Recommendations on Implementation of Mortgage Backed Securitization Final Report

RECOMMENDATIONS ON IMPLEMENTATION OF MORTGAGE BACKED SECURITIZATION FINAL REPORT

USAID GOVERNING FOR GROWTH (G4G) IN GEORGIA

28 September 2018 This publication was produced for review by the United States Agency for International Development. It was prepared by Deloitte Consulting LLP. The author’s views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government.

RECOMMENDATIONS ON IMPLEMENTATION OF MORTGAGE BACKED SECURITIZATION FINAL REPORT

USAID GOVERNING FOR GROWTH (G4G) IN GEORGIA CONTRACT NUMBER: AID-114-C-14-00007 DELOITTE CONSULTING LLP USAID | GEORGIA USAID CONTRACTING OFFICER’S REPRESENTATIVE: PHILLIP GREENE AUTHOR(S): BLC LAW FIRM CAPITAL MARKETS: 5820 LANGUAGE: ENGLISH 28 SEPTEMBER 2018

DISCLAIMER: This publication was produced for review by the United States Agency for International Development. It was prepared by Deloitte Consulting LLP. The author’s views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government.

USAID | GOVERNING FOR GROWTH (G4G) IN GEORGIA RECOMMENDATIONS ON IMPLEMENTATION OF MORTGAGE BACKED SECURITIZATION i

DATA

Reviewed by: Giorgi Amzashvili, Tamar Buadze

Project Component: GoG Capacity Strengthening Component

Practice Area: Capital Market

Key Words: Mortgage, Assets, Securitization, Covered Bonds, SPV

USAID | GOVERNING FOR GROWTH (G4G) IN GEORGIA RECOMMENDATIONS ON IMPLEMENTATION OF MORTGAGE BACKED SECURITIZATION ii

ACRONYMS

BLC BLC LLC, a Georgia based law firm qualified in the Georgian law CIT Corporate Income Tax G4G Governing for Growth in Georgia MBS Mortgage Backed Security MFO Micro-Finance Organization MNKS MNKS S.à r.l. as Luxembourg law firm NBG National Bank of Georgia SPV Special Purpose Vehicle TCG Tax Code of Georgia USAID United States Agency for International Development VAT Value Added Tax

USAID | GOVERNING FOR GROWTH (G4G) IN GEORGIA RECOMMENDATIONS ON IMPLEMENTATION OF MORTGAGE BACKED SECURITIZATION iii

CONTENTS

1. EXECUTIVE SUMMARY ...... 5

2. SECURITIZATION ...... 6

2.1. SECURITIZATION IN A NUTSHELL ...... 6

2.2. IDENTIFIED GAPS ...... 8

A. LEGAL STRUCTURE OF SPV ...... 8

B. INSOLVENCY REMOTENESS ...... 11

C. TRANSFER OF ASSETS ...... 13

D. TRADABILITY ...... 14

E. TAXATION ...... 16

2.3. RECOMMENDATIONS FOR IMPLEMENTATION OF SECURITIZATION MECHANISM ...... 18

A. LEGAL STRUCTURE OF AN SPV ...... 18

B. INSOLVENCY REMOTENESS ...... 21

C. TRANSFER OF ASSETS ...... 23

D. TRADABILITY ...... 23

E. TAXATION ...... 24

3. COVERED BONDS...... 25

3.1. COVERED BONDS IN A NUTSHELL ...... 25

3.2. GAP ANALYSIS ...... 25

A. COVERED BOND ISSUER ...... 26

B. ASSETS ELIGIBLE FOR COVER POOL...... 26

C. BANKRUPTCY REGIME ...... 27

APPENDIX: 1 ...... 29

I. ANALYSIS OF PROPOSED LAW ON CIS ...... 29

USAID | GOVERNING FOR GROWTH (G4G) IN GEORGIA RECOMMENDATIONS ON IMPLEMENTATION OF MORTGAGE BACKED SECURITIZATION iv

1. EXECUTIVE SUMMARY

In the foregoing Report, the Project Team (which implies BLC and international consultants, Mr. Femelat and Mr. Joseph of MNKS, the Luxembourgian Law Firm, specializing in structured finance) briefly describes the notion and mechanics of Mortgage Backed Security (MBS) and covered bonds as understood by Luxembourg law and identifies the key characters of the structure relevant for successful operation of these legal mechanisms in Georgia. It further detects shortfalls and/or gaps under the Georgian legislation, which may hinder successful implementation of MBS and/or covered bond system in Georgia and provides for recommendations on the legislative changes for enabling proper establishment and operation of MBS and/or covered bond system in Georgia. Furthermore, the discussion and analysis provided in this Report is limited to the MBS and covered bonds only and does not cover any other form of structured finance transactions. Term “securitization” whenever used in this Report and unless context otherwise requires shall refer to MBS. Although it does not fit int\o the securitization mechanism, the covered bond mechanisms, are also analyzed in parallel. Information provided in the Report regarding the laws of the Grand Duchy of Luxembourg (Luxembourg) and practice has been elaborated and verified by international consultants. Femelat and Joseph. This Report is limited to the matters directly addressed herein and shall not be deemed applicable to the explanations, clarifications or matters other than expressly contemplated herein. In rendering the following Report, the Project Team is opining on the matters herein referred to only insofar as they are governed by the laws of Georgia. Any reference to the laws of Luxembourg has been verified by international consultants. The Project Team expresses no opinion on the future changes that may be made to the respective legislative acts of Georgia or those of Luxembourg. In this Report, Luxembourg legal concepts are expressed in English terms and not in their original French terms. The concepts concerned may not be identical to the concepts described by the same English terms as they exist under the laws of other jurisdictions. Without prejudice to conclusions and assessments outlined in this Report, the Project Team would like to limit its statements by the considerations that the legal system of Georgia is relatively new and is undergoing rapid development. Besides ambiguity and lack of clarity of legislative norms, there is little official interpretation available, and there has been insufficient time for the laws to be thoroughly tested in practice, either at the administrative or judicial level. Accordingly, the assessments and conclusions reflect the Project Team’s best understanding of the laws currently in effect based on the legislation in force, on available official interpretation and on unofficial discussions of the issues with the relevant authorities and private sector. As regards to Luxembourg legal concepts, all explanations, description and interpretation are exclusively based upon, governed by and shall be construed in accordance with Luxembourg law effective on the date of this Report. Owing to the lack of available official interpretations and the lack of experience of the authorities and courts in interpreting the laws in Georgia, BLC can provide no assurance that the authorities, courts or tribunals in Georgia will take a position consistent with conclusions and assessments contained in this Report.

2. SECURITIZATION

2.1. SECURITIZATION IN A NUTSHELL In its most generic terms, securitization refers to financial structure of pooling assets funded by the issuance of securities. In general, a pool of cash-generating financial assets are transferred from the initial creator/owner of the assets (i.e. the Originator, as defined below) to a Special Purpose Vehicle (SPV) created for this occasion. The acquisition of such assets are financed by the SPV from the funds generated from issuance of securities. Principal and interest on such securities are payable from and backed by the proceeds from such assets. Acquisition of the portfolio of assets is usually made by a true sale (cession parfaite) but the SPV may also acquire an exposure to the underlying assets/risks using derivatives instruments in “synthetic transactions” as further detailed below. Structural considerations characteristic to MBS under the Luxembourg law can be summarized as follows:  Standard securitization transaction involves an originating party (the “Originator”) contemplating to remove a portfolio of receivables1 from its balance sheet and transferring them to the SPV;  SPV is initiated by the Originator2 itself and set up by a corporate services provider, a financial institution and/or a sponsor3of the project4, specifically for the purpose of acquiring the portfolio and in a view to (i) remove from its balance sheet the receivables forming the part of the portfolio, and/or (ii) have access to an alternative source of funding. There are varying approaches to the organizational-legal form of the SPV and it may be formed either in the form of a company or a fund. SPV may create one or further perfectly ring-fenced compartments. All the assets and liabilities allocated to one specific compartment will only be available to the investors of this specific compartment.5 If one compartment becomes bankrupt and/or is liquidated this does not affect the existence of the other compartments nor the SPV itself (unless in case of a fund, the liquidation of the last compartment implies liquidation of the fund since the fund has no legal personality by itself). In addition, the SPV may either be regulated or unregulated. An SPV which carries out a public offering of the securities6 and on a continuous basis (i.e. more than 3 issuances per year to non-professional investors – the two criteria are cumulative) should obtain a

