Turkish banks, since the early 1990s, have used their offshore cash flows by entering into offshore securitization arrangements to avoiding the sovereign ceiling for Turkey and access cheaper sources of financing. We can expect to see more of these offshore financings, as well as a revival in the domestic securitization market, in light of current proposed legislative changes and the present stable economic environment.
Against this background of change, this article sets out a broad overview of the prevailing legal environment governing securitization, especially in relation to offshore securitizations. We also consider the impact of the Draft Law Amending Certain Laws Relating to Housing Finance which, among other things, will introduce a legislative framework for the issuance of mortgage securities by amending Capital Market Law No 2499 on securitization transactions.
At the time of this report the Draft Law on Housing Finance has been submitted to the Turkish Parliament for review and enactment.
The securitization market
Turkish originators, mostly Turkish banks, have securitized a wide range of assets, such as diversified payment rights, tourism receipts, export payments and credit card receivables denominated in hard currencies. Credit enhancement and political risk insurance are common structural features of these transactions.
According to the 2004 annual report of the Turkish Banking Regulation and Supervision Authority, Turkish banks raised a total of $1.3 billion in 2003 and $2.2 billion in 2004 from offshore securitizations.
The domestic securitization market, on the other hand, has been stagnant since 1995, although the enactment of the Draft Law on Housing Finance is expected to trigger a rise in domestic securitization in Turkey.
Legal framework
Domestic securitization transactions are governed by several statutes and regulations, primarily the Capital Market Law and the Communiqué Regarding the Registration of Asset Backed Securities and the Principles of Establishment and Operation of General Finance Companies Serial III No 14 of 1992. After the enactment of the Draft Law on Housing Finance the Capital Market Board will issue implementing legislation that is expected to repeal and replace the 1992 Communiqué.
There is no specific law or regulation governing offshore securitizations. Accordingly, the general provisions of Turkish law apply to offshore securitizations by a Turkish originator.
True sale
Turkish law recognizes the true sale of receivables as the assignment of existing and future receivables. A Turkish law assignment requires the execution of a written agreement.
Receivables originating from a contract may be assigned to a third party without obtaining the consent of the debtor, absent a contractual or statutory prohibition. Nevertheless, for such assignment to be directly enforceable against the debtor, the assignment should be notified to the debtor. In the absence of notice a debtor can discharge its obligation by making payment to the assignor directly. Further, it is advisable, from an evidential point of view, to obtain an acknowledgement of notice from the debtor.
Future claims are assignable under Turkish law, provided that the assigned future receivables are identified or identifiable. Accordingly, an assignment of future receivables would be valid provided that the debtor, as well as the source and amount of the receivables, are or may be sufficiently determined.
A valid assignment of receivables effects the automatic transfer of all rights ancillary thereto. Accordingly, security interests attached to the receivables assigned by the originator, such as mortgage and pledge interests, are also automatically assigned to the assignee (usually the issuing/funding vehicle). Nevertheless, to avoid possible complications in enforcement, it is advisable to amend the relevant registers and records to reflect the transfer. Independent instruments such as negotiable instruments and guarantees do not qualify as ancillary rights and need to be transferred separately.
Servicing
In principle, Turkish law would recognize a servicing arrangement between the issuer and the originator. A valid assignment of receivables would transfer the title of the originator to such receivables thereby ending any and all disposal rights of the originator. Accordingly, explicitly identifying the legal nature and scope of the relationship between the originator and the assignee in respect of servicing the assigned receivables would be useful in evidencing the intention of the parties to the securitization transaction, and help avoid possible challenges to the assignment.
Re-characterization risk
Re-characterization risk does exist. A third party may claim that the parties' real intention is to create a security interest rather than transfer title under the securitization. Contracts of this nature would qualify as simulation and would be deemed null and void under Turkish law. Re-characterization risk is, of course, greatest in a bankruptcy. The intention of the parties to transfer title to the assigned receivables outright, and not merely create a security interest, should be stated as clearly as possible to mitigate this risk.
Voidability
The Code of Execution and Bankruptcy No 2004 lists those transactions that may be voidable at the onset of bankruptcy. However these provisions are not exhaustive. The Turkish courts decide on the issue of voidability of other transactions and dispositions in accordance with the legal framework laid down in the Bankruptcy Code, on a case-by-case basis.
Subject to the conditions set forth in the Bankruptcy Code, the transactions and dispositions which may be voidable include:
- gratuitous dispositions and donations by a debtor (other than those undertaken in the ordinary course of business): these are, mainly, transactions where there is a material imbalance in the contractual consideration between the parties;
- fraudulent conveyances: these dispositions are entered into with the intention of eroding the bankrupt party's assets to hamper the collection ability of its creditors; and
- other dispositions: such as prepayments of obligations, transactions for non-cash consideration and liens granted to secure existing debt, in the absence of a previous contractual commitment.
Different hardening periods are prescribed by the Bankruptcy Code for different voidable transactions. However, the maximum statute of limitations applicable to voidable transactions is five years.
