Asset-backed Securities: Securitisation and Structured Products

Author: | Published: 2 Apr 2003
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Market overview

There was strong growth in Germany's asset-backed market in 2002. The highlights included:

  • a number of new entrants to the asset-backed commercial paper market and a 47% increase in the amount of commercial paper outstanding - a rate in excess of the average growth of the European market;
  • a continuing prevalence of synthetic over true sale securitisations with the PROVIDE and PROMISE platforms sponsored by the state owned KfW (Kreditanstalt für Wiederaufbau) accounting for more than half the entire transaction volume in Germany; and
  • regulatory clarification on the ability of insurance companies and pension funds to invest in credit-linked structured products.

Most commentators expect continued growth during the remainder of 2003, driven in part by the need of Germany's banking sector to free up regulatory capital in anticipation of the Basel II Accord. The current squeeze on bank lending as a result of the general economic situation and the impending withdrawal of the state guarantee of the public sector Landesbanks will also be a factor.

The main determinant of growth will be the development of the legal, tax and accounting framework in Germany which, despite some evidence of a readiness on the part of the government to encourage securitisation, still hampers the asset-backed market, and true sale securitisation in particular.

Legal, tax and accounting issues

Trade tax
The position in relation to trade tax is an obstacle to true sale securitisation in Germany. Local tax authorities collect trade tax from business enterprises with a permanent establishment in their area. It is essentially a tax on profit, but for this purpose 50% of interest paid by a business enterprise on its long-term liabilities is deemed to be part of its taxable income. This adjustment means that a special purpose vehicle (SPV) that has a minimal level of profit can nevertheless have a large potential trade tax liability. While trade tax is only an issue for SPVs with a permanent establishment in Germany, some local tax authorities argue that the servicing and monitoring of securitised receivables by a servicer based in Germany can bring the SPV onshore.

Recently, the government published draft legislation that would remove the potential trade tax liability of SPVs that are used exclusively to buy certain types of receivables, or the credit risk in such receivables, from German credit institutions. The new proposals only apply to receivables arising from the credit, bill-broking and guarantee business of a credit institution (a definition that would include, for example, both residential and commercial mortgages). If enacted, the new legislation will be a boost for true sale securitisations by credit institutions. The trade tax issue will remain for transactions involving other types of assets, such as trade receivables.

The accounting issue
Many originators require off-balance sheet treatment of securitised receivables for accounting purposes. In October 2002, the German Institute of Auditors (Institut der Wirtschaftsprüfer - IdW) released a statement (IdW RS HFA 8) on the balance sheet treatment of true sale securitisations. Briefly, off-balance sheet treatment requires:

  • a legal true sale of the assets with no restrictions on their free disposal by the SPV;
  • the absence of any obligation on the part of the originator to repurchase the assets; and
  • an effective transfer to the SPV of the credit risk relating to the assets.

Statement IdW RS HFA 8 elaborates on the concept of an effective transfer of credit risk. Where the sale involves a variable deferred purchase price, the potential range of the discount must be in line with historical default experience and must be consistent with the transfer being at fair value. Other forms of credit enhancement are permissible only if the retained credit risk does not exceed the amount that would be a fair discount.

If any of these three requirements are not fulfilled, IdW RS HFA 8 re-qualifies the sale of the assets as a secured loan granted to the originator by the SPV. The result is that the asset remains on the originator's balance sheet. In practice, IdW RS HFA 8 has made it more difficult to achieve off-balance sheet treatment, though discussions with the originator's auditors in relation to the appropriate treatment for particular structures are common.

Banking secrecy
The standard terms of business upon which banks operate in Germany contain a restriction on the disclosure of confidential information by the bank about its customer. These standard terms have been agreed between banks and, while in theory it is possible for a bank to deviate from them, this may be difficult from a commercial perspective. Moreover, the enforceability of standard terms of business is subject to the German Civil Code. It is doubtful that a contractual term purporting to permit free disclosure of information in connection with a securitisation would be upheld - at least in the context of an ordinary consumer/retail banking relationship. In practice, a German credit institution would therefore be likely to seek customer consent before embarking on a true sale securitisation of retail loans.

