The Growing Need for Securitisation in the UAE

Securitisation has emerged as a vital instrument in modern financial markets, playing a key role in capital allocation, risk management and liquidity enhancement. Modern securitisations find their origin in the 1970s with the first US mortgage-backed securities, and since then the market for securitisations has grown exponentially across continents, in particular the US and Europe. In fact, the term securitisation is often used loosely to refer to all asset backed securities (ABS), including repackagings, collateral debt obligations and “true” securitisations. ABS transactions play a pivotal role in mature financial markets as they allow borrowers and originators to raise finance from sources outside the more traditional bank finance and the public capital markets.

Despite its many advantages, the securitisations market in the UAE remains relatively undeveloped. A growing securitisation market would benefit the UAE financial markets in several ways:

• A vibrant securitisation market would create additional sources of financing which would benefit SMEs in particular – bank finance in the UAE is generally hard to come by for companies which are not government-related entities or investment grade, and of course the conventional public bond markets are generally inaccessible to businesses that are not mature companies with large creditworthy balance sheets that can also handle large amounts of disclosure.
• Securitisations may provide for a cheaper source of finance than would otherwise be available to the borrower/originator – this cheaper cost is achieved through an arbitrage between the yield paid under the underlying receivables and that paid by the issuer under the securitisation.
• Securitisations give originators the ability to remove receivables from their balance sheets – this is of particular importance to banks and financial institutions, as removing receivables from their balance sheets will result in lower capital ratio requirements.

Securitisations can have a transformative effect, in that they are generally used to transform an asset which is not a debt security (such as loans, credit card receivables and other receivables, rentals or mortgages) into a marketable debt security. It is this transformative feature that makes securitisations so incredibly useful at allocating capital and matching the risk-return profiles of investors with originators seeking finance. This gives companies access to a pool of investors who would otherwise be unreachable, in particular at a time where investment funds, pension funds, insurance companies and family offices have become key investors in public and private placement issuances.

Securitisations in UAE

As mentioned above, historically the UAE has not been an active market for securitisations. Some of the securitisations that stand out include the Tamweel ABS Sukuk (2005 and 2007) and Sun Finance Sukuk (2009). Both issuances were public and were issued prior to the global financial crisis and since then securitisations have been predominantly privately placed. However, the securitisation market in the UAE remains relatively small. There are legal and tax reasons for caution. This article will examine some of the legal obstacles to securitisation structures in the UAE.

True sale

True sale under the Securitisation Law

True sale is one of the most important factors in a securitisation. However, the true sale of receivables has not, until now, been recognised under UAE law (and for this reason many of the UAE securitisations have been undertaken under a secured loan structure). Recently, the UAE Securities and Commodities Authority (SCA) issued Chairman of the Board of Director’s Resolution No (22/RM) of 2023 regulating securitisation and all parties to securitisation transactions or operations in the UAE (the “Securitisation Law”). Article 5 of the Securitisation Law expressly recognises the principle of true sale of securitised assets, differentiating a sale of receivables from a financing transaction. This is a very welcomed development in UAE law which should provide a more certain environment for UAE-based securitisations. However, under Article 4 of the Securitisation Law, the sale of receivables must be notified to the receivables’ debtor – failure to notify entails that the receivables’ debtor may discharge the debt by payment to the originator.

The scope of the Securitisation Law is limited: it applies to public and private joint stock companies the shares of which are listed on the market exchanges, or where the securitised notes are to be listed in the UAE, or where the securitisation transaction is conducted through a securitisation entity regulated by the SCA. The Securitisation Law does not apply to internal securitisation transactions conducted by banks or financial institutions, which are regulated by the UAE Central Bank when the securitised notes are issued on a private placement basis, or securitisation transactions conducted by government entities and fully government-owned companies.

In addition, the Securitisation Law requires registration with the SCA, which is time consuming and requires lengthy disclosure. Thus privately placed securitisations will fall outside the application of the Securitisation Law and the concept of true sale advanced thereunder.

