Banking (prudential standard) determination No. 6 of 2006 - Prudential Standard APS 120 - Funds Management and Securitisation
Guidance Note AGN 120.4Guidance Note AGN 120.4
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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).
All references to “credit enhancement” should be read in conjunction with Guidance Note AGN 120.2 Credit Enhancement (AGN 120.2).
Liquidity facilities
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.
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]
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.
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.
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]
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.
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.
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.
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.
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
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.
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.
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.
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.
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.
An ADI may participate in a revolving underwriting facility, or an underwriting facility covering subsequent issues of securities by a SPV, where:
(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.
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.
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.
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:
(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.
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
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.
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
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.