Contributed By Mayer Brown LLP
Insolvency laws are a major consideration in securitisation in Hong Kong. Typically, the subject assets backing the notes to be issued to investors, such as loan receivables, will need to be insulated from the financial and credit risks of the originator (ie, the seller of the assets), such that where the originator becomes insolvent, these assets will not form part of the originator's estate and thus will not be subject to insolvency proceedings in respect of the originator. In this chapter, "originator" and "seller" refers to the seller of the assets in securitisation, and "issuer" and "buyer" refers to the buyer of these assets.
To achieve such insulation and hence bankruptcy remoteness, a true sale of the assets should be effected. After the true sale, the subject assets are no longer the assets of the originator and, as noted above, will not form part of the originator’s estate.
There are a number of fundamental differences between a true sale and a secured loan. In determining whether a transaction constitutes a true sale, a Hong Kong court will look at several factors, including the parties' intention and the substance of the transaction. More specifically, the court will take into account the following distinguishing features in the determination: (i) under the transaction documents, whether the originator has the contractual right to repurchase the subject assets and if so, under what circumstances; and (ii) in the event that the assets are realised by the issuer at a profit, whether the issuer is contractually required to account to the originator for any such profit and, in the event that the assets are realised by the issuer at a loss, whether the issuer is entitled to recover from the originator for such loss.
A transaction will not be treated as a true sale by the sole reason that it is so characterised by the relevant parties. Judging by the above factors, if the court finds the transaction resembles a secured loan rather than a true sale, the court may recharacterise the transaction as a secured loan. The court may also consider other relevant factors in the overall circumstances of a securitisation transaction, but no absolute criteria have been established in the determination of whether a transaction constitutes a true sale or a secured loan.
In the case of a true sale, upon transfer of the assets to the issuer, the originator will cease to be the beneficial owner of the assets and therefore these assets will not form part of the originator’s estate or be subject to any insolvency proceedings in respect of the originator.
In the case of a secured loan, the assets being charged in favour of the issuer will remain the assets of the originator, subject to the security interest created over the assets.
A true sale opinion may be requested by and delivered to the arrangers, investors and auditors, as applicable, to provide comfort to these parties, for investing purposes and/or for accounting treatment. A true sale opinion normally opines on the effectiveness of the sale of the assets to the issuer and that the assets will not form part of the originator's assets after the sale. A true sale opinion would be subject to usual and fair assumptions such as the capacity and corporate authorities of the originator to enter into the transaction and the legal title of the originator to the assets being sold.
An SPE is typically used in securitisation transactions in Hong Kong. The SPE typically acts as the beneficial owner of the subject assets transferred from the originator and the issuer of the asset-backed notes. The SPE, therefore, is being used to insulate the subject assets from the financial and credit risks of the originator.
There are no required aspects of an SPE in securitisation in Hong Kong. An SPE is typically structured as an orphan entity and usually a limited liability company, with its share capital being held by a charitable trust.
Depending on the transaction structure, the transaction parties often seek to incorporate the below aspects when establishing the SPE.
Under such structure, the originator normally will not be able to exercise influence or control over the SPE.
Although the SPE can be incorporated in Hong Kong, more commonly the transaction parties will use an offshore SPE (such as a Cayman Islands limited liability company) to achieve, inter alia, more favourable tax treatments.
Currently, 'substantive consolidation' is not a concept recognised under Hong Kong law or by Hong Kong courts. A company (including an SPE) incorporated under Hong Kong law will have its own legal personality. Where the originator becomes bankrupt, an insolvency official would not have the power to consolidate the issuer's assets with those of the originator, unless exceptional circumstances, such as fraud, exist.
A transaction opinion will be provided in respect of the SPE's capacity and corporate authorities to enter into the transaction documents and the securitisation transaction generally. The transaction opinion also reports the results of the relevant searches (including bankruptcy searches) in respect of the issuer. The transaction opinion is typically subject to usual and fair assumptions such as the authenticity of the signatures and documents reviewed by the legal counsels.