Conflict of laws
Pursuant to the Private International and Procedure Law No 2675 parties are free to determine the governing law in connection with contractual relationships involving a foreign element. Turkish courts generally confirm the validity and effectiveness of choice of law clauses, subject to the exclusive jurisdiction of the Turkish courts in relation to public order matters and mandatory provisions of Turkish law. Citizenship, residence, location of goods, services or rights and the location where the transactions is carried out should be taken into consideration in determining the existence of a foreign element. There is also precedent that the Turkish Court of Appeals can find that a contractual provision for a foreign governing law would by itself suffice in constituting a foreign element.
Accordingly, the parties to the assignment of receivables may freely determine the governing law applicable to the assignment agreement provided that the securitization involves a foreign element. It is common practice to execute a parallel agreement subject to the laws of Turkey for the sale and assignment of receivables since, the originator is a Turkish entity and so is subject to mandatory provisions of Turkish law in particular insolvency rules.
Mortgage backed securitizations
The Draft Law on Housing Finance introduces legislation that will govern domestic mortgage backed securitizations and the Capital Markets Board is expected to issue secondary legislation regarding mortgage-backed securities. Below is a brief synopsis of the proposed legislation regarding domestic mortgage backed securitizations.
Mortgage backed securities are defined as securities representing the investor's undivided beneficial ownership interest in specific housing finance receivables, the proceeds of such housing finance receivables, and the ancillary rights such as mortgages by which such housing finance receivables are secured. The requirements pertaining to the registration of mortgage backed securities with the Capital Markets Board will be regulated under secondary legislation.
Housing finance receivables include residential mortgage receivables, mortgage backed securities, mortgage covered bonds and other securities backed by housing finance receivables. Residential mortgage receivables are receivables secured by authorized residential property, that is, property that is completed and authorized for occupancy.
Mortgage backed securities may be issued in various classes with different terms and conditions relating to maturity, priority on fund pool proceeds or liquidation proceeds. Housing finance receivables that are in excess of the amounts due to the holders of the mortgage backed securities will be paid to the founder.
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Housing finance funds
Mortgage-backed securities are issued by housing finance funds. Housing finance institutions, mortgage finance institutions and certain other capital market institutions are expected to be authorized to establish housing finance funds as founders. Housing and mortgage finance institutions are new capital market institutions to be introduced by the Draft Law on Housing Finance.
Housing finance institutions will operate as liquidity providers in the primary mortgage market by virtue of financing the purchase of eligible real property. Banks, financial lease companies and consumer finance companies will be qualified to operate as housing finance institutions. Mortgage finance institutions, on the other hand, are intended to operate as liquidity providers in the secondary mortgage market, assuming a role similar to Fannie Mae in the US, mainly, purchasing housing finance receivables from housing finance institutions.
Fund pool
Housing finance funds, like mutual funds, do not have legal personality, and the nature of the investors' interest in the fund pool is characterized as fiduciary ownership. This structure was initially created for mutual funds as a means of achieving what the common law concept of trust achieves for special purpose vehicles in securitization transactions, under Turkish law.
The Turkish law concept of fiduciary ownership is not a well developed concept because fiduciary ownership is rarely used in structuring transactions in Turkey. The Draft law on Housing Finance provides that the provisions of the Turkish Code of Obligations on agency shall apply where there is no explicit provision.
The eligible assets for the fund pool are: (i) housing finance receivables, (ii) cash, short term investments, derivatives transactions (derivatives for hedging interest rate or foreign exchange risks only), and (iii) real property (property acquired via foreclosure of mortgage proceedings only).
The fund pool will be subject to various other limitations that will be prescribed by the Capital Markets Board such as restrictions on non-performing assets and limitations on delinquent assets and valuation requirements. Further, a register for the fund pool will be kept where detailed information identifying the assets in the pool shall be recorded.
Removal, replacement of assets from and addition of assets to the fund pool is possible in compliance with the requirements to be set forth by the Capital Markets Board.
Bankruptcy remoteness
The Draft Law on Housing Finance explicitly provides that until the mortgage backed securities are redeemed in full, the assets in the fund pool may not be used, encumbered or disposed or subject to injunction, attachment or collection proceedings (including collections for public receivables) for any purpose other than securing the mortgage-backed securities. In case of the bankruptcy of the founder, pending the redemption of the mortgage-backed securities, the fund pool will not be included in the estate of the bankrupt founder.
During the financial crisis of 2001 and 2004 the Banking Regulation and Supervision Agency, Savings Deposit Insurance Fund and the Capital Markets Board successfully liquidated and restructured various mutual funds owned by banking institutions taken over by the Savings Deposit Insurance Fund with full adherence to bankruptcy remoteness. In light of these precedents, the bankruptcy remoteness of housing finance funds should be properly observed.
Housing finance institutions
Housing finance institutions will act as originators in domestic mortgage-backed securitizations for housing financing provided directly to consumers. An agreement for the purchase of receivables will be executed between the housing finance institution and the housing finance fund.
