty is not open‑ended and, in particular, does not relate to the future creditworthiness of the assets, the performance of the SPV and/or the securities the SPV issues.

14. The exercise of a representation or warranty, requiring an ADI to purchase or replace assets (or any parts of them) sold to a SPV or third party, must be:

(a) undertaken within 120 days of the transfer of assets to the SPV; and

(b) conducted on the same terms and conditions as the original sale.

The 120-day limit does not preclude the subsequent payment of damages by an ADI for breach of warranty or representation, provided that the agreement to pay damages complies with paragraph 15.

15. An ADI that is required to pay damages for breach of representation or warranty can do so without prior APRA approval, provided that the agreement to pay damages meets the following conditions:

(a) there exists documentary evidence that the negotiation of the agreement to pay damages was conducted in good faith;

(b) the onus of proof for breach of representation or warranty remains at all times with the party so alleging;

(c) the party alleging the breach serves a written Notice of Claim on the ADI, specifying the basis for the claim; and

(d) damages are limited to losses directly incurred as a result of the breach.

16. An ADI should notify APRA of any instance where it has agreed to pay damages arising out of any representation or warranty.

Purchase of assets from SPVs

17. An ADI may purchase assets from a SPV, whether or not the assets were originally supplied by the ADI. The assets purchased may be risk weighted according to Prudential Standard APS 112 Capital Adequacy: Credit Risk, where:

(a) the purchase is conducted at arm’s length, on market terms and conditions (including price/fee) and is subject to the ADI’s normal credit approval and review processes;

(b) the ADI has no pre-existing obligation to undertake the purchase;

(c) the purchase is completed within six months from the time when the ADI commits to the purchase;

(d) the total value of assets purchased, and held on the books of the ADI, represents less than 10 per cent of the maximum value of assets held by the SPV. Where an ADI seeks to repurchase assets above this level, the acquisition will be subject to APRA’s prior approval and will be assessed on a case-by-case basis. This provision does not apply to acquisitions in the normal course of the ADI’s trading operations, for example, trading government securities or banks bills; and

(e) non-performing assets are purchased:

(i) the assets must be marked-to-market for financial and regulatory reporting purposes; and

(ii) the ADI is able to demonstrate that the assets are acquired at a fair market price that fully reflects the non-performing status of the assets and the presence of any credit enhancement(s) by an independent party.[15]

Where any of these conditions are not met, the purchase should be regarded as a credit enhancement (refer AGN 120.2).

18. Where APRA assesses that an ADI’s purchase of assets implies that it is supporting investments in a SPV beyond any legal obligation, the ADI will be required to hold capital against all the securities issued by the SPV.

Purchase of securities issued by SPVs

19. An ADI may purchase securities issued by a SPV, and treat them for capital adequacy purposes according to the risk weight attached to the securities themselves, provided:

(a) the conditions in sub-paragraphs 17(a)-(c) are satisfied; and

(b) the volume of purchases is not disproportionate to the amount of securities issued by the SPV (i.e. less than 20 per cent of the value of securities outstanding as a guide). APRA will consider holdings above 20 per cent in an SPV on a case-by-case basis, where an ADI is seeking to develop new funds management or securitisation products.

20. An ADI should have in place adequate systems and controls to ensure that it does not accumulate disproportionate levels of aggregate exposure to securities issued by SPVs, relative to the ADI’s total assets and capital.

21. Purchases of subordinated securities issued by a SPV should be treated as a credit enhancement, as either a first or a second loss facility depending on the level of loss the securities are supporting. Where subordinated securities are protected only by an unfunded credit enhancement, the securities held should be treated as a first loss facility.

22. An ADI may undertake to make a market in securities issued by a SPV, provided that:

(a) the ADI’s role in making the market is on a “reasonable endeavours” basis only and the ADI is under no obligation to purchase securities at any time;

(b) the ADI can withdraw from its market-making role at any time following reasonable notice (90 days as a guide);

(c) offers of prices by the ADI are broadly based and not directed solely at current investors; and

(d) investors are informed as to the terms under which the ADI’s market‑making activities will be conducted.

Where these conditions are not met, any acquisitions arising from market-making activities should be regarded as credit enhancements.

23. Where APRA assesses that an ADI’s purchase of securities implies that it is supporting investments in a SPV beyond any legal obligation, the ADI will be required to hold capital against all the securities issued by the SPV.

Purchase and Supply of Assets (including Securities Issued by Special Purpose Vehicles)

1. This Guidance Note details the “clean sale” requirements when an authorised deposit-taking institution (ADI) sells assets to special purpose vehicles (SPVs) or third parties. It also covers an ADI’s involvement in funds management or securitisation schemes, via:

(d) “spread accounts” and similar arrangements;

(e) the supply of revolving facilities to a SPV;

(f) the purchase of assets from a SPV; and

(g) the purchase of securities issued by a SPV.

2. All references to a “credit enhancement” should be read in conjunction with Guidance Note AGN 120.2 Credit Enhancement (AGN 120.2).

“Clean sale” supply of assets

3. An ADI will be required to hold capital against the value of any assets sold to a SPV or third party unless the transfer of the assets constitutes a “clean sale”. A “clean sale” will occur where the following conditions are addressed:

(a) the ADI retains no beneficial interest in the assets transferred;

(b) the ADI retains, in relation to the assets sold, no obligation, risk or return other than arising out of facilities covered by Prudential Standard APS 120 Funds Management and Securitisation;

(c) the SPV or third party has no formal recourse to the ADI for costs, expenses or losses resulting from the transfer of the assets except where such losses arise from breach of any service agreement, or other representations or warranties made to the SPV or third party;

(d) where the ADI transfers an undrawn commitment to lend, the transfer is effected by novation or assignment, and accompanied by a formal acknowledgement of the transfer by the borrower/debtor;

(e) the ADI receives a fixed amount of consideration for the assets no later than at the time of the transfer of the assets;

(f) the ADI is under no obligation to repurchase any part of the assets except where the obligation arises as a result of representations or warranties made by the ADI; and

(g) the document of transfer specifies that, if cashflows relating to an asset are re-scheduled or re-negotiated, the purchaser/SPV will be subject to the re-scheduled or re-negotiated terms.

4. The ADI should provide confirmation from appropriately qualified internal or external legal advisers that any obligations, risks or rewards relating to the assets subject to sale will be transferred.

5. Where an ADI is under an obligation to:

(a) substitute other assets for assets held by a SPV or third party except pursuant to any representations or warranties made; or under a revolving structure to replace performing assets which have been paid out in part or full; or to replace defaulting assets which have been repaid through recovery; or

(b) provide additional assets to a SPV to maintain a “coverage ratio” of collateral to issued securities except as permitted under a revolving structure,

the obligation should be regarded as a credit enhancement.

