The goal of this White Paper is to supply basic steerage to transaction members and practitioners of their consideration of the appliance of the provisions of Part 15G of the Securities Trade Act of 1934, as amended (the “Trade Act”), as added by part 941 of the Dodd-Frank Wall Avenue Reform and Client Safety Act (“Dodd-Frank”) and the federal interagency credit score danger retention guidelines promulgated thereunder, codified at 17 C.F.R. Half 246 (the “CRR Guidelines”), to a typical issuance of securities by a newly shaped particular goal car that owns or will personal, amongst different issues, a portfolio of marine containers and associated leases which can be entered into instantly or not directly by the use of a number of administration agreements (a “Structured MCP Transaction”). This White Paper was ready by Watson Farley & Williams LLP (“WFW”) however doesn’t replicate the view of WFW within the context of any explicit transaction. The steerage set forth on this White Paper is for informational functions solely and is topic to vary in gentle of future federal interagency choices deciphering the CRR Guidelines or relevant legislative or judicial motion. Neither this publication nor the regulation agency that authored it are rendering authorized or different skilled recommendation or opinions on particular information or issues, nor does the distribution of this publication to any particular person represent the institution of an attorney-client relationship.
1. INTRODUCTION
The CRR Guidelines require every securitizer of “asset-backed securities” (as such time period is outlined in Part 3(a)(79) of the Trade Act, an “Trade Act ABS”) to retain an financial curiosity in a portion of the credit score danger for all property transferred, bought or in any other case conveyed to a 3rd celebration by such securitizer by the issuance of asset-backed securities. The CRR Guidelines got here into impact on December 24, 2016 for all lessons of asset-backed securities (apart from these collateralized by residential mortgages, which took impact from December 2015). Because the CRR Guidelines solely apply to Trade Act ABS, the important thing consideration is whether or not a typical Structured MCP Transaction constitutes an issuance of:
“a fixed-income or different safety collateralized by any kind of self-liquidating monetary asset (together with a mortgage, a lease, a mortgage, or a secured or unsecured receivable) that permits the holder of the safety to obtain funds that rely totally on money movement from the asset,…”.¹ (emphasis added)
2. ANATOMY OF A TYPICAL STRUCTURED MCP TRANSACTION
The sponsor of a Structured MCP Transaction (the “Sponsor”) is usually both (a) a container leasing firm whose major enterprise is to personal, lease and handle a portfolio of containers for itself (in addition to handle portfolios of containers owned by different unaffiliated third events (a “Lease Supervisor“) or (b) an entity that providers a portfolio of containers owned by different group associates (a “Servicer”) which can be leased to completely different lessees by a number of Lease Managers. The related portfolio(s) of containers, alongside any related leases and the related administration agreements with the Lease Managers (the “Lease Administration Agreements”), are then bought by the Sponsor to a newly shaped particular goal car (the “Issuer”). The Issuer itself is often both an entirely owned subsidiary of the Sponsor or an orphan particular goal car owned fully by a charitable or goal belief.
With a view to purchase the portfolio of containers, the Issuer will get hold of finance by issuing a number of lessons of debt securities and, in some current circumstances, promoting some or all of its residual (or fairness) pursuits to a third-party purchaser, within the type of atypical shares within the Issuer or a revenue taking part observe (e.g., an E observe). The inclusion of the sale of fairness pursuits (or an E observe) to a third-party implies that the purchaser will typically, akin to the due diligence a purchaser would carry out in reference to the acquisition of a goal firm, carry out due diligence on the Sponsor, the vendor (if completely different), the Lease Supervisor(s) and their respective related associates, in addition to on the containers that are owned or to be bought by the Issuer and any related Lease Administration Settlement(s) pursuant to which lease proceeds are collected.