Regulatory capital treatment
The Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht - BaFin) has issued regulatory guidance on the capital treatment of true sale securitisations for German credit institutions. Under Circulars No.4 of 1997 and No.13 of 1998, the removal of assets from a credit institution's balance sheet for regulatory purposes as the result of the true sale transaction requires the sale of assets to be legally effective and without recourse to the seller (except in relation to warranties concerning the legal existence of the receivables). In addition, a number of further requirements have to be met. To date no express framework has been published by BaFin in relation to the capital treatment of synthetic securitisations, though Circular No.13 of 1998 requires credit institutions to consult BaFin before embarking on these transactions. However, it is understood that BaFin is now preparing a new Circular that will create guidelines for the regulatory capital treatment of synthetic securitisations. The key issues likely to be addressed include the acceptable scope of definitions in relation to credit events, materiality thresholds for the notification of credit events, the treatment of first loss tranches, substitution in the portfolio and early termination provisions. In addition, the new Circular is likely to deal with the interest sub-participation mechanic (Zinsunterbeteiligung) used in a number of German synthetic securitisations.

Legal Services Act
One welcome change in 2002 was the amendment of the Legal Services Act (Rechtsberatungsgesetz) to remove a concern that an originator of securitised receivables would require a licence to act as servicer on behalf of the SPV. The amendment does not, however, apply to third party servicers.

Transactions and structures

Term Securitisations
The most striking feature of the German term securitisation market is its dependence on synthetic as opposed to true sale structures. Essentially, a synthetic securitisation relies on the transfer of the credit risk in a receivable (usually by means of a credit default swap, credit linked note or similar product), rather than a true sale of the receivable itself. The normal motivation for synthetic securitisations is regulatory capital relief for credit institutions. The main reasons for the prevalence of synthetic structures are:

  • true sale transactions are impeded by structural problems, particularly in relation to trade tax and banking secrecy (see above); and
  • the structural weakness of synthetic transactions (ie that investors have an exposure to the originator and/or the collateral for the transaction) has been less of an issue in Germany than elsewhere (at least before the current economic recession).

Recently however, the downgrading of Pfandbriefe used as collateral for a number of German synthetic securitisations has resulted in rating downgrades in relation to the transactions themselves - a clear illustration of the additional exposure inherent in synthetic structures.

The synthetic PROVIDE and PROMISE programmes sponsored by KfW have been used by a number of credit institutions to securitise residential mortgages and loans to small and medium enterprises. A typical PROVIDE or PROMISE structure is shown below:


The structure involves:

  • a sale by KfW of credit protection to a credit institution that has originated a reference portfolio of receivables (in this example a credit default swap is used, though KfW may enter into a guarantee);
  • the purchase by KfW of equivalent credit protection from the junior and senior swap counterparties and the SPV (ie the transaction is partially funded); and
  • the issue of credit linked notes by the SPV that pass its risk to investors (losses from the reference portfolio not absorbed by the junior swap counterparty are allocated to the notes in sequential order of priority).

Notable synthetic transactions in 2002 included Promise Austria 2002 (the first time the PROMISE programme has been used for an originator outside Germany) and Nymphenburg 2002-1 - a synthetic securitisation of commercial mortgages originated not only in Germany, but also in a number of other European jurisdictions and the US.

Asset-backed commercial paper conduits
There are a number of established multi-seller asset-backed commercial paper programmes in the German market, including Dresdner's Silver Tower programme, Commerzbank's Kaiserplatz Funding and HVB's Arabella Funding. In addition, a number of Landesbanks set up new programmes in 2002.