True sale under the Factoring Law

Outside of the Securitisation Law, future receivables are generally recognised to be subject to a true sale under UAE Federal Law No 16 of 2021 in relation to factoring and the assignment of receivables (the “Factoring Law”). However, whilst the Factoring Law does not require registration of the sale of the receivables in the Emirates International Collateral Registry (EICR), there are obvious advantages to doing so:

• Article 7 (Enforceability vis-à-vis third parties by registration and priority of assignee’s rights) of the Factoring Law states that the enforceability of assignments against third parties is as set out in the UAE Movables Security Law; and
• Article 8 (Priority among competing claimants) of the Factoring Law provides that the provisions of the UAE Movables Security Law relating to priority of claims over the receivables applies to the priority of claims under a sale of receivables.

There are also advantages to notifying the relevant counterparties of the sale of the receivables to the issuer – where a notice of assignment is sent to the receivable’s debtor, that receivable’s debtor may only effect a good discharge of the receivable if it settles such receivable in accordance with the notice of assignment. Thus the notice of assignment serves to ensure that the assignee receives the proceeds from the receivable’s debtor directly, even without an acknowledgement of assignment which may be operationally cumbersome to obtain, in particular in securitisation structures with a reinvestment or accumulation period for the purchase of new assets. As a consequence, the true sale of receivables under the Factoring Law remains rather cumbersome insofar as both the registration of the sale in the EICR and a notice of assignment are preferable.

Special purpose vehicles

UAE securitisations are typically structured using a special purpose vehicle (SPV) incorporated in the Cayman Islands, and more recently in the UAE’s special economic zones: the Abu Dhabi Global Market (ADGM) and the Dubai International Financial Centre (DIFC). The New Commercial Companies Law No 32 of 2021 introduces the concept of an onshore SPV, but issues such as non-consolidation and the absence of the concept of the “trust” under UAE law will have to be considered. There is still no concept of an incorporated cell company or similar, which is a key feature of many common law jurisdictions for multi-issuances, under onshore UAE law.

Regulated activities

One of the reasons why secured loan securitisations structures are often used in lieu of true sale structures is the UAE regulatory environment which typically requires specific licensing for the conduct of activities onshore. As a consequence, foreign SPVs would typically be barred from performing commercial activities in the UAE, such as leasing of equipment or vehicles or holding loans and credit car debt. In particular, financial activities, including finance leases, are heavily regulated.

Bankruptcy remoteness

One of the main features of securitisations is bankruptcy remoteness – that is reducing as much as possible any leakage of cashflows thus reducing the risk of insolvency of the securitisation vehicle. Such bankruptcy remoteness is typically achieved through a number of structural techniques, including the establishment of the SPV in a zero tax jurisdiction, restricting the activities of the SPV to the securitisation transaction and generally restricting the incurrence of any liabilities other than those required for the purposes of the transaction, restricting the SPV’s ability to hire employees (the SPV must use third-party service providers instead) and incorporating limited recourse and non-petition language into the relevant transaction documents. The use of Cayman Islands SPVs for UAE securitisations (and to lesser extent DIFC and ADGM SPVs) is primarily driven by bankruptcy remoteness concerns.

Trusts

Historically, the concept of trust was not recognised under UAE law. This had several ramifications from an international finance perspective, including the validity of standard turnover trusts in the context of subordination provisions and security documents, and in particular in three important ways in the context of securitisations:

• For loan structure securitisations, security would typically be held by a security agent rather than a security trustee. Because an agent is unlikely to be able to prove a claim against the originator in an insolvency, parallel debt provisions are used to create a debt between the originator and the agent, such that the agent can prove such debt in insolvency proceedings, with such parallel debt being deemed to be reduced upon payment of the underlying debt.
• For tax reasons, securitisation transactions are often structured as a receivables trust with receivables being sold to a trust, with the beneficial ownership of the receivables split between the SPV (up to the amount required for servicing payments due under securities issued by it), with any surplus held on trust for the originator. This structure was not available to securitisation vehicles and originators incorporated onshore.
• In Sharia-compliant securitisations a trust must be created over the underlying Sharia assets used for the purposes of the issuance of trust certificates, which again was not viable until now for onshore UAE vehicles.