1 Generally, receivables may be created out of the obligations of retail or corporate clients to pay various debts owed to the Originator. However, for the purposes of this Report, the Project Team shall limit its analysis to the receivables that are secured through mortgage or pledge. Furthermore, any type of receivables are eligible under the specific Luxembourg law dated 22 March 2004 on securitization undertakings (the “Luxembourg Securitization Act”) and there is no quality requirement or other standards to take into consideration for a SPV, which intends to acquire a portfolio of receivables. The purpose of the Luxembourg Securitization Act is to allow the securitization of a large variety of risks relating to all types of assets. No standards and/or guarantee are required at the level of the borrowers as long as sufficient disclosure has been made to the investors regarding the underlying assets, related debtors and potential risks. 2 Any entity having the need to securitize risks/assets may be qualified as an Originator for securitization transaction within the meaning of the Luxembourg Securitization Act. Originators are not limited to financial institutions only. 3 Sponsors may invest in the structure and e.g. act as shares/units holders in the Luxembourg securitisation company/fund in a view to (i) assist on the set-up and ignition of the structure, (ii) hold the investment as the case may be, and/or more generally (iii) subscribe to the securities in a view to ultimately transfer them to other end investors (i.e. act as underwriters). 4 Please, note that the Luxembourg Securitization Act does not contain any specific rules for conflict of interest policy. The conflict of interest, if any, shall be dealt with under the general corporate governance rules and the relevant policy of each entity involved. However, if the ultimate beneficial owner(s) of the Originator is/are also the same as the one of the securitization vehicle (i.e. the investors), the transaction will not qualify as a securitization transaction since the risk to be transferred pursuant to the contemplated transaction remains supported by the same ultimate beneficial owner(s). 5 Tranching is not required, as such, under the Luxembourg Securitization Act. Subordination of securities is however recognized and given full effect under the Luxembourg Securitization Act. The allocation of profits may be contractually agreed and a waterfall of payment inserted in the transaction documents. Kindly note that tranching is important under CRR (and other European Regulations) in order to qualify as securitization within the meaning of those regulations. This requirement is however usually relevant as far as it relates to institutional securitization. 6 In case a Luxembourg securitization vehicle offers securities to general public, the said vehicle shall prepare a prospectus for securities to be issued (similarly to all other type of Luxembourg issuers). Elements are being listed to assess whether securities are issued to the “public”. Among others, the fact that a securitization undertaking issuances of the securities to professionals within the meaning of the MiFID rules and/or where securities issued have a denomination of at least EUR 125,000 are to be assumed as issues which are not made to the public. In case a prospectus has to be issued, it will need to be compliant with the Luxembourg law on prospectuses for securities implementing the 2010 prospectus directive.

preliminary license7 and be regulated by the Luxembourg financial sector regulator (the Commission de Surveillance du Secteur Financier or “CSSF”) before starting its public and continuous issuing activity;  SPV funds the acquisition of the receivables through issuing tradable security (usually debt securities consisting in notes/bonds, but all form of “securities” being equity, debt or hybrid are possible) to investors. Issuance and placement of the securities may be effected through private or public offerings, depending on particular considerations of specific transactions;  An SPV may, within certain limits8, also fund the acquisition of the portfolio by an external financing (the financing by a credit institution and/or alternative lender). It shall only be limited to (i) an ancillary amount/portion of the transaction in the long term, or (ii) a full funding for a preliminary period during 12 to 18 months maximum;  Assignment of receivables can be structured as so called “cash flow securitization” or “true sale” (i.e. when the actual assignment of receivable is made and funds flow generating by the underlying receivables is transferred to the SPV) or a “synthetic securitization” (i.e. when the actual assignment may not be effected, but the economic interest or rather the risk exposure to a specific portfolio is transferred using some type of derivative (Credit Default Swap, for example);  The proceeds generated by the SPV from the receivables is used to fund the payments (interest and principal) to be made to the investors (tracking element), as well as to cover any other transaction costs; By the use of contractual mechanism of “limited recourse” clauses into the documentation, the SPV and the investors agree that payments to be received by the investors are limited to the cash flows generated by the securitized underling assets;  The Originator generally continues to manage the receivable (including, where applicable, the processing of personal data) based on a service agreement entered with the SPV and receives management/service fee in return. In certain scenarios, an alternative service provider can be appointed9 with the same scope and/or to act as “back-up servicer”. It is noteworthy that although the underlying debtors may not be even aware of the fact of its claims’ assignment, the payments shall be made to the specific account of the SPV;10  Any moneys left after payment of all sums due to the investors may be passed back to the Originator using various profit extraction techniques;  The collaterals securing underlying debt obligations are usually transferred together with the principal obligation (if the transfer is made) and are generally held by the security trustee, who holds the securities on behalf and in the interest of the investors11;

7 In addition to the potential publication of a prospectus and general obligation to file annual accounts, all Luxembourg securitisation vehicles have to declare themselves to the Luxembourg Central Bank (for statistical purpose in order to collect legal information about the securitisation vehicle, nature of securitisation, etc.). In addition, securitisation undertaking may be subject to provide balance sheet (in case annual accounts have not been filed with the competent authority in a timely manner). Securitisation undertakings having assets above a 70 million EUR threshold are also subject to a quarterly statistical reporting. 8 Kindly note that there is no direct control on this, especially when an unregulated vehicle is involved (as it is not subject to prudential supervision). Any securitisation undertaking has to conduct its activities in compliance with the provisions of the Securitisation Act and all applicable requirements to avoid losing the status of securitisation vehicle and potential liability of the directors. 9 A third party may be appointed as servicer to manage the receivables. In practice (and in case of secured securitisation operation) the security agent’s role is usually limited to the holding of security interest on behalf of the secured investors and it is not advisable to have the security agent also servicing the underlying assets. Servicing of the assets is delegated either to the seller of the securitised receivables or to a professional servicer. 10 In order to be enforceable against debtors, an assignment of claims has to be notified to them. This general principle set forth in the Luxembourg Civil Code is also reflected in the Luxembourg Securitisation Law. In practice, assigned debtors in the context of a securitisation transaction may not be informed of the transaction upon acquisition of the portfolio by the SPV. However, the identified account over which payment shall be made (and which is to be reflected on invoices sent to the debtors) could, in certain cases, be the one of the securitisation company. A specific statement may also be made on the invoice addressed to the debtor for that purpose. 11 Kindly note that the transfer of security attached to claims is possible under the Luxembourg Civil Code and is the automatic (if not contractually dismissed) regarding receivables pursuant to the provisions of the Luxembourg Securitization Act. In case of the acquisition of a secured claim (true sale), the assignee may benefit from the security attached to these claims provided that the assignment is possible (under the terms of the underlying claim) and the correct references to the transmission of security is also being

 Depending on the landscape of the portfolio, the SPV may contract investment manager or security administrator for the management and administration of the assets forming portfolio, being understood that the portfolio of a securitization company should be managed passively (i.e. in a diligent way and without adding an additional risk to the simple holding of the securitized assets);  In order to secure the interests of the investors, the SPV is usually limited in disposing its assets. Such prohibition shall be of a statutory or contractual nature. However, it is fair to say that it is always present in certain form. Under Luxembourg law, the assets may be sold/transferred only with the preliminary information or agreement of the investors and for their benefit, and any such possibility to dispose of the assets shall be specified in the articles of association of the SPV12;  Customarily, SPVs enjoy a specific and dedicated tax treatment: they are subject to the normal corporate income tax, but distributions and commitments assumed vis-à-vis the investors and any other creditor by securitization companies are considered to be fully tax-deductible business expenditures (regardless of whether the securities issued to investors take the form of shares, beneficiary unit, notes, bonds, or another form), resulting in a taxable basis for the SPV close to nil. Moreover, dividend and/or interest paid by the SPV is exempted from withholding tax. They are also exempt, in principle, from VAT that may potentially accrue on management service fee payable by the SPV;  From accounting perspective, as a sole legal entity, an SPV must present a single set of financials but is allowed and incited to prepare specific break-down for each compartment.

2.2. IDENTIFIED GAPS A. LEGAL STRUCTURE OF SPV SPV, established for the purpose of carrying out one or more securitizations, can be organized in the form of a company or a fund. Securitization undertaking organized in the form of a fund does not have a legal personality, rather it exists as co-ownership or fiduciary estate. Such funds are represented and managed by dedicated management companies13. There is no equivalent legal structure available under the Georgian law, which could have been used for the securitization vehicles in Georgia. The term “fund” commonly relates to a non-commercial (not-for-profit) legal entity established pursuant to the Civil Code of Georgia.14 This is usually an entity created to serve charity or other altruistic aims, which cannot engage in any commercial activity other than a supplementary business, proceeds of which are used for the charity goals of the entity. The concept of investment funds, as defined in the Law of Georgia on Investment Funds of 24 July 2013, likewise fails to accommodate the needs of SPV securitization structure. Apart from the fact that there is no clear regulation on creation and activities of investment funds in Georgia, this vehicle is designed to pool the assets (only cash, cash equivalents of securities)15 of the beneficiaries to carry out various investment activities and provide the fund beneficiaries with return on their investment. The Project Team does however note that investment fund is a sui generis structure envisaged in the Law of Georgia on Investment Funds. Therefore,

made (for the sake of clarity). The fact that the securitisation undertaking is set up in the form of a company or a fund does not impact its capacity to acquire secured assets. Security will however be held by the security agent/trustee on behalf of the investors. 12 As a general principle, the Luxembourg securitisation undertaking’s action must be limited to a prudent man passive management of the securitised portfolio. This implies that the SPV is usually limited in disposing of the securitised assets. However, in practice it is sometimes observed that contractual provisions allow the SPV to dispose the assets under certain specific circumstances/conditions. Investors have to expressly agree to these provisions while subscribing to the securities issued, as this is usually part of the issue documents. In case of sale, proceeds received will indeed be likely to be used for the purpose of repayment of the subscribed securities and/or repurchase of new securitised assets in the case of revolving transactions. 13 Management companies of securitisation funds do not have to be regulated by the CSSF nor any other supervisor. 14 Articles 27-39 of the Civil Code of Georgia. 15 Article 3 (5) of the Law of Georgia on Investment Funds.