A typical programme (as shown in the diagram on the next page) features:

  • a legal true sale of assets (in Germany typically trade receivables, loans, leases or debt securities) to a bankruptcy remote purchaser SPV;
  • the provision of credit enhancement to the purchaser SPV typically in the form of interest-rate swaps and liquidity facilities/deposits; and
  • the funding of the purchaser SPV through a finance agreement entered into by the issuer, which finances itself through the issue of euro-commercial paper or (indirectly through a Delaware subsidiary) US commercial paper.
Asset-backed commercial paper programme

Trade tax and accounting treatment are concerns for these programmes just as they would be for any other true sale structure. However, the short-term nature of commercial paper would make it relatively easy to unwind a transaction if trade tax were imposed. It also makes the programmes suitable for financing short-term assets such as trade receivables originated by corporate customers of the sponsoring banks.

Structured products programmes
Structured products (also known as repackagings) accounted for nearly 30% of the asset-backed market in Germany in 2002. Structured products programmes involve the sale of assets such as corporate bonds, Genussscheine or Pfandbriefe to an SPV, which then grants security over the assets as security for its debt obligations (generally issued in the form of medium term notes or Schuldscheine) and its obligations under an asset swap that is used to convert the cashflows from the collateral to those required by investors.

Individual series of notes or Schuldscheine issued under structured products programmes are ring-fenced (in other words the obligations of the SPV in relation to each series are limited in recourse to the assets for that series). However, while each series is economically discrete, the use of programme technology results in savings in terms of time and cost.

Many structured products are credit linked and are motivated by regulatory capital relief. From the investor side, the German market has benefited from new regulatory guidance on the ability of German insurance companies and pension funds to invest in asset-backed securities and credit-linked notes (Circular 1/2002 published by BAV - the former insurance supervisory authority which is now part of BaFin).

Whole business securitisation
Whole business securitisation involves the issue of debt in the capital markets secured on the cashflows from a business enterprise. To date, the only public transaction in Germany has been Tenovis securitisation, which closed in November 2001. Tenovis is a German provider of business communication solutions and related services that enters into long term lease and service contracts with corporate customers. The securitisation involved an SPV issuing notes and using the proceeds to make a loan to the Tenovis operating company. The loan is secured on receivables resulting from lease and service contracts and over the related lease equipment.

The performance of the servicing contracts (upon which the cashflow depends) is the responsibility of another Tenovis group company that acts as servicer. A back-up servicer has been appointed to take over in the event of the insolvency or a failure to perform on the part of the servicer. This back-up servicer has the benefit of call options over both the share capital of the servicer and its assets to enable it to do so. The servicing of the contracts was a particular concern for the rating agencies given that German law does not permit the appointment of an administrative receiver by the security trustee. This ability is seen as central to the legal analysis of whole business securitisation in the UK (by far the most fertile ground for transactions to date). Further structural innovations in connection with whole business securitisation are expected in Germany with sale and lease back transactions providing one potential model for further development.


The proposed amendments in trade tax legislation and BaFin's anticipated Circular on synthetic securitisation will help credit institutions to securitise loan portfolios. For corporates, growth in the use of asset-backed commercial paper conduits is likely to continue as banks target small and medium-sized enterprises and continue to restrict the availability of conventional bank credit. Even if the economic environment improves, this trend can be expected to continue given the Basel II Accord and the increased cost of funding faced by Landesbanks when their state guarantees are withdrawn in 2005. Further growth can be expected from new asset classes such as non-performing loans and project finance loans, and also from further whole business securitisations. There may also be further new entrants to the market both among domestic German banks and possibly other originators such as governmental agencies.

The outlook for asset-backed securities in Germany seems good. The proposed change to trade tax, as well as other reforms such as the amendment last year of the Legal Services Act, shows that there is recognition of the importance of these new financing tools. If further changes in relation to the remaining structural issues (such as trade tax in relation to securitisations by corporates, banking secrecy and accounting treatment) can be achieved, then the prospects will be even stronger.

Simmons & Simmons
Friedrich - Ebert - Anlage 49
60308 Frankfurt am Main
Tel: +49 69 90 74 54 0
Fax: +49 69 90 74 54 54