The Issuer is mostly managed by a Board of Administrators (the “Board”) which engages third events to handle its enterprise and supply extra administrative providers to the Issuer and its Board. The Lease Supervisor(s) sometimes handle the leasing of the containers on behalf of the Issuer pursuant to a number of Lease Administration Agreements and are accountable for, amongst different issues, gathering lease leases, sale proceeds and complete loss proceeds, imposing the phrases of the lease agreements and remarketing the containers on the market and/or re-lease following the expiry or termination of the lease. In a Servicer-sponsored transaction, the Servicer will enter right into a servicing settlement with the Issuer underneath which the Servicer will monitor the efficiency of the Lease Managers on behalf of the Issuer. The Sponsor will even be required to interact a number of alternative Lease Managers upon the resignation or termination of an current Lease Supervisor. The Sponsor can be accountable for getting ready (or procuring that the Lease Managers put together) monetary reporting with respect to the container portfolio and also will present different monetary administration and money administration providers. The Board of the Issuer retains rights in respect of sure particular actions, together with the winding up of the Issuer.
As soon as acquired, the containers are used to generate earnings for the Issuer to pay working prices and bills, service its debt securities and make fairness distributions. The earnings stems from (a) lease and associated funds underneath leases of the containers to varied lessees (that are remitted to the Issuer from the Lease Supervisor(s) pursuant to the Lease Administration Settlement(s)) and (b) the proceeds of the sale or different last disposition of the containers themselves.
Structured MCP Transactions are structured such that the anticipated earnings from the preliminary container leases might be insufficient to repay the debt securities and that the estimated current worth of such money flows is comfortably lower than the acquisition value of the portfolio by the Issuer (topic to the Finance Lease Proviso mentioned beneath). With a view to generate enough earnings to totally repay the debt securities, every container will must be bought, re-leased a number of occasions over the lifetime of a Structured MCP Transaction or scrapped. Due to this fact, it’s important to the efficiency of a Structured MCP Transaction that the Issuer (by the related Sponsor, Lease Supervisor, the Issuer’s Board and different service suppliers) remarket off-lease containers on the market or lease as applicable, in addition to handle storage prices, upkeep bills, repositioning prices and transition prices.
3. DEFINITION OF ASSET-BACKED SECURITY
(a) SEC Steering
The Securities and Trade Fee (the “SEC”) has not expressly interpreted the definition of Trade Act ABS. It has, nonetheless, in Regulation AB that was codified in 2005², outlined sure ‘key ideas’ that it considers are inherent in any “asset-backed safety” (in such generic type, an “ABS”); such ideas included “a basic absence of energetic pool administration” and an emphasis on “the self-liquidating nature of pool property that by their very own phrases convert into money.”³.
Earlier than the implementation of Regulation AB, securities backed by property which required constructive motion to generate earnings (for instance, the sale of non-performing property and bodily property) had been usually thought to not represent an ABS underneath the then current regimes associated to registration, disclosure and reporting for “asset backed securities”. As a part of the amendments being made to Type S-3 in 1992, the SEC initially adopted a definition of “asset-backed safety” (the “pre-2005 ABS definition”) overlaying securities that had been “primarily serviced by the money flows of a discrete pool of receivables or different monetary property, both mounted or revolving, that by their phrases convert into money inside a finite time interval plus any rights or different property designed to guarantee the servicing or well timed distribution of proceeds to the safety holders”.
Then, in 2005, the SEC codified the pre-2005 regime in respect of “asset-backed securities” in Regulation AB and expressed that its pre-2005 ABS definition would must be amended if it was supposed to seize lease-backed ABS the place it was anticipated that a part of the money flows to repay the securities would come from the disposal of the bodily asset underlying the lease (as these didn’t fall inside the SEC’s then current ‘core ideas’). The end result of this codification was that the ‘core ideas’ from the pre-2005 ABS definition remained in place with expansions being made to seize lease-backed securities inside the registration, disclosure and reporting necessities for asset-backed securities underneath the Securities Act and the Trade Act (the “Regulation AB definition”).⁴ You will need to observe that the SEC’s Regulation AB definition was not adopted in Part 15G of the Trade Act and the CRR Guidelines, which as a substitute makes use of a definition which adheres way more carefully to the pre-2005 ABS definition (that is mentioned additional beneath).