if SPV is to be organized in the form of a fund, respective legal nature, registration and corporate management details must be put in place in the separate law on securitizations to achieve the same effect – creation of a fully detached entity (with or without legal personality), with no beneficial ownership and management structure reflecting interests of all stakeholders of securitization and primarily those of the investors16. As noted above, SPV may take a form of a company. When choosing the form, one needs to take into consideration various factors including, operational costs, ability to issue securities to the public, minimum capital requirement, minimum shareholder requirement, corporate governance structure, etc. Whatever the legal form of the SPV is, it is intended to be isolated from the obligations of the originator. To isolate the obligations of the SPV from those of the originator, the SPV capital and funding shareholding is frequently owned by an orphan structure17 (Dutch Stichting or similar vehicle, whereby the entity does not have beneficial owners nor direct link to the Originator). Under the Georgian law, at least as it stands now, it is not possible to achieve such structure in a commercial entity. Therefore, an alternative could be a regular limited liability company or a joint stock company18 established with 100% share participation of organizer (investment back or brokerage company) and fully detached from the Originator. If SPV is intended to carry out more than one issuance (especially if compartment-based structure is achieved in Georgia), then above-referred financial actors will be keen to form such an entity or entities, provided that liabilities and especially bankruptcy risk of the SPV are fully ring-fenced (either on a compartment level or at least on the level of the SPV itself) and may not be carried back to its shareholder(s) (primarily through piercing of corporate veil). In addition, off-balance treatment of shares held in SPV will be required to achieve full financial separation of SPV from its inceptors, which is not available under the existing legislation19. The principal idea behind the SPV is to shield the assets from originator’s liabilities. Therefore, it is equally important to ensure that the SPV does not engage in any business, other than issuance of MBS and related activities, thus limiting its financial exposure. The concept of an SPV – a special purpose vehicle created for carrying out only a specific project- is not entirely extrinsic to the Georgian law. By analogy, the Law of Georgia on Oil and Gas provides for an obligation of an investor to create an operation company, through which the investor runs oil and gas operations in Georgia on no-profit-no-loss basis.20 The limited scope of activity and other operational restrictions related to such operational company are usually set out in the respective standardized production sharing agreement between the Government of Georgia and the investor. However, other than a contractual arrangement and subject to respective licensing or permitting requirements, there is no legal basis for precluding a private company from engaging in any activity other than its primary business.21 Even though the charter of the SPV and/or the MBS prospectus may include restrictive covenants regarding business of the SPV, statutory regulation of the matter is desirable for the investors’ comfort. Apart from risks undertaken in the ordinary course of business22, SPV must be further protected from other extraordinary liabilities in order to protect the interests of the investors. Therefore,

16 In case a securitisation fund is created, sponsors are investing/subscribing to units issued by the fund for the purpose of “creating” the fund. For the purpose of the securitisation transaction, notes/debt instruments are to be issued to investors and there is no prohibition to have the founders of the fund also subscribing to the notes being issued (different classes of notes may for example be issued). Alternatively, the securitisation could be conducted by the issue of new “units” of the fund. 17 In order to qualify as a securitisation transaction, risks have to be transmitted by the Originator to the SPV. If the ultimate beneficial owner of the SPV and the one of the Originator are similar, there is a risk that the operation falls outside the scope of the Luxembourg Securitisation Act as the SPV would conduct activities, which are potentially not in compliance with the applicable provisions. It is therefore necessary to ensure to have risks being supported by third party investors rather than by a group entity having the same ultimate beneficial owner as the Originator. The Originator may or may not be part of the SPV’s group. Furthermore, having no capital link between the Originator and the SPV allows to have a “bankruptcy proof” structure where the insolvency of the Originator may never extend to the SPV and the securitisation structure. 18 If SPV is to issue equity securities as well, then obviously a joint stock company would be the most suitable form of and SPV under the Georgian law. 19 Financial separation between the SPV and the founders could be the case or not. This is not legally required from a Luxembourg law perspective even if it belongs well to the general spirit of securitisation transactions. In certain cases, independent SPVs will “consolidate” its balance sheet with Originators on a voluntary basis for financials/accounting reasons. 20 Article 13 (5) (l) of the Law of Georgia on Oil and Gas. 21 Article 10 (2) of the Civil Code of Georgia. 22 The term “ordinary course of business” is a generic term used by the Georgian legislation and the content thereof will be highly dependent on particular circumstances. In case of securitization SPVs, management and due care of the securitized assets can be considered as ordinary course of business, while taking any other liabilities not typically characteristic to such undertakings will fall beyond.

SPV’s right to issue guarantees, obtain loans or dispose of the assets must be limited, save when otherwise required to protect the interests of the investors. This too has to be specifically addressed in the law. It is very convenient practice that SPV is divided into several perfectly ring-fenced compartments23. All the assets and liabilities allocated to one specific compartment will only be available to the investors of this specific compartment. If one compartment becomes bankrupt and/or is liquidated this does not affect the existence of the other compartments nor the SPV itself. The multiple-compartment concept within one legal entity represents one of the main advantages of the Luxembourg legal securitization environment, compared to other jurisdictions, allowing Luxembourg SPVs to create new compartments for each new investment and securitization of a portfolio of assets and then reducing sensibly the structuration and maintenance costs of the structure while offering the best level of security for both the Originator and the investors. This concept allows to establish frequent-issuer platforms enabling new issuance in a time efficient manner through board decisions and without creating additional timing constraints or legal setup costs. However, current legislation of Georgia does not allow for such compartment system (i.e. segregation of assets) as the liability of a legal entity extends to its entire property.24 Likewise, if bankrupt, all assets of the company are pooled in the bankruptcy estate.25 SPV may be regulated or non-regulated entity. In Luxembourg, an SPV which issues securities to the public and on a continuous basis (i.e. more than 3 issuances per year to non-professional investors) should obtain a license and be regulated by the Luxembourg financial regulator before being able to conduct its first transaction. If the Georgian regulator considers it necessary to establish licensing or registration requirement for SPVs issuing MBSs, then respective amendments shall be made to various laws and implementing legislation concerning licensing/registration of financial institutions by the National Bank of Georgia (NBG). Under the Georgian law, each public offering is subject to scrutiny by the NBG.26 By the same token, once a company issues securities through a public offering (and in case of debt securities, until such securities are fully redeemed), it is regarded as a reporting entity subject to various requirements provided in the Law of Georgia on Securities Market.27 Such requirements include maintaining supervisory board with one independent member (unrelated to the company either legally or financially),28 audit committee, annual, semi-annual and current reporting obligations, maintaining the registry of securities with an independent registrar, reporting on securities held by the management of the issuer, reporting on significant acquisition of securities, tender offering rules, etc. In order to achieve a cost-effective system, carving out the SPV from some of the above obligations may be considered29. When a securitization transaction matures, or in case of a multi-compartment securitization company, the last securitization transaction matures, the issued security has been fully repaid in accordance with the issuance terms and conditions and it is not intended to use the securitization company for a new securitization transaction, the SPV is normally dissolved. Under the exiting legal framework, assets of the company remaining after the liquidation are distributed to its shareholders pro rata to their shareholding interest / shares in the company. However, unless there is a separate contractual arrangement in place

23 Compartments are created by board resolutions of the SPV in Luxembourg. The process is therefore straightforward and cheap to implement. The possibility to create compartment has to be specified in the SPV’s Articles of Association. 24 Articles 44 (1) and 51 (1) of the Law of Georgia on Entrepreneurs. 25 Articles 3 (q) and (s) and 38 of the Law of Georgia on Bankruptcy Proceedings. [BLC Comment: Since the SPV will not be a commercial bank, we do not see the necessity to discuss the potential changes to the Law on Commercial Banks]. 26 Articles 3-8 of the Law of Georgia on Securities Market. 27 Article 9 of the Law of Georgia on Securities Market. 28 Article 131 of the Law of Georgia on Entrepreneurs and Article 91 of the Law of Georgia on Securities Market. 29 Annual accounts and the related financials are to be audited by an external expert (réviseur d’entreprise agréé) in accordance with the provisions of the Luxembourg Securitisation Act. Accounts are deposited with the Luxembourg Trade and Companies Register at the end of each financial year. We also refer to the above reporting obligation (statistical) which may be imposed to Luxembourg SPVs. Regulated vehicles have also additional disclosure obligations towards the CSSF.

between the shareholder of the SPV30 (investment bank, brokerage company, etc.) and the originator, assets remaining after the liquidation of the SPV may not be handed to the Originator automatically31. If SPV holds portfolio purchased from several different originators and carries out different issuances of securities, then particular scheme of distribution of left assets to each such originator must specifically be addressed in the law.

1. REVERSIBILITY OF TRANSFER OF ASSETS In order to analyze whether the transfer of assets (receivables) can be reversed as part of the insolvency proceedings of the Originator pending under the Georgian law, it shall be considered whether the clawback rights are envisaged in the Law of Georgia on Insolvency Proceedings (adopted on 28 March 2007, as amended) (hereinafter cited as the “Law on Insolvency”). Under Article 35 of the Law on Insolvency, it is considered that the following actions carried out throughout the period of one year immediately before submitting the application on insolvency to the court may be considered as detrimental to the creditors’ interests: a) the debtor’s action, which hindered the equal satisfaction of creditors and one particular creditor was put in a preferential condition comparing to other creditors of the same rank (for example, mortgage created in favor of one of the creditors); and b) the action/transaction carried out by the debtor, which resulted in depreciation of its property. If the creditor placed in a preferential condition is related to the debtor, the aforementioned one-year term shall be prolonged to 2 years. Although it is highly unlikely that transfer of assets in securitization settings may be considered as putting one creditor into preferential conditions, it clearly may be argued such transfer resulted in depreciation of insolvency estate and this, is potentially subject to the creditors’ clawback rights.

30 Luxembourg securitisation companies are commercial companies which opt for the specific regime provided for in the Luxembourg securitisation Act. Rules governing the distribution of profits are therefore contained in the Luxembourg companies law (allocation to the legal reserve (5%) and any additional reserve required by Articles of Association, if any, determination of profit for the period and profits carried forward, minus losses carried forward). If profits are eligible to distributions, any such distribution has to be adequately approved by the general meeting of shareholders (either the vehicle itself or compartment’s shareholders in case of a multi- compartment vehicle and in accordance with the provisions of the Articles of Association of the company). Luxembourg securitisation companies normally end into a tax neutral situation. In this respect, a provision into the Articles of Association shall specify that all profit will be distributed within 5 years in order to benefit from the possibility to deduct such future engagement to distribute and consequently reduce the taxable basis of the SPV as specified in the Luxembourg tax law. A securitisation company’s commitment to remunerate investors for securities and other creditors qualify as interest on debt even if paid as return on equity. These shall be treated as operating expenses resulting in most of the cases into a very limited tax liability. 31 Kindly note that in case of a true sale, securitised assets are fully acquired by the Luxembourg securitisation vehicle and it is generally not subject to any return of the assets to the originator upon liquidation of the SPV. This may however be contractually foreseen as nothing prevent any such agreement under the Luxembourg Securitization Act. Kindly note that for the purpose of the analysis we assume that originator and SPV’s shareholders are different entities.

