April 04 2001
Securitizing receivables involves the sale of a pool of receivables to a dedicated special purpose vehicle (SPV). The purchase is financed by the issuance of securities. Repayment of principal and payment of interest due under the securities are made with the cash flow generated by the assigned receivables. The word 'securitization' describes this transformation of receivables into securities.
French legislation on securitization was implemented by the act of December 23 1988 and the decree of March 9 1989. This legislation created the Fonds Commun de Créances (FCC), SPVs exclusively dedicated to securitization transactions. The FCC does not have a legal personality but is characterized as a co-ownership of receivables among unit holders. An FCC is created by two founders. The management company is a commercial company licensed by the Commission des Opérations de Bourse. It is responsible for managing the FCC and represents it in its dealings with third parties and in any legal proceedings, both as plaintiff and as defendant.
The other founder is the depositary, which is a credit institution with its registered office in France. It is responsible for the custody of the FCC's assets, and for monitoring compliance of the management company's decisions with the legislation and the FCC regulations.
The transfer of receivables to an FCC is one of the easiest ways to assign receivables under French law. It is effected by the originator delivering an acte de cession de créances to the management company of the FCC. The receivables are identified on this document and the transfer becomes effective on the date indicated on the document at the time of its delivery. There is no need to notify the assigned debtors. Such delivery automatically effects the transfer to the FCC of the security interests attached to the receivables without the need for further formalities. In accordance with the legislation, this means of transfer gives rise to a 'true sale', and therefore permits off-balance sheet treatment for the originator, without the risk that a court may recharacterize the transfer as a loan.
In addition, the FCC is a tax-transparent vehicle (exempt from income tax or indirect taxation such as value added tax (VAT) or registration duties) and is recognized by rating agencies as a bankruptcy remote vehicle.
During the last two years French legislation has been amended several times in order to make the FCC an ideal vehicle for the securitization of trade receivables.
Until 1998 only credit institutions, the Caisse des Dépôts et Consignations and insurance companies were allowed to assign their receivables to an FCC. Before then companies that wished to securitize their receivables had to either use offshore securitization SPVs or transfer their receivables to a credit institution. This in turn securitized the receivables in accordance with the FCC legislation. A 1998 amendment now allows companies to securitize their receivables directly to an FCC.
Today, FCCs may purchase future receivables arising out of an agreement where the amount and maturity are unspecified (eg, future revenues from a determined client). FCCs may also purchase receivables that are doubtful or subject to litigation, with the limitation that in order to protect investors, the units issued by such FCCs may only be subscribed or held by the seller, non-French resident investors or qualified investors.
Further, an FCC may acquire receivables and issue securities in foreign currencies, thus preparing FCCs for the introduction of the euro and enlarging the scope of possible originators and investors. If the securities are in foreign currency, the FCC is allowed to enter into any type of hedging transaction (eg, swaps and options) to match the cash flow received by the FCC under the receivables with the amounts to be paid under the securities.
The 1996 and 1997 amendments have also contributed to the development of the securitization of trade receivables. These amendments authorize the FCC to be reloaded, that is, to purchase new receivables after its constitution, and to issue securities.
Most trade receivables have a short maturity. However, an FCC may purchase new receivables during its lifetime to maintain its pool of outstanding receivables. Such purchases are financed either by the collections received from the maturity of the assigned receivables, or by the issuance of new securities by the FCC. This avoids the costs involved in forming a new FCC.
The only condition is that neither purchases of new receivables nor issuances of new securities can result in a deterioration of the level of security granted to the original investors. Thus, if the securities are rated, new securities may only be issued if this does not negatively affect the rating of the outstanding securities.
Since 1998 the originator is no longer required to notify the assigned debtors of the transfer of their receivables to an FCC, as such notice appears to be detrimental to the commercial relationship between the originator and the assigned debtors.
The legislation initially provided that the debtor be informed by a simple letter. There were no sanctions if this did not occur. This provision proved to be unsuitable for massive transfers of receivables. Further, such a letter is not justified by any compulsory rule of French law, since other means of transfer (eg, subrogation or the cession Dailly) do not require such notification.
Before June 1999 the FCC was not entitled to assign its receivables unless it was liquidated. Only then was it entitled to assign all of its receivables. This prohibition raised two issues.
Firstly, the collection of receivables subject to litigation frequently involves a transaction between the creditor and a guarantor or a partner of the debtor, who will repurchase the receivables for a fraction of their price and collect them from the debtors directly. The fact that an FCC was not allowed to assign defaulted receivables prevented it from entering into such transactions, leaving the FCC in a less favourable position than other creditors.
Secondly, the VAT relating to unrecoverable receivables can only be recovered from the French Treasury by the original creditor of such receivables, provided that this creditor is still the owner of the receivables. Therefore, the original creditor must be entitled to repurchase unrecoverable receivables to recover the related VAT.
An amendment to the FCC legislation dated June 25 1999 now provides that an FCC is allowed to assign, at any time, any receivable that matures or for which the maturity has been accelerated.
Many securitization professionals wanted to create umbrella FCCs similar to umbrella mutual funds authorized in France in 1998.
Investors generally penalize new issuers or new financial products entering the markets by imposing additional margins reflecting the innovation factor. Every newly created FCC that is considered as a new issuer may be penalized by refinancing costs.
The act of June 25 1999 expressly permits FCCs to contain different classes of receivables, just like umbrella mutual funds. Each receivables class is segregated to avoid the risk of having a class of receivables affected by defaulted receivables of another class, and is also financed by a specific class of securities.
