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INTERNATIONAL PRACTICE |
Until fairly recently, the main asset classes eligible for Japanese securitisation comprised lease receivables, auto receivables and instalment credits. The originators of these assets are regulated by Japan's Ministry of International Trade and Industry (MITI), which in 1992 promulgated The Law for the Regulation of Business Relating to Specified Claims (MITI Law) setting out specific securitisation structures that overcame long-standing legal obstacles to securitisation in Japan. The principle advantages of utilising the structures established by the MITI Law include the ability to perfect an assignment of certain obligations without giving individual notices to each obligor and to permit delegation of services to the originator without breaching certain Japanese restrictions.
By the early part of last year, originators regulated by Japan's Ministry of Finance (MOF), which could not take advantage of the MITI Law structures, were carrying out securitisations that dealt with the difficult issues of perfection in a number of ways, including contingent perfection mechanisms, the use of guarantees from appropriately rated entities and occasionally by giving notice to obligors under cumbersome and expensive civil code procedures.
On 1 October 1998, legislation amending Japan's Civil Code (Specified Claims Law) was passed, simplifying the procedures for the perfection of transfers of debt obligations, creating new opportunities for the securitisation of a new range of asset classes. The last few months have seen a number of originators taking advantage of the new law. This trend is expected to continue, particularly for Japanese consumer loan companies (which are regulated by the MOF) that have seen significant growth and require alternative sources of finance to fund this expansion as traditional borrowing sources dry up. This article examines some of the legal and regulatory hurdles to a securitisation of consumer loans.
The last decade has seen significant growth in lending by consumer finance companies in Japan as traditional bank sources of finance have focused more and more on corporate lending.
Broadly, a consumer finance company will enter into a contract (typically with a five year term) to make unsecured loans to a creditworthy individual up to a specified amount, typically Japanese Yen 500,000. Borrowers may draw the loan at any time during the term of the contract by using the originator's automated teller machines. Repayment of a proportion of the loan (typically on the order of 2 to 3 per cent of the outstanding principal amount) is made monthly, together with all outstanding interest. Principal amounts repaid are available for re-borrowing.
Consumer finance companies are regulated by the MOF under the Regulation of Money Lending Business Law (RMBL). In addition, there are a number of restrictions on the interest rates that may be charged on consumer loans. Under the Acceptance of Deposits,Contributions, Money Deposits and Interest Law (ACMIL), it is a criminal offence for consumer finance companies to charge more than 40.004 per cent per annum. In addition, under Japan's Interest Rate Restriction Law (IRRL) any interest charged at a rate above 20 per cent per annum is unlawful and irrecoverable in the courts (though charging interest above this rate is not criminal).
In addition, consumer finance companies listed on Japan's OTC market or on the Tokyo Stock Exchange are subject to additional restrictions, including a requirement that consumer finance companies may not charge interest at a rate above 20 per cent per annum.
Many unlisted consumer finance companies charge up to 40 per cent interest per annum on consumer loans, relying on consumers to voluntarily pay interest in excess of the 20 per cent per annum limit prescribed by the IRRL.
A number of factors need to be taken into account in structuring a securitisation of consumer loans. These include:
the fact that the consumer loans may be revolved and that the amount of any drawings by a particular borrower may vary each month means that the principal amount of the consumer loans that requires funding is unpredictable (at least within certain parameters);
regulatory restrictions require that borrowers are required to be informed of the owner of the consumer loan, each time an advance is made;
Japanese law is uncertain as to the ability to transfer future receivables generated under a presently existing contract;
the Specified Claims Law simplifies procedures for perfection as against third parties but leaves open certain opportunities for borrowers to exercise set offs;
the high rates of interest typically charged by consumer finance companies mean that the vehicle will have significant taxable income, which needs to be passed back to the originator in a tax efficient manner;
Japanese law restricts the ability of an SPC outsourcing the collection of debt obligations to non regulated third parties; and
applicable withholding taxes must be mitigated by adopting certain structures, which are now fairly standard in Japan's growing cross-border securitisation market.
In addition, factors typical to most securitisations also need to be taken into account, including segregation of assets, establishing clear origination and collection policies for the consumer loans and establishing appropriate cash management procedures.
Although not the first of such deals, a recent transaction by Nice Co Ltd ('Nice'), a mid-sized, unlisted Japanese consumer finance company, was one of the first to take advantage of the Specified Claims Law to establish AAA rated notes which were privately placed.
As with previous consumer loan transactions in Japan, all of the loans generated under particular eligible contracts originated prior to the financing date, together with all loans made under such contracts after the financing date, were sold to the Japanese branch of Major Capital Limited, a special purpose vehicle established in the Cayman Islands ('Major Capital').
The sale of the consumer loans was perfected by:
including acknowledgements of and consents to the transfer to Major Capital by borrowers in the contracts themselves;
making a central filing at the Legal Affairs Bureau in Tokyo under the Specified Claims Law, which makes the transfer effective against third party creditors of Nice; and
incorporating changes to Nice's lending procedures so that when borrowers draw money from its ATMs they are specifically informed of the transfer to Major Capital.
An additional complication is that future consumer loans generated under the contracts may only be sold within a specified period. As this aspect of Japanese law is untested, a conservative view was taken and the assignments refreshed on each anniversary of the financing date.
The price payable for the consumer loans was their outstanding principal amount on the financing date, and for future consumer loans, on or shortly after the date they were originated. The purchase price payable for consumer loans originated by the financing date was funded by Major Capital issuing senior bonds to Major Asset Finance (Cayman) Limited, another Cayman Island special purpose company ('Major Asset Finance'), and subordinated bonds to Nice. Major Asset Finance financed the purchase of the senior bonds by issuing euronotes. The use of two special purpose vehicles is necessary to avoid the application of Japanese withholding tax and is now a well-established structure for Japanese securitisations.
To ensure that Major Capital was able to fund further purchases of consumer loans, it would have available to it receipts of principal repayments (the senior and subordinated bonds had a bullet maturity), interest and a subordinated revolving loan from Nice. As the outstanding balances of Nice's consumer loans over the last few years have remained fairly steady, it was not expected that advances under the subordinated loan would be significant.
Overcollateralisation for the transaction was provided effectively through the subordinated bond and excess interest on the consumer loans. This was returned to the originator at regular intervals using a number of standard techniques. Additional comfort was obtained by the creation of reserves. (This is a key commercial aspect of the deal that you would not want to disclose.)
As is usual, Nice as originator was appointed initial servicer to collect payments in respect of the consumer loans and to account for these at regular intervals to a cash manager appointed to act on behalf of Major Capital. In certain circumstances, including the insolvency of Nice, servicing is transferred to Deloitte Tohmatsu Consulting Co Ltd, which in turn will delegate collection to another consumer finance company.
Now that a number of transactions for consumer finance companies have been completed, it is expected that securitisations of this asset class will increase significantly. This will be assisted in turn by anticipated changes in the regulatory environment, which will remove present restrictions on consumer finance companies utilising the proceeds of bond financings and sales of consumer loans to make additional consumer loans.
Salim Nathoo
Alanna Lee
Allen & Overy
(Tokyo)
Robert Ryan
CIBC World Markets
(Tokyo)