Therefore, to ensure that transfer of assets (receivables) is shielded from any clawback claims as part of the insolvency proceedings of the Originator, relevant regulations shall be included in the Law on Insolvency.32 By the same token, it shall be emphasized that the insolvency of commercial banks (which, from practical standpoint, will act as Originators in predominant part of cases) is not regulated through the Law on Insolvency. Rather, insolvency rules applicable to commercial banks are primarily regulated with the Law of Georgia on the Activities of Commercial Banks (adopted on 23 February 1996, as amended) (hereinafter cited as the Law on Commercial Banks”) and Decree N 119 issued by the President of the National Bank of Georgia on Declaring Insolvency and Bankruptcy of Commercial Bank, adopted on 23 May 2003, as amended (hereinafter cited as the “Insolvency Decree”). Under Article 37.7 of the Law on Commercial Banks, the liquidator is authorized, through submitting a claim to the courts of general jurisdiction of Georgia, to challenge any transaction executed by the bank’s administrators/managers over the period of one year leading up to the moment of appointment of a liquidator and claim voidance thereof if, as a result of the challenged transaction, persons related to commercial bank gained undue profit or were somehow advantaged and it resulted in damaging the creditors’ interests. Therefore, as evidenced from the above paragraph, the clawback rights can be exercised by the liquidator, in case the following preconditions are met: (a) the challenged transaction is executed with a party related to commercial bank; (b) as a result of the challenged transaction, related parties gained advantage; and (c) it resulted in damaging the creditors’ interests. The criteria listed herein are cumulative in nature, which means that even if one of the listed preconditions is absent, no clawback rights will be applicable. The term “related party” is defined by the Law on Commercial banks as bank’s administrators, shareholders, their relatives or persons having business interests with them. Similar regulations are embodied in the Law of Georgia on Insurance (adopted on 2 May 1997) (as amended), which regulates the insolvency rules applicable to insurance companies, as well as the Law of Georgia on Micro Finance Organizations (adopted on 18 July 2006) (as amended), which regulates the insolvency rules applicable to the micro-finance organizations. Based on the above discussion and provided that the SPV will most probably will not qualify as the party related to the Originator (even when the Originator is the shareholder thereof), the arguably clawback rights shall not be applicable in case of insolvency of a commercial bank and/or insurance company and/or micro financial organization. However, given that the commercial banks will be the primary players of the relevant market, once the securitization regulations are enacted, it is highly advisable to specify the inapplicability of the liquidator’s clawback rights to the receivables transferred to the SPV as part of a securitization transaction.

2. ENSURING THAT THE SPV IS TREATED SEPARATELY FROM ORIGINATOR As in most legal systems, Georgian legal practice is familiar with the notions of “alter ego procession”, “piercing of corporate veil”, “fraudulent” transactions or “substantive consolidation” and so on, which may be used to bring the SPV’s assets as part of the Originator’s insolvency proceedings. Consolidation may be a mechanism used by the courts when the holding entity, such as the Originator or other shareholder of an SPV does not honor the legal separation of the SPV and there is a mix of balance sheets and funds of the two. In such event the creditors may seek to create the link between the obligations of the parent and the SPV to increase the chances of recoverability of the outstanding sums. As part of the ongoing reform, the securitization law shall include provisions ensuring that such arguments are difficult, if any, to be made vis-à-vis the Originator and the SPV. To achieve the distinctiveness, certain mechanisms shall be incorporated into the constitutional framework of the SPV. To name a few, separate books and records; prohibition on commingling of assets with the assets of other entities; to act and always represent oneself towards third parties as a separate entity; not to

32 The only exception to this rule may be when the transfer is of a fraudulent nature without having any commercial content and is aimed at concealing the assets. However, such transactions may be voidable though the general application of Article 56 of the Civil Code of Georgia and securitization transactions shall be shielded from application of Article 35 of the Law on Insolvency Proceedings under any circumstance.

secure the debts of third parties through its corporate guarantees or otherwise; to be on arm’s length basis with all related parties; to comply with its financial obligations from its own funds and never undertake the obligation to comply with the dues of a related party; to maintain credible corporate governance structure that ensures adequate involvement of independent Board members in the corporate governance, etc. It is advisable to reflect predominant part of the above considerations in the statutory framework applicable to securitization SPV.

3. OPERATIONAL ISSUES RELATED TO INSOLVENCY REMOTENESS OF THE SPV And lastly, it is material that the SPV is operated in a manner that makes its chances of insolvency slim to none. Certainly, there will be number of practical issues in this regard (to name a few, efficiency and qualification of the management, efficient management of the portfolio, adequate collateralization of the relevant receivables, etc.) However, certain issues related to such operational matters can be subjected to legislative regulations. For example: i. As noted above, the law shall strictly regulate that the SPV is a true special purpose vehicle and has limited capacity. It shall be prohibited to commence any other line of business and shall solely manage the portfolio assigned by the Originator; ii. if the SPV is a regulated entity, it may be subject to certain capital adequacy requirements, including but not limited to restrictions on lending; iii. Statutory prohibitions on reorganization / merger to avoid commingling of rights and obligations of the SPV with the merged entity; iv. Creating the legislative basis, which ensures that the SPV will have independent directors in its Board, which shall exercise the oversight functions over the company management to the benefit of the investors; v. Imposing transparency and reporting requirements on the SPV, which ensures easy access to required information for the investors; vi. Ensuring that the investor has limited recourse, i.e. only to the assets of the SPV and underlying collateral, which were used as a security for the papers held by the investor in question (in case the SPV makes several issuances in relation to several different portfolios); vii. Adding contractual provisions derogative from common corporate law rules, as the case may be, like “Non Petition clause” and “Subordination clause” to avoid that one or several investors may challenge the SPV and all the structure. It is noteworthy that the effective legislation of Georgia is not at all familiar with the concept of a special purpose vehicle or a special purpose entity and thus, the operational matters discussed above that are fundamental for the insolvency remoteness of the SPV are not yet embodied in the relevant laws of Georgia.

C. TRANSFER OF ASSETS The primary assets to be transferred to the SPV as part of the securitization transaction will be the Georgian law receivables either unsecured or secured through pledge or mortgage. Under the effective legislation of Georgia, secured or unsecured receivables are freely transferrable assets, unless the relevant restrictions are embodied in relevant banking contracts. Moreover, mortgage created over immovable assets, as well as pledge of movables/tangibles/intangibles is an accessory right that passes on to the assignee together with the assigned receivable. However, please, note that there may be certain practical constrains associated with the transfer. To exemplify: pledge of any asset (as well as mortgage) is subject to mandatory registration at the National Agency for Public Registry

(the “Public Registry”)33. Since pledge is an accessory right, it shall be assigned to the assignee and thus, registered in the name of the assignee based on a deed/instrument created and signed by the assignor and the assignee only. However, on occasions, the Public Registry tends to request either the amendment to the relevant pledge agreement or the consent issued by the pledger to effect registration of pledge in the name of the assignee. Certainly, compliance with such obligation will be unfeasible in securitization setting. Therefore, relevant amendments will be required in the Civil Code of Georgia, as well as the Law of Georgia on Public Registry. And lastly, in a standard securitization setting, the primary debtors may even be unaware on the fact of assignment of claim because they continue to make payments to the Originator, which on the other hand acts as a financial servicer based on a service agreement entered with the SPV. Under the Civil Code of Georgia, parties are obliged to notify the primary debtors on the fact of assignment. While the only sanction for the failure to do so is that the primary debtors shall not be in breach of their contractual obligations if they pay the relevant payables to the assignor, it is advisable to make the relevant amendments and exempt the parties from the obligation to notify in securitization setting34.

D. TRADABILITY Georgian legislation generally acknowledges the notion of secured bonds. This is enshrined in the Order N79 of the President of the National Bank of Georgia dated 5 August 2016 on Approval of Regulation on Issuance, Public offering and Placement of Corporate Bonds (the “NBG Regulation”). Under the NBG Regulation, corporate bonds can be secured with assets of adequate value as well as the bank guarantee or corporate guarantee. Thus, authority of the corporate issuers to issue and place asset backed securities under local security laws is clearly established.35 However, the existing Georgian legal framework for collateralization renders issuance of freely transferable asset backed securities fairly impossible to implement as it will be discussed below. Investors holding the MBSs must have all proper mechanisms in place to make sure that the foreclosure of the underlying security is effected in due course in case of default of the debtor. This can be achieved either (i) through SPV committing under the prospectus to ensure swift collection of the underlying debt, or (ii) through a security agent representing interests of the investors or (iii) by vesting foreclosure rights in to the investors themselves. Scenarios (ii) and (iii) seem the most beneficial for the investors as it is likely that they will not wish to leave the foreclosure mechanism exclusively in the hands of the SPV. Holding collateral and foreclosure rights is directly linked to the tradability of the MBS, as detailed out below. Mortgage on the immovable property as well as pledge on the movable property are perfected by way of registration with the Public Registry.36 Most importantly, not only primary attainment but also each subsequent transfer of mortgage/pledge right is subject to registration with the Public Registry.37 Therefore, to obtain security rights over the assets, each subsequent noteholder/investor will have to be registered with the Public Registry as a mortgagee or pledgee, as the case may be. Further, vesting each investor which the right to step in into the existing collateral arrangements and independently exercise foreclosure rights does not seem to be a very practical solution either, considering the unlimited number of the noteholders at a relevant time.