6. Where an ADI transfers assets to a SPV or third party at below-book value (e.g. pursuant to an over-collateralisation agreement or by sale at a discounted price), the amount short of book value should be considered as a first loss credit enhancement unless it is written off in the ADI’s profit and loss (and capital) accounts.

Spread accounts and similar arrangements

7. Where an ADI sells its assets to a SPV, it may be entitled to surplus income or payments generated by the securitisation scheme. Such arrangements may take the form of a residual interest, excess servicing income, a spread account or similar arrangement.

8. The transfer of assets under such arrangements should be considered a clean sale where:

(a) the ADI makes no payment to the SPV in exchange for an income stream, unless the payment is written off in the ADI’s profit and loss (and capital) accounts;

(b) the ADI has no right, and is under no obligation as a result of its entitlement to receive fees or other income, to repurchase any non-performing assets, or otherwise cover losses on assets or losses of investors;

(c) the ADI is under no obligation to return any fees or income once received; and

(d) the ADI does not recognise, for profit and loss (and capital) purposes, such fees or income until irrevocably received.

9. Where an ADI provides funds to establish a spread, reserve or similar account, those amounts should be treated as a first loss credit enhancement unless the funds are written off in the ADI’s profit and loss (and capital) accounts. The funds should be treated as a first loss credit enhancement until such time as the funds are irrevocably repaid to the ADI. Where the future earning capacity of any “excess spread” is recognised as an asset, it need not be included in credit risk assets for capital adequacy purposes provided the ADI deducts the amount of the asset from its capital.

10. Where an ADI contributes to the start-up costs of a funds management or securitisation scheme, the amounts involved need not be treated as a credit enhancement provided:

(a) the funds contributed are not intended to protect investors against loss;

(b) the funds involved represent a one-off commitment;

(c) the amounts involved are strictly limited and are in line with normal market expenses for similar schemes;

(d) there is no direct repayment of the contributions or direct fee earned for contributing to the start-up costs; and

(e) the contribution of funds is not linked to the provision of any specific facilities by the ADI.

Revolving facilities

11. An ADI may sell the receivables arising from a revolving finance facility to a SPV and retain an interest in those receivables. The sale of these revolving credit receivables can be considered a clean sale where:

(a) the rights and obligations of the ADI and investors are clearly specified at the commencement of the securitisation scheme;

(b) the distribution of the principal and other cashflows during the run-down period is clearly stated at the commencement of the program;

(c) the distribution of:

(i) interest flows during the on-going or revolving period;

(ii) all expenses; and

(iii) the principal and other cashflows during the run-down or repayment/amortising period of the securitisation scheme,

accord with the interests of the ADI and investors in the receivables;[11]

(d) the ADI shares in any losses or liquidity shortfalls associated with receivables on a pro rata basis, not exceeding the proportion of its interest in receivables held by the SPV;

(e) any discount rate on the sale to a SPV of additional receivables provided by an ADI during the revolving period, is fixed at the commencement of the securitisation scheme;[12]

(f) the ADI does not provide additional receivables, or cashflows from other receivables, to maintain a given cashflow or a coverage ratio once the amortisation period has commenced;

(g) the selection of receivables does not systematically favour investors, and the receivables transferred are chosen from a random selection of eligible revolving facilities;[13]

(h) the scheme provides for the amortising period to commence on a stipulated date (subject to the occurrence of any specified early amortisation date);[14]

(i) following the commencement of the amortising period, the ADI retains the right to cancel (without notice) any undrawn limits on revolving facilities whose receivables have been sold to the SPV. This is not required where the ADI holds capital against the undrawn facilities through the “revolving” and “amortising” periods in accordance with normal capital adequacy requirements;

(j) the ADI is able to demonstrate that the payment of principal on outstanding receivables held by the SPV will be sufficient to ensure repayment of the ADI and investors over the amortising period;

(k) any provision for early amortisation of assets held by a SPV cannot be precipitated by regulatory action affecting the seller of the assets;

(l) the effect of early or rapid amortisation events (if any) on the ADI’s capital and liquidity management has been considered by the ADI; and

(m) the ADI is under no obligation to:

(i) repurchase outstanding balances in a default situation;

(ii) alter the amortisation period except upon the occurrence of any specified early amortisation events; and

(iii) alter the principal allocation percentage which stipulates the share that investors would bear in any losses incurred by the SPV.

12. Where a securitisation scheme includes provision for early or rapid amortisation events, the potential effect of these events should be considered by an ADI in its capital and liquidity management plans. APRA may wish to review with the ADI such provisions and their potential impact in determining the treatment to be accorded the sale of securitised receivables by the ADI for capital adequacy and liquidity reporting purposes.

Representations and warranties

13. An ADI that provides facilities and services, or supplies assets, to a SPV, may make representations and warranties concerning those functions or assets. The ADI will not be required to hold capital against such representations and warranties where the following conditions are met:

(a) any representation or warranty is provided only by way of a formal written agreement, and the ADI is able to demonstrate that it accords with market practice (unless otherwise approved by APRA);

(b) the ADI undertakes appropriate due diligence before providing or accepting any representation or warranty;

(c) the representation or warranty refers to an existing state of facts that is capable of being verified by the ADI at the time the services are contracted or the assets are sold; and

(d) the representation or warranty is not open‑ended and, in particular, does not relate to the future creditworthiness of the assets, the performance of the SPV and/or the securities the SPV issues.

14. The exercise of a representation or warranty, requiring an ADI to purchase or replace assets (or any parts of them) sold to a SPV or third party, must be:

(a) undertaken within 120 days of the transfer of assets to the SPV; and

(b) conducted on the same terms and conditions as the original sale.

The 120-day limit does not preclude the subsequent payment of damages by an ADI for breach of warranty or representation, provided that the agreement to pay damages complies with paragraph 15.

15. An ADI that is required to pay damages for breach of representation or warranty can do so without prior APRA approval, provided that the agreement to pay damages meets the following conditions:

(a) there exists documentary evidence that the negotiation of the agreement to pay damages was conducted in good faith;

(b) the onus of proof for breach of representation or warranty remains at all times with the party so alleging;

(c) the party alleging the breach serves a written Notice of Claim on the ADI, specifying the basis for the claim; and

(d) damages are limited to losses directly incurred as a result of the breach.

16. An ADI should notify APRA of any instance where it has agreed to pay damages arising out of any representation or warranty.

