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What is Securitization and Its Examples

Securitization is the process of converting illiquid assets into liquid assets by converting longer duration cash flows into shorter duration cash flows. It is a structured finance which was originated in USA in 1970 out of the necessity faced by the saving and loan associations of the United States to save themselves from the bankruptcy. When inflation began to rise and the market interest rates rose these institutions found that they had to pay high market rates for attracting short term deposits which were higher than the rates they were earning on the long term mortgage loans. For resolving these problem these institutions turned towards securitization of debt by selling long term debt in the form of securities of different maturities and denominations and sold it to various investors according to their risk- return profiles. Hence therefore any resource with predictable cash flows can be securitized. For example tickets that is to be sold at a cinema hall, credit card receivables, loans that are to be paid to housing finance company, non performing assets of a financial company, etc

Securitization of Financial Assets


Timothy C. Leixner
HOLLAND & KNIGHT LLP

GENERAL BACKGROUND Mortgage backed (MBS) and asset backed (ABS) securitizations, or more generally, the securitization of financial assets (for purposes of this outline, Securitizations), is a form of structured finance initially developed in the early 1980's in MBS format. It matured in the late 1980's in both MBS and ABS formats and is now a $400 billion industry in the U.S. alone. In recent years, it has spread to Europe (the largest market outside the U.S.), Latin America and Southeast Asia (primarily Japan). Virtually all forms of debt obligations and receivables (Receivables) have been securitized in the U.S.: residential mortgages; home equity loans; manufactured housing loans; timeshare loans; auto, truck, RV, aircraft and boat loans and leases; credit card receivables; equipment loans and leases; small business loans; student

loans; trade receivables (just about any type, i.e., airline tickets, telecommunications receivables, toll road receipts); lottery winnings; and record album receivables (David Bowie and Pavarotti). Although the basic concepts, many based upon tax and accounting effects and desired results, are essentially the same, each asset class presents unique structuring considerations, and the players are constantly looking for ways to improve structures to achieve higher ratings (and thus lower costs) and reduced expenses. Securitizations outside the U.S. have been more limited because of certain impediments (discussed below). In Latin America the principal asset class securitized has been trade receivables (primarily the "future flow" from trade receivables, discussed in more detail below). BASIC STRUCTURE In its simplest form a Securitization involves (1) the sale of a large pool of Receivables by an entity (Originator) that creates such Receivables (or purchases the Receivables from entities that create them) in the course of its business to a "bankruptcy-remote," special purpose entity (SPE) in a manner that qualifies as a "true sale" (vs. a secured loan) and is intended to achieve certain results for accounting purposes, as well as protecting the Receivables from the claims of creditors of the Originator, and (2) the issuance and sale by the SPE (Issuer), in either a private placement or public offering, of debt securities (Securities) that are subsequently satisfied from the proceeds of and secured by the Receivables. When the Securitization is "closed," funds flow from the purchasers of the Securities (Investors - usually banks, insurance companies and pension funds) to the Issuer and from the Issuer to the Originator. All of these transactions occur virtually simultaneously. In the United States, the Issuer in the basic structure is normally a trust (grantor, owner or business, depending upon the Originator's objectives and the structure), which issues Securities consisting of notes or other forms of commercial paper (Notes) and certificates evidencing an undivided ownership in the Issuer (Certificates). Frequently, there is also created a residual interest in the Issuer that entitles the holder (usually the Originator) to funds remaining after all obligations to the holders of the Notes and Certificates (Securityholders) have been satisfied. During the term of the Securitization, payments on the Receivables are collected by a servicing entity, usually the Originator (Servicer), deposited and invested (in "eligible securities") in various accounts under the control of a trustee (Trustee), and disbursed by the Trustee to the Securityholders in payment of the Securities. In many instances a "two step" structure has been used whereby the Receivables are first transferred by the Originator to an intermediate SPE (Intermediate SPE) that is a wholly owned subsidiary of the Originator, but which is only permitted to engage in