33 Only the pledge of vehicles is subject to registration at the Service Agency under the Ministry of Interiors. 34 This does not mean that the debtor’s obligation shall not be deemed fulfilled if they pay to the Originator. However, exempting the securitization transactions from notification requirements shall serve the mere purpose of avoiding the formal breach. Certainly, the debtors shall be considered compliant if they pay to the Originator. 35 Article 2 (e) of the Order N79 of the President of the National Bank of Georgia dated 5 August 2016. 36 Article 289 (1) and Article 258 (1) of the Civil Code of Georgia. BLC notes that possessory pledge does not require registration with the Public Registry. However, this type of security is rarely ever used in practice (save for the pawnshops) and is highly inefficient as it entails deposition of the property to be used as a collateral in pledgee’s possession. 37 Articles 295 and 269(2) of the Civil Code of Georgia. Further, in case of transfer of pledge, it is well established practice in Georgia that each subsequent pledgee must be registered at the Public Registry, although this is not directly envisaged in the law. Further, Article 2891 of the Civil Code of Georgia recognizes a concept of a mortgage certificate which is designed to be a freely transferable security evidencing the security interest of the holder. However, BLC notes that the provisions of the Civil Code of Georgia related to such certificate is inoperable and there is no practice of issuing such certificates by the Public Registry. However, even if the said provisions are enacted, this may remove the registration related obstacles but all other considerations regarding the parallel debt structure and foreclosure mechanics still stand.

In addition to the above, under the Georgian law, the security interest is accessorial to the underlying claim it secures (i.e. with assignment of the underlying claim, the security interest is also assigned by operation of law and is perfected through registration, as discussed above). Currently, Georgian law is not familiar with the concept of a security agent – a third party who holds the security rights for and on behalf of the investors and acts as their agent with respect to perfection, maintenance and even foreclosure of the underlying collateral. Notwithstanding of the fact that there is no notion of security agent in the Georgian law, several transactions have been executed on the local market with the participation of this actor. To achieve the legal validity thereof, the market has introduced the notion of so-called “parallel debt obligation”. This is a contractual mechanism declaring all payables of the borrower/issuer to the investors as a joint liability towards the security agent also. Thus, attempting to grant claim to the security agent to enable the latter to hold and foreclose the collateral. Notably, this mechanism was used in the past in Luxembourg until the law on financial collateral has been amended to expressly recognize the right of a trustee or security agent to act in the name and in the interest of all investors. Similar approach can be implemented in the Georgian legislation. In addition to the above, pooling collateral in the hands of a security agent further entails the following risks, none of which can be effectively mitigated under the existing legal framework: 1. Security ranking risk – tax pledge/mortgage, if levied on the underlying asset at any point in time, will have a priority over that of the security agent;38 Under the Tax Code of Georgia as well as the law of Georgia on Enforcement Proceedings, in case of foreclosure of collateral, tax debt shall be covered first, regardless of the time of registration of the tax pledge/mortgage. However, the same laws provide for the limited carve-out for certain financial institutions such as commercial banks, Micro-Finance Organizations (MFO), insurance companies, international financial institutions or financial institutions of developed countries, which shall be satisfied from the proceeds of such foreclosure if the mortgage or pledge of such institutions is registered before the tax pledge/mortgage; No such or equivalent carve- out is available for the security agent; 2. Sham transaction risk – the structure is designed to circumvent a conventional securitization scheme. Therefore, such structure may be qualified as a sham transaction under Article 56 of the Civil Code of Georgia; 3. Bankruptcy risk – the structure is not bankruptcy remote. The Law of Georgia on Insolvency Proceedings is not familiar with any special regime of treatment of claims held by the insolvent company in nominal holding (i.e. on behalf of other parties). Therefore, if insolvency proceedings commence against the security agent, it is not clear how the collateral and underlying rights held by the agent will be treated and may end up being consolidated in the agent’s estate; 4. Registration risk – it is unclear whether the noteholders will be regarded as mortgagees/pledgees without having undergone through the registration procedure with the Public Registry. The Project Team notes that Georgian law is familiar with the notion of mortgage/pledge certificate which is intended to be a transferable security.39 However, in absence of proper regulation of such certificates, the respective provisions of Georgian law setting out the right to obtain mortgage/pledge certificate are devoid of legal certainly and enforceability. The Project Team notes that there is a contractual mechanism to vest the security agent with the right to foreclose the securities in the name of the SPV, without assignment of underlying claim and security interest. Namely, such authorization can be granted to the security agent under the mandate contract enshrined under Article 709 of the Civil Code of Georgia. Such contract can be entered into between the security agent and the SPV, granting the agent right to start foreclosure for an on behalf of the SPA (being the holder of the security rights and the underlying claims) and carry out any and all actions required for the collection of the debt. However, Georgian law does not recognize an irrevocable mandate. Either party is entitled to terminate such arrangement at any time and limiting such right of the parties is voidable under Article 720 of the Civil Code of Georgia. Therefore, such contractual arrangement does not provide for a sufficient security for the investors.

38 Article 239 (6) of the Tax Code of Georgia and Article 82.3 of the Law of Georgia on Enforcement Procedures. 39 Articles 258.1 and 289.1 of the Civil Code of Georgia.

In view of the above, considering that, under the current legislation, each noteholder/investor will have to remain registered as the secured creditor of the record or choose the “parallel debt obligation”, which has number of drawbacks, it will be necessary to create the legislative framework that will recognize the nominal holding of security by the security agent40 and, at the same time, maintain the beneficial interest of the investors over the collateral. This will effectively mean introducing limited exception to the accessorial rule currently embodied in the Civil Code of Georgia. Respectively, as part of the reform to achieve workable legal framework for securitization, it is advisable to make the required amendments to the Civil Code of Georgia, as well as the Law of Georgia on Insolvency Proceedings and the Law on Public Registry, which together with the specific securitization statute will ensure that appointment of a security agent will be an enforceable mechanism.

E. TAXATION The main gap identified in the process of assessing tax implications of securitization is the following: the Tax Code of Georgia dated 17 September 2010 (as amended) (the “TCG”) states that the interest paid by the licensed financial institutions are exempted from withholding at the source of payment and such income is not included in the income of recipient for further taxation purposes. TCG does not provide for the definition of “financial institution”. This term is defined in the Law of Georgia on Securities. Securitization vehicles does not fall under the list of financial institutions provided therein. Moreover, its activities are definitely not subject to licensing under the laws of Georgia. Based on this, interest paid by SPV to the bondholders shall be subject to taxation at the source of payment (if income recipient is resident individual, non-commercial legal entities or foreign company) at 5% rate and at 15% rate in case of offshore resident recipients, whereas interest recipient resident commercial legal entities should include this interest into their income for tax purposes. Also if the SPV is qualified as financial institutions, tax implications of this Gap Analysis should be re- examined once again (financial institutions declare and pay CIT in accordance with the old model, i.e. they are not subject to the so-called “Estonian Model” of CIT). Below the Project Team analyzes tax implications of securitization by following each step of transaction and elaborating on tax implications thereof:  Transfer of receivables from the Originator to the SPV – the Originator sells receivables for the price, which is lower than the principal amount and the interest to be accumulated thereon over the maturity period of the receivable41. For this reasons, Originator will in any case be in operational loss after selling the portfolio. As concerns the SPV, it should reflect the positive difference between the receivables and its purchase price in its income. Considering that SPV will most likely not qualify as a financial institution under the effective legislation of Georgia, it is not obligated to pay CIT from its income, unless dividends are actually distributed to its shareholders;  Payment of interest and principal to SPV – receiving principal amount from the credits/loans do not trigger any taxable scenario. As concerns the interest, the following should be noted: due to the reason that the SPV does not qualify as a financial institution, interest paid to the latter shall be included in its income. Net profit of companies like the SPV are taxed by CIT at 15% rate, only when such profit is distributed among the shareholders;  Management service rendered to SPV – ordinarily financial activities are exempted from VAT with no right to credit. Provided that SPV’s activities are financial activities (even though SPV itself does not qualify as a licensed financial institution), SPV is not obligated to charge VAT on the services supplied to the third parties. However, it is questionable whether services supplied by the third parties (security agent, payment agent, Originator and etc.) to SPV are likewise exempted from VAT. TCG allows exemption from VAT for the services that are inherently related to the financial

40 Any person authorized to hold client’s assets under nominal ownership can be authorized to act as a security agent. The authority to have nominal holding accounts is more significant than prudential supervision. However, from international practice, we see that the financial institutions are the ones acting as security agents most often. Since the security agent will hold the securities in its name, it will have the foreclosure entitlements without the necessity of further transfer. 41 The Project Team understands that the precise percentage of discount and pricing model will be dependent on the nature of the receivable itself, its maturity, creditworthiness, etc.

services and activities, without specifying the list of such services. For avoiding any misunderstandings, it is advisable to specify that the services provided to the SPV and inherently related to financial activities (such as security agent, payment agent, services rendered by the Originator with respect management and collection of funds related to the portfolio transferred to SPV, etc.) can be qualified as financial activities and thus, relieved from VAT. Otherwise, unless the SPV’s contractors are financial institutions themselves, SPV will be obligated to charge VAT on their service fees, which SPV will not be able to credit. Please note that all other services/products purchased by SPV from ordinary contractors (i.e. services that are provided throughout ordinary course of business, without having any direct link to the financial activities) will still be subject to VAT, which SPV is not able to credit;  Placement of bonds – tax consequences vary depending on the public and private placement. In case of public placement within Georgia, income received by SPV from transfer of securities (bonds) is exempted from taxes. In case of private placement, such exemption is not granted. Capital gain received from private placement should be included in the income of the SPV. CIT shall apply only in case of distribution of dividends;  Income received through holding the preferred shares – income received by the preferred shareholder from preferred shares is qualified as dividend according to TCG. Dividends paid to the resident non-registered individuals, non-commercial legal entities or foreign residents are subject to taxation at the source at 5% rate. Dividends paid to the local commercial legal entities are neither taxed at the source of income payer, nor included in the income of the recipient;  Payment of interest on bonds – tax consequences differ depending on the public or private placement of bonds. In case of public placement in Georgia, resident individuals and nonresident entities/individuals are exempted from taxation on the interest earned from bonds traded at organized markets recognized as such by the NBG. Resident entities include interest generated from such bonds into their income. As concerns private placement, income paid to the resident individuals or nonresident entities/individuals is subject to withholding at the source of payment at 5% rate (in case of offshore entities – at 15% rate). As in case of public placement, resident entities include interest generated on such bonds into their income.