Federal Decree Law No 31/2023 Concerning Trusts (the “Trust Law”) was passed in 2023. It stipulates that the trust assets to be transferred to the trust must be owned by the trust founder. The trust shall have legal personality from the date of registration in a specialised register set up in each emirate. If the trustee is a corporate entity, then it must be licensed to undertake trustee activities. The Trust Law is very recent, and although the concept of a UAE trust was first introduced by Federal Decree Law No 19/2020 (which the Trust Law abrogates), the market has not yet widely adopted onshore trust structures, which remain largely untested. In particular, the fact that the trust is a common law concept, adds uncertainty as how to local courts in a civil law jurisdiction such as the UAE will apply the new Trust Law.

It is worth noting that the Securitisation Law does not incorporate the concept of trust. However, assets transferred to the securitisation vehicle are to be segregated from the assets of the originator and the relevant custodian. Article 10.1 of the Securitisation Law provides that amounts collected from the securitisation portfolio must be credited by the originator into a separate account and the creditors of the originator “shall have no right to attach on such account”. Article 10.4 goes on to say that in the event of the insolvency of the originator (or the custodian if applicable), none of the creditors of the originator or the custodian may claim any amounts collected by them in respect of the dues of the securitisation portfolio. It is yet to be seen whether the UAE onshore courts would uphold the right to ownership of the noteholders of the underlying assets in an onshore UAE securitisation, in particular in the context of an insolvency. This is of particular importance where there are several issuances by the same SPV.

Sharia structures

Securitisations also lend themselves well to Sharia compliant financings, in particular sukuk (or Islamic notes), which are a major source of funding in the UAE. In fact, one could say that all sukuk are in essence securitisations – they share some key structural features, including the sale of an asset or assets to a bankruptcy remote special purpose vehicle which are purchased using the proceeds of the issuance of certificates. However, Sharia-compliant securitisations must be carefully structured in order to avoid a direct sale of receivables, which under Sharia rules can only be traded at par, as Sharia prohibits the sale of a debt (Bay al Dayn) at a price other than par. In particular, since the creation of the Shair’ah Higher Authority (HSA) first by a UAE cabinet decision, as reaffirmed by Decretal Federal Law No (14) of 2018, regarding The Central Bank of the UAE and the organisation of financial institutions and amendments, the HSA, which is mandated with the supervision of Islamic financial institutions, mandated the adoption of Accounting and Auditing Organization for Islamic Financial Institutions standards in the UAE, and therefore the Sharia rules regarding debt trading will apply to onshore securitisations originated or otherwise sold to UAE Islamic financial institutions.

Tranching

A key feature of many securitisations is the tranching of liabilities of the issuer: by issuing various classes of securities with different levels of priority and return, investors who own the top tranches are senior in right of payment and insolvency to the more junior tranches at the bottom. The holders of lower tranches are compensated in turn for the increased risk with a higher return, thus slicing up the risk and allocating it to different sets of investors depending on their risk appetite. Tranching is also useful as a credit enhancement tool for the senior tranches, as the junior tranches are structured to absorb losses first thus providing a “cushion” to the senior tranches in the same way as equity provides a loss absorbing “cushion” to debt claims. However, the effectiveness of tranching depends on the recognition of subordination provisions. In the UAE, the effectiveness of subordination arrangements in insolvency remain largely untested. There has been a recent helpful decision from the Dubai Court of Cassation, upholding the validity of a subordination agreement. The court also held that the subordinated creditor bears the burden of proof to show that the higher ranking debt has been paid. In the context of an insolvency, however, the liquidator may decide to ignore any subordination agreement on the basis that the mandatory insolvency rules in the UAE require that all unsecured creditors be treated equally.