Purchase of assets from SPVs

17. An ADI may purchase assets from a SPV, whether or not the assets were originally supplied by the ADI. The assets purchased may be risk weighted according to Prudential Standard APS 112 Capital Adequacy: Credit Risk, where:

(a) the purchase is conducted at arm’s length, on market terms and conditions (including price/fee) and is subject to the ADI’s normal credit approval and review processes;

(b) the ADI has no pre-existing obligation to undertake the purchase;

(c) the purchase is completed within six months from the time when the ADI commits to the purchase;

(d) the total value of assets purchased, and held on the books of the ADI, represents less than 10 per cent of the maximum value of assets held by the SPV. Where an ADI seeks to repurchase assets above this level, the acquisition will be subject to APRA’s prior approval and will be assessed on a case-by-case basis. This provision does not apply to acquisitions in the normal course of the ADI’s trading operations, for example, trading government securities or banks bills; and

(e) non-performing assets are purchased:

(i) the assets must be marked-to-market for financial and regulatory reporting purposes; and

(ii) the ADI is able to demonstrate that the assets are acquired at a fair market price that fully reflects the non-performing status of the assets and the presence of any credit enhancement(s) by an independent party.[15]

Where any of these conditions are not met, the purchase should be regarded as a credit enhancement (refer AGN 120.2).

18. Where APRA assesses that an ADI’s purchase of assets implies that it is supporting investments in a SPV beyond any legal obligation, the ADI will be required to hold capital against all the securities issued by the SPV.

Purchase of securities issued by SPVs

19. An ADI may purchase securities issued by a SPV, and treat them for capital adequacy purposes according to the risk weight attached to the securities themselves, provided:

(a) the conditions in sub-paragraphs 17(a)-(c) are satisfied; and

(b) the volume of purchases is not disproportionate to the amount of securities issued by the SPV (i.e. less than 20 per cent of the value of securities outstanding as a guide). APRA will consider holdings above 20 per cent in an SPV on a case-by-case basis, where an ADI is seeking to develop new funds management or securitisation products.

20. An ADI should have in place adequate systems and controls to ensure that it does not accumulate disproportionate levels of aggregate exposure to securities issued by SPVs, relative to the ADI’s total assets and capital.

21. Purchases of subordinated securities issued by a SPV should be treated as a credit enhancement, as either a first or a second loss facility depending on the level of loss the securities are supporting. Where subordinated securities are protected only by an unfunded credit enhancement, the securities held should be treated as a first loss facility.

22. An ADI may undertake to make a market in securities issued by a SPV, provided that:

(a) the ADI’s role in making the market is on a “reasonable endeavours” basis only and the ADI is under no obligation to purchase securities at any time;

(b) the ADI can withdraw from its market-making role at any time following reasonable notice (90 days as a guide);

(c) offers of prices by the ADI are broadly based and not directed solely at current investors; and

(d) investors are informed as to the terms under which the ADI’s market‑making activities will be conducted.

Where these conditions are not met, any acquisitions arising from market-making activities should be regarded as credit enhancements.

23. Where APRA assesses that an ADI’s purchase of securities implies that it is supporting investments in a SPV beyond any legal obligation, the ADI will be required to hold capital against all the securities issued by the SPV.

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Guidance Note AGN 120.4

Liquidity, Underwriting and Lending Facilities

1. This Guidance Note applies to the provision of liquidity, underwriting and lending facilities by an authorised deposit-taking institution (ADI) to a special purpose vehicle (SPV).
2. All references to “credit enhancement” should be read in conjunction with Guidance Note AGN 120.2 Credit Enhancement (AGN 120.2).

Liquidity facilities

3. Liquidity facilities enable SPVs to make timely payments of principal and interest to investors for reasons including, but not limited to, market disruption or timing differences in the payment and receipt of interest and principal from the pooled assets. Such facilities are needed when SPVs hold long-term assets funded by the issuance of short-term securities.

4. Where a liquidity facility fails to meet the following conditions, it should be treated as a credit enhancement for capital adequacy purposes:

(a) the conditions set out in sub-paragraphs 3(a)-(e) of AGN 120.2;

(b) funding is provided to the SPV and not directly to investors;

(c) the facility is not capable of being drawn for the purpose of credit support. The commitment should only be capable of being drawn where there is a sufficient level of non-defaulted assets to cover drawings, or the full amount of non-performing assets are covered by a substantial credit enhancement;

(d) the facility is not available for funding additional assets to be held by a SPV, to acquire the assets of the vehicle, to fund the final scheduled repayment of investors, or to cover against dilution of seller’s risk;[16] and

(e) repayment of drawings under the facility are not subordinated to the interests of investors.[17]

5. Where drawings under a liquidity facility remain outstanding after three months, an ADI should inform APRA of the advances involved and the reasons for non-repayment.

6. Where an ADI alone provides a liquidity facility in the absence of a substantial credit enhancement from an independent party, the facility should be regarded as a credit enhancement for capital adequacy purposes.

7. An exception to paragraph 6 arises where an ADI provides a limited liquidity facility (up to 10 per cent of outstanding securities on an unsecured basis and up to 20 per cent on a fully secured basis) for the purpose of:

(a) providing short-term funding for smoothing time differences in payment flows (excluding the retirement of securities at maturity or on roll-overs); and/or

(b) meeting margin payments on futures transactions; and/or

(c) covering delays in settling asset transactions involving the SPV.

An ADI may treat such a facility as a commitment to provide finance for capital adequacy purposes.[18]

8. Where a substantial credit enhancement (refer AGN 120.2) covering a SPV is provided by an independent party,[19] and an ADI alone provides a liquidity facility, the facility may be treated as a commitment to provide finance for capital adequacy purposes.

9. Where an independent party provides part of the liquidity facility, and an ADI provides not more than 80 per cent of the liquidity facility, the facility provided by the ADI may be regarded as a commitment to provide finance for capital adequacy purposes, provided that funding is shared pro-rata between the two parties. The ADI must not be liable to meet any shortfall in liquidity support provided by the independent party.

10. During a scheme’s establishment phase, an ADI may provide the full amount of a liquidity facility on the basis that it will find an independent party to participate in the facility as described in paragraph 9. The ADI has three months to locate such a party. In the interim, provided the full amount of such facilities in aggregate does not exceed 10 per cent of the ADI’s capital, the ADI should consider the facility as a commitment to provide finance for capital adequacy purposes.

11. High quality underlying assets of a SPV may render credit enhancement unnecessary (for example, where underlying assets are claims on the Commonwealth Government). In such a situation, APRA will consider treating a liquidity facility as a commitment to provide finance for capital adequacy purposes, provided that:

(a) the SPV holds only high quality assets;

(b) the SPV is not permitted to enter into unrelated investment activities nor incur unrelated liabilities; and

(c) the agreement for the facility expressly provides that the ADI may reduce (and ultimately withdraw) its funding if the quality of the SPV’s assets deteriorate below some appropriate and specified level.