the business of acquiring, owning and selling the Receivables, has at least one independent director and is restricted in various ways from entering into voluntary bankruptcy and other prohibited acts. Frequently, this transfer is, at least in part, a contribution of capital by the Originator to the Intermediate SPE. In the second of the "two steps," the Intermediate SPE sells the Receivables to the Issuer. This structure is intended to enhance the "true sale" and "bankruptcy remote" characteristics of the transaction. That is, the transaction is structured to insure that the sale of Receivables to the Intermediate SPE is a "true sale" rather than a financing device, which is necessary for the Originator to get the Receivables off its balance sheet and book a profit or loss for accounting purposes and, combined with the second transfer by the Intermediate SPE to the Issuer, an essential part of the required protection from the claims of creditors, including by avoiding consolidation of the Receivables with the assets of the Originator in the event of the bankruptcy of the Originator. Beginning in 1997, a change in accounting rules in the U.S. pursuant to FASB 125 has virtually mandated the use of the two step structure to obtain an "isolation of assets" and, therefore, a "true sale," whenever the Originator retains an interest in the Securities issued by the Issuer (usually for credit enhancement purposes, as discussed below). However, it should be noted that in some cases the Originator does not want a true sale to occur (and book a gain or loss) and deliberately structures the transaction as a secured loan. The above description of the Securitization structure is very basic. Actual structures involve many more elements and participants. The classes of assets also result in different and, in many cases, more complex structures. For example, in securitizing motor vehicle leases, to avoid the very high costs of multiple transfers of titles to the vehicles, a new structure was developed several years ago (in which the author of this outline participated) where the vehicles are initially titled in and the leases made through an "origination trust" and that trust then issues, in a series of complex transfers to other trusts, limited partnerships and limited liability companies, units and sub-units of beneficial interest in the trust which are actually the "receivables" that are securitized, the Securityholders having no interest, beneficial or otherwise, in the underlying vehicles or leases. ADVANTAGES The Securitization structure is intended to provide significant advantages to Originators, such as: 1. The Receivables are moved "off balance sheet" and replaced by a cash equivalent (less expenses of the Securitization), thus improving the Originator's balance sheet and resulting in gain or loss, which itself is usually an intended, beneficial consequence.

2. The Originator does not have to wait until it receives payment of the receivables (or, in a "future flow" securitization, until it even generates them) to obtain funds to continue its business and generate new Receivables. In many cases this is essential, and a role otherwise filled by more traditional methods of financing, including factoring (in some ways Securitization is a very sophisticated form of factoring). This is more significant when the Receivables are relatively long term, such as with real property mortgages, auto loans, student loans, etc., and not as significant with short term Receivables, such as trade and credit card Receivables. 3. The Securities issued in the Securitization are more highly rated by participating rating agencies (because of the isolation of the Receivables in a "bankruptcy-remote" entity), thus reducing the cost of funds to the Originator when compare to traditional forms of financing. In instances where the Receivables bear interest, there is usually a significant spread between the interest paid on the Securities and the interest earned on the Receivables. Ultimately, the Originator receives the benefit of the spread. In addition, the Originator usually acts as Servicer and receives a fee for its services. 4. In non-revolving structures, and those with fixed interest rate Receivables, assets and related liabilities can be matched, eliminating the need for hedges. 5. Because the Originator usually acts as Servicer and there is normally no need to give notice to the obligors under the Receivables, the transaction is transparent to the Originator's customers and other persons with whom it does business. These advantages are tempered by the fact that the Securitization structure results in higher costs than traditional forms of financing, but this is more than offset by the advantages. However, these higher costs mean that the value of a pool of Receivables must be significant to justify Securitization. An offering of Securities in a Securitization should be valued at $30,000,000 or more and most are in excess of $100,000,000, a number even in excess of $1 billion. In fact, most Securitizations at the low end are not structured by the Originators, but use "conduit" Issuers maintained by banks and investment bankers. In these securitizations, Originators sell Receivables to conduits that aggregate Receivables from multiple Originators (even different forms of Receivables) to create large pools to support the Securities issued by the Issuer-conduit. Because the operators of the conduits keep a bigger share of the "pie," an Originator is usually better off structuring a Securitization that uses its own Issuer in a "stand-alone" Securitization when its pool of Receivables is sufficiently large. MAJOR PLAYERS

