Underpinning any viable economy is the existence of a thriving financial system backed by healthy financing structures with the ability to shoulder the huge responsibility associated with supporting sustainable enterprises, which in turn facilitates commerce and guarantees the making of a strong economy.
Securitisation, famously known as a structured financing technique or infamously as a synthetic transaction is a means of transferring risk from the books of financiers and originators, enabling the reflation of books, diversification of funding sources and management of balance sheet.
This is not to say that this approach to structured financing is without peculiar hiccups, after all it has often been blamed in the U.S. as a major catalyst to the 2008 financial crisis which shook the global financial system, led to the demise of numerous banking giants, collapse of formidable industry players and bailouts of unprecedented nature, coupled with numerous ripple effects which many institutions and economies are yet to fully recover from.
The above notwithstanding, the recovery of the global financial system and the attendant measures put in place by the US Securities and Exchange Commission alongside other European regulators in the leading markets across the globe have led to a somewhat stable climate where structured financing and securitisation have flourished and taken center stage as effective financial engineering techniques.
Securitisation is especially worthy of consideration to any growing economy due to the numerous upsides including liquidity, increased investment activity, trading volumes and market maturity which are hallmarks of a healthy investment climate and which further lays a solid foundation for foreign direct investment, creation of jobs and financing for new ventures.
Although securitisation in the European market like other developed markets has not been without its own unique challenges, there have been gradual but consistent increase in the volume of securitisation deals since the global financial crisis in 2008. According to the Association for Financial Markets in Europe (AFME) in its Securitisation Data Report 2018, “In Q4 2018, EUR 88.4 billion of securitised product was issued in Europe, which formed an increase of 62.1% from Q3 2018 and an increase of 19.3% from Q4 2017. Of the EUR 88.4 billion issued, EUR 35.2 billion was placed, representing 39.9% of issuance, compared to the 55.1% of issuance in Q3 2018 and the 42.5% of issuance in Q4 2017.” While this is a far cry from the EUR 450 billion annually placed issuance levels of the pre-crisis years, it has demonstrated the resolve of the European markets and more importantly European Parliament to promote a safer form of securitisation as a means of raising capital, irrespective of its somewhat negative perception due to the fallout of the financial crisis. This conscious but yet measured approach of the European Parliament speaks volume about the instrumentality of securitisation in improving the efficiency and stability of the European financial system as well as providing more investment opportunities.
An additional testament to the resolve of the European Parliament was the introduction of the EU Securitisation Regulation which came into force on 1 January 2019, and which reiterated the requirement for institutional investors to observe defined criteria and procedures for investment making decisions as well as the observance of risk retention (skin in the game) requirements by originators or lenders. Institutional investors have been further saddled with the duties of establishing processes for monitoring asset performance by the originators, sponsors or lenders in each securitisation transaction, as the case may be. In addition to the foregoing, due diligence and disclosure obligations are reproduced in the Regulation, for example the loan-by-loan disclosure requirements in the Credit Rating Agency Regulation (also known as “Article 8b” disclosure) is included and it provides that information regarding credit quality, cashflow, performance data must be disclosed to investors every quarter for asset backed securities and monthly for asset backed commercial papers
Another interesting highlight of the Securitisation Regulation is the Simple, Transparent and Standardised (STS) securitisation framework which aims to promote amongst other things, the issuance of simpler and transparent securitisation transactions which are capable of diligent appraisal and observation by both retail and institutional investors as well as regulators. Additionally, the framework provides that for certain securitisation transactions to fall under the STS classification, the underlying asset pool should be homogenous in nature, bearing in mind that STS securitisations are eligible to benefit from more favourable regulatory capital treatment. It is the hope of the European Parliament and European Union that this would serve as an incentive for simpler securitisation transactions which are capable of promoting transparency and healthy developments in a more sustainable fashion.