12. An ADI may, in the normal course of its business, provide a cheque agency facility to a SPV for the benefit of its investors, provided the arrangements do not constitute a de facto form of liquidity, buy-back or credit enhancement facility. The provision of a cheque agency facility should be discussed with APRA. Where APRA considers that an ADI has provided a liquidity, buy-back or credit enhancement facility via a cheque agency facility, the ADI will be required to apply the appropriate capital treatment.

Underwriting of SPVs

13. An ADI may act as an underwriter or committed dealer for the issue of securities by a SPV, and treat the facility as an underwriting facility for capital adequacy purposes, where:

(a) the extent of any undertaking provided to a SPV is clearly specified in a written agreement, and there is no recourse to the ADI beyond the contractual obligations contained therein;

(b) the ADI is able to demonstrate that the facility is provided on an arm’s length basis, on market terms and conditions (including price/fee) and is subject to the ADI’s normal credit approval and review processes;

(c) the facility is limited to a specified amount and time period;

(d) the SPV has an express right to select an alternative party to provide the facility;

(e) the facility is documented in a manner that clearly separates it from any other facility provided by the ADI;

(f) the underwriting is exercisable only when an issuer cannot issue securities into the market at a price equal to (or above) the benchmark predetermined in the underwriting agreement;

(g) the ADI has the ability to withhold payment, and to terminate the facility if necessary, upon the occurrence of specified events (e.g. material adverse changes or defaults on assets above a specified level); and

(h) there is a market for the type of securities underwritten, or for which the ADI acts as a committed dealer.[20]

Where these conditions are not met, the facility should be regarded as a credit enhancement.

14. Where an ADI commits to underwrite or to acquire subordinated securities issued by a SPV, the ADI will be deemed to have entered into a credit enhancement. The ADI should report, for the term of such facilities, the portion of the facility covering subordinated securities as a credit enhancement facility for capital adequacy purposes.

15. An ADI that underwrites, or acts as the sole dealer for the initial issue of securities by a SPV, may underwrite up to 100 per cent of the initial issue and/or acquire up to 100 per cent of the initial issue. Where, at any given time, an ADI is committed to underwriting and/or acting as “sole dealer” for multiple issues of securities by a SPV or collection of vehicles it should inform APRA. An ADI should endeavour to ensure that its risk (particularly in relation to credit and liquidity) exposures from these activities are modest relative to the resources of the ADI. An ADI may not act as a committed dealer in any other circumstance without APRA approval.

16. An ADI may undertake further acquisitions of securities issued by a SPV for its own account in the three months period following the underwriting. The ADI should on-sell its holding of securities acquired through underwriting so that its overall holding would not exceed the limit placed on purchases of securities (paragraph 19(b) of AGN 120.3) three months after the underwriting has been completed.

17. Where an ADI’s holdings of securities through underwriting have not fallen below the 20 per cent threshold three months after acquisition, the ADI should inform APRA of the reason for the continued holdings above this level. The ADI must mark to market the securities held for regulatory and financial statement reporting purposes. The ADI should demonstrate to APRA that it has a strategy in place, to either reduce its holding below the 20 per cent threshold over the medium term, restructure the scheme, or wind up the SPV. Where it cannot demonstrate this, the holding in excess of the 20 per cent level may be subject to a penal capital treatment e.g. a deduction from the capital base or a risk weighting above 100 per cent.

18. An ADI may participate in a revolving underwriting facility, or an underwriting facility covering subsequent issues of securities by a SPV, where:

(a) the conditions in sub-paragraphs 13(a)-(h) are met;

(b) the ADI’s commitment to take up securities cannot be triggered by the failure of the SPV to meet its obligations, other than where such failure results from an inability to roll-over securities due to adverse market conditions; and

(c) an independent party acts as co-underwriter, or a sub-underwriting agreement exists, for at least 20 per cent of securities to be issued. The ADI should hold only “several” liability under the terms of the facility.

19. For the purposes of sub-paragraph 18(c), the sub-underwriting agreement should provide that:

(a) the sub-underwriter is independent of the ADI;

(b) the agreement is executed before the securities are issued;

(c) the agreement is transacted on an arm’s length basis, on market terms and conditions, and is subject to the ADI’s normal credit approval and review processes;

(d) the sub-underwriter can be excused from meeting its obligations only on the same basis upon which the ADI may be excused from meeting its obligations under the underwriting facility; and

(e) the ADI does not perform its functions as underwriter where the sub‑underwriter exercises its right to be excused from meeting its obligations.

20. Where the conditions in paragraph 18 (and 19, if applicable) are satisfied, the revolving underwriting facility may be treated as an underwriting facility for capital adequacy purposes. Otherwise, the facility should be regarded as a credit enhancement.

21. Where it is not practicable for an ADI to locate a co- or sub-underwriter (e.g. due to the small size of the issue of securities, client sensitivities or other matters), the ADI may underwrite 100 per cent of the issue of securities and treat the facility as an underwriting facility for capital adequacy purposes, provided:

(a) the conditions in sub-paragraphs 13(a)-(h) are met;

(b) the ADI can demonstrate its ability in placing securities of the type underwritten; and

(c) the amount of the ADI’s aggregate commitment under all such underwriting facilities (as “sole dealer”) is less than 20 per cent of the ADI’s capital base.

Where any of these conditions are not met, the facility should be regarded as a credit enhancement.

22. Where an ADI has taken up securities as a result of a revolving underwriting facility or dealing commitment, provisions of paragraphs 16 and 17 will apply.

Lending Facilities

Lending to SPVs

23. An ADI may provide a lending facility to a SPV for the purchase of assets to gear up investors’ interests. An ADI should treat such a facility as a commitment to provide finance (and as a loan once drawn), provided:

(a) the conditions set out in sub-paragraphs 3(a)-(e) of AGN 120.2 are met;

(b) any draw-down of the lending facility incorporates a specified maturity date[21];

(c) the lending facility is provided solely for the purpose of acquiring additional assets or for the refinancing of an existing loan (not securities issued by the scheme) used to fund the acquisition of assets by the SPV; and

(d) repayments of drawings under the facility are not subordinated to the interests of investors.

Where these requirements are not satisfied, the lending facility should be treated as a credit enhancement and assessed as a first or a second loss facility according to its characteristics.

24. An ADI may offer temporary funding to a SPV during a scheme’s establishment phase to facilitate the acquisition of assets pending the issue of securities[22], provided:

(a) the ADI is only committed to fund the initial acquisition of assets;

(b) assets to be acquired are not impaired at the time the ADI is required to advance funding;

(c) the ADI is fully secured against any funding provided;

(d) drawings under the facility will be repaid within 6 months; and

(e) the ADI has in place adequate systems and controls to ensure that it does not accumulate disproportionate levels of aggregate exposure (relative to the ADI’s asset portfolio and capital) to assets held by SPVs[23].

A lending facility that does not meet these requirements should be treated as a credit enhancement and assessed as a first or a second loss facility according to its characteristics.