When increasing upon the definition of “asset-backed securities” in 2005, the SEC clarified that such enlargement was a particular lodging to the pre-2005 ABS definition which was particularly designed to seize such lease-backed ABS inside the remit of the Regulation AB regime.⁵ Importantly, the SEC was additionally clear in that the change didn’t characterize a shift in its elementary perception as to what kinds of securities ought to represent an “asset-backed safety”. Moderately, by increasing the definition for the needs of Regulation AB, the SEC acknowledged that the inclusion of any important quantity of residual worth in a securitization represented a deviation in one of many core ideas of the that means of an asset-backed safety, explaining on the time:
“Nonetheless, as we defined within the Proposing Launch, although we’re recognizing the expansion in lease-backed ABS that embrace securitizations of residual worth, such securitizations are topic to extra components that aren’t current in securitizations backed solely by monetary property that convert into money. Residual worth is usually decided on the inception of a lease contract and represents an estimate of the leased property’s resale worth on the finish of the lease. Assumptions and modelling are obligatory to find out the quantity of the residual worth. As well as, the transaction shouldn’t be merely depending on the servicing and amortization of the pool property, but in addition on the potential and efficiency of the celebration that might be used to transform the bodily property into money and thus understand the residual values.
The upper the proportion of money flows which can be to come back from residual values, the extra vital these different components develop into and the much less the transaction resembles a standard securitization of monetary property for which our regime for asset-backed securities is designed. Though some commenters didn’t consider we must always have any limits on residual values, we proceed to consider, as mentioned above, that the core precept that an asset-backed safety must be primarily serviced by monetary property that by their phrases convert into money must be retained. On the identical time, we consider an outlined restricted exception to this basic precept is suitable and constant for entry to the alternate regulatory regime for sure lease-backed ABS.” (2005 ABS Adopting Launch)
Additional to this, the SEC sought to mitigate any adversarial results of this deviation from this core precept:
“As we defined within the Proposing Launch, we’re addressing considerations with the deviation from the core precept in two principal methods. First, we’re adopting disclosures… on how residual values are estimated and derived, statistical data on historic realization charges and disclosure of the way and course of by which residual values might be realized, together with disclosure concerning the entity that can convert the residual values into money. Second, we’re establishing limits on the proportion of the securitized pool stability attributable to residual values as a way to be thought-about an “asset-backed safety.” We consider these modifications will increase eligibility of lease-backed transactions for shelf registration and appropriately allow lease-backed transactions underneath our new guidelines whereas persevering with to use the core ideas underlying the definition of “asset- backed safety.” (2005 ABS Adopting Launch)
The SEC has additionally thought-about the that means of an “asset-backed safety” in contexts exterior of Regulation AB definition and the pre-2005 ABS definition. The SEC additionally defines “eligible property”⁶ inside the that means of Rule 3a-7 of the Funding Firm Act of 1940, as amended (the “40 Act definition”), which is mostly thought-about as ‘functionally equal’ to the pre-2005 ABS definition.⁷
Though Dodd-Frank didn’t undertake the pre-2005 definition or the ’40 Act definition,⁸ it’s nonetheless analogous to the definition of Trade Act ABS. In all circumstances (a) the first property collateralizing the relevant securities have to be “self-liquidating” (typically referred to by the SEC as “convert[ing] into money inside a finite time interval”⁹) and (b) these definitions don’t expressly embrace securities backed by non-self-liquidating leases (opposite to the Regulation AB definition).
Notably, the ’40 Act definition has not been amended according to the Regulation AB definition. As such, asset-backed securities that predominantly depend upon the residual worth of the leased property for reimbursement sometimes fall exterior of the ’40 Act definition. This additional displays the intention to exclude sure asset-backed securities that exhibit traits that don’t accord with the core ideas from the definition of Trade Act ABS. As acknowledged by the American Bar Affiliation in its November 2011 response to the SEC’s discover of proposed rulemaking concerning Rule 3a-7:
“The present definition of “eligible property” in Rule 3a-7 limits the power to execute sure lease securitizations. This definition covers solely monetary property that “by their phrases convert into money inside a finite time interval.” Nearly all auto leases, and a good portion of apparatus leases, allow the lessee to return the car or leased tools upon lease termination in lieu of buying that property. The residual worth of the auto or tools that’s realized upon liquidation of the returned auto or tools is a crucial a part of the securitization worth of the leasing association.
This residual worth, nonetheless, doesn’t at the moment fall inside the definition of “eligible asset,” as a result of such residual worth shouldn’t be itself a monetary asset that “convert[s] into money inside a finite time interval.”