The major "players" in the securitization game, all of whom require legal representation to some degree, are as follows (this terminology is typical, but different terms are used; for example the "originator" is often referred to as the "issuer" or "seller"): Originator - the entity that either generates Receivables in the ordinary course of its business, or purchases and assembles portfolios of Receivables (in that sense, not a true "originator"). Its counsel works closely with counsel to the Underwriter/Placement Agent and the Rating Agencies in structuring the transaction and preparing documents and usually gives the most significant opinions. It also retains and coordinates local counsel in the event that it is not admitted in the jurisdiction where the Originator's principal office is located, and in situations where significant Receivables are generated and the security interests that secure the Receivables are governed by local law rather than the law of the state where the Originator is located. Issuer - the special purpose entity, usually an owner trust (but can be another form of trust or a corporation, partnership or fund), created pursuant to a Trust Agreement between the Originator (or in a two step structure, the Intermediate SPE) and the Trustee, that issues the Securities and avoids taxation at the entity level. This can create a problem in foreign Securitizations in civil law countries where the trust concept does not exist (see discussion below under "Foreign Securitizations"). Trustees - usually a bank or other entity authorized to act in such capacity. The Trustee, appointed pursuant to a Trust Agreement, holds the Receivables, receives payments on the Receivables and makes payments to the Securityholders. In many structures there are two Trustees. For example, in an Owner Trust structure, which is most common, the Notes, which are pure debt instruments, are issued pursuant to an Indenture between the Trust and an Indenture Trustee, and the Certificates, representing undivided interests in the Trust (although structured and treated as debt obligations), are issued by the Owner Trustee. The Issuer (the Trust) owns the Receivables and grants a security interest in the Receivables to the Indenture Trustee. Counsel to the Trustee provides the usual opinions on the Trust as an entity, the capacity of the Trustee, etc. Investors - the ultimate purchasers of the Securities. Usually banks, insurance companies, retirement funds and other "qualified investors." In some cases, the Securities are purchased directly from the Issuer, but more commonly the Securities are issued to the Originator or Intermediate SPE as payment for the Receivables and then sold to the Investors, or in the case of an underwriting, to the Underwriters.

Underwriters/Placement Agents - the brokers, investment banks or banks that sell or place the Securities in a public offering or private placement. The Underwriters/Placement Agents usually play the principal role in structuring the transaction, frequently seeking out Originators for Securitizations, and their counsel (or counsel for the lead Underwriter/Placement Agent) is usually, but not always, the primary document preparer, generating the offering documents (private placement memorandum or offering circular in a private placement; registration statement and prospectus in a public offering), purchase agreements, trust agreement, custodial agreement, etc. Such counsel also frequently opines on securities and tax matters. Custodian - an entity, usually a bank, that actually holds the Receivables as agent and bailee for the Trustee or Trustees. Rating Agencies - Moody's, S&P, Fitch IBCA and Duff & Phelps. In Securitizations, the Rating Agencies frequently are active players that enter the game early and assist in structuring the transaction. In many instances they require structural changes, dictate some of the required opinions and mandate changes in servicing procedures. Servicer - the entity that actually deals with the Receivables on a day to day basis, collecting the Receivables and transferring funds to accounts controlled by the Trustees. In most transactions the Originator acts as Servicer. Backup Servicer - the entity (usually in the business of acting in such capacity, as well as a primary Servicer when the Originator does not fill that function) that takes over the event that something happens to the Servicer. Depending upon the quality of the Originator/Servicer, the need and significance of the Backup Servicer may be important. In some cases the Trustee retains the Backup Servicer to perform certain monitoring functions on a continuing basis. CREDIT ENHANCEMENT Credit enhancements are required in every Securitization. The nature and amount depends on the risks of the Securitization as determined by the Rating Agencies, Underwriters/Placement Agents and Investors. They are intended to reduce the risks to the Investors and thereby increase the rating of the Securities and lower the costs to the Originator. Typical forms of credit enhancement are: 1. Over-collateralization - transferring to the Issuer, Receivables in amounts greater than required to pay the Securities if the proceeds of the Receivables were received as anticipated). The amount of over-collateralization (usually 5% to 10%) is determined by the Rating Agencies and the Underwriters/Placement Agents, and this in turn will depend upon the quality of the Receivables, other credit enhancement that may be