Lending to Investors

25. An ADI may advance funds directly to investors for the purpose of investing in securities issued by a SPV. Such a facility should be treated as a commitment to provide finance (and as a loan once drawn) for capital adequacy purposes, where:

(a) the conditions set out in sub-paragraphs 3(a)-(c) of AGN 120.2 are satisfied;

(b) any draw-down of the facility incorporates a specified maturity date;

(c) there is no implication that the facility acts other than as a stand-alone lending facility to the customer of the ADI; and

(d) the ADI has full recourse to the investor beyond any collateral for repayment of advances.

Where these conditions are not met, the advance should be treated as a credit enhancement and assessed either as a first or a second loss facility according to its characteristics.

Liquidity, Underwriting and Lending Facilities

1. This Guidance Note applies to the provision of liquidity, underwriting and lending facilities by an authorised deposit-taking institution (ADI) to a special purpose vehicle (SPV).
2. All references to “credit enhancement” should be read in conjunction with Guidance Note AGN 120.2 Credit Enhancement (AGN 120.2).

Liquidity facilities

3. Liquidity facilities enable SPVs to make timely payments of principal and interest to investors for reasons including, but not limited to, market disruption or timing differences in the payment and receipt of interest and principal from the pooled assets. Such facilities are needed when SPVs hold long-term assets funded by the issuance of short-term securities.

4. Where a liquidity facility fails to meet the following conditions, it should be treated as a credit enhancement for capital adequacy purposes:

(a) the conditions set out in sub-paragraphs 3(a)-(e) of AGN 120.2;

(b) funding is provided to the SPV and not directly to investors;

(c) the facility is not capable of being drawn for the purpose of credit support. The commitment should only be capable of being drawn where there is a sufficient level of non-defaulted assets to cover drawings, or the full amount of non-performing assets are covered by a substantial credit enhancement;

(d) the facility is not available for funding additional assets to be held by a SPV, to acquire the assets of the vehicle, to fund the final scheduled repayment of investors, or to cover against dilution of seller’s risk;[16] and

(e) repayment of drawings under the facility are not subordinated to the interests of investors.[17]

5. Where drawings under a liquidity facility remain outstanding after three months, an ADI should inform APRA of the advances involved and the reasons for non-repayment.

6. Where an ADI alone provides a liquidity facility in the absence of a substantial credit enhancement from an independent party, the facility should be regarded as a credit enhancement for capital adequacy purposes.

7. An exception to paragraph 6 arises where an ADI provides a limited liquidity facility (up to 10 per cent of outstanding securities on an unsecured basis and up to 20 per cent on a fully secured basis) for the purpose of:

(a) providing short-term funding for smoothing time differences in payment flows (excluding the retirement of securities at maturity or on roll-overs); and/or

(b) meeting margin payments on futures transactions; and/or

(c) covering delays in settling asset transactions involving the SPV.

An ADI may treat such a facility as a commitment to provide finance for capital adequacy purposes.[18]

8. Where a substantial credit enhancement (refer AGN 120.2) covering a SPV is provided by an independent party,[19] and an ADI alone provides a liquidity facility, the facility may be treated as a commitment to provide finance for capital adequacy purposes.

9. Where an independent party provides part of the liquidity facility, and an ADI provides not more than 80 per cent of the liquidity facility, the facility provided by the ADI may be regarded as a commitment to provide finance for capital adequacy purposes, provided that funding is shared pro-rata between the two parties. The ADI must not be liable to meet any shortfall in liquidity support provided by the independent party.

10. During a scheme’s establishment phase, an ADI may provide the full amount of a liquidity facility on the basis that it will find an independent party to participate in the facility as described in paragraph 9. The ADI has three months to locate such a party. In the interim, provided the full amount of such facilities in aggregate does not exceed 10 per cent of the ADI’s capital, the ADI should consider the facility as a commitment to provide finance for capital adequacy purposes.

11. High quality underlying assets of a SPV may render credit enhancement unnecessary (for example, where underlying assets are claims on the Commonwealth Government). In such a situation, APRA will consider treating a liquidity facility as a commitment to provide finance for capital adequacy purposes, provided that:

(a) the SPV holds only high quality assets;

(b) the SPV is not permitted to enter into unrelated investment activities nor incur unrelated liabilities; and

(c) the agreement for the facility expressly provides that the ADI may reduce (and ultimately withdraw) its funding if the quality of the SPV’s assets deteriorate below some appropriate and specified level.

12. An ADI may, in the normal course of its business, provide a cheque agency facility to a SPV for the benefit of its investors, provided the arrangements do not constitute a de facto form of liquidity, buy-back or credit enhancement facility. The provision of a cheque agency facility should be discussed with APRA. Where APRA considers that an ADI has provided a liquidity, buy-back or credit enhancement facility via a cheque agency facility, the ADI will be required to apply the appropriate capital treatment.

Underwriting of SPVs

13. An ADI may act as an underwriter or committed dealer for the issue of securities by a SPV, and treat the facility as an underwriting facility for capital adequacy purposes, where:

(a) the extent of any undertaking provided to a SPV is clearly specified in a written agreement, and there is no recourse to the ADI beyond the contractual obligations contained therein;

(b) the ADI is able to demonstrate that the facility is provided on an arm’s length basis, on market terms and conditions (including price/fee) and is subject to the ADI’s normal credit approval and review processes;

(c) the facility is limited to a specified amount and time period;

(d) the SPV has an express right to select an alternative party to provide the facility;

(e) the facility is documented in a manner that clearly separates it from any other facility provided by the ADI;

(f) the underwriting is exercisable only when an issuer cannot issue securities into the market at a price equal to (or above) the benchmark predetermined in the underwriting agreement;

(g) the ADI has the ability to withhold payment, and to terminate the facility if necessary, upon the occurrence of specified events (e.g. material adverse changes or defaults on assets above a specified level); and

(h) there is a market for the type of securities underwritten, or for which the ADI acts as a committed dealer.[20]

Where these conditions are not met, the facility should be regarded as a credit enhancement.

14. Where an ADI commits to underwrite or to acquire subordinated securities issued by a SPV, the ADI will be deemed to have entered into a credit enhancement. The ADI should report, for the term of such facilities, the portion of the facility covering subordinated securities as a credit enhancement facility for capital adequacy purposes.

15. An ADI that underwrites, or acts as the sole dealer for the initial issue of securities by a SPV, may underwrite up to 100 per cent of the initial issue and/or acquire up to 100 per cent of the initial issue. Where, at any given time, an ADI is committed to underwriting and/or acting as “sole dealer” for multiple issues of securities by a SPV or collection of vehicles it should inform APRA. An ADI should endeavour to ensure that its risk (particularly in relation to credit and liquidity) exposures from these activities are modest relative to the resources of the ADI. An ADI may not act as a committed dealer in any other circumstance without APRA approval.