2.3. RECOMMENDATIONS FOR IMPLEMENTATION OF SECURITIZATION MECHANISM At the outset, strategic decision shall be made whether the securitization reform will be implemented through amendments to related legislative acts (Civil Code of Georgia, Law of Georgia on Entrepreneurs, Law of Georgia on Securities Market, Law of Georgia on Insolvency proceedings, etc.) or whether a unified securitization act (the “Securitization Law”) shall be adopted. It is the position of the Project Team that it is advisable to adopt the Securitization Law, which shall govern all legal aspects specific to the securitization structure and at the same time, provide carve outs (through referencing the relevant legislative acts), from which it seeks the escape. This is because, given the specific nature of codification characteristic to the Georgian legal system, the Securitization Law cannot function in isolation and it shall accommodate the clauses or concepts of the relevant legislative acts, from which it seeks to derogate. Having the stated approach in mind, please, see below the summary of concepts that should be implemented in the Securitization Law. For convenience only, the recommendations for implementation of the securitization mechanism will follow the same structure as it was offered in case of the relevant Gap Analysis. In particular, we shall first analyze the changes that need to be made for accommodating the legal structure of the SPV followed by the relevant sequence on insolvency remoteness, transfer of assets, tradability and taxation. Before analyzing the specific topics referenced above, it is significant to note several structural and strategic decisions to be made: 1. The decision shall be made whether the SPV is a regulated entity or not. It is the recommendation of the Project Team that the SPV shall not be a regulated entity. However, it may become subjected to the NBG regulations in case it decides to issue public securities. In such event, the SPV will become a reporting entity (as defined under the Law of Georgia on Securities Market) and all applicable regulations will be relevant mutatis mutandis; 2. Definition of “Securitization” – to avoid any complications in practice and ensure that the Law on Securitization will be able to meet the requirements of dynamic securities market, it is advisable to define the term as broadly as possible – in line with the Luxembourg Securitization Act, which views “securitization” as a transaction, by which the securitization undertaking acquires or assumes, directly or through another undertaking, risks related to claims, other assets or obligations assumed by third parties or inherent to all or part of the activities of third parties and issues securities, the value of which or yield depends on such risks; 3. Securitization Law shall directly state that the transactions envisaged therein does not constitute insurance activities and therefore, shall not be subjected to the requirements of the Law of Georgia on Insurance.

A. LEGAL STRUCTURE OF AN SPV As noted above, in order to achieve successful implementation of the proper legal structure of SPV in Georgia, the following concepts must be reflected in the new Securitization Law and, to the extent necessary, other laws of Georgia through legislative amendments: 1. First and foremost, the Securitization Law must introduce a proper definition of securitization undertakings (SPV), the broader the definition is, the better. In essence, the securitization undertaking or an SPV can be defined as an undertaking which carries out securitization by way of assuming all or part of the securitized risks (securitized receivables) and issues securities to ensure the financing thereof. Notably, since SPV is to be established for the purpose of carrying out one or more securitization, the definition must ensure that an SPV is not limited to a single issuance but rather is entitled to carry out multiple issuances of different types of securities; 2. The Securitization Law must further provide that the SPV can be organized in the form of a company or a fund. Whichever structure is chosen, its charter / incorporation documents, management regulations as well as the issue documents shall provide that the SPV is subject to the provisions of the Securitization Law. Depending on the legal form chosen, the structure of the SPV can be as follows:

i. If organized as a fund - securitization undertaking will be a contractual undertaking with the objective to manage a pool of securitized risks (receivables), with no legal personality. Such fund shall be represented by a management company. It will be created by (i) the sponsor of the project and/or, (ii) the Originators, and/or (iii) directly the investors, as specified under the management regulations42. The rights of the investors in the fund could also be represented by securities issued by the fund. Management company can be an investment bank, financial broker or other financial actor or its subsidiary, a commercial entity whose object is to manage securitization funds. It draws up the management regulations for the securitization fund, acts on behalf of the securitization fund and its investors vis-à-vis third parties. The management company must perform its duties in an independent manner and in the sole interest of the securitization fund and the investors. It may not use the assets of the securitization fund for its own needs and it is liable towards the investors and third parties for the proper performance of its duties. Under the Luxembourg law, such fund consists of one or several co-ownerships or one or several fiduciary estates. The most similar notion under the Georgian law is an investment fund as envisaged by the Law of Georgia on Investment Funds of 24 July 2013. Securitization fund is, in essence, a type of investment fund (investment scheme), which unlike all other types of funds provided in the current version of the said law, is a pool of secured risks (secured receivables) assigned/purchased by the fund ultimately from the proceeds generated through issuance of securities. As such, the notion of the securitization fund must be properly reflected in the Law of Georgia on Investment Funds of 24 July 2013 or any other legislative instrument replacing the above law. We note that in number of developed jurisdictions, including Luxembourg, the securitization funds are regulated directly in the Securitization Act and not elsewhere. Arguably, there may be certain historical reasons behind (for example, the fact that Luxembourg has separate acts depending on the form of the investment structures, etc.). However, it is a fact that even where the securitization funds are not regulated through investment fund laws, the Securitization Act cross references number of provisions of the investment fund law to accommodate the relevant requirements (for example, the Securitization Act references the reporting and disclosure requirements applicable to investment funds). Therefore, it is recommended to set out the legal structure and management requirements of securitization fund in the law regulating investment funds with relevant cross references in the Securitization Law. The law must specify the minimum information, rules and procedures to be set out in the management regulations of securitization funds (e.g. name, object and duration of the fund, name of the management company, specific administration and management rules which apply to the fund, the possibility for the securitization fund to consist of several compartments, the circumstances in which the fund or one of its compartments will be in, or may be put into, liquidation, the respective rights and obligations of the management company and, as the case may be, of the investors, the rules governing the assumption of risks and the issuance of securities, the procedures for amending the management regulations, rules on removing existing management company and appointment of the new one by the investors, etc.). The provisions of such regulations are deemed accepted by the investors in the securitization fund by the mere acquisition of securities issued by the fund. This too shall be specified in the Securitization Law. Last but not least, unless it is decided to regulate the SPVs through licensing by or registration at the NBG, securitization fund must be excluded from the mandatory registration requirement at NBG applicable to other types of investment funds under the Law of Georgia on Investment Funds (or any other legislative act replacing such law); If the securitization fund is regarded as a regulated entity, then the management agreement as well as any subsequent amendment thereto must be lodged with the NBG. ii. If organized as a company – securitization companies shall have a legal personality and shall be organized in the form of either a limited liability company or a joint stock company. Since the obligations of the SPV must be fully detached from those of the organizer and vice versa, limited

42 The management regulations of a fund are equivalent to the Articles of Association or Charter of a company to the extent that these are the basic rules for the operation and management of the fund. If a fund wants to issue securities, it has to prepare specific documents in this respect (T&Cs, subscription agreement, info memo/prospectus, etc.).