Accordingly, we consider that securities which have a fabric dependence on energetic administration of the underlying bodily asset to generate earnings and make funds (together with the re-leasing, sale or different disposition of such property) fall exterior of the scope of Trade Act ABS, and due to this fact the CRR Guidelines don’t apply to such securitizations. This aligns with the remedy of most securities backed by leased property, which had been excluded from the scope of the pre-2005 ABS definition and proceed to be excluded from the ’40 Act definition right this moment.
(b) Legislative Historical past
The legislative historical past additional illustrates the intentional variations between (i) the Trade Act ABS definition and the ’40 Act definition and (ii) the Regulation AB definition. The ultimate Home Invoice (H.R. 4173) (Dodd Frank) initially proposed utilizing the Regulation AB definition, which might have established a “vibrant line” check of larger (or much less) than 50% of residual worth,¹⁰ and undoubtedly captured lease-backed ABS inside the scope of an “asset-backed safety”. This was, nonetheless, rejected by the Senate in favour of the definition of Trade Act ABS, which doesn’t embrace language that may expressly increase its that means to incorporate lease-backed ABS to the extent depending on the sale (or different disposition) of the leased asset for reimbursement. This, taken along with the then prevailing interpretation of the pre-2005 definition, the Regulation AB definition and the ’40 Act definition and the SEC’s statements on the traits of an asset-backed safety in these contexts, leads us to consider that the CRR Guidelines had been drafted to purposefully exclude from the definition of Trade Act ABS any transaction involving a non-self-liquidating lease-backed ABS.
4. APPLICATION OF DEFINITION TO STRUCTURED MCP TRANSACTION
(a) Are Belongings in a Structured MCP Transaction Self-Liquidating Monetary Belongings?
When contemplating what constitutes a “monetary asset”, the SEC provides no interpretation or steerage which might point out {that a} container, or one other related bodily asset, constitutes a monetary asset. On a plain studying of the phrases, a conclusion could be drawn {that a} container shouldn’t be a monetary asset. On this foundation, it follows that the presence of container leases must proof, in accordance with the necessities of the Trade Act ABS, that the “property” encompass self-liquidating monetary property “that enable[s] the holder of the safety to obtain funds that rely totally on money movement from the asset”.
Topic to the Finance Lease Proviso (mentioned beneath), we don’t consider that this is applicable to Structured MCP Transactions, for the explanations set out within the following paragraphs.
Though neither Part 15G of the Trade Act nor the related CRR Guidelines outline the phrases “self-liquidating” and “primarily”, the time period “self-liquidating” has been (a) utilized by the SEC to explain an asset that “converts into money funds inside a finite time interval”¹¹ and (b) outlined by the courts since 1937:
“The mechanism is known as a self-liquidating mortgage as a result of when the banks buy the notes, additionally they buy the appropriate to obtain curiosity funds earlier than the notes mature. Thus, the cash expended to purchase a observe might be repaid by the interim curiosity funds and the ultimate principal fee.” United States v. Esogbue, 1996 U.S. App.
LEXIS 45265, No. 94-20615 (fifth Cir. Feb. 12, 1996).
“A self-liquidating undertaking could also be outlined as one whereby the revenues obtained are enough to pay the bonded debt and curiosity expenses over a time frame.” Kelley v. Earle, 325 Pa. 337, 345 (Pa. 1937).
Based mostly on the foregoing, the commonly accepted authorized that means of “self-liquidating” refers to an asset that can independently generate earnings enough to pay again its unique value.
To find out whether or not or not a Structured MCP Transaction falls inside the that means of “self-liquidating”, it’s essential to analyse the contracted money flows from the preliminary leases and the breakdown of the container portfolio by lease kind.
Within the marine container leasing market, container leasing corporations sometimes lease their containers underneath three completely different lease sorts: (i) a long-term working lease underneath which the lessee is required to return the container to the lessor on the expiry of the lease time period, with a time period that ranges between three to seven years (a “Lengthy-Time period Lease”); (ii) a short-term working lease, with a time period that ranges between 12 months to 3 years (a “Quick-Time period Lease”); and (iii) a finance lease underneath which the lessee is granted a purchase order choice for lower than the market worth of the asset and/or is in any other case economically incentivised to amass title to the container on the expiry of the lease (a “Finance Lease”).