available, the risk of the structure (such as the possible bankruptcy of the Originator/Servicer), the nature and condition of the industry in which the Receivables are generated, general economic conditions and, in the case of foreign-based Securitizations, the "Sovereign risk" (see discussion below under "Foreign Securitizations"). If all goes well, it is repurchased at the end of the transaction (see "Anatomy of a Securitization")or returned as part of the residual interest. This form of credit enhancement is required in virtually all Securitizations. 2. Senior/subordinated structure - issuance of subordinated or secondary classes of Securities, which are lower-rated (and bear higher interest rates) and sold to other Investors or held by the Originator. In the event of problems, the higher rated (senior) Securities receive payments prior to the lower rated (subordinated) Securities. It is not uncommon for there to be a number of classes of Securities that are each subordinated to the more highly rated, resulting in a complex "waterfall" of payments of principal and interest. In the common structure described above, senior and subordinated classes of Notes would be paid, in order of priority, prior to classes of Certificates, and Certificates prior to any residual interest in the Issuer. This form of credit enhancement has become routine, but cannot be used in a grantor trust structure, which is why the owner trust has become most common. 3. Early amortization - if certain negative events occur, all payments from Receivables are applied to the more senior securities until paid. Very common. 4. Cash collateral account - the Originator deposits funds in account with Trustee to be used if proceeds from Receivables are not sufficient. Adjustable depending upon events. May be in the form of a demand "loan" by the Originator to the account. 5. Reserve fund - subordinated Securities retained by the Originator or Trustee and pledged for the benefit of the Trust (and, therefore, the Investors). 6. Security bond - guarantee (or wrap) of all payments due on the Securities. Issued by AAA-rated monoline insurance companies (if available). 7. Liquidity provider - in effect, a guarantee by the Originator (or its parent) or another entity of all or a portion of payments due on the Securities. 8. Letter of credit (for portion of amounts due on Securities) - not used much anymore because of costs. These were common in the late 1980's when issued by Japanese banks at low rates. LEGAL OPINIONS

Legal opinions are very important documents in every Securitization and result in considerable negotiations among counsel for the Originator, Underwriter/Placement Agent and Rating Agencies. The opinions given by the Originator's counsel are the most extensive, frequently running 50 or more pages because of the need for reasoned opinions, as courts have not ruled upon many of the underpinnings of the Securitization structure. In addition to the usual opinions regarding due organization, good standing, corporate power, litigation, etc, others deal with the validity and priority of security interests, true sale vs. secured loan, substantive consolidation in bankruptcy, fraudulent transfer, tax consequences and compliance with securities laws and ERISA. Opinions are also given by counsel for the Trustees and frequently by counsel to the Underwriter/Placement Agent in regard to tax and securities matters. As indicated above, local counsel opinions may be required as well. For reasons of structuring and such opinions, in addition to attorneys who are experienced in Securitizations, expertise is required in the areas of securities law, tax law, bankruptcy and the UCC. Expertise is also required in many instances in the substantive laws relating the business of the Originator and the nature of the Receivables. FOREIGN SECURITIZATIONS This Securitization structure has presented problems in civil law-based countries, where the concepts of trust law have traditionally not existed. In addition, in many countries there are concerns about government intervention in the international flow of funds and other aspects of Securitizations, the ability of the Servicer and Trustee to enforce the collection of Receivables in a commercially reasonable manner, additional tax burdens, the unpredictable nature of courts and government instability. These are known as the "sovereign risk" and have either completely blocked in-country Securitizations or have resulted in ratings of the Securities no higher than the rating of the country. As a result, many Securitizations, particularly those involving Latin American originated Receivables, have used a structure where the Receivables are transferred to offshore entities ("offshore" may be in the U.S.) and the entire transaction takes place outside the country of origin. This situation continues to prevail in most countries, but a few have adopted legislation to permit the limited use of trusts (Argentina and Brazil) or the creation of special purpose corporations to serve the same purpose (France). However, even where such legislation has been adopted, sovereign risk issues may prevent a Securitization that is able to take advantage of international money markets, particularly outside of Western Europe. Further, such legislation has often been incomplete or flawed. For example, Securitizations are rarely based in France because