The insolvency law of the jurisdiction of the SPE (if not Hong Kong) would apply in the event of an insolvency of the SPE. However, insolvency courts in Hong Kong are not bound to recognise or enforce the laws of the SPE's jurisdiction, especially if they are considered contrary to public policies, for instance.
In order for the transfer of the subject assets to be valid and enforceable, the originator will transfer the assets to the issuer by way of an assignment and the assignment can be legal or equitable. In order to achieve a legal assignment, certain conditions will need to be satisfied, including:
If an assignment fails to meet any of the above conditions, it would still be enforceable but would be an equitable assignment instead until such time as it does satisfy all these conditions. In particular, if the original obligor has not been notified of the transfer, although the transfer would not be ineffective solely because of such failure of notification, in the event of default by the obligor, the issuer (being the buyer of the assets) will not be able to enforce its rights directly against the obligor. Rather, the issuer would be required to join the originator in the proceedings against the obligor by adding the name of the originator as a claimant to any claim form issued against the obligor.
Other than being an express written notice, there are no other requirements as to the form of the notice save that it must bring to the notice of the original obligor with reasonable certainty the fact that there has been an assignment of the assets so that the original obligor knows to whom it has to pay in the future and the notice must be unconditional. It would be prudent to ensure the notice was in English or Chinese, where necessary or applicable. A notice cannot be served on the obligor prior to the transfer of the assets as the transfer has not yet occurred.
An assignment is perfected once the above conditions have been satisfied. The requirements are more specifically set forth in Section 9 of the Law Amendment and Reform (Consolidation) Ordinance (Chapter 23).
In practice, the transaction parties will review the underlying contracts in respect of the subject assets (eg, the relevant facility agreement) to determine whether there is any restriction on transfer of these assets. These restrictions are generally enforceable under Hong Kong law. If such restrictions exist, unless otherwise consented by the original obligor, the originator may be in default of these contracts for making the transfer and the transfer could be challenged by the obligor under the contracts.
Under Hong Kong law, security can be granted (i) through an assignment by way of security or (ii) by way of a charge.
In the case of an assignment by way of security, the assets (eg, loan receivables) will be assigned to the secured party (eg, the lender) with a condition for reassignment of the assets when the underlying obligations being secured are fully fulfilled. Assignment by way of security can be legal or equitable, depending on whether the assignment has been perfected by notifying the obligor of the receivables. The perfection requirements are the same as those set out above.
In the case of security by way of a charge, it essentially creates an encumbrance over the receivables and therefore no ownership right over the receivables is transferred to the issuer at the time the charge is created. Note that a charge is perfected when it is properly registered with Hong Kong's Companies Registry within the prescribed period if the chargor is a Hong Kong company or a foreign company registered with the Companies Registry to do business in Hong Kong under Part 16 of the Companies Ordinance.
As noted above, an assignment that fails to comply with any requirements in respect of a legal assignment will be an equitable assignment. In an equitable assignment:
Although there are certain alternatives to effect the transfer of the subject assets, such as through a declaration of trust or through synthetic swaps, depending on how they are constructed, these alternatives may not necessarily achieve the bankruptcy remoteness as desired in a securitisation.
The potential tax involved would be stamp duty. Whether stamp duty is payable for the transfer of the subject assets depends on the nature of these assets. Generally, transfer of receivables (whether trade or lease receivables) is not subject to stamp duty, while transfer of interests in land and stocks could be subject to payment of stamp duty. Receivables would not be regarded as 'stock' for Hong Kong stamp duty purposes and, as such, no charge to Hong Kong stamp duty would arise in relation to receivables in securitisation. The requirements are more specifically set forth in the Stamp Duty Ordinance (Chapter 117).
Profits tax is chargeable on a person who is carrying on a trade, profession or business in Hong Kong in respect of the person's assessable profits arising in or derived from Hong Kong for a particular year from such trade, profession or business. Nevertheless, as the SPE normally will not undertake any business other than purchasing the assets and issuing the notes, it might not be deemed to be carrying on a trade, profession or business in Hong Kong.