Having an umbrella FCC containing various classes of similar securities should
allow a reduction of the additional margins imposed on new products or issuers,
as well as an economy of scale for FCCs.
FCCs may now directly purchase trade receivables from companies. The latter now have direct access to off-balance sheet refinancing, avoiding the costs resulting from the interference of an intermediary and at optimal market conditions provided that appropriate credit enhancement has been set up at the FCC level. Although the FCC appears to be the ideal vehicle for the securitization of trade receivables, some companies continue to prefer offshore trading.
Why go offshore?
Today, the main reasons for offshore securitization include the following:
Nonetheless, using an SPV instead of an FCC as a final issuer does not prevent the use of an FCC to purchase the receivables in the first place. Current trends favour having an FCC issue units by way of private placement. The units are then subscribed by an SPV, which in turn finances the subscription of the units by issuing financial instruments on the market. This scheme is intended to combine the advantages of both the FCC legislation (compliance with the French banking act, tax transparency, bankruptcy remoteness and 'true sale' characterization) and the issuance of financial instruments familiar to investors.
How to go offshore?
The main regulatory constraint for setting up offshore securitization transactions is the French Banking Act of January 24 1984. Pursuant to this act, any person other than a credit institution is prohibited from engaging in banking transactions on a regular basis and for consideration.
Under long-standing case law confirmed by the French Banking Commission the purchase of outstanding receivables, if done for consideration and on a regular basis, constitutes a banking transaction restricted to the monopoly of credit institutions. Violation of the banking monopoly is a criminal offence and may result in the nullification of the transaction.
However, the Banking Act specifically provides an exception to this banking monopoly. It provides that any company may engage in cash transactions (including credit transactions) with companies with which they have a capital relationship, whether direct or indirect. The capital relationship must confer effective control to one of the related entities over the others.
Therefore, a French originator is not permitted to sell its outstanding receivables, on a regular basis and for consideration, directly to an offshore vehicle that is not a related entity. In order to comply with the Banking Act, the purchaser must be either (i) a credit institution located in an EU country or (ii) an affiliated company, whether French or foreign, that will act as a conduit between the French originator and the offshore vehicle.
In this second case the conduit will transfer the receivables to the offshore SPV pursuant to the banking law of the jurisdiction of the conduit. This law is presumably less constraining than the Banking Act with respect to the sale of outstanding receivables. Tax considerations must also be taken into account in order to ensure that payment made by the French originator to the conduit and by the conduit to the SPV will not be subject to any withholding tax, or that the conduit will not be subject to corporate income tax. Usually, conduits are located in the United Kingdom, Ireland, Belgium, Netherlands or Luxembourg, and SPVs are located in either Jersey or Luxembourg.
Means of transfer
The choice of the conduit determines the means of transfer of the receivables.
Unless the securitization involves a limited number of large claims, the common means of transfer governed by Articles 1689 of the French Civil Code will be avoided since, to be binding on third parties, it requires that either a bailiff has given notice of the transfer to the assigned debtor, or the transfer has been accepted by the debtor in a notarized deed. This process is costly and time consuming.
If the conduit is an entity of the group of the originator, the receivables
will be transferred by way of subrogation. In that case, the conduit will be
subrogated in the rights of the originator up to the amount actually paid for
the receivables, against delivery of a subrogation receipt to the conduit. Subrogation
operates a full transfer, binding on third parties from the payment date, without
the need of any notice to the assigned debtors. The only constraint is that
the transferee will ultimately be entitled only to the rights on the receivables
up to the amount paid to the transferor (ie, any discount which reduces such
rights proportionately with respect to the receivables). However, this is not
a major constraint since the conduit purchases the receivables in order to transfer
them to the SPV and any discount in the purchase price may be effected at the
If the conduit is an EU credit institution, the receivables will be transferred either by way of subrogation or by way of cession Dailly. The assignment under the Dailly Act of January 2 1981, is straightforward. The transferor completes and signs a transfer form very similar to an acte de cession de créances, describing the amount and type of receivables to be transferred, and delivers it to the transferee. From the date set forth on the transfer form by the transferee, the transfer of receivables is binding on both the transferor and the transferee, as well as third parties. No notice to the debtors is required to complete the transfer. The only constraint is that the debtors must be either a company or an individual acting in the course of its business.
Receivables transferred to the conduit must then be transferred to the SPV
in accordance with the type of transfer chosen by the parties. Care should be
taken concerning this second transfer to verify that it will qualify under French
law as a means of transfer that does not require any notification to be binding
on third parties (ie, it meets all the conditions of validity of the French
Traditional bank financings may present a high degree of risk (eg, the brutal acceleration of the facility if the borrower meets financial difficulties). It may also be expensive for the borrower as the financial conditions applicable to such financings depend only on its credit rating. This is why the securitization of trade receivables is used more and more as a refinancing alternative for companies. It allows them to have direct access to an off-balance sheet refinancing, thus avoiding the intermediation costs and offering optimal market conditions. These market conditions are a result of the de-linkage between the rating of both the borrower and the securities (which have benefited from credit enhancement). Today, domestic securitization and offshore securitization need not be opposed. In most cases FCCs issue units subscribed by multi-seller conduits, therefore optimizing the advantages of both structures.
For further information on this topic please contact Xavier de Kergommeaux or Gilles Saint Marc at Gide Loyrette Nouel by telephone (+33 1 40 75 29 34) or by fax (+33 1 40 75 37 62) or by e-mail (firstname.lastname@example.org).
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