it decided it should impose a tax on the special purpose corporations permitted under the new law. Nevertheless, economic and financial market conditions in many countries have provided strong incentives for Originators in countries such as Brazil and Argentina, and the non-US market is growing every year, although the Asian and South American markets are very difficult at this time. Moreover, because of a lack of experienced underwriters, trustees and attorneys in most countries, many such service providers have expanded into Europe and Latin America. In Latin America, one of the most common asset classes is "future flow" receivables. In this type of Securitization, involving trade receivables of short duration, only a relatively small amount of existing Receivables are transferred to the Issuer and the Investors purchase Securities with a much higher face value based upon the subsequent transfer by the Originator to the Issuer of a "future flow" of Receivables to be generated by the Originator with the proceeds of the Securitization. In effect, the Originator receives payment for Receivables that do not exist, and will only come into existence through the future conduct of the Originator's business. Obviously, this can only be accomplished by Originators with strong track records and engaged in businesses with a high likelihood of continuing at profitable levels. In addition, it usually involves foreign Receivables that can readily be transferred and collected offshore. An example of this is the Securitization of airline ticket receivables by Varig. Wednesday, September 01, 1999 ntroduction to Securitization
by: Jason Kravitt, Mayer, Brown & Platt, 1998 "When you measure what you are speaking about, and express it in numbers, you know something about it; but when you cannot measure it, when you cannot express it in numbers, your knowledge is of a meager and unsatisfactory kind . . . ." William Thomson, Lord Kelvin, Popular Lectures and Addresses (1891--1894). (i) The Nature of Securitization Most attempts to define securitization make the same mistake; they focus on the process of securitization instead of on the substance, or meaning, of securitization. Hence, the most common definition of securitization is that it consists of the pooling of assets and the issuance of securities to finance the carrying of the pooled assets. Yet, surely, this reveals no more about securitization than seeing one's image reflected in a mirror reveals about one's inner character. In Lord Kelvin's terms, it is knowledge of "a meager and unsatisfactory kind." A better definition of securitization is that it consists of the use of superior knowledge about the expected financial behavior of particular assets, as opposed to knowledge about the expected financial behavior of