Hong Kong generally does not impose a withholding tax except in limited circumstances (eg, royalties) that would not be applicable in securitisation.
Tax issues in Hong Kong are normally handled by accountants.
Whether a securitisation transaction can receive off-balance sheet treatment from the originator’s group is subject to auditor’s accounting analysis.
Lawyers do not usually give legal opinions in this respect.
There are no disclosure requirements specifically relating to securitisation under Hong Kong law. Please see 4.2 General Disclosure Laws or Regulations for certain general rules for disclosure applicable to securitisation.
Where a securitisation involves the issuance of debt securities, the issuance may be subject to the disclosure/registration regime under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Chapter 32) (CWUMPO) and the Securities and Futures Ordinance (Chapter 571) (SFO), as applicable.
Under the CWUMPO, an offer of debt securities to the public in Hong Kong, unless otherwise exempted, must be issued with a prospectus that complies with the mandatory requirements set forth in the CWUMPO. For instance, the prospectus must specify the general nature of the business of the issuer, the investors' rights in respect of interest, security and redemption, and other information that is sufficient to enable a reasonable person to form a valid and justifiable opinion in investing in such debt securities. Additionally, unless otherwise exempted, the issuance must also be authorised by the Securities and Futures Commission (SFC).
Nevertheless, the CWUMPO and the SFO also provide a number of exemptions in respect of the above requirements. The below two exemptions are often sought by the parties in a securitisation.
Additionally, the Code on Unlisted Structured Investment Products promulgated by the SFC also sets forth certain disclosure requirements that might be applicable in a securitisation transaction in Hong Kong. For instance, the prospectus for the debt securities should contain a description of the key components of the transaction structure, a description of the events of default in which the debt securities may be terminated before the scheduled maturity and the rights of the investors in the event of such termination.
As noted above, a prospectus is used to satisfy the disclosure requirements. The prospectus typically summarises the transaction structure, describes the relevant parties and the terms and conditions of the notes, and lays out the risks that might be involved in investing in the notes for the investors’ attention.
Where a prospectus is not explicitly required under the law (eg, in certain private issuances), an offering circular or offering memorandum is normally produced for disclosure to investors. Contents typically follow those in public transactions.
The principal regulator is the SFC. For authorised institutions, the Hong Kong Monetary Authority (HKMA) is the principal regulator.
Under Section 40 of the CWUMPO, where the prospectus contains misstatements that cause an investor to incur loss or damage, civil liability may arise and the following persons could be liable to pay compensation to the investor for such loss or damage:
In addition to the civil liability above, under Section 40A of the CWUMPO, any person who authorised the issuance of the prospectus that contains untrue statements can also be liable for criminal liability, including imprisonment and a fine. Nevertheless, such person would not be liable for criminal liability if he can prove that the statement in question is not material or that he had reason to believe and did believe that statement was true.
On the other hand, under Section 103(4) of the SFO, a person who makes a public offering of securities without the SFC's authorisation or exemption can be subject to a fine of HKD500,000 and imprisonment for three years. Where there is a continuing offence, such person can be subject to a further daily fine of HKD20,000 for each day that such offence continues.
There are no significant differences between the public market and the private market in terms of the size of securitisation or the types of investors. As noted above, a public offering of the asset-backed notes will be subject to the disclosure and registration requirements under the CWUMPO and the SFO, as applicable, while a private offering may be exempted from such requirements. Most securitisation transactions, however, involve issuance in the private market to sophisticated investors.
A Hong Kong law legal opinion normally does not specifically opine on whether the content of the prospectus satisfies the above disclosure and registration requirements.
There is no specific credit risk retention requirement under Hong Kong law. The HKMA has published a supervisory policy manual module (CR-G-12) with the aim of providing guidance to authorised institutions (eg, banks) on the vital elements of an effective risk management system for credit risk transfer activities.