liability company or a joint stock company are the most obvious options under the Georgian law to achieve full limitation of liability. When choosing the form of the SPV, one needs to take into consideration various factors including, operational costs, ability to issue securities (both, debt and equity) to the public, corporate governance structure, etc. If SPV is to issue equity securities, then obviously a joint stock company would be the most suitable form of an SPV under the Georgian law. The Securitization Law must provide for the possibility of establishing the securitization company with share participation of financial actors (investment bank or brokerage company) and fully detached from the Originator. The Securities Law shall opt out from application of the Law of Georgia on Investment Funds and the Law of Georgia on Entrepreneurs, as relevant, where the different regulation of the structure or operation of the securitization undertaking is required. Thus, for the ease of comprehension, the SPVs may take the form already existing under the Georgian law and any different regulations, which will be characteristic only to securitization undertakings (as further listed below) will be spelled out directly in the Securitization Law; 3. The Securitization Law shall further provide that partners in a securitization fund are only liable for the debts of the securitization fund up to the assets of the fund and in proportion to their participation. Also, the Securities Law shall indicate that securitization fund shall not be liable for the debts of the management company or of its partners. The creditors of the management company or of the partners shall have no rights of recourse against the assets of the securitization fund. The above is already inherent in the legal nature of the LLC and JSC under the Georgian law and we see no need to further spell this out in the Securitization Law with respect to securitization companies. However, the Securitization Law must certainly provide for a general exception from the limitation of liability of the management company or the originators/shareholders of the securitization company or their directors and officers for fraud or other actions in breach of their fiduciary duties to the investors or creditors of the SPV; 4. The Securitization Law may provide for an off-balance treatment of shares held in SPV to achieve full financial separation of SPV from its inceptors. Please note that financial separation between the SPV and the founders is not a mandatory requirement even under the Luxembourg law. In certain cases, independent SPVs will “consolidate” its balance sheet with Originators on a voluntary basis; 5. Further, apart from risks undertaken in the ordinary course of business, SPV must be further protected from other extraordinary liabilities in order to protect the interests of the investors. The Securitization Law shall expressly limit the scope of activity of the SPV to the securitization and related activities only. The same restriction shall be envisaged in the charter of the securitization company and the management regulations of the securitization fund. Management and due care of the securitized assets can be considered as related activities in the ordinary course of business, while taking any other liabilities not typically characteristic to such undertakings will fall beyond the scope of permitted activity. Therefore, SPV’s right to issue guarantees, obtain or grant loans or dispose of the assets must be limited, save when otherwise required to protect the interests of the investors. This too has to be specifically addressed in the law; 6. The Securitization Law shall expressly provide that the charter of a securitization company or management regulations of the securitization fund may authorize the board of directors of such SPV to create one or more compartments each compartment corresponding to a distinct part of its assets and liabilities (in case the SPV is a company), or distinct fiduciary estate (in case the SPV is a fund). Securitization funds, consisting of several compartments, may determine by separate management regulations the characteristics of and the rules applicable to each compartment. The Securitization Law shall expressly provide that the rights of the investors and of the creditors are limited to the assets of the securitization undertaking and where such rights relate to a compartment or have arisen in connection with the creation, the operation or the liquidation of a compartment, they shall be limited to the assets of that compartment. The Securitization Law shall expressly state that the assets of a compartment are exclusively available to satisfy the rights of investors in relation to that compartment and the rights of creditors whose claims have arisen in connection with the creation, the operation or the liquidation of that compartment. As between investors, each compartment shall be treated as a separate pool of assets and liabilities, except if otherwise provided for in the constitutional documents. Each compartment of a securitization

undertaking may be separately liquidated without such liquidation resulting in the liquidation of another compartment. Compartment system allows for segregation of assets and the liabilities linked to such assets from all other assets and/or liabilities of the securitization vehicle. Technically, such segregation can be achieved through operation of separate accounts or sub-accounts for each compartment, reflection of each compartment separately in the balance sheet of the SPV, etc. A securitization undertaking may thus issue securities whose value or yield is linked to specific compartment and whose repayment is subject to the repayment under the underlying securitized risks (receivables). Notably, this may as well be achieved through a limited recourse rights of the investors under the respective issuing document (private placement memorandum, prospectus, etc.), however, statutory limit of investors rights is nevertheless required to overcome the general rule of liability of an entity towards its creditors with its entire property. Respective changes are to be made in the definition of a limited liability company and a joint stock company in the Law of Georgia on Entrepreneurs, specifying that in case of securitization undertakings, liability of such each SPV to its creditors shall be limited in accordance with the Securitization Law. Likewise, Law of Georgia on Insolvency proceedings shall be amended to allow for ring-fencing the insolvency of each compartment of the SPV separately and bankruptcy and/or liquidation of one or several compartments the rest of the compartments shall survive; 7. If the SPVs are regulated entities, then in order to achieve a cost-effective system, carving out the SPV from some of the reporting obligations applicable to the reporting entities under the Law of Georgia on Securities Market must be considered; Further, consider setting out the eligibility criteria for the members of the board of directors and/or supervisory board of the securitization company and the management company of a securitization fund, if it is decided to regulate the SPV.

B. INSOLVENCY REMOTENESS As emphasized above, one of the primary aspects of SPV to make the structure an attractive investment is its insolvency remoteness, which is manifested in several major considerations: 1. The transfer of assets shall not be challengeable as part of the insolvency proceedings of the Originator; 2. Ensuring that the SPV, in general, is treated as separate from the Originator (opting for orphan structure when possible); 3. The SPV shall itself be operated in a manner that makes the chances of its insolvency highly unlikely, by amongst other, limited the rights of its creditors. In order to ensure that each of the relevant consideration is duly accommodated by the relevant Georgian regulations, the following legislative amendments shall be implemented: i. To eliminate the possibility of reversing the transfer of assets, the Securitization Law should state that the transfer of assets to the securitization vehicle cannot be reversed in any scenario, including but not limited to the protection from standard insolvency claw-back rights (reversal of the asset transfer transaction shall not be possible in case of insolvency proceedings of the Obligor). Relevant reference shall also made in the Law of Georgia on Insolvency Proceedings and, in case of regulated entities, in the relevant legislative acts governing the insolvency proceedings of relevant regulated entities (Law of Georgia on Commercial Banks, Law of Georgia on Insurance, Law of Georgia on Micro Finance Organizations); ii. Securitization Law shall also include the possibility of declaring insolvency of separate compartments, which shall reinforce the principle of ring-fencing and shall not have effect on the pool of assets and liabilities of other compartments; iii. The Securitization Law shall include strict reporting and accounting rules applicable to the securitization vehicles to ensure that no “piercing of corporate veil” claim can be initiated by the investors against the Obligor:

 SPV shall be subject to strict accounting and reporting regulations. It is advisable to ensure that securitization vehicles are considered as “an entity of public interest”, as this terms if defined under the Law of Georgia on Accounting, Reporting and Audit (adopted on 8 June 2016) (as amended) and relevant regulations shall be applicable thereto. In addition, where the securitization vehicle is an investment fund, the accounting and reporting requirements generally applicable to the collective investments schemes under the relevant investment fund law should be incorporated by reference;  The rights of the investors shall be statutorily limited to the securitized assets held by the securitization undertaking and there shall be no recourse vis-a-vis the Obligor.  Furthermore, the same principle shall be set out for the compartments – investors of one compartment shall not have recourse to the assets of another compartment. The Securitization Law shall ensure that this carve-out is clearly given notwithstanding the opposing regulations of the Civil Code of Georgia, the Law of Georgia on Entrepreneurs and the Law of Georgia on Enforcement Proceedings;  The assets of the securitization vehicle shall be strictly separated from the assets and/or obligations of any third party and it shall be prohibited to use these assets as a collateral for any third party obligations;  The SPV shall be managed by the management, which is entirely independent from the Obligor. The relevant independence criteria can be included in the Law on Securitization and can resemble the requirements applicable to independent Supervisory Board Members under the Law of Georgia on Entrepreneurs;  The SPV shall have a statutory obligation that all related party transactions shall be executed on arm’s length basis and the failure to do so can result in liability before the investors;  The Law on Securitization should prohibit merger / comingling with other entities, with the exception of merger of two securitization undertakings, in which case, each of them can be treated as separate compartment with distinct asset and liability pool. Any other type of merger shall be explicitly prohibited; iv. As noted above, the Securitization Law shall introduce the concept of the special purpose vehicle, effectively meaning that the securitization vehicle shall be prohibited to undertake any liability, guarantee any obligation or implement any business act unless it is directly related to compliance with the obligations it has assumed as part of the securitization transaction towards the investors; v. Notwithstanding the relevant provisions of the Civil Code, the security and guarantees given by the securitization undertaking in favor of investors shall extend to the proceeds and income generated by such assets through operation of law; vi. The Securitization Lay may envisage that collection services can be outsourced to any third party (whether regulated or unregulated). However, the securitization undertaking shall be the one maintaining the financial liabilities towards the investors. Furthermore, such third entity shall (a) either have the right to maintain the collected funds at a nominal account opened in the name of the Client (the securitization undertaking) or (b) the Securitization Law shall directly indicate that, notwithstanding anything to the contrary in the Law of Georgia on Insolvency Proceedings, the securitization undertaking shall have the right to claim recovered funds from the service provider immediately, notwithstanding any claims initiated by the insolvency trustee, the bankruptcy manager and/or the insolvency manager or any creditor of such service provider; vii. The securitization vehicles, even if they are not reporting entities, shall be subject to comprehensive disclosure requirements. It shall have the obligation to submit and publicly disclose annual audited statements, as well as semi-annual financial reviewed by the auditor. The relevant information shall be published on the SPV’s web-page and shall be easily accessible to the investors.

viii. Insolvency of securitization vehicles shall be subject to general insolvency regulations. However, it is advisable to include several special rules in the Securitization Law and cross- reference them in the Law of Georgia on Insolvency Proceedings. In particular: (a) if one of the compartments enters bankruptcy, this shall not affect the solvency of the SPV or other compartments; and (b) the law shall honor and enforce the contractual undertaking of the SPV’s investors or creditors to subordinate their claims to the claims of other investors or creditors, undertake not to seize the SPV’s assets and/or petition for bankruptcy.

C. TRANSFER OF ASSETS i. The Securitization Law should state that de-registration of the relevant security, if necessary, in the name of the SPV shall be executed based on a bilateral act executed between the Obligor and the SPV only and the relevant registration authority shall not request the consent of the owner; ii. The transfer of assets shall become effective upon execution of the relevant transfer agreement, unless otherwise determined therein. Furthermore, the Securitization Law shall allow transfer of future assets as long as they are sufficiently identifiable. However, transfer of any future assets of claims shall become effective upon realization of the relevant assets/claims; iii. Notwithstanding any other provisions of the Civil Code of Georgia (especially with regard to contractual security mechanisms), any assignment of claims to securitization vehicle should entail transfer of any guarantee and security as a matter of law, unless otherwise agreed contractually; iv. The transfer of claims can be effected even before formal incorporation or establishment of the security undertaking. The transfer of claims should not be subject to annulment based on the ground that the relevant undertaking was not existent as of the moment of assignment; v. If the debt agreement prohibits assignment of the claims derived from it, such transfer of claim shall be null and void, unless the relevant debtor consents to the assignment. The Securitization Law may also envisage other exceptions from this rule (for example, when the assignment relates to monetary claims). The interests of the debtor can be safeguarded by ensuring that, as it is regulated under the current Civil Code of Georgia, the debtor shall be released from all liabilities if it performs the payment obligation towards the transferor (the Obligor).