the originator of the chosen assets, with the help of structure to more efficiently finance the assets. This definition is superior because it better explains the need for the most essential aspects of any securitization any where in the world under any legal system, and it better defines the place of securitization within several of the broader financial trends that have occurred at the end of our century. The first trend has been the break down of individual, segregated and protected, capital markets into one, increasingly world-wide, capital market. The result of this trend has been a drive to find ever more efficient forms of raising capital, particularly in the form of debt financings. The more efficient forms will, by definition, in capital markets that are not segregated or protected from other competing markets, replace the less efficient forms. Securitization, in the correct circumstances, is one of the very most efficient forms of financing. This is because of two additional trends. The first is the increasing importance of the use of information to create wealth. The second is the increasing sophistication of computers and their uses. Securitization is made possible by the combination of these two trends. Computers enable one to store and retrieve extensive data about the historical behavior of pools of assets. This historical data in turn enables one to predict, under the right circumstances, the behavior of pools of such assets subsequently originated by the applicable originator. Because our knowledge about such behavior may be so precise and reliable, when structured correctly, a securitization may entail less risk than a financing of the entity that originated the securitized assets. Again in Lord Kelvin's terms, our knowledge about the likely behavior of pools of assets is "measurable" and we "express it in numbers." It is a superior sort of knowledge from the perspective of the world of finance. Accordingly, such a securitization may be fairly labeled to be more efficient and indeed may require less over-all capital than competing forms of financing. The preferred definition of securitization with which this essay began thus reveals why securitization often is preferable to other forms of financing. It also explains most of the structural requirements of securitization. For, to take advantage of superior information of the expected behavior of a pool of assets, the ability of the investor to rely on those assets for payment must not be materially impaired by the financial behavior of the related originator or any of its affiliates. In most legal systems, this is not practicable without the isolation of those assets legally from the financial fortunes of the originator. Isolation, in turn, is almost always accomplished by the legal transfer of the assets to another entity, often a special purpose entity ("SPE") that has no businesses other than holding, servicing, financing and liquidating the assets in order to insure that the only relevant event to the financial success of the investors' investment in the assets is the behavior of such assets. Finally, almost all of the structural complexities that securitization entails are required either to create such isolation or to deal with the indirect effects of the creation of such isolation. For example, the (i) attempt to cause such transfers to be "true sales" in order to eliminate the ability of the originator to call on such assets in its own bankruptcy, (ii) "perfection" of the purchaser's interest in the transferred assets, (iii) protections built into the form of the SPE, its administration and its capital structure all in order to render it "bankruptcy remote", and (iv) limitation on the liabilities that an SPE may otherwise incur are each attributes of the structure of a securitization designed to insure that the isolation of the transferred assets is not only theoretical but also real. Similarly, attempts to (i) limit taxes on the income of the SPE or the movement across borders of the interest accrued by transferred receivables, (ii) comply with the various securities or investment laws that apply to the securities issued by the various SPEs in order to finance their purchases of the assets, or (iii) comply with the bank regulatory restrictions that arise in connection with such transfers, the creation of SPEs and the other various roles played by banks in connection with sponsoring such transactions each constitute a reaction to indirect problems caused by the structuring of the above described transfer and the SPE to receive the transferred assets. (ii) Current and Future Trends A recent trend in the United States in securitization has been attempts by regulators to "catch up" with the market. Two examples are the modifications to the risk-based capital rules of the Basle Accords proposed

by certain federal bank regulators, and the proposed replacement of FAS No. 77, the accounting rules for when a transfer of financial assets removes the assets from the transferor's balance sheet, with an entirely new conceptual framework, the financial components approach. In the case of the risk-based capital rules, the bank regulators believed that the rules contained a logical anomaly in that a bank that credit enhanced, on behalf of an SPE, a pool of assets that the bank had not originated was required to maintain less capital against its enhancement obligation than a bank that provided the same amount of credit enhancement to such an SPE with regard to assets that the bank had originated and subsequently transferred to the SPE. The regulators believed that the risk was the same and merited the same amount of capital. The industry objected and demonstrated to the regulators that in the case of third party provided credit enhancement the bank nearly always was taking the second or third level of risk and almost never the first level of risk (which was usually born by the transferor/originator). On the other hand, in the case of the bank that transferred the assets after originating them, the bank, in its combined role of originator and credit enhancer, usually was taking the first or second level of risk. Further, an even greater logical anomaly would be created by the rules as originally proposed as, if adopted in such form, unsecured loans made by commercial banks to holding companies would require many times less capital to be held by such banks than secured contingent obligations in the form of credit enhancement given for the benefit of companies actually holding the related assets. The regulators then reformed their proposal and eventually proposed that the amount of capital required to be held for credit enhancement should be a function of a rating agency assessment of the level of the risk involved. The proposal is now under consideration by the Federal Financial Institution Examination Council ("FFIEC"). In the case of accounting rules, members of the Financial Accounting Standards Board ("FASB") had for some time believed that FAS No. 77 had been rendered obsolete by the rapidly developing complexities of the securitization market place. Hence, in 1994 the FASB proposed to adopt an entirely new conceptual framework in which the material question would no longer be whether the risks or benefits of the assets to be transferred had been retained or transferred by the transferor but instead who controlled the various benefits of the transferred assets. Those that were controlled by the transferee would be derecognized by the transferor, and those that remained with the transferor would be reflected on its balance sheet. While the new approach is a brilliant conceptual breakthrough, the FASB made the mistake of not defining "control" consistently with various accounting interpretations but instead relying on the legal concept of whether the transfer constituted a "true sale at law". This aspect of the proposal provoked an uproar from the entire securitization community as it failed to recognize the practical structural means by which the market accomplished the isolation of the assets from the transferor's bankruptcy estate and instead relied on a legal doctrine on which there was no agreement or accepted standard in the legal community. Accordingly, the FASB is now attempting to fashion a definition of control that takes account of the practical means by which market participants in fact transfer control over the transferred assets. What do these processes reveal? In each case, the applicable regulators believed that the markets had evolved so quickly and diversely that existing rules that had not been adopted with securitization in mind were hopelessly inadequate to deal with the intricacies of the securitization market. However, when regulators who were unfamiliar with how the market functioned in fact attempted to craft new rules, the new rules were even more impractical than the existing ones. As a result of a dialogue by regulators with market participants, the amended proposed rules become much more practical and consistent with market practice. In the U.S., because of the extensive breadth of the market, and the rapid pace of change, no regulatory body can hope to adopt practical rules without an extensive dialogue with active participants in the market place. This experience also demonstrates that it is extremely difficult to craft rules that will work in any event because of the immense and ever changing diversity of market practice. The situation in Europe is, of course, some what different. The United Kingdom, with its tradition of common law, is the most similar to the United States. Different forms and structures may evolve freely for the most part so long as not prohibited. Structures would function more smoothly with some law and

