Understanding Islamic Finance - Doha Academy of Tertiary Studies

Sukuk and Securitization 395The legal structure of an SPV depends upon the regulatory and legal environment in which ithas to work. It has to be ensured that the sale to the SPV is true and there is a proper segregationof the asset from the original owner. Once the ownership has been transferred to the SPV, thediscretion of the original owner in respect of the asset comes to an end, and it cannot be reversedin the case of insolvency of the original owner or otherwise.Alternative payment structures adopted by SPVs include the “pass-through structure” –the SPV remits any funds collected completely and immediately to the investors – andthe “pay-through structures” – desynchronization of servicing of the securities from theunderlying cash flows. SPVs may also have discretion to reinvest the funds and pay investorsaccording to a predetermined schedule. They may also serve as “conduits” – vehicles set upfor multiple issuances (typically in the case of securitization of receivables of credit cardsand commercial papers).15.3.3 Risk, Contract and Cash Flow AnalysisThe lead bankers have to undertake minute risk analysis in respect of credit and bankruptcyrisk (the ability of the entity to pay its obligations and survive as a viable entity); performancerisk (the ability to fulfil contractual obligations); asset/collateral risk (variation in thevalue of the underlying asset); payment risk (the ability of other parties, particularly creditenhancement providers, to meet their obligations); return rate risk (variation in return ratestructure); exchange rate risk; liquidity risk (the ability to liquidate the underlying assetsor the collateral to service the investor); risk of loss of money collected and retained bythe servicer for a short period before remitting to the SPV; prepayment risk (variation inmaturity of the investments made by the investors due to prepayment by obligors); reinvestmentrisk in pay-through structures (variation in the returns earned on investments made bythe SPV for the period until the prespecified dates, and the legal/regulatory/tax related risk(interpretation of various laws, regulations and complex documentation).Contract analysis focuses on rights and obligations, performance requirements, termination,events of default and consequences of defaults, with the purpose of knowing the abilityto fulfil the rights and obligations. It also includes study of transaction documentation.Cash flow analysis is conducted to identify key variables and expected patterns of theunderlying cash flows under various scenarios and to determine the rating.Box 15.2:Securitization Mitigates the RisksOriginator’s perspective• mitigates liquidity risk of anilliquid asset;• reduced cost of funding;• takes assets off balance sheet,without loss of use;• reduced cost of finance if SPV isserving as multiple originators bypooling assets.Investors’ perspective• foreign exchange risk is reducedif underlying asset is denominated inmultiple currencies;• pooling of diversified assets withheterogeneous risk mitigates earningsrisk;• undivided ownership of the asset is anadded protection.