Securitisation

Objective

To protect and promote the financial integrity and efficiency of the State-based financial institutions scheme and to ensure that depositors are adequately protected from the risks that credit unions incur in the process of financial intermediation. Towards this end, to ensure that a credit union is not exposed to undue risk as a result of involvement in the securitisation of its assets.

General Background

Since the commencement of the FI Scheme, credit unions have become more involved in the securitisation of assets. This standard, while based on the RBAs Prudential Statement dealing with Funds Management and Securitisation, focuses on the transfer of risk associated with the sale of loan assets into a securitisation scheme.

Securitisation involves the pooling of assets (or interests in assets), usually in a special purpose vehicle, funded by the issue of securities. The payment of earnings, and the return of capital, to investors hinges on the cash flows from the underlying assets in which their funds are invested.

Generally a credit unions involvement in securitisation activities is likely to be restricted to the sale to and subsequent servicing of assets in a securitisation program sponsored by an independent third party. Any credit union intending to be active in other aspects of securitisation of assets such as issuing asset backed securities on its own behalf, providing credit and liquidity support, offering other lending or treasury services, funding investor purchases of securities or securitising revolving credit facilities should first consult with its SSA. We would generally expect an SSA to discuss any approach with AFIC.

The securitisation of revolving credit facilities (eg credit cards) can create difficulties in meeting the requirements for a clean sale outlined in the standard. A credit union which plans to securitise revolving credits should discuss this issue with its SSA. It must be able to demonstrate that the retention of a sellers interest does not expose it to a disproportionate share of the credit risk on the loans transferred to the securitisation scheme.

This standard sets out the process by which a credit unions involvement in securitisation of assets will be reviewed and the basis of that review. In principle:

(a) A securitisation scheme must stand clearly separate from the credit union.

(b) Dealings between a credit union, a special purpose vehicle and investors must always be conducted at arm's length and on market terms and conditions.

(c) Any undertakings given by a credit union to a special purpose vehicle must be subject to the usual approval and control processes within the credit union.

(d) Any undertakings to a special purpose vehicle must be described clearly in the legal documentation and must be fixed as to time and amount.

(e) No impression must be given, through marketing material or otherwise, that recourse to a credit union extends beyond its contractual legal obligations.

AFIC recognises that a credit union's involvement in securitisation activities can give rise to risks, such as operational and legal risks which will be difficult to quantify. Securitisation of low risk assets could also lead to a deterioration in the average quality of assets remaining on a credit unions balance sheet. Against this background, where the level of a credit union's activities suggests that the overall level or concentration of risk within the group has become excessive relative to its capital, the SSA may, following consultation with AFIC, adjust the credit unions minimum capital ratio to better reflect the additional risk borne by the credit union.

The prudential standard establishes the framework in which a credit union can expect to participate in securitisation activities and by which an SSA (and if relevant AFIC) will review the documentation and securitisation program. Despite its detailed nature, this standard cannot encompass every aspect of a credit unions securitisation activities. Where a credit union may have plans for particular securitisation initiatives that may raise issues not covered in the standard, it should discuss them with its SSA as early as possible.

Where a particular securitisation scheme may have wide application within the industry it would be appropriate for it to be initially reviewed by AFIC, in consultation with the SSAs. Otherwise it will be subject to review by its SSA. AFICs review of a securitisation scheme will be for the purpose of assessing whether it has the potential to meet the technical requirements of the standard. If a particular credit union wishes to access the scheme, it will need to satisfy its SSA that it has adequately identified the risks arising from its participation and has adequate systems and procedures to manage the risks. In addition, the SSA will monitor its practical compliance with the standard.

The responsibility for the prudent participation of a credit union in securitisation rests with its board and management. A credit union should have in place clear strategies and board approved policies governing participation in this activity. In addition, a credit union must maintain appropriate systems to identify, measure and control risks arising from its participation in securitisation. A credit unions SSA will need to be satisfied of this before it will endorse participation in a scheme.

Specific breaches of the standard will be handled on a case-by-case basis. It is likely however that following consultation with AFIC, an SSA will require a credit union to hold capital against the full value of assets committed to a securitisation program with which it is involved.

This standard applies to all securitisation even if a special purpose vehicle or the issue of securities is not involved. It is also intended to apply to origination agreements where the loans do not cross the credit unions balance sheet. Unless otherwise indicated reference to a credit union includes any subsidiaries which exist within its consolidated group.

Securitisation

4.6.1 Disclosure

4.6.1.a To safeguard against investor confusion, a credit union must ensure that any marketing or promotion of a securitisation scheme with which it is associated does not give any impression that it stands behind the capital value or performance of the securities issued by the scheme. It must be clear to investors that the securities in which they invest do not represent deposits or other liabilities of the credit union.

4.6.2 Separation: Structuring Securitisation Schemes

4.6.2.a A central tenet of this standard on securitisation is that there is clear separation between the credit union involved and any special purpose vehicle. To this end, a credit union must not without prior approval from its SSA:

(i) Have any ownership or beneficial interest (otherwise than may arise via its equity in an SSP) in a special purpose vehicle.