16. An ADI may undertake further acquisitions of securities issued by a SPV for its own account in the three months period following the underwriting. The ADI should on-sell its holding of securities acquired through underwriting so that its overall holding would not exceed the limit placed on purchases of securities (paragraph 19(b) of AGN 120.3) three months after the underwriting has been completed.

17. Where an ADI’s holdings of securities through underwriting have not fallen below the 20 per cent threshold three months after acquisition, the ADI should inform APRA of the reason for the continued holdings above this level. The ADI must mark to market the securities held for regulatory and financial statement reporting purposes. The ADI should demonstrate to APRA that it has a strategy in place, to either reduce its holding below the 20 per cent threshold over the medium term, restructure the scheme, or wind up the SPV. Where it cannot demonstrate this, the holding in excess of the 20 per cent level may be subject to a penal capital treatment e.g. a deduction from the capital base or a risk weighting above 100 per cent.

18. An ADI may participate in a revolving underwriting facility, or an underwriting facility covering subsequent issues of securities by a SPV, where:

(a) the conditions in sub-paragraphs 13(a)-(h) are met;

(b) the ADI’s commitment to take up securities cannot be triggered by the failure of the SPV to meet its obligations, other than where such failure results from an inability to roll-over securities due to adverse market conditions; and

(c) an independent party acts as co-underwriter, or a sub-underwriting agreement exists, for at least 20 per cent of securities to be issued. The ADI should hold only “several” liability under the terms of the facility.

19. For the purposes of sub-paragraph 18(c), the sub-underwriting agreement should provide that:

(a) the sub-underwriter is independent of the ADI;

(b) the agreement is executed before the securities are issued;

(c) the agreement is transacted on an arm’s length basis, on market terms and conditions, and is subject to the ADI’s normal credit approval and review processes;

(d) the sub-underwriter can be excused from meeting its obligations only on the same basis upon which the ADI may be excused from meeting its obligations under the underwriting facility; and

(e) the ADI does not perform its functions as underwriter where the sub‑underwriter exercises its right to be excused from meeting its obligations.

20. Where the conditions in paragraph 18 (and 19, if applicable) are satisfied, the revolving underwriting facility may be treated as an underwriting facility for capital adequacy purposes. Otherwise, the facility should be regarded as a credit enhancement.

21. Where it is not practicable for an ADI to locate a co- or sub-underwriter (e.g. due to the small size of the issue of securities, client sensitivities or other matters), the ADI may underwrite 100 per cent of the issue of securities and treat the facility as an underwriting facility for capital adequacy purposes, provided:

(a) the conditions in sub-paragraphs 13(a)-(h) are met;

(b) the ADI can demonstrate its ability in placing securities of the type underwritten; and

(c) the amount of the ADI’s aggregate commitment under all such underwriting facilities (as “sole dealer”) is less than 20 per cent of the ADI’s capital base.

Where any of these conditions are not met, the facility should be regarded as a credit enhancement.

22. Where an ADI has taken up securities as a result of a revolving underwriting facility or dealing commitment, provisions of paragraphs 16 and 17 will apply.

Lending Facilities

Lending to SPVs

23. An ADI may provide a lending facility to a SPV for the purchase of assets to gear up investors’ interests. An ADI should treat such a facility as a commitment to provide finance (and as a loan once drawn), provided:

(a) the conditions set out in sub-paragraphs 3(a)-(e) of AGN 120.2 are met;

(b) any draw-down of the lending facility incorporates a specified maturity date[21];

(c) the lending facility is provided solely for the purpose of acquiring additional assets or for the refinancing of an existing loan (not securities issued by the scheme) used to fund the acquisition of assets by the SPV; and

(d) repayments of drawings under the facility are not subordinated to the interests of investors.

Where these requirements are not satisfied, the lending facility should be treated as a credit enhancement and assessed as a first or a second loss facility according to its characteristics.

24. An ADI may offer temporary funding to a SPV during a scheme’s establishment phase to facilitate the acquisition of assets pending the issue of securities[22], provided:

(a) the ADI is only committed to fund the initial acquisition of assets;

(b) assets to be acquired are not impaired at the time the ADI is required to advance funding;

(c) the ADI is fully secured against any funding provided;

(d) drawings under the facility will be repaid within 6 months; and

(e) the ADI has in place adequate systems and controls to ensure that it does not accumulate disproportionate levels of aggregate exposure (relative to the ADI’s asset portfolio and capital) to assets held by SPVs[23].

A lending facility that does not meet these requirements should be treated as a credit enhancement and assessed as a first or a second loss facility according to its characteristics.

Lending to Investors

25. An ADI may advance funds directly to investors for the purpose of investing in securities issued by a SPV. Such a facility should be treated as a commitment to provide finance (and as a loan once drawn) for capital adequacy purposes, where:

(a) the conditions set out in sub-paragraphs 3(a)-(c) of AGN 120.2 are satisfied;

(b) any draw-down of the facility incorporates a specified maturity date;

(c) there is no implication that the facility acts other than as a stand-alone lending facility to the customer of the ADI; and

(d) the ADI has full recourse to the investor beyond any collateral for repayment of advances.

Where these conditions are not met, the advance should be treated as a credit enhancement and assessed either as a first or a second loss facility according to its characteristics.

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Guidance Note AGN 120.5

Servicing, Managing and Treasury Dealings

1. This Guidance Note applies where an authorised deposit-taking institution (ADI) acts as a service provider to a special purpose vehicle (SPV). Services which may be provided include servicing and managing funds management or securitisation schemes, advising investors or SPVs, and conducting treasury transactions with a SPV.
2. An ADI should not subordinate, defer or waive the receipt of fees or other income for its role as service provider without consulting with APRA.

Offering advice

3. An ADI may act as adviser to a SPV.

4. An ADI may offer investment advice to investors regarding securities issued by SPVs or insurance and other funds management products. It may also act as a broker in obtaining securities (and other products) on behalf of investors or market such products directly to investors. In conducting such business, there is a risk that investors may be confused as to the relationship between an ADI and the issuer of a security (or other product), and a possibility of the ADI feeling some moral or commercial obligation to investors as a result of its actions.

5. To minimise the moral risks with providing advice, an ADI should ensure that where it undertakes these activities:

(a) they are conducted with investors or the SPV on an arm’s length basis and on market terms and conditions;

(b) the decision making rests with investors or the SPV, who are aware that they are responsible for, and will bear all risks associated with, the decision taken; and

(c) policies and procedures are in place to ensure that staff (and any agents of the ADI) dealing with investors are appropriately trained and avoid misleading or confusing them concerning the risks involved or the ADI’s relationship with (or support for) the securities and products recommended or offered for sale.

6. Where an ADI makes investment decisions or purchases securities for customers or a SPV at the ADI’s own initiative or discretion, the ADI will be deemed to be acting as a “manager” and the provisions below regarding managing will apply.

Servicing

7. A funds management or securitisation scheme may involve the participation of an entity acting as a “servicer” or “servicing agent”. An ADI may undertake the role of servicing a pool of assets held by a SPV provided:

(a) there is a formal written agreement in place which specifies the services to be provided and any required standards of performance. These standards should be reasonable and in accordance with normal market practice. There should be no recourse to the ADI beyond the fixed contractual obligations so specified. The agreement should not obligate an ADI to the provision of any other services (e.g. funding of payments to investors, recompense investors for losses, absorb losses on assets or purchase of securities, etc);

(b) that the ADI is able to demonstrate that the agreement is undertaken on an arm’s length basis, on market terms and conditions (including remuneration), and is subject to the ADI’s normal approval and review processes;

(c) the agreement is limited as to a specified time period (i.e. the earlier of the date on which all claims connected with the issue of securities are paid out or the ADI’s replacement as party to the agreement). A fixed termination date need not be specified provided the ADI is able, at its absolute discretion, to withdraw from its commitments at any time following a reasonable period of notice. Withdrawal must not be conditional upon the appointment of an alternative service provider. As a general rule, an ADI should be able to relinquish its role after giving 90 days notice;

(d) subject to reasonable qualifying conditions, the SPV and/or investors have the express right to select an alternative party to provide the facility;

(e) the agreement is documented in a fashion which clearly separates it from any other facility provided by the ADI. An ADI’s obligations under each facility should be stand‑alone; and

(f) the ADI’s operational systems are adequate to meet its obligations as a servicer.

8. An ADI acting as servicer should be under no obligation to remit funds to the SPV or investors until the funds are received from the underlying assets (unless otherwise provided for in terms of a separate liquidity facility). This may not preclude, subject to conditions set by APRA, the provision of very limited short‑term advances by a servicer, at its sole discretion, to cover unexpected cash shortfalls arising from delayed payments on assets.

9. A member of an ADI may receive a performance‑related payment (or benefit from any surplus income generated) for its role as servicer, in addition to its base fee, provided that the base fee is on market terms and conditions and any performance‑related payment does not commit the ADI to any additional obligations. Such payment should be recognised for profit and loss (and capital) purposes only after it has been irrevocably received.

10. Where a servicing agreement does not meet the conditions above, an ADI will be required to hold capital against the assets it is servicing as if they were held on its balance sheet.

Managing

11. Funds management and securitisation schemes usually involve an entity acting as “manager”. An ADI, in its capacity as an authorised deposit‑taker, cannot act as a manager. Subsidiaries or associates of an ADI can act as a manager, provided that the management agreement meets conditions (a)-(e) in paragraph 7 above. A member of an ADI acting as manager may also receive a performance-related payment for its role as manager, as long as the provisions described in paragraph 9 are met.

12. Where a managing agreement does not meet the conditions above, the ADI will be required to hold capital against the assets it is managing as if they were held on its balance sheet.

13. An ADI, acting as manager, may enter into a contractual undertaking to provide a limited buy‑back facility to repurchase securities from investors provided:

(a) any obligation to buy back is specified in the management agreement and limitations on the entity’s obligations are prominently and clearly noted in the documentation associated with the issue of the securities;

(b) the obligation to buy back is entered into only as part of a management facility provided by the entity. The obligation should terminate immediately if the entity ceases to act as manager; and

(c) the undertaking of the entity to buy back is capped at a set Australian dollar amount.

14. A buy‑back facility should be treated as a credit enhancement (refer Guidance Note AGN 120.2 Credit Enhancement (AGN 120.2)). The ADI should ensure the potential effect of buy‑backs is considered in its liquidity management plans.

15. The above provisions do not apply where the entity is required by statute to provide a buy-back facility or exercises a completely discretionary right to buy back investments in special circumstances (e.g. such as personal hardship). Investors should, however, be put on notice that any buy-backs under these circumstances need to be undertaken at market prices and may invoke interest penalties. It is expected that over the life of a funds management or securitisation scheme the total value of such buy-backs would not be substantial relative to the amount of securities on issue.

Treasury operations

16. An ADI may enter into treasury (market‑related) transactions with a SPV provided such transactions are undertaken in accordance with the following conditions:

(a) the ADI is not obliged to enter into any transactions with the SPV;

(b) the ADI is able to demonstrate that the transactions are conducted on an arm’s length basis and are subject to the ADI’s normal approval and review processes. Transactions should be undertaken on market terms and conditions (including price/fee). Where a market price is impossible to determine, the ADI should seek APRA’s approval before undertaking the transaction;

(c) the transactions involve specified principal amounts and cover specified time periods;

(d) the SPV has the express right to select an alternative party with whom to deal before entering into any transaction (subject to any contractual arrangements/qualifying conditions);

(e) the ADI has reasonably satisfied itself that the counterparty has the power to undertake the transactions, and the counterparty could reasonably be expected to be aware of the risks that it might face from the transaction; and

(f) the transactions do not involve the acquisition of securities issued or assets held (including a beneficial interest in assets held) by a SPV, except as permitted by Guidance Note AGN 120.3 Purchase and Supply of Assets (including Securities Issued by Special Purpose Vehicles).

17. A transaction can cover an undetermined amount provided the contract fixes a maximum principal amount, e.g. a swap contract covering the amount of mortgage loans held at any point in time is permissible provided the amount of the potential advances in relation to the underlying mortgages is capped. Transactions that involve mismatches of more than 90 days between the payment by the ADI to, and subsequent receipt from, the SPV of underlying cashflows, should receive the prior approval of APRA.

18. Where the conditions in paragraphs 16 and 17 are satisfied, an ADI may treat treasury transactions involving SPVs as market-related transactions for the purposes of Prudential Standard APS 112 Capital Adequacy: Credit Risk. Where these conditions are not met, the transaction should be regarded as a credit enhancement, and assessed in accordance with AGN 120.2.

Servicing, Managing and Treasury Dealings

1. This Guidance Note applies where an authorised deposit-taking institution (ADI) acts as a service provider to a special purpose vehicle (SPV). Services which may be provided include servicing and managing funds management or securitisation schemes, advising investors or SPVs, and conducting treasury transactions with a SPV.
2. An ADI should not subordinate, defer or waive the receipt of fees or other income for its role as service provider without consulting with APRA.

Offering advice

3. An ADI may act as adviser to a SPV.

4. An ADI may offer investment advice to investors regarding securities issued by SPVs or insurance and other funds management products. It may also act as a broker in obtaining securities (and other products) on behalf of investors or market such products directly to investors. In conducting such business, there is a risk that investors may be confused as to the relationship between an ADI and the issuer of a security (or other product), and a possibility of the ADI feeling some moral or commercial obligation to investors as a result of its actions.

5. To minimise the moral risks with providing advice, an ADI should ensure that where it undertakes these activities:

(a) they are conducted with investors or the SPV on an arm’s length basis and on market terms and conditions;

(b) the decision making rests with investors or the SPV, who are aware that they are responsible for, and will bear all risks associated with, the decision taken; and

(c) policies and procedures are in place to ensure that staff (and any agents of the ADI) dealing with investors are appropriately trained and avoid misleading or confusing them concerning the risks involved or the ADI’s relationship with (or support for) the securities and products recommended or offered for sale.

6. Where an ADI makes investment decisions or purchases securities for customers or a SPV at the ADI’s own initiative or discretion, the ADI will be deemed to be acting as a “manager” and the provisions below regarding managing will apply.

Servicing

7. A funds management or securitisation scheme may involve the participation of an entity acting as a “servicer” or “servicing agent”. An ADI may undertake the role of servicing a pool of assets held by a SPV provided:

(a) there is a formal written agreement in place which specifies the services to be provided and any required standards of performance. These standards should be reasonable and in accordance with normal market practice. There should be no recourse to the ADI beyond the fixed contractual obligations so specified. The agreement should not obligate an ADI to the provision of any other services (e.g. funding of payments to investors, recompense investors for losses, absorb losses on assets or purchase of securities, etc);

(b) that the ADI is able to demonstrate that the agreement is undertaken on an arm’s length basis, on market terms and conditions (including remuneration), and is subject to the ADI’s normal approval and review processes;

(c) the agreement is limited as to a specified time period (i.e. the earlier of the date on which all claims connected with the issue of securities are paid out or the ADI’s replacement as party to the agreement). A fixed termination date need not be specified provided the ADI is able, at its absolute discretion, to withdraw from its commitments at any time following a reasonable period of notice. Withdrawal must not be conditional upon the appointment of an alternative service provider. As a general rule, an ADI should be able to relinquish its role after giving 90 days notice;

(d) subject to reasonable qualifying conditions, the SPV and/or investors have the express right to select an alternative party to provide the facility;

(e) the agreement is documented in a fashion which clearly separates it from any other facility provided by the ADI. An ADI’s obligations under each facility should be stand‑alone; and

(f) the ADI’s operational systems are adequate to meet its obligations as a servicer.

8. An ADI acting as servicer should be under no obligation to remit funds to the SPV or investors until the funds are received from the underlying assets (unless otherwise provided for in terms of a separate liquidity facility). This may not preclude, subject to conditions set by APRA, the provision of very limited short‑term advances by a servicer, at its sole discretion, to cover unexpected cash shortfalls arising from delayed payments on assets.

9. A member of an ADI may receive a performance‑related payment (or benefit from any surplus income generated) for its role as servicer, in addition to its base fee, provided that the base fee is on market terms and conditions and any performance‑related payment does not commit the ADI to any additional obligations. Such payment should be recognised for profit and loss (and capital) purposes only after it has been irrevocably received.

10. Where a servicing agreement does not meet the conditions above, an ADI will be required to hold capital against the assets it is servicing as if they were held on its balance sheet.

Managing

11. Funds management and securitisation schemes usually involve an entity acting as “manager”. An ADI, in its capacity as an authorised deposit‑taker, cannot act as a manager. Subsidiaries or associates of an ADI can act as a manager, provided that the management agreement meets conditions (a)-(e) in paragraph 7 above. A member of an ADI acting as manager may also receive a performance-related payment for its role as manager, as long as the provisions described in paragraph 9 are met.

12. Where a managing agreement does not meet the conditions above, the ADI will be required to hold capital against the assets it is managing as if they were held on its balance sheet.

13. An ADI, acting as manager, may enter into a contractual undertaking to provide a limited buy‑back facility to repurchase securities from investors provided:

(a) any obligation to buy back is specified in the management agreement and limitations on the entity’s obligations are prominently and clearly noted in the documentation associated with the issue of the securities;

(b) the obligation to buy back is entered into only as part of a management facility provided by the entity. The obligation should terminate immediately if the entity ceases to act as manager; and

(c) the undertaking of the entity to buy back is capped at a set Australian dollar amount.

14. A buy‑back facility should be treated as a credit enhancement (refer Guidance Note AGN 120.2 Credit Enhancement (AGN 120.2)). The ADI should ensure the potential effect of buy‑backs is considered in its liquidity management plans.

15. The above provisions do not apply where the entity is required by statute to provide a buy-back facility or exercises a completely discretionary right to buy back investments in special circumstances (e.g. such as personal hardship). Investors should, however, be put on notice that any buy-backs under these circumstances need to be undertaken at market prices and may invoke interest penalties. It is expected that over the life of a funds management or securitisation scheme the total value of such buy-backs would not be substantial relative to the amount of securities on issue.

Treasury operations

16. An ADI may enter into treasury (market‑related) transactions with a SPV provided such transactions are undertaken in accordance with the following conditions:

(a) the ADI is not obliged to enter into any transactions with the SPV;

(b) the ADI is able to demonstrate that the transactions are conducted on an arm’s length basis and are subject to the ADI’s normal approval and review processes. Transactions should be undertaken on market terms and conditions (including price/fee). Where a market price is impossible to determine, the ADI should seek APRA’s approval before undertaking the transaction;

(c) the transactions involve specified principal amounts and cover specified time periods;

(d) the SPV has the express right to select an alternative party with whom to deal before entering into any transaction (subject to any contractual arrangements/qualifying conditions);

(e) the ADI has reasonably satisfied itself that the counterparty has the power to undertake the transactions, and the counterparty could reasonably be expected to be aware of the risks that it might face from the transaction; and

(f) the transactions do not involve the acquisition of securities issued or assets held (including a beneficial interest in assets held) by a SPV, except as permitted by Guidance Note AGN 120.3 Purchase and Supply of Assets (including Securities Issued by Special Purpose Vehicles).

17. A transaction can cover an undetermined amount provided the contract fixes a maximum principal amount, e.g. a swap contract covering the amount of mortgage loans held at any point in time is permissible provided the amount of the potential advances in relation to the underlying mortgages is capped. Transactions that involve mismatches of more than 90 days between the payment by the ADI to, and subsequent receipt from, the SPV of underlying cashflows, should receive the prior approval of APRA.

18. Where the conditions in paragraphs 16 and 17 are satisfied, an ADI may treat treasury transactions involving SPVs as market-related transactions for the purposes of Prudential Standard APS 112 Capital Adequacy: Credit Risk. Where these conditions are not met, the transaction should be regarded as a credit enhancement, and assessed in accordance with AGN 120.2.