accounting changes, but it is not necessary to change the laws for securitization to thrive so long as this form of financing makes economic sense. However, countries with civil law traditions are in a different predicament. In large part, they must pass new laws in order for the securitization market to develop. This is a partial (though by no means complete) explanation for the volume of securitization in France or Spain (where such laws have been passed) compared to Italy or Germany (where less extensive laws have been passed). But because it is so difficult to build legal and accounting rules that can accommodate the tremendous creative energies of the market, markets in countries where rules must be created to permit securitization to flourish will inevitably develop more slowly than they could otherwise develop. If the market is dependent on regulators in order to thrive, the market is constantly catching up. Conversely, if the market will thrive so long as the regulators do not discourage such activity, it is more likely that the regulators will be the ones who are catching up. Consistently with the aforesaid discussion, because of the widespread belief in the United States that securitization is socially valuable, legislation has continued to be proposed that promotes securitization. Hence, there are proposals to change the tax laws to make securitization of non-real estate assets easier and laws have recently been passed to facilitate the securitization of small business loans and leases. It is reasonable to expect that, so long as there is no highly visible disaster with regard to a prominent securitization transaction, laws of this nature will continue to be proposed and adopted in the U.S. However, there has been no explosion of transactions securitizing small business loans. This is undoubtedly because such transactions, given the mix of the high returns of such loans and the present abundance of bank capital, do not today make great economic sense. Legislation can enable transactions to occur but it will not make them occur if they do not make economic sense. While this principle applies to Europe as well, for the reasons stated in the second preceding paragraph, the situation is more complicated. While enabling legislation usually won't change basic economics, such legislation may be necessary in order to enable basic economics to take their natural course. A further trend is the evolution of the structure of SPEs that permit maximum flexibility for the issuer. Hence the development in the U.S. of owner trusts, master trusts and multi- seller conduits. In the case of owner or master trusts, SPEs that take these forms may issue multiple tranches of fixed or floating rate securities with maturities that vary from 30 days to 12 years or more. Such trusts may enter into private or public offerings and access the capital markets only once or repeatedly over an unlimited period of years. Similarly, conduits that issue asset-backed commercial paper or medium term notes may purchase assets of all types (including operating as well as financial assets) from multiple sellers, of investment or noninvestment grade ratings, and in multiple countries. The U.S. Securities and Exchange Commission allows issuers of asset- backed or mortgage-backed securities to utilize so-called "shelfs" to access the public markets without prior review, in many circumstances, after the initial filing, allowing issuers to take advantage of favorable market conditions in a matter of days. The efficiency of execution in the assetbacked and mortgage-backed world has become, even to the most experienced, startling. Another similar development has been the creation of automobile titling trusts. To overcome the difficulties caused by state automobile titling statutes, trusts have now been developed that hold title to the automobiles and related leases and the structures of which permit securitization of their assets by the transfer to investors of beneficial interests in the trusts themselves. This trend must certainly be reflected in time in Europe, but on the whole it will be more difficult to duplicate in countries where legislation is necessary to permit the creation and operation of the form of SPEs now being developed in the U.S. than in countries where market forces may operate naturally without such legislation. Yet another trend in the U.S. has been the evolving notion of what constitutes a "true sale." This has been a particularly vexing problem. For legal bankruptcy purposes, when a transfer is a "true sale", the transfer is so complete that it effectively removes the assets from the bankruptcy estate of the transferor. In the U.S., courts have focused on the substance of the transaction, rather than on its form, and thus, as the risk and rewards of the transferred assets are distributed between both the transferor and transferee, for legal purposes there is often a not trivial amount of ambiguity. There is the added problem that there is no