The Nigerian conundrum
The International Finance Corporation (IFC), a member of the World Bank Group as of 2017 had estimated that small and medium enterprises (SMEs) in Africa were facing a financing gap of over $136 billion annually. This financing gap is further exacerbated by the limited funding sources or more appropriately the lethargic and narrow financing options that have become the staple option of most SMEs in Nigeria even with the obvious prospects of securitisation.
Now, some breakthrough has been recorded in the securitisation regime in Nigeria since the issuance of Securities and Exchange Commission Nigeria (“SEC”) Rules on Securitisation and also concerted efforts to pass the Securitisation bill but even with this nascent progress there has been only 3 successful securitised issuance programs in the past decade (i.e. the Cerpac Future Flow Securitisation of Expatriate Receivables programme, the FMBN Mortgage Backed Securities (MBS) Series 2 & 3 bond issuances and the Nigeria Mortgage Refinance Company (NMRC) bond issuances) and surprisingly sponsors have not been able to exploit the existing framework to enable them generate the much needed liquidity for their businesses and the question then is whether there are any lessons to be learnt from the international markets especially Europe especially given their measured approach to securitisation.
In as much as the key role of the state and regulators through legislation is to formulate and drive sound economic policies capable of bridging the huge funding gap, it would be most diligent to outline as well as appraise the role that financial engineering can play if deployed effectively and responsibly in the Nigerian lending space. In simpler terms, financial engineering is the use and development of quantitative techniques (which are mostly innovative) to create solutions to financial challenges as well as minimizing risk for the purposes of achieving increased earnings and profits. We are by no means suggesting a hook, line and sinker approach to applying financial engineering techniques, mainly due to the nuances and variances between a fully developed economy and a developing one. We can, however, borrow a leaf from certain aspects of the concept especially securitisation, which has over time proven to be an effective approach to creating liquidity, diversifying risk and recycling capital for re-ploughing into the financial system. This can be achieved by identifying and avoiding the pitfalls that plagued the often complex securitisation techniques which ultimately contributed to the 2008 global financial crisis and basically applying a simple and transparent approach, in the process breaking down all the complexities capable of constituting further problems.
Given the possibility of securitising all on-balance sheet assets in Nigeria even intellectual property assets subject to the proviso that the underlying assets represents the debt obligations of a homogenous pool of obligors, it is important to interrogate the lack of interest in accessing capital.
On a surface level, the ambivalence towards securitisation options seems to be a function of 2 integral factors. Firstly, lack of sufficient market knowledge and awareness about this option and secondly, the seeming complexity and costs associated with this option (even though the benefits far outweigh the costs). Notwithstanding these patent issues, there are other more structural latent issues that may be contributing towards the unpopularity of securitised transactions and these relate to the following:
Taxation: There exists no specific Nigerian tax laws governing the taxation of securitised transactions and a dearth of tax cases dealing with securitisation, meaning there is a lack of precedent on which to base most of the subjective issues associated with securitisation. Further compounding the situation is the absence of waivers or incentives for contentious areas such as Stamp Duty tax and Capital Gains Tax all of which impact these transactions.
Insolvency: An integral requirement for securitisation transactions is that the SPV issuer of the asset backed securities must be insolvency remote meaning that the possibility of the SPV becoming the subject of any insolvency proceedings or exposed to the originators liquidators as a result of the originators insolvency is far off. Under the current legal regime the construct of the insolvency protections does not guarantee the insolvency remoteness of the SPV even though the SEC provisions prescribe some common steps to achieve insolvency remoteness including ensuring the SPV is operated on a solvent basis (by not having any operational employees and only undertaking activities within the narrow purview of the securitisation transaction). However more needs to be done in terms of legislation to ringfence the SPV from the insolvency proceedings of the originator and from the originators’ liquidators by limiting the statutory powers in terms of the SPV assets, including adding non-petition and limited recourse wording in all significant transaction documents that restricts a counterparty’s ability to take unilateral enforcement action against the SPV.
