Next month, or perhaps the month after that, a revised version of one of the most significant corporate legislative changes in the UK's history will make its final trip down the hallowed corridors of Westminster. The outcry from London's financiers at provisions in an earlier draft of the country's Enterprise Bill, considered detrimental to the UK's securitization industry, will be little more than a murmer as a new more acceptable draft receives royal assent and takes its last traditional step on the road to becoming part of the law.
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"In order to meet the high criteria set by the rating agencies you need to be able to show that you have the right to appoint an administrative receiver" |
Geoffrey Yeowart, Lovells |
It has not been an easy journey. Those people involved in the process of bringing the legislation from its white paper proposal form to that of a bill before parliament will be glad that the intense debate and argument that greeted its first publication at the end of March has finally been laid to rest.
But as the UK legislature delays that final step for a well-earned summer break, London lawyers are digesting the compromise they have worked out with the UK government and finding that all is not quite as fine as it might have seemed.
The good, the bad ...
The route to the awkward compromise on securitization began in June last year with the good intentions of a newly re-elected Labour government. The party's Enterprise for All legislative programme was first announced with much fanfare and promised a series of measures including a crackdown on cartels and, most importantly, a shift in the country's bankruptcy regime aimed at stimulating small business activity.
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"I can see a situation where you might have to put new elements into securitization transaction just to come within the carve out" |
Robin Parsons, Sidley Austin Brown & Wood |
The enterprise bill was touted as the best way to achieve the change needed in the way that companies in difficulty were dealt with in the UK. The white paper and subsequent bill put to parliament moved bankruptcy away from what some saw as an antiquated procedure to something similar to US Chapter 11 procedures. Creditors of bankrupt UK companies had traditionally been able to appoint administrative receivers to parcel out a company's assets as it was wound down. It was proposed that these companies would receive protection from creditors thus encouraging entrepeneurs to take on the risk of starting a new business.
The move was part of a gradual cultural change in UK, and indeed European, attitudes to bankruptcy. Companies in difficulty would now be helped, rather than hindered. Herbert Smith corporate specialist Richard Fleck explains. "For quite a long period of time there has been movement in this country away from the black-and-white-life-and-death situation that used to exist in UK bankruptcy to a more pragmatic environment. You only have to look at companies such as Energis and Marconi to see there is a distinct move away from the blunt instrument in bankruptcy law," he says.
The key part of the Enterprise Bill proposed that secured creditors would lose the luxury allowed to them under UK law to appoint an administrative receiver and thus retain some control over bankruptcy proceedings. Because so many UK securitization structures had been based on the ability to appoint a receiver the move was anathema as far as London's securitization specialists were concerned.
"The original White Paper proposal would have reduced the level of control and could have led to an increase in risk," says Lovells partner Geoffrey Yeowart. "In order to meet the high criteria set by the rating agencies you need to be able to show that you have the right to appoint an administrative receiver."
Yeowart chaired the banking-law sub-committee of the City of London Law Society, which for nine months pressed the government's Department of Trade and Industry (DTI) to make some amendments. In particular the committee wanted the bill to allow a holder of a charge over all or the majority of a company's assets to choose whether to appoint an administrator or administrative receiver, a provision allowed in similar legislation in Australia.
In May this year the DTI relented by publishing an amended bill that gave such charge holders carve outs allowing them to retain the right to appoint a receiver. But crucially the amended bill and its subsequent revisions would only allow the noteholders to claim this right if they could satisfy a short list of confusing capital market arrangements. For some lawyers working with the committee to get the law changed it was almost a phyrric victory. "Part of the problem was that we were trying to carve out exemptions for special purpose vehicles, which in the minds of civil servants are not real companies and therefore should not be granted the same exceptions," says Clifford Chance securitization specialist and committee member Chris Oakley. "For some reason they were not prepared to listen to industry professionals about what exemptions were necessary for deals to function. We have ended up with a mishmash from something that should have been relatively straightforward but is relatively obscure."
...and the awkward
To qualify for a carve out under the amended bill a transaction has to involve at least £50 million ($76 million) and include the issue of a capital market investment, which the bill defines as one of four arrangements: granting a security to a trustee, agent or nominee for a holder of capital market investments issued by a party to the arrangement; one party guaranteeing the performance of the obligations of another party; at least one party providing security in respect of the performance of another party; or granting an option, future or contract for differences within the meaning of the 2000 Financial Services and Markets Act.
Transactions closed before the law comes into force early next year have been grandfathered and will not be affected by the new rules. But Oakley and other lawyers like Sidley Austin Brown & Wood partner Robin Parsons are concerned that new transactions may have to be structured to qualify for the exceptions, which they argue are not as clear as they might have been.
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"For some reason [the civil servants] were not prepared to listen to industry professionals about what exemptions were necessary for the deals that are done to function" |
Chris Oakley, Clifford Chance |
"I can see a situation where you might have to put new elements into a securitization transaction just to come within the carve out," says Parsons. "The wording of the exceptions doesn't quite fit whole business securitizations where the originator with the business might give security to the special purpose vehicle which then might issue sub-security to the trustee. The security granted by the originator would not be granted to a person holding it as trustee for the noteholders as required by the proposed Schedule 2A to the Insolvency Act. Arguably, if the trustee appointed receivers of the business of the originator, those receivers would not fall within the carve out and could not be administrative receivers."
In such cases securitization lawyers say it is possible that securitization transactions would have to build in derivative or swap arrangements or arrange for notes to be rated or have a guarantee provision that would serve no purpose in the transaction but would have to be in place to qualify for the exceptions. While rating agencies Fitch and Moodys, which were worried about the initial proposals, say they are not aware of any adverse effects of this, lawyers are concerned about the DTI's refusal to budge any further on the issue.
Building derivative arrangements that would not otherwise be needed into a normally straightforward securitization transaction is seen by some market specialists as an unnecessarily complicated provision that hinders transparency. It could also make securitization more expensive because more professionals are needed to structure transactions, though few in the industry will say how much more that cost might be.
"This doesn't mean that deals can't be done but it could mean that future transactions will be more distorted to fit with the carve out," says Yeowart. "You may not need to a do a hugely sophisticated derivatives transaction as a result of this legislation but it does mean that the people who do these deals will have to do a lot of rethinking."
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"There may be more to disclose and there may be a few more words on pages but I would be very surprised if it made a difference to whether a client did a securitization deal or not" |
Julian Tucker, Allen & Overy |
Oakley agrees and admits to feeling a little uneasy at the prospect of giving a legal opinion on structures the robustness of which is based heavily on whether or not they qualify for the carve out provisions of the new law. However no-one seriously believes the provisions will disadvantage law firms that are already familiar with derivative transactions used as a matter of course in other securitization deals. In any case, says Oakley, the City of London Law Society may be tempted to push for more change when securitization drops off the political agenda again.
In the meantime, while London's securitization specialists do not think the boom in such transactions will seriously be affected by the legislation, they are divided on whether clients and their advisers should be ready to make the necessary tweaks. For every lawyer, like Parsons, Oakley and Yeowart, who takes a wait-and-see stance towards the possible effect of the amended bill there is a least one like Allen & Overy's securitization partner Julian Tucker who feels the whole issue has been overstated.
"The capital markets exemption gets most of the things that most people wanted and the effect of the new law will not be as root and branch as had been initially feared," he says. "There may be more to disclose and there may be a few more words on pages but I would be very surprised if it made a difference to whether a client did a securitization deal or not. Most kinds of deals in the market at the moment would stroll through this legislation sipping a pina colada."
Andrew WhittakerIFLR talks to the general counsel of the Financial Services Authority about corporate governance, listing rules, conflicts of interest and market abuse
In December 2001 the UK's financial services regulator, the Financial Services Authority (FSA), became one of Europe's first super regulators. Under extra powers granted to it by the Financial Services and Markets Act the FSA expanded its remit to tackling market manipulation promoting public understanding of financial systems and reducing financial crime. The Act introduced the concept of market abuse, an area that had proved difficult to regulate in the past, and a much-criticized financial promotion regime which turned upside down the accepted norms of investment advertising and cold calling. At the same time the FSA is bracing itself for what some see as a knee jerk response in US legislation that could have a profound effect on the corporate governance of companies on the UK regulator's patch. As general counsel of the FSA, Andrew Whittaker is at the centre of this maelstrom. IFLR asked him how the regulator is coping. The new Sarbanes-Oxely Act in the US will have a big effect on UK companies with a US listing. It has already been argued that this will bring US regulators into conflict with their European counterparts. To what extent does the legislation conflict with UK requirements? What advice does the FSA have for these kinds of companies? Of course, we will need to study the terms of the new Act. But UK companies with a US listing already meet different requirements without serious problems of conflict. UK and US regulators share the objective that listed company accounts should properly state the company's financial position. This promotes the investor confidence that we have all seen is so important. So I would expect there to be little likelihood of conflict between regulators. UK companies with a US listing will, no doubt, review the new requirements, but we would expect most if not all to accept them as a cost of raising capital in US markets. At the end of July the FSA started its consultation process for the modernization and simplification of UK listing rules governing corporate governance, communication, shareholder rights and the role of the professional adviser to companies. What has your rule as general counsel been in this process? What are the key areas where the FSA is hoping to change and why? What kind of feedback have you had so far? Modernization and simplification of UK listing rules is important to the FSA, both to ensure that investors can have confidence in listed securities, and to ensure that we do not unnecessarily restrict the cost of raising capital in London. With Ken Rushton, our director of listing, and others, I have been an active member of the Steering Group guiding the review under our managing director Michael Foot . My own particular focus has been on the impact on the review of developments in Europe. The issue of selective disclosure will be an early issue to resolve, and it would also be good to simplify the rules as a whole. The main feedback so far has been support for the review, but concern that European developments may make it more difficult to deal with corporate governance issues through the listing regime. In March Sir Howard Davies said he wanted companies to increase their due diligence on credit derivative transactions in order to prevent litigation and flaws. How well do firms conduct due diligence in this area? What can the regulator do to improve the situation? It is important to recognise that the main responsibility for a firm's risk management lies with its senior officers. We are keen that players in this market should review and if necessary upgrade their due diligence arrangements. There is no simple solution. Effective risk management requires firms to look out, day by day, for risks as well as opportunities. The FSA has suggested it was considering new regulations that might force analysts to label reports as advice or marketing material and to list the number of buy and sell recommendations they make. The regulator also said it had found evidence that investors had been misled by biased stock picks. How widespread do you think this problem really is in the UK market? Do you think that these measures are necessary? What do you intend to do to tackle this problem? We have seen in the US that analyst recommendations can undermine investor confidence in markets, and lead to major litigation costs for firms. Our analysis shows that the UK market is different from the US in a number of ways. There are fewer individuals who invest directly in the UK and there is far less emphasis here on star analysts. We have also not had any specific examples of bias or corrupted advice. On the other hand, the market here is dominated by the same firms who operate in the US market and there is some evidence both that analysts' recommendations have been systematically more positive than market performance would justify, and that this is particularly the case where the firm acts as corporate broker or adviser to the company. Our recent discussion paper canvasses a range of possible options, including letting the market find its own solutions and improving consumer education, and we are especially interested in comments from investors, both institutional and individual. Some of the powers granted to the FSA under the Financial Services and Markets Act give it a wider remit in the area of market abuse. Yet the track record for tackling this difficult area in the UK is arguably not as good as it should be. Why has this been the case? What would be different about the way the FSA tackles this problem? Difficulties in the past about achieving criminal convictions for insider dealing led the government to conclude that the criminal law should be complemented by a civil alternative, under which fines could be imposed for market abuse. The FSA is able to operate this civil alternative, and we have made plain that we will use it to tackle serious cases of market abuse, which could, if left unchecked, damage confidence in the integrity and reliability of London markets. |
Why red tape is strangling public-private projectsThe UK government has tried to find a better way to run projects. But do its suggestions go far enough? In July the Office of Government Commerce (OGC), the government agency charged with overseeing the use of Private Finance Initiative (PFI) contracts in the UK, published a new set of guidelines on how such deals should be structured. PFI was introduced to the UK in 1992 by the Conservative government of the time and is used to contract out the financing, building and operation of public sector projects to private companies for a fixed term. To date over £22 billion ($33.8 billion) worth of PFI deals have been signed, though they are now more commonly operated by the Labour government as Public Private Partnerships (PPPs). The OGC's document was a revision of advice laid down by the original Treasury Task Force in 1997 and was in part designed to redress the balance between the public and private sector's share of risk and profits. Some of the provisions contained in the guidelines reflect criticism of PFI projects based on the perception that they have allowed the private sector to make record profits at the expense of the UK taxpayer. Although the guidelines have no legislative force the fact they are the main source of guidance for the UK local authorities that put PFI contracts up for tender means they are significant for the industry. The guidelines stipulate, for example, that profits from the refinancing of PFI contracts should be split evenly between the local government authority and the contracting company. Costly business Specialists believe that while seeking to address public concern over PFI contracts, the OGC has missed an opportunity to tackle some of the more chaotic aspects of PPP deal structuring while encouraging local authorities to negotiate aggressively for better terms. Already handicapped by new accounting rules that require them to include bidding costs in their profit and loss accounts, contracting companies have to contend with costly bidding procedures and rules that appear stacked against them in a harsher economic environment. The length of time it can take to bid for a PFI contract in the UK varies but is invariably too long to secure bids from the number of companies a local authority might like to participate to make a tender competitive. The extension of the Docklands Light Railway in south-east London to a nearby airport is the kind of project that might be expected to attract committed bids from several quarters but still has only two. Similarly the Supertram project for the northern English city of Leeds has only two bidders even though nearly 100 companies attended the meeting to launch the tendering process in June. PFI specialists say it is not unusual for contracts like this to be out for tender for a year or more before the service provider is named. "If you have contractors involved in a large project like the London Underground PPP where they are expected to carry large bid costs for a long time there is only so much they can carry on their books before they have to stop bidding for other projects," says Stuart Rowson a partner at Linklaters. "The public sector needs to streamline the bidding process. Contractors are going to pick and choose the projects they bid for because bids are going on for too long." Though the companies that dropped out of the Leeds Supertram project did not cite the bidding process specifically, Rowson's fears are not ill-founded. Earlier this month Amey, a major participant in PFI involved in the project to revitalise London's underground, said it would be more selective when bidding for government projects. Just two months earlier property developer Unite shelved a progressive dividend policy because of the new requirements to reflect bidding costs in company accounts. If these companies have to pull out of a deal at a later date, UK guidelines mean that they could be prevented from recouping part of their investment in the project during the subsequent retendering process. Local government authorities only have to point to potential bidders to prove the existence of a liquid market for the tender and avoid paying off the incumbent project companies. Allen & Overy partner David Lee says that reluctance to tackle this point may be part of a shift towards making contractors more accountable for the projects they run. "The more unpalatable termination of a contract is for the operator the less likely they are to mess it up, " he says. Properly covered While PFI bidding procedures squeeze would-be service providers from one side, pressure is also building from another aspect of the process which lawyers feel has not been adequately addressed in the new guidelines. Even before last year's attacks on the World Trade Centre in New York, contracting companies were having a tough time trying to find the insurance they are obliged to carry on these projects. UK guidelines and regulations prescribe types of insurance that insurance companies, wary of the risks inherent in many public projects, are reluctant to provide . Clifford Chance partner Andrew Rolfe says the government needs to tackle this problem as a matter of urgency if projects are not to fall apart because of increasing insurance costs. "If the premium increases, at the very least it reduces the profits that the sponsors are expecting to receive or, even worse, there will not be enough money to pay for the premium. Either the sponsor puts in more money or they go bust depending on the size of the premium increase," he says. Norton Rose partner Jon Ellis agrees that the way in which PFI insurance costs are lumped completely on the private sector is a problem and also argues that lack of flexibility allowed in the guidelines for the use of different kinds of insurance products causes unnecessary difficulties for the service provider. "It may be fair to say the sponsor will have to dig deeper into its pockets to provide this itself and perhaps reduce returns to shareholders in the process," he says. "But this shouldn't result in the termination of the contract just because a particular term or amount is not exactly as required when the Project Agreement was originally entered into." Complaints from industry and PFI practitioners over the need for clearer guidelines on insurance requirements have not gone unheeded. As IFLR went to press civil servants were drafting new rules and it is expected that new guidelines on this subject will be published later this month. The OGC guidelines have gone some way to addressing the concerns of market participants and the general public in the UK about the use of PFI structures. But changes in market conditions have put pressure on the private sector and made existing rules and additional safeguards more onerous to comply with. PFI in the UK is still picking its way through a political minefield and countries taking an interest in this alternative method of financing public projects are waiting to see what the UK government comes up with next. |
London's key deals for 2002
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