An annotation will be made in the land title registry records of the mortgaged property securing the purchased receivables regarding sale and transfer of the secured housing finance receivables. The Capital Markets Board may impose requirements for the registration of the mortgage interest or ownership of the mortgaged property, in the name of the housing finance fund, with the land title registry.
Servicer
An originator may act as the servicer in respect of the receivables originating from its business. Founders may also act as servicers provided that they qualify as housing finance institutions. The Capital Markets Board may authorize other entities to act as servicers.
The terms and conditions of servicing will be set forth in a servicing agreement to be executed between the servicer and the housing finance fund. The servicer will be required to segregate the assets of the serviced housing finance fund from its own assets.
Credit enhancement
Various enhancement methods may be employed by the founder of a housing finance fund for the purpose of reducing the credit risk of the issued mortgage backed securities. Some examples of permitted credit enhancement are guarantees, letters of credit and insurance to be provided in favour of the holders of the mortgage backed securities by the founder or third persons, over collateralization and debt service reserve accounts.
Considerations
The existing housing finance system in Turkey is insubstantial, serving less than 3% of the population. Outstanding housing loans correspond to only 1.5% of GDP compared to an average of 46% in the EU and 71% in the US. The lack of a functional housing finance market in Turkey is due to the historically high inflationary environment, which was only brought under control with the implementation of the latest economic programme. Housing loans with a tenure in excess of 120 months only became available in 2005, in response to improvements in macroeconomic conditions, creating a favourable environment for rapid increases in the level of housing finance. Now housing finance loans are available up to 300 months.
Housing finance loans are denominated in Turkish Lira or foreign currencies. Floating rate interest and prepayment fees are not permissible pursuant to the Law on Consumer Protection No 4077. However, with the enactment of the Draft Law on Housing Finance, the prohibition on floating interest rates will be abolished and prepayment fees will be permissible for fixed interest rate loans, subject to a 2% cap.
Finance housing loans are extended by Turkish banks under framework loan agreements tailored to housing finance. The documentation that is requested from the consumer and the performance records for housing finance loans may vary for each bank, and it is not clear whether these records would meet the standards required for a mortgage securitization transaction. Turkish banks would eventually need to standardize their records and procedures to ensure that their housing finance portfolios meet internationally accepted standards.
Turkish banks fund their housing finance loans with deposits. This creates a maturity mismatch in the balance sheet of Turkish banks, as deposits remain as short term liabilities and housing finance loans long term assets of these banks, emphasizing the need for efficient means of hedging and achieving off-balance sheet treatment.
Eligible housing finance receivables
It is estimated that more than 50% of residential property in Turkey lacks proper licensing due to inadequate urban planning and illegal urbanization. This substantially diminishes the portfolio of eligible assets that would be available for securitization of the housing finance system in Turkey, as the Draft Law on Housing Finance explicitly provides that only housing finance loans for property having occupancy permits qualify as eligible receivables for a fund pool.
Foreclosure of mortgage proceedings
The foreclosure of mortgage proceedings are governed by the mandatory provisions of the Bankruptcy Code and these provisions may not be altered by contract. Self-help remedies are not available under Turkish law. Foreclosure is a lengthy and complicated process and can take up to three or four years.
The Draft Law on Housing Finance includes various provisions to simplify and streamline the enforcement process for mortgages including: (i) a requirement for the valuation of the relevant property by experts licensed in accordance with the capital markets legislation, (ii) the grant of the right to initiate execution proceedings in favour of the mortgagee in addition to foreclosure of mortgage proceedings, and (iii) more stringent liabilities on superfluous claims and objections against foreclosure proceedings.
These amendments aim to minimize the time delays often caused by mortgagors in foreclosure of mortgage proceedings in an effort to impede the collection efforts of the mortgagee, and would certainly improve the effective legislation on foreclosure proceedings. Nevertheless, we will need to see how the Turkish courts and execution offices implement these amendments in practice, before concluding that foreclosure of mortgage proceedings are improved.
Opportunity
The Turkish market is ready to kick-start what could become a fully-fledged housing finance market. Turkish banks are in strong competition with each other to seize the opportunity to dominate this new market. This will eventually lead to a more active secondary market, includi ng an increase in the number of securitization transactions. To eliminate any impediments to these developments it is critical that all necessary legislative initiatives are implemented in time. The Draft Law on Housing Finance and its implementing legislation must therefore, be enacted without further delay.
| Author biography |
Guniz Gokce
Gide Loyrette Nouel
Guniz Gokce: currently based in London, admitted to the New York State Bar and Izmir Bar, Turkey. Legal education: Georgetown University Law Center (Master's Degree in Finance Law, 2000, with distinction); thesis: The Suitability Liability of Online Brokerage Firms, University of Ankara, School of Law (LLB 1996), Representative of Patent and Trademarks. Practice areas: securities law, banking law, commercial and corporate law, mergers and acquisitions. Languages: Turkish and English.
Email: ggokce@gide.com |