(ii) Act as a manager, trustee, custodian or similar role in a securitisation scheme.

(iii) Provide any credit support, other lending, liquidity or transaction facilities (such as cheque or settlement facilities) or underwrite the issue of securities.

(iv) Have any of its directors, officers or employees on the board of a special purpose vehicle.

(v) "Control" a special purpose vehicle such that it would need to be consolidated in accordance with Australian Accounting Standards.

4.6.3 Servicing

4.6.3.a A credit union may undertake the role of "servicer" or "servicing agent" of a pool or part of a pool of assets held by a special purpose vehicle provided:

(i) There is a formal written servicing agreement in place which specifies the services to be provided and any required standards of performance. Those standards should be reasonable and in accordance with normal market practice. There should be no recourse to the credit union beyond the fixed contractual obligations specified. The servicer should be under no obligation to fund payments, absorb losses on assets, or otherwise recompense investors for losses.

(ii) The services are provided on an arm's length basis, on market terms and conditions (including remuneration), and subject to the credit union's normal approval and review processes. The servicing fee should not be subordinated, deferred or waived (without prior approval of an SSA).

(iii) The servicing agreement is limited as to a specified time period (ie the earlier of the date on which all claims connected with the issue of securities are paid out or the credit union's replacement as servicer). A fixed termination date need not be specified provided the credit union is able, at its absolute discretion, to withdraw from its commitments at any time with a reasonable period of notice.

(iv) Subject to reasonable qualifying conditions, the special purpose vehicle has the clear right to select an alternative servicer.

(v) The servicing agreement is documented in a fashion which clearly separates it from any other service provided by the credit union.

(vi) The credit union's operational systems are adequate to meet its obligations as a servicer.

4.6.3.b A credit union acting as servicer should be under no obligation to remit funds to the special purpose vehicle or investors until they are received from the underlying assets. This may not preclude, subject to conditions set by its SSA, the provision of:

(i) Very limited short-term advances by a servicer, at its sole discretion, to cover unexpected cash shortfalls arising from delayed payments on assets.

(ii) An undertaking that the interest rate charged on the currently performing loans it has sold will exceed a benchmark rate, provided the benchmark rate does not depend on the actual funding cost of the scheme.

4.6.3.c A credit union 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 credit union to any additional obligations. This payment should be recognised for profit and loss (and capital) purposes only if it has been irrevocably received.

4.6.3.d Where a servicing agreement does not meet the conditions above a credit union will be required to hold capital against the assets it is servicing as if they were held on its balance sheet.

4.6.4 Representations and Warranties

4.6.4.a Where a credit union undertakes to sell assets to a special purpose vehicle, it is customary to make representations and warranties concerning the assets. Where all of the following conditions are satisfied, a credit union will not be required to hold capital as a result of providing representations and warranties. Otherwise, it will need to hold capital against the assets to which the representations and warranties relate.

The conditions are:

(i) Any representations and warranties are provided only by way of a formal written agreement and are in accordance with market practice.

(ii) The credit union undertakes appropriate review procedures before providing or taking on any representations and warranties.

(iii) The representations and warranties refer to an existing state of facts that the credit union can verify at the time services are contracted or assets sold.

(iv) Representations or warranties are not open-ended and, in particular, do not relate to the future creditworthiness of assets or the performance of the special purpose vehicle or the securities it issues.

(v) The exercise of any representation or warranty requiring the credit union to repurchase or replace assets sold to the special purpose vehicle, or any part of them, must be undertaken within 120 days of their transfer to the vehicle and any transfer should be conducted on the same terms and conditions as the original sale. This time limit does not preclude the subsequent payment of damages by a credit union as a result of breaches of representations and warranties.

4.6.4.b Any agreement by a credit union to pay damages as a result of a notice of claim being made must be conditional on:

(i) There being documentary substantiation of the negotiation of the agreement to pay damages in good faith.

(ii) The onus of proof for a breach of a representation or warranty resting with the purchaser.

(iii) Damages being limited to the loss incurred as a result of the breach.

(iv) The written notice of claim specifying the basis for the claim.

The credit unions SSA should be notified of any instance where a credit union has agreed to pay damages arising out of any representation or warranty.

4.6.5 Supply of Assets: Clean Sale

4.6.5.a A credit union will be relieved of the need to maintain capital in support of assets which it has sold only where their transfer is clean and final, that is:

(i) beneficial ownership of the assets has been transferred (although the credit union may still retain legal ownership of the assets); and

(ii) the risks and rewards on the assets have been substantially transferred,

to the purchaser of the assets. A credit union may, however, incur risks and rewards associated with the assets as a result of providing servicing arrangements covered by this standard. Outside of these arrangements, unless otherwise approved by its SSA, the credit union should have no remaining obligation or interest in respect of the assets.