agreement in the legal community on what constitutes a "true sale" for bankruptcy purposes. The market has developed practical means of dealing with this problems with the so-called "two-tier" structure, but the recent FASB proposal described above has highlighted the problems caused by the uncertainty in the legal arena. The FASB proposal also illustrates the difficulty of determining conceptually what a true sale should be for accounting proposes. While the legal precedents focus, in some part, on the transfer of risks, accounting standards have traditionally focused on rewards. The new financial components approach is an attempt to break out of these conceptual traps as all securitizations will divide risks and rewards among both the transferor and transferee leaving such transactions difficult to characterize with certainty by those who believe that risks or rewards should be the determinative factors. The idea behind the financial components approach is that a pool of assets and their attendant liabilities can be divided into an unending succession of conceptual risks and benefits. Rather than agonizing over how much of each must be transferred and to whom in order to find a sale (or a financing) of all of the assets and liabilities at issue, why not recognize that the transferor and transferee may each record on their own balance sheets those aspects of the assets that they control, and those liabilities for which they are liable. This will create balance sheets that are less misleading than balance sheets constructed on the basis of an all-or-nothing formulation that by definition must be at least partially misleading. It is still too early to determine if the intellectual ferment occasioned by the FASB proposal will cause a more rational true sale standard to evolve for legal or accounting purposes in the U.S. Again, the situation in Europe is more complex. Both accounting and legal rules vary widely form country to country. On the legal side, form seems to be much more important than in the U.S. Ironically, this means that isolation of assets, at least insofar as a true sale is required, may be easier to accomplish in many European countries than in the U.S. Often this advantage is negated, in practice, however, by the necessity of giving notice to obligors on the receivables if the investors in the securitization wish to avoid certain risks. Hence the need for legislation in countries such as France or Belgium. These is also tremendous diversity among different nations in their accounting rules. The United Kingdom ("U.K.") has gone through a very painful process in reforming its accounting rules in leading to the adoption of Financial Reporting Standard 5. By focusing on risks and rewards, the U.K. Accounting Standards Board faced the all too typical dilemma of how to satisfy market participants when the use of such standards inevitably lead either to ambiguity for many transactions or the outright elimination as sales of many market structures. The only solution is a compromise that causes some damage to the integrity of such standards as the basis for making decisions. The "linked presentation" is clearly such a compromise. The lesson to be learned from these difficulties in defining "true sales" is that notions of what constitutes or should constitute - a "true sale" will continue to evolve until a more satisfying intellectual framework is found that can accommodate market realties. Finally, we may end where we began. Securitization is no more than a tool, but what a wonderful tool it is. It is ever changing, ever growing, ever striving to become even more efficient. While, of course, I cannot know, I believe that Lord Kelvin would have found securitization to be the most satisfactory of all forms of finance.