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Structured Alternatives to Structured Notes

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Structured Alternatives to Structured Notes Masterclass: Structured Alternatives to Structured Notes Tuesday, February 23, 2016 8:30 AM – 9:30 AM EST Seminar Presenter: Anna T. Pinedo, Partner, Morrison & Foerster LLP 1. Presentation 2. Morrison & Foerster FAQ Guide: “Frequently Asked Questions about Unit Investment Trusts” 3. Morrison & Foerster FAQ Guide: “Frequently Asked Questions about Closed-End Funds” 4. Morrison & Foerster Newsletter: “Structured Thoughts – Volume 7, Issue 2” 5. Morrison & Foerster Newsletter: “MoFo Tax Talk – January 2016” Masterclass: Structured Alternatives to Structured Notes © 2009 Morrison & Foerster LLP All Rights Reserved Attorney Advertising NY2-657166 NY2 766600 © 2010 Morrison & Foerster LLP All Rights Reserved | mofo.com Rights | All Reserved mofo.com & LLP Morrison MorrisonLLP | Foerster & Foerster Rights© 2010 © 2016 All Reserved Agenda Addressing TLAC through finance sub issuances Basic repackaging concepts Repackaging through a trust on an exempt basis Repackaging in reliance on Reg ABII 40 Act vehicles This is MoFo. | 2 TLAC and New Issuance Programs This is MoFo. | 3 TLAC and new issuance programs US G-SIB issuers of structured notes already are making plans to prepare to comply with the requirements of the Federal Reserve Board’s proposed long-term debt (LTD), total loss-absorbing capacity (TLAC), and clean holding company rules For structured products that reference asset classes other than rates, and without addressing the 5% excluded liabilities provision, it is likely that US G-SIB issuers of structured notes will establish finance company subsidiaries that will be the issuers of structured products. If the G-SIB issuer establishes a new subsidiary that is a finance company, the issuer’s SEC disclosure obligations are reduced (as opposed to issuing through a subsidiary that is an operating company This is MoFo. | 4 TLAC and new issuance programs (cont’d) Likely, the structure will take the following form: BHC guarantee BHC Direct or indirect wholly owned sub Structured Notes Investors Finance Co This is MoFo. | 5 TLAC and new issuance programs (cont’d) The parent BHC guarantee enables the securities of the finance company to be registered on a Form S-3 (shelf) The guarantee must comply with the guidance in the FRB’s proposal, which requires that a failure of the BHC will not trigger a payment acceleration on the finance company’s notes This is MoFo. | 6 Basic Trust Structure This is MoFo. | 7 Basic structure Institutional investor seeks structured product-like exposure and has, on a reverse inquiry basis, identified a basic pay out Institutional investor may want to diversify issuer concentration A structured note equivalent can be issued through a trust the assets of which will be a plain vanilla bond and a derivative or option This is MoFo. | 8 Using a trust A trust is a common vehicle for repackaging debt (or other) securities as well as accompanying derivatives or options. However, there are a number of structuring concerns associated with a trust vehicle. A trust usually is a passive vehicle (neither the trustee nor other parties actively manage the investment). With a trust, often there is a concern that the trust will be an investment company under the Investment Company Act of 1940 (1940 Act). It will be necessary to structure the vehicle so that it is exempt from the 1940 Act. This is MoFo. | 9 1940 Act Why avoid investment company status? If a trust is determined to be an investment company, it must register as such under the 1940 Act. Subject to regulatory scheme of the 1940 Act – reporting and other filing obligations. Limits on ability to transact with affiliates (sponsor/depositor may not be able to engage in business with the trust - for example, an affiliate that “underwrites” offerings of an investment company is subject to restrictions). Restrictions on the issuance of debt. Must satisfy asset coverage test – 300% immediately following issuance of debt and 200% immediately following issuance of preferred securities. This is MoFo. | 10 1940 Act (cont’d) An investment company is defined as an issuer that: Is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities; Is engaged in the business of issuing face-amount certificates of the installment type; or Is engaged in the business of investing, reinvesting, owning, holding or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40% of its assets. This is MoFo. | 11 1940 Act exemptions There are a number of exemptions from the 1940 Act; however, most would not be suitable. Some exemptions require limiting the number of investors: For example, Section 3(c)(1) exempts from the definition of investment company any issuer whose outstanding securities are owned by not more than 100 persons and is not making a public offering. Some exemptions limit the scope of the business activities: Section 3(c)(5) exempts from the definition