4.6.5.b All of the following conditions should be satisfied if a transfer of assets is to constitute a "clean sale":

(i) The credit union should have no residual beneficial interest in the assets (or that part which has been transferred).

(ii) The credit union should have obtained advice from external auditors and legal advisers that the risks and rewards associated with the assets (outside those retained by the credit union arising from servicing arrangements) have been transferred to the purchaser of the assets.

(iii) The loans sold should not be subject to an offset account or other contractual arrangement under which the rights of the borrower will be affected by the sale.

(iv) The purchaser should have no recourse to the selling credit union for any losses or costs incurred by the scheme (except where they result from the breach of the servicing agreement or representations and warranties covered by the standard). The selling credit union should be under no obligation to make good (in any fashion) any dilution risk on assets transferred to a special purpose vehicle.

(v) The credit union must not guarantee a level, or rate, of return to any participant in the special purpose vehicle or scheme. It should not reimburse any party for taxes or other costs arising from their participation in the scheme.

(vi) Where a credit union transfers an undrawn commitment to lend, the transfer is effected by novation or by an assignment accompanied by a formal acknowledgment by the borrower/debtor of a transfer of obligations by the credit union to the purchaser of the commitment.

(vii) The credit union receives a fixed amount of consideration for the assets no later than at the time of their transfer to the special purpose vehicle. The sale price should reflect the current value of the assets transferred. A credit union must seek prior approval from its SSA if it intends to transfer assets for a value below their book value or to provide any form of overcollateralisation.

(viii) The credit union should have no obligation to repurchase an asset (or any part of it), at any time, except where that obligation arises under a breach of its representation or warranty.

(ix) The documented terms of the transfer of the assets should specify that, if cashflows relating to a sold asset are re-scheduled or re-negotiated, the purchaser and not the selling credit union will be subject to the re-scheduled or re-negotiated terms. Similarly, where payments are routed through the credit union, the credit union may not (unless permitted under the section on servicing arrangements) remit funds to the purchaser of an asset until they are received irrevocably from the borrower.

(x) The credit union must be under no obligation to:

(a) substitute other assets for assets purchased by the special purpose vehicle except where it is permitted by section 4.6.4 on Representations and Warranties; or

(b) provide additional assets to the special purpose vehicle to maintain a "coverage ratio" of collateral to issued securities.

4.6.5.c If any of the above conditions have not been complied with, the credit union will be required to hold capital against the transferred assets as if they were held on its balance sheet.

4.6.6 Spread Accounts and Like Arrangements

4.6.6.a A credit union involved in a securitisation scheme, through the sale of assets into a special purpose vehicle, may be entitled to share in the surplus income generated over the life of the scheme or to receive payments related to the performance of the portfolio of assets sold. This may take the form of a "residual interest", "excess servicing income", a "spread account" or like arrangement.

4.6.6.b Even though it may retain some interest in the performance of assets sold, a credit union will be able to treat the transfer of assets as a "clean sale" (and avoid holding capital against those assets) under the following conditions:

(i) The credit union makes no payment, direct or indirect, to the special purpose vehicle involved in exchange for this income stream (or if a payment is made there is no carrying value in its books ie it is written off against profit and loss (and capital)).

(ii) The credit union has no right or is under no obligation as a result of its entitlement to receive this income, to repurchase any non-performing asset or otherwise cover losses on assets or losses of investors in the scheme.

(iii) The credit union is under no obligation to return the income once received.

(iv) The credit union does not recognise for profit and loss (and capital) purposes the income until irrevocably received.

4.6.7 Purchase of Securities

4.6.7.a A credit union will be permitted to purchase securities issued by any special purpose vehicle (but may not act as a market maker in them) provided:

(i) The purchases are at the sole discretion of the credit union, are acquired on an arm's length basis on market terms and conditions (including price), and are subject to the credit union's normal credit approval and review processes.

(ii) Purchases are completed within a short time period (less than one week as a guide) from the time the credit union commits to purchase the securities.

(iii) Any security holding is less than 10 per cent of the stock in the specific tranche of securities issued by the special purpose vehicle.

(iv) They do not represent subordinated securities issued by the scheme.

(v) The securities are fully performing.

4.6.7.b A credit union should have in place adequate systems and controls to ensure that it does not accumulate a disproportionate exposure (vis a vis the group's asset portfolio and capital) to securities issued by special purpose vehicles, eg large aggregate exposures arising from holdings of securities issued by associated special purpose vehicles or vehicles holding similar or related assets.

4.6.7.c A credit union should not purchase assets from any special purpose vehicle without first obtaining approval from its SSA. An exemption to this is the purchase of Prime Liquid Assets (PLA) from a special purpose vehicle in the normal course of a credit unions liquidity management or trading operations.

4.6.7.d Should an SSA come to the view that the pattern of a credit union's purchases of securities (and/or assets), or its willingness to do so, suggests that the credit union is supporting investments in a special purpose vehicle, then the credit union may be required to hold capital against the value of all securities issued by the special purpose vehicle.