Assuming {that a} lessee underneath a Finance Lease workout routines its buy choice, a Finance Lease will fall inside the usually accepted authorized that means of “self-liquidating”. Due to this fact, we consider {that a} portfolio consisting primarily of containers which can be topic to Finance Leases would doubtless be topic to the CRR Guidelines (the “Finance Lease Proviso”).
Nonetheless, a typical container portfolio for a Structured MCP Transaction will comprise solely a small and insignificant portion of containers topic to Finance Leases and as a substitute will principally comprise Lengthy-Time period Leases and Quick-Time period Leases. The web current worth of the leases underneath such Lengthy-Time period Leases and Quick-Time period Leases might be considerably decrease than the acquisition value of the corresponding containers. Our view is that Structured MCP Transactions comprising such portfolios wouldn’t be topic to the CRR Guidelines as a result of nearly all of the container leases in such a portfolio (i.e. these not topic to a finance lease) can’t be thought-about to be “self-liquidating”. Firstly, the unique value of the containers (and preliminary leases) can’t be repaid by the money flows generated solely from the preliminary container leases. Secondly, neither a container Lengthy-Time period Lease nor a container Quick Time period Lease “convert into money” as a result of the Issuer expects to retake possession of the container upon the expiry of such lease. As such, the extent of energetic administration required for these kind of portfolios exemplifies their dependence on extra money flows which can be contingent on profitable enterprise actions sooner or later, which doesn’t accord with the that means of “self-liquidating”.
(b) Does Reimbursement Rely Totally on Money Circulation from Self-Liquidating Monetary Belongings?
As described in larger element above, within the case of a typical Structured MCP Transaction (and for the needs of this part, ignoring the Finance Lease Proviso), reimbursement of the Issuer’s debt by way of the technology of earnings from the securitized “monetary property” (a defining attribute of ABS) is determined by the energetic administration of such “monetary property” and the power to generate enough working earnings because of the profitable operation of its enterprise.
As famous above, a defining function of ABS is the power of the “monetary property” topic to the securitization to generate enough cashflow to repay the Issuer’s debt. Nonetheless, in a typical Structured MCP Transaction, the unique acquisition value of the containers (and preliminary leases) can’t be repaid by the inadequate money flows from the preliminary leases. Moreover, such money flows from the preliminary leases are considerably lower than the quantity required to repay the Issuer’s securities. The Issuer should even have enough monetary sources out there to pay out-of-pocket bills incurred in relation to the redelivery, refurbishing and repositioning any container for a brand new lease or sale as this requires the Lease Supervisor and/or Servicer, as relevant, to interact in remarketing, upkeep and different container administration experience. Regardless as as to if the container is on- or off-lease, the prices, sources and time concerned listed below are incongruous with the principal situation of Trade Act ABS in that the reimbursement of the securities doesn’t rely totally on money flows generated from a pool of self-liquidating monetary property.
Allow us to suppose that container leases had been characterised individually from the worth of the bodily container as “self-liquidating monetary property” in a typical Structured MCP Transaction. In that case, it could nonetheless be inaccurate to explain reimbursement of the securities as relying totally on the money flows from the preliminary leases. As an alternative, the final word reimbursement of the securities nonetheless is determined by the re-leasing and disposal of the bodily containers, which requires energetic administration from the Lease Supervisor or the Servicer.
5. CONCLUSION
Regardless of the shortage of an interpretation of the definition of Trade Act ABS from the SEC and different related federal businesses, the ideas mentioned by the SEC within the context of the pre-2005 ABS definition, the Regulation AB definition and the ’40 Act definition ought to equally apply to an evaluation of the securities in a Structured MCP Transaction. Additional, the “property” in a typical Structured MCP Transaction (topic to the Finance Lease Proviso) shouldn’t be thought-about self-liquidating monetary property. For that reason (and people mentioned additional above), we consider that, if correctly interpreted and utilized, the definition of Trade Act ABS wouldn’t (topic to the Finance Lease Proviso) embrace a Structured MCP Transaction and due to this fact such a Structured MCP Transaction wouldn’t be topic to the CRR Guidelines.
Supply: Watson Farley & Williams
