European documentation issues examined

European securitisation documentation has performed largely as it should have throughout the financial crisis. However, a number of hot-button issues still need to be resolved by the industry.

One area where documentation has been tested in ways that were never envisaged is engagement with rating agencies and trustees in terms of rating agency confirmations (RACs). It has become apparent that a range of engagement levels are necessary, depending on how material the change in the documentation is.

"In the past, rating agencies have been asked to confirm every small change, but this goes too far," observes Kevin Ingram, partner at Clifford Chance. "More thought needs to be given as to when and how rating agencies should be engaged, as well as how to get comfortable without a RAC when a change is self-evidently not material. Some situations require formal confirmation, such as for the issuance of a new security off an existing platform; others - such as minor technical amendments - could be done without a RAC or indeed formal consideration by the trustee."

If documentation states that a RAC is required, it is often assumed that rating agencies are obliged to provide one. "While we may choose to do so, there may be circumstances where we won't," notes Stuart Jennings, credit officer for the European structured finance group at Fitch. "For example, we may not be comfortable giving a RAC when there is a fundamental criteria review or where we're presented with a restructuring that involves a proposed change in servicer and the impact on the deal is unclear at that time."

He adds: "We may need to see an inexperienced servicer in action before assessing the rating impact. But we may provide one where we're comfortable and the issue is material to our rating opinion."

Jennings notes that it's best for documents to be flexible; otherwise there may be circumstances where a deal is in paralysis. "Ultimately, trustees need the power to go to noteholders or to make non-material changes without a RAC; for example, if there is a manifest error in the documentation. Having said that, we always prefer to be notified about changes to assess their materiality."

This issue has been most evident in the CMBS market. Traditional documentation has a set of provisions that were intended to deal with one-off situations where a single direction to the trustee was required.

But it is now being used in some CMBS transactions as a basis for obtaining ongoing operational guidance for dealing with the relevant commercial property. Ingram suggests that the introduction of provisions explicitly contemplating the appointment of a noteholder representative could be a good alternative in this case.

"Ideally, the industry should reach a point where only certain issues need to be voted on by a formal meeting of all noteholders," he says. "Noteholder representatives are a natural progression to address asset management issues. More detailed ongoing asset management is already contemplated in the infrastructure/utility bond sector with hard-wired arrangements for property substitutions or covenant replacements."

Jennings agrees that noteholder representatives are a possible solution. He also suggests that trustees should have sufficient contingency funds to engage advice on making any necessary amendments.

Overall, however, documentation has been interpreted in an appropriate commercial way and without the established principals of law being overridden, according to Ingram. "Structures have generally worked as they should: for example, there haven't been any challenges around true sale. Underlying legal analysis has proved to be robust in the main."

And, on the whole, litigation cases - in the UK at least - haven't resulted in the courts upholding the view that investors are protected come what may. "The courts have largely put forth a considered opinion: that securitisation is clearly a product aimed at sophisticated investors and that sophisticated investors should know what they're getting into," Ingram adds.

However, a couple of decisions have given the industry pause to think. Ingram cites the Eurosail and Dante cases (SCI passim) as examples. Certainly it was not obvious that anti-deprivation in the Dante case would be analysed in such depth by the UK courts, given that the case touched on a US-specific provision regarding anti-depravation in bankruptcy.

"The court could have ruled that the general over-arching principal of US bankruptcy law doesn't apply in the UK, but instead it seemed to accept that a similar general principle could exist under english law. This could potentially allow an anti-deprivation argument to be run in respect of particular clauses in documentation for the transaction being considered, albeit the courts may not uphold the argument in many cases. Given that, I wouldn't be surprised if a senior appellate court tried to clarify the issue at some point in the future," Ingram explains.

He suggests that going forward participants will spend more time on 'what ifs' and interpretations of waterfalls to address both the flip clause and other documentation issues. But he points out that this trend for increased documentation clarity is going with the grain of the market anyway: investors want simpler, clearer transaction structures and fewer switches of payment priorities. Equally, sponsors are more concerned about getting good execution than creating structures to extract every last efficiency.

Meanwhile, uncertainty over how the powers granted under European special resolution regimes will be exercised has created some concern in the securitisation market. It has also prompted speculation about whether safeharbour legislation will be introduced for securitisations in the region.

But Jennings notes that some comfort can be found in Northern Rock's rescue in 2007, when Granite remained intact, despite the government's emergency powers. "In addition, significant amounts of repoed ABS collateral is still held by the ECB, so governments are unlikely to exercise powers in a way that could disrupt such collateral. However, over time, pressure for harmonisation between jurisdictions could lead to some form of US-style safeharbour being introduced," he continues.

Ingram reckons that providing a deal is structured as a true sale, it should be immune from bail-ins. "I'm not a big fan of safeharbours because they represent significant margin cliffs: if a set of documentation is in line with the spirit of a safeharbour but fails on a technicality, it is out," he adds. "It would be better to have a broader set of principles applied more flexibly, allowing the market to deal with new circumstances as they arise."

Ingram concludes: "Europe has less of a tradition of safeharbours. They're effective in the US due to the ongoing dialogue between the SEC and industry in terms of no-action letters. There's nothing like this in Europe and ESME is unlikely to get to that level."

CS