any issuer not engaged in investment company activities but that is engaged in purchasing or acquiring notes, making loans or purchasing or acquiring mortgages, among other activities. This is MoFo. | 12 1940 Act exemptions (cont’d) Other exemptions limit ownership to certain classes of investors. For example, Section 3(c)(7) exempts from the definition of investment company any issuer whose securities are owned by “qualified purchasers” and is not making a public offering. A “qualified purchaser” is: Any person that owns not less than $5,000,000 in investments; Any company that owns not less than $5,000,000 in investments and that is owned, directly or indirectly, by or for two or more related natural persons; Any trust not covered by the preceding clause that was not formed for the specific purpose of investing in the securities offered whose trustee and each settlor are qualified purchasers; or Any person acting for its own account or the account of other qualified purchasers, who owns and invests not less than $25,000,000 in investments. This is MoFo. | 13 Preliminary concerns Assuming the trust approach: The trust may be consolidated with and into the “issuer” or with and into the entity that is the “principal beneficiary” The trust securities will be issued in a private placement and will be restricted securities The “sponsor” of the trust if it is a Banking Entity (as understood under the Volcker Rule) may not be able to proceed with this approach as the trust is likely a “covered fund” The institutional investor (if affiliated with a Banking Entity) may not be able to proceed with this approach because holding the trust securities may constitute holding an “ownership interest” in a covered fund This is MoFo. | 14 Repackaging Structure and Analysis This is MoFo. | 15 Public alternative A trust that sells its securities pursuant to Regulation ABII (similar to a securitization) and is exempt from the 1940 Act. This is MoFo. | 16 Overall repackaging structure Structured Note 1 Deposited Structured Note 2 or Trust sold securities Structured Note 3 Trust Depositor Investors Issuer Structured Note 4 $ $ Etc. Swap Counterparty This is MoFo. | 17 Basic structure Intermediate subs Issuer B/D Affiliated Swap Equity Counterparty ownership (51% or greater) Trust Trust securities Issuer Investors $ Issues to consider: • Trust likely will be consolidated for accounting purposes (on balance sheet) • Accounting for: (1) swap; (2) trust securities; (3) equity interest in trust • Disclosure/reporting issues This is MoFo. | 18 Third-party (rent-a-shelf) issuer Intermediate subs Issuer B/D Swap Contractual Counterparty relationship Portfolio of plain vanilla Trust Third notes $ Trust securities Party Investors Issuer Sponsor $ Equity interests Issues to consider: • Ratings agency analysis: will ratings agencies “look through” or rely on swap counterparty rating? • The only “swaps” or “options” allowed in an SEC-registered vehicle are: rate-linked or currency-linked. No equity-linked or credit-linked exposure is possible through the swap or option. This is MoFo. | 19 Repackagings or resecuritizations In a repackaging or resecuritization, assets (usually debt securities) are repackaged in a special purpose vehicle and the special purpose vehicle sells securities to the public. The “repackaging” concept can be applied to any number of underlying assets— for example, a trust the assets of which are a diverse series of plain vanilla bonds issued by different issuers; a trust the assets of which are a series of CDs; etc. Resecuritizations rely on the regulatory scheme established by Regulation ABII(for purposes of this presentation, we will refer to it as “Reg AB”). Asset-backed issuers are exempt from the 1940 Act pursuant to Rule 3a-7. This is MoFo. | 20 1940 Act considerations for ABS Most ABS issuers are exempt from the 1940 Act pursuant to Rule 3a-7, which states: Any issuer engaged in the business of purchasing, or otherwise acquiring and holding eligible assets and who does not issue redeemable securities will not be deemed an investment company. Redeemable securities are defined in Section 2(a)(32) as “any security other than short-term paper, under the terms of which the holder upon its presentation to the issuer (or someone designated by the issuer) is entitled to receive approximately his proportionate share of the issuer’s current net assets, or the cash equivalent thereof.” This is MoFo. | 21 1940 Act considerations for ABS (cont’d) Rule 3a-7 contains a number of conditions: The issuer must issue fixed income securities or other securities that entitle their holders to receive payments that depend on the cash flow from eligible assets; Securities sold must be rated investment grade; Acquisitions and dispositions of eligible assets may be made only in accordance with governing documents and may not trigger a downgrade in the issuer’s rating; and Must appoint a non-affiliated trustee that has a perfected security interest in the assets.
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