In particular, where an authorised institution acts as the originator in a securitisation, it is required to carry out, among others, the following actions: (i) assessing its risk exposures to the subject transaction on an arm’s length basis according to its normal assessment and approval processes, and (ii) applying to the assets of the securitisation transaction a due diligence process, credit underwriting criteria and standards of analysis that are as rigorous as those for assets that are originated or acquired by the institution for its own retention; and ensuring that investors in the securitisation transaction have access to all materially relevant data concerning the transaction.
Additionally, unless otherwise agreed with the HKMA, an authorised institution, such as a bank, should refrain from making investments in, or incurring an exposure to, a securitisation transaction where the originator has not disclosed its compliance with applicable risk retention requirements; that is, requirements designed to ensure originators in securitisations retain certain economic exposure to the transactions for the purposes of aligning the parties' interests.
Module CR-G-12 is a non-statutory guideline issued as a guidance note and the above actions are recommendations by the Hong Kong Monetary Authority. No penalties are stipulated for non-compliance with Module CR-G-12.
As noted above, the HKMA is the principal regulator for authorised institutions such as banking institutions.
The Code of Unlisted Structured Investment Products requires continuing reporting in respect of certain matters.
Under the Code of Unlisted Structured Investment Products, the issuer has the obligation to comply with certain requirements throughout the period during which any of its obligations remain outstanding. For instance, the issuer shall inform the SFC and all investors in the event that the issuer ceases to meet any of the core requirements specified in this code (including that the issuer should have a net asset value of not less than HKD2 billion and that it should not be the subject of any winding-up, dissolution, or bankruptcy proceedings). The issuer should also notify the SFC and all investors, to the extent permitted by applicable law, of changes in circumstances (including financial conditions) that could reasonably have a material adverse effect on the ability of the issuer (or the guarantor, if any) to perform its obligations in connection with the securitisation.
The SFC is the principal regulator. If the issuer fails to meet any of the above requirements, the issuer might be required to cease advertising to and inviting offers from the public in Hong Kong. The issuer might also be required to rectify the situation as soon as possible.
Rating agencies' activities are subject to the regulations under the Code of Conduct for Persons Providing Credit Rating Services (the CRS Code).
The CRS Code provides for certain requirements that must be met by an RA licensed in Hong Kong, including that an RA may not undertake any business that could potentially cause any conflict of interest in relation to its credit rating business. In connection with the foregoing, representatives of an RA are prohibited from making recommendations regarding the structural design of structured finance products, including securitisations.
Additionally, an RA has the obligation to encourage the issuer of a securitisation to disclose all relevant information regarding securitisations for the purposes of enabling the investors and other rating agencies to conduct independent analysis. In respect of rating announcements, the RA is required to disclose as to whether the issuer has informed the RA that it is disclosing all relevant information or whether any information remains non-public.
The SFC is the principal regulator. The CRS Code is a guiding document for the SFC in considering whether an RA satisfies the requirement that the RA is fit and proper to be or to remain licensed or registered. The CRS Code does not have the force of law.
Hong Kong is expected to implement the Basel III requirements fully by 2022. Currently, an authorised institution incorporated in Hong Kong (eg, a bank) is required to disclose certain information relating to its securitisation transactions, including (i) the qualitative information on its strategy and risk management, (ii) a breakdown of its securitisation exposures in the banking book, and (iii) a breakdown of its securitisation exposures in the trading book. The specific requirements are set forth in the Banking (Disclosure) Rules (Chapter 155M).
The HKMA is the principal regulator in respect of such requirements.
There are no specific laws or regulations that apply to the use of derivatives in securitisations or with regard to SPEs, although there are regulations relating to derivatives generally.
The Code of Conduct for Persons Licensed by or Registered with the SFC (the Code of Conduct), promulgated by the SFC, provides for general investor protection in Hong Kong, although it is not applicable specifically to securitisation.
The Code of Conduct provides for some major protection to investors of investment products (including securitisations). For instance, a licensed person (eg, an arranger) is required to take all reasonable measures to establish the true and full identity of an investor, the investor's financial situation and investment experience, and the investor's investment objectives. When making any investment recommendation or solicitation, the arranger is also required to ensure the suitability of such recommendation or solicitation is reasonable in all the circumstances for the investor.