D. TRADABILITY In order to achieve efficient mechanism of vesting the investors with the foreclosure rights, which, in its turn, enhance the tradability of the secured bonds, it is necessary to create the legislative framework that will recognize the nominal holding of security by the security agent - a third party who holds the security rights for and on behalf of the investors and acts as their agent with respect to perfection, maintenance and even foreclosure of the underlying collateral. While the security agent is the nominal holder of the collateral, the investors maintain the beneficial interest thereon. To achieve the above, the limited exception must be introduced to the accessorial rule currently embodied in the Civil Code of Georgia, whereby a security agent shall be entitled to hold a security for and on behalf of the beneficial owners (the investors), even though such security agent may or may not be a creditor under the underlying collateralized claim. Also, neither such collateral not the underlying claim shall be considered to be owned by the security agent, unless the latter is also a creditor with respect to the underlying claim, in which case, only that portion of the claim can be considered to fall within the agent’s estate in case of latter’s bankruptcy. Change of the beneficial owner of the security interest (the investor) shall not require entry in a Public Registry. Respective amendments shall be made on the level of registrar of the securities. Apart from the Civil Code of Georgia, the above shall require number of amendments in the Law of Georgia on Public Registry relevant for the registration of security interests. We further note that amendments to the Tax Code of Georgia and the Law of Georgia on Enforcement Proceedings are highly recommended to make sure that investors (represented by security agents) of the SPVs have priority over the tax claims

levied after the registration of such security interest. In other words, carve-out already provided for the banks and other financial institutions must be further extended to cover securitization mechanism.

E. TAXATION i. In order for the SPV to enjoy the same tax specific treatment as in Luxembourg model, TCG has to be amended respectively – clauses explicitly stating that the interest and/or dividend paid by SPV to its investors and/or shareholders are exempted from local withholding tax should be included in a specific Articles elaborating on the list of exemptions from personal income tax (PIT) and (CIT). Noteworthy, however that such amendments will not exempt SPV from CIT at 15% which will be payable from its profit distributed to the shareholders. Amendments mentioned here are designated for exempting dividends and/or interest distributed or paid by SPV from withholding tax (which is payable at 5% and in some cases at 15% rate); ii. Article of TCG providing for definition of financial instruments and financial operations should explicitly state, that the service provided by the security agent to SPV is classified as financial services (which will respectively result in exemption of security agent’s service fee from VAT). iii. Important to note that financial services are exempted from VAT with no right to credit. Therefore, if SPV and/or security agent intend to credit input VAT paid by them to various goods/service providers, activities of SPV and its security/payment agents should be explicitly carved out from the definition of financial services and should be included into the list of VAT exemptions, but with the right to credit.

3. COVERED BONDS

3.1. COVERED BONDS IN A NUTSHELL In most generic terms, covered bonds are debt instruments issued by credit institutions having as their main object the covered bond activities43 and secured through various types of assets (where most often these assets include mortgage loans or public-sector debt), to which the covered bond investors have a preferential claim in case of insolvency of the issuer (the “Covered Bond Issuer”) and/or in the event of default. While number of details of the legal regulations characteristic to covered bonds may differ (starting from the level of regulating the Covered Bond Issuers and the cover pool assets to the insolvency remoteness and pertinent regulations), there are several features of this financial instrument that may be considered universal. In particular, covered bonds are financial instruments characterized with the below listed features:  They are issued by qualified entities, i.e. financial institutions (most frequently – the banking institutions) that are subject to oversight of the financial sector regulator;  The asset pool of covered bonds is dynamic, which means that, for example, mortgages that are already covered or that are in default may be replaced with new mortgages usually without the necessity to seek additional approval of the covered bondholders;  Dual recourse – often named as the most profound feature of the covered bonds, the principle of “dual recourse” means that the bondholders have preferential claim over the cover pool assets.  If the assets are not sufficient for covering the bondholders’ claims, they maintain recourse towards the issuer, i.e. they become unsecured creditors of the insolvent issuer for the residual amount and benefit from an ordinary claim in this context.

3.2. GAP ANALYSIS Please note that the foregoing chapter aims to analyze the issues specific to covered bonds. It does not purport to repeat or reinstate the problematic issues of the Georgian law, which have already been summarized in the first part of this Report. Before analyzing the specific characteristics of the covered bonds and identifying the shortfalls of the existing Georgian legislation to ensure the viability of this financial instrument, it is noteworthy that in most European jurisdictions covered bonds, due to their specific nature, are regulated by a separate legislative act and distinct set of insolvency rules (including, but not limited to, specific rules applicable in the context of proceedings involving credit institutions44). In absence of such legislative instrument(s), as well as pertinent regulations embodied in the Georgian civil/insolvency/securities law, most parts of the relevant issues remain open and highly under-regulated.

43 In Luxembourg financial institutions shall be authorised to issue covered bonds to be in a position to do so in accordance with Article 12-1 of the Luxembourg financial sector act of 5 April 1993, as amended. 44 In Luxembourg, covered bonds’ regime is contained in the Luxembourg financial sector act of 5 April 1993, as amended.

A. COVERED BOND ISSUER 1. General Description As noted above, most frequently the issuer of covered bonds is the financial institution itself, i.e. no transfer of assets is affected and thus, this is one of the features that distinguishes covered bonds from securitization mechanism4546. On top of general banking license requirements, the Covered Bond Issuers shall obtain additional authorization for issuing such financial instruments. In granting such license, the regulator checks whether the relevant eligibility criteria is met and properly documented, whether the quality of assets is satisfactory and offer sufficient security and whether the statutory requirements, including but not limited to minimum mandatory overcollateralization requirements are met. Provided that the issuer is a financial institution, it is usually subject with relevant capital adequacy and/or reporting requirements. Furthermore, mandatory disclosure requirements are applicable to the Covered Bonds Issuers. In particular, they need to disclose information on the cover pool assets, covered bonds and the Issuer itself.

2. Current Regulations of Georgia

As noted above, currently corporate issuers have the authority to issue secured bonds. However, the remaining items summarized above (including but not limited to licensing requirements, as well as the details of prudential supervision, disclosure and reporting criteria applicable to Covered Bond Issuers) are not regulated so far.

B. ASSETS ELIGIBLE FOR COVER POOL

1. General Description Most developed legislative systems contain detailed regulations as to which assets are eligible for inclusion in the cover pool assets. In Luxembourg, the below listed assets can be used as such:  Cover pool for mortgages (lettres de gage hypothécaires) ;  Cover pool for assets granted to or guaranteed by the public sector (lettres de gage publiques);  Cover pools for loans collateralized through tangible real estate rights (lettres de gage mobilières);  Cover pool for loans granted to credit institutions, which are members of a system of mutual guarantee (lettres de gage mutuelle)s;

45 In Luxembourg, banks issuing covered bonds may grant loans including in the form of the acquisition of bonds or other debt instruments which are issued by a securitization vehicle where 90% of the assets is made up of loans and advances: - secured by public entities; - secured by credit institutions, members of an institutional guarantee scheme - secured by rights in rem in immovable property or by charges on real property - secured by rights in rem in moveable property or by charges on moveable property secured by rights in rem in assets generating renewable energy and by rights of substitution of the bank issuing covered bonds in project contracts and the issue bonds secured by those rights (as introduced by the Luxembourg Law of 22 June 2018 on green covered bonds amending certain provisions of the Luxembourg financial sector act of 5 April 1993, as amended). 46 It is noteworthy that in some jurisdictions (for example, United Kingdom), covered bonds are issued through the mixture of these two instruments, i.e. the relevant assets are transferred to the SPV, which issues a guarantee for securing the debt obligations of the Issuer derived from the covered bonds. However, this analysis is limited to “on-balance” issuances, i.e. where the relevant asset pool is maintained on the balance sheet of the Issuer itself.

 Cover pool for renewable energy (lettres de gage énergies renouvelables)47. Usually the issuer is the owner of the underlying assets backing the covered bonds. However, assets purchased in the secondary market are also eligible. Needless to say that the quality requirements listed above will be applicable to the assets purchased at secondary market also. There are no legal restrictions applicable to the geographical scope of the covered pool assets. However, the regulator may impose certain limitations in the interest of credit quality. To the extent that the Loan-to-Value (LTV) ratio of covered bonds is usually regulated (there are specific thresholds imposed by the regulator), the covered pool assets are subject to regular evaluation and auditing. The minimum mandatory overcollateralization ratio may also be applicable and the specific threshold may vary depending on the jurisdiction. However, it amounts to 102% in Luxembourg48. Furthermore, the Covered Bond Issuers usually have the statutory obligation to mitigate market risks (currency risk, interest risk, etc.). The Covered Bond Issues may also be required to apply routine stress testing to ensure that the covered pool is solvent. As noted above, the distinctive feature of covered bonds is that the relevant cover pool is dynamic (the assets can be replaced subject to ongoing supervision and oversight)49. There may be multiple players who regularly monitor the cover pool assets: the securities market regulator, rating agency, trustee/cover pool monitor (which is a contractual mechanism set up by the Issuer at issuing the covered bonds) and/or external auditor. In Luxembourg a special auditor (approved statutory auditor) is appointed in accordance with the relevant provisions of the Luxembourg law of 5 April 1993 on financial sector, as amended. The special auditor has to verify the covered pool assets and the valuation of those assets. It is distinct from the approved statutory auditor who carries out the statutory audit of their accounts

2. Current Regulations of Georgia  Under the Civil Code of Georgia, mortgage entitles the creditor to receive preferential satisfaction from the subject of mortgage50. Herewith, the legislation determines the formal requirements for validating the mