Banking (prudential standard) determination No. 6 of 2006 - Prudential Standard APS 120 - Funds Management and Securitisation
Guidance Note AGN 120.3Guidance Note AGN 120.3
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Purchase and Supply of Assets (including Securities Issued by Special Purpose Vehicles)
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.
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
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.
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.
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.
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
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.
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.
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.
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
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.
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
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.
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.
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.
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
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).
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
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:
(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.
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.
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.
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.
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.