Additionally, the arranger is required to disclose to the investor information relevant to the transaction before or at the point of sale, including the arranger's capacity, affiliation with the issuer (if any), benefits received by the arranger and terms under which the investor may receive a discount of fees. Where a cooling-off period has been incorporated into a securitisation product, the arranger is also required to execute the investor instruction promptly where the investor decides to exercise its right to back out of the transaction and the arranger should pass on to the investor the refund received from the relevant issuer, although the arranger may charge a reasonable administrative fee for such services.
Investors may also rely on the protections provided in relation to the issuance of debt securities (see 4.2 General Disclosure Laws or Regulations).
The SFC is the principal regulator.
There are no specific rules that apply to the form of SPEs or restriction as to the entity of SPEs used in securitisations. For the typical features of an SPE, please see 1.2 Special-Purpose Entities.
Securitisers typically use offshore SPEs.
Typically, the material factors include tax treatment, bankruptcy remoteness and that there are no particular current problems regarding enforcement in Hong Kong.
As discussed above, the business undertaken by SPEs is usually restricted.
Typically, unless the transaction specifically requires it, SPEs will avoid activities that require appropriate licensing, such as advising on securities and dealing in securities.
A typical securitisation structure would not require the SPE to obtain any licences.
Depending on the applicable laws and regulations, the regulators involved may vary. These may include the HKMA and/or the SFC.
Depending on the transaction structure and the goal that the originator is trying to achieve (eg, off-balance sheet treatment), various forms of credit enhancement may be used in securitisation. Typically, bank accounts and assets of the issuer are charged in favour of the note-holders and the note trustee to secure the payments under the notes. The originator can also provide liquidity support to the issuer (eg, letter of credit) if the issuer becomes unable to fulfil its repayment obligations under the notes and the originator (or an affiliate of the originator) may also provide a guarantee or other collateral to the note-holders and the note trustee.
Government sponsored entities do participate in the securitisation market. For example, the Hong Kong Mortgage Corporation Limited, an entity wholly owned by the Hong Kong government through Hong Kong's exchange fund, has participated in securitisation to provide a platform for banks to convert illiquid assets (eg, mortgage portfolios) into more liquid assets, among other purposes.
Investors in securitisations include various financial institutions and private funds. There is no law specifically prohibiting or limiting investment in securitisation products by any type of entity.
As loan receivables are a major type of asset being securitised in Hong Kong, for the purpose of this section, loan receivables will be used as an example. As discussed above, the sale of the receivables in a securitisation will be effected by way of an assignment and through a sale agreement.
The principal subject matters in a sale agreement include the following:
Typical warranties made by the originator include its capacity and corporate authorities to enter into the sale transaction. The originator will also warrants as to its legal title to the subject receivables and the compliance of any eligibility criteria with respect to the nature or quality of the receivables. In some transactions, the issuer may also provide warranties in respect of its capacity and corporate authorities.
Perfection requirements and provisions vary depending on the type of the assets over which security is created. In the case of a legal assignment of loan receivables, for example, notice must be given to the original obligor under the loans in respect of such assignment so that the issuer may take actions directly against the obligor in the event of a default by the obligor under the loan document.
The principal covenants provided by the originator to the issuer are usually set forth in the receivables sale agreement. Typical covenants include that the originator (i) will not transfer or otherwise dispose of the receivables to any other third parties other than as contemplated by the receivables sale agreement and the securitisation transaction, (ii) will not do or omit to do any action that would prejudice the interests of the issuer in the receivables and (iii) will reimburse the issuer for any reduction in the amount received by the issuer under the loan documents due to any set-off by the obligor therein.
The principal covenants provided by the issuer to the note-holders and the note trustee are set forth in the trust deed and include positive covenants such as (i) the issuer will keep proper books of account, (ii) the issuer will notify the trustee upon the occurrence of default and (iii) the issuer will send to the note trustee any financial statements upon request by the note trustee. In addition to the positive covenants, the issuer would also provide negative covenants such as (i) the issuer will not create security interest over its assets other than those in connection with the notes, (ii) the issuer will not engage in any activity that is not incidental to or necessary in connection with the notes and (iii) the issuer will not incur any indebtedness or give any guarantee or indemnity other than in connection with the notes.
Typically in a securitisation, the originator will also take up the role of a servicer (or an administrator as it is sometimes called) to provide services with respect to the receivables being transferred to the issuer. The originator will enter into a service agreement with the issuer, which sets forth the detailed services to be provided and the payment arrangements in respect of the servicing fee. The terms and conditions of the service agreement would be on an arm’s-length basis.
Major services provided by the servicer include without limitation (i) collecting the payments from the obligors under the loans or directing the obligors to make payments to the issuer; (ii) enforcing the covenants, undertakings and obligations of the obligors in respect of the loans; and (iii) maintaining full and proper records in respect of the loans.
The principal defaults used in note documents are contained in the trust deed and include (i) non-payment by the issuer of the principal or interest on the notes, (ii) default by the issuer in respect of other indebtedness incurred by the issuer and (iii) winding-up or bankruptcy in respect of the issuer.
The principal defaults used in receivables sale documents include (i) breach of warranties made by the originator and (ii) winding-up or bankruptcy in respect of the originator.
The originator (as the seller and servicer of the loans) typically agrees to indemnify the issuer for damages and losses sustained by the issuer in connection with the originator's failure to fulfil its obligations or breach of the contracts.
On the note level documents, the issuer would agree to indemnify the note trustee against damages and losses caused by the issuer. Furthermore, the issuer would also agree to indemnify the note trustee for other damages and liabilities sustained by the note trustee (and its directors and officers, etc) in connection with (i) the note trustee's exercise of its powers in accordance with the terms of the transaction documents and (ii) the costs and expenses incurred by the note trustee of defending itself against or investigating any claim with respect to the note trustee's exercise of its powers.
As discussed above, the issuer is often an SPE with a restricted scope of business permitted to be undertaken. The issuer’s obligations include acquiring and holding the financial assets, issuing the ABS and providing security for the benefits of the note-holders and the note trustee. The issuer also pays for the interests under the notes and, when mature, repays the principal of the notes to the note-holders.
A sponsor is often referred to as an originator in securitisation in Hong Kong. The originator is normally the initiator of the securitisation transaction with the aim of achieving its commercial and financing objectives. In relation to the loan receivables, the originator (or its subsidiaries) is the lender of the loans and sells the loan receivables to the issuer. In Hong Kong, originators are often large commercial enterprises or financial institutions.
An underwriter is often referred to as an arranger in securitisation in Hong Kong. Typically, the arranger is an investment bank and assists the originator in devising the overall securitisation structure, advises the originator on the viability of the transaction, and identifies and liaises with potential investors. The arranger will also enter into the subscription agreement with the issuer for underwriting. Sometimes, an arranger, through an affiliate, also invests in the notes.
See 5.5 Principal Servicing Provisions.
An investor purchases the debt securities (ie, asset-backed notes) from the arrangers. Investors can be financial institutions, private funds or governmental entities.
The note trustee acts under the instructions of the noteholders in respect of the actions being taken by the noteholders. The note trustee also holds for the benefits of the noteholders the rights in the financial assets.
The security trustee, on the other hand, holds on behalf of the noteholders the security created over the issuer's assets (eg, bank accounts and corporate assets).
The note trustee and the security trustee can be the same institution with the capability to provide all the above services.
Synthetic securitisation is not expressly prohibited under Hong Kong law and can be achieved under the current legal framework. However, there have been only a few synthetic securitisation transactions in the past two decades.
Various types of financial assets have been seen in securitisation in Hong Kong, including trade receivables, corporate loan receivables, project loan receivables, consumer loan receivables and property mortgages.
Securitisations in respect of the above categories of financial assets usually adopt a similar structure, unless there are unique features or commercial, accounting, or rating factors that require variations on the structure to satisfy the relevant requirements.