Accounting treatment: The IFRS rules have made securitisation structures that allow an originator to remove receivables from its balance sheet harder to achieve because the originator would need to show that it is not only unconnected to the SPV but also it does not have a significant interest in the risks and rewards associated with the receivables.
Adapted, simple and clear securitisation as a solution
A simple true sale securitisation transaction would involve a corporate/licensed financial institution/originator trading financial receivables derived from payments owed from loans, purchase of goods or services or any other circumstance creating a financial obligation to a securitisation undertaking or entity. The securitisation undertaking would then issue corresponding asset backed securities to investors (mostly institutional), this notwithstanding, the Originator would be subjected to risk retention regulations which would see such originator maintaining a certain percentage of the risk of the receivables on their books to ensure they oversee long term performance and servicing of the underlying receivables. In the above scenario, there are 3 categories of beneficiaries – (i) the obligors/SMEs who have access to financing needed to scale their businesses, (ii) the originator who has succeeded in eliminating the receivables from its balance sheets, increased its funding and liquidity capacity for other capital requirements, diversified the attendant risk as well as strengthened its ratios, (iii) the investor who has been provided with an appealing and consistent avenue to invest its portfolios without the complexities typically associated with such. The ultimate winner in all of these is the financial system as it becomes more efficient, attains growth and stability which can further translate to the real economy.
Still being mindful of the peculiarities which a Nigerian securitisation transaction would bring about, it is still necessary to outline the potential wins that such a development would bring in the Nigerian context. For one, the shenanigans involved with the use of taxpayer funds to bail out banks with toxic assets would end and in the same stroke promote financial responsibility; the increased access to funds by SMEs will in no small way improve the economic situation of the country – from the creation of jobs, to tackling unemployment as well poverty and ultimately insecurity. Alternatively, development financial institutions affiliated with the government can be pre-funded with clear priorities including lending to MSMEs, after which securitisation of the loans can be undertaken to allow for liquidity and utilization of recycled capital.
The application of securitisation, although a welcome idea would not be devoid of the “Nigerian factor” which in practical terms would mean the huge risks that financial institutions, originators or investors would be exposed to if and when these structures are abused, misused and defaulted on by the “Nigerian” debtor. It is no news that Nigeria lacks the infrastructure (comprehensive database) with which to monitor, identify and allocate corresponding credit scores to individuals and would-be directors or officers of these MSMEs, in the event that loans are consistently defrayed overtime or outrightly defaulted. There also exists the problematic topic of adequate security (ranging from unavailability of collateral to actual value of the collateral) to unrealistic and unfriendly interest rates.
The above, in addition to the various challenges typically known to the lending/credit space coupled with general inconveniences surrounding doing business in Nigeria, have proven to be enough to stifle access to finance as a whole due to the associated high probability of default. This high probability of default has historically been largely responsible for the unreluctant attitude of financial institutions/originators towards financing businesses or projects not driven by high networth individuals or well-known corporate brands.
While this is not an ideal situation for any emerging economy that has aspirations towards developed economy status, it has left open a void of massive but yet untapped potential; which from a prudential and entrepreneurial point of view would be most rewarding for whomever is able to deploy the highest levels of creativity and innovation to build a well-adapted securitisation product and/or collaboration capable of withstanding the identified systemic rigours surrounding SME lending. Such product would not only revolutionize the banking and finance sector but would, upon the securitisation of the underlying loans align the interests of borrowers, banks, originators, investors and translate to a colossal win for the financial system and the economy.
As the saying goes fortis Fortuna adiuvat (“fortune favours the brave.”)
Abayomi Adebanjo & Chuka Ikele
•Abayomi Adebanjo, Sector Head Financial Services Sector of Jackson, Etti & Edu is a qualified lawyer and holds a MBA from the prestigious LBS.
•Chuka is a qualified lawyer and legal counsel at CrossLend GmbH, a Berlin/Luxembourg based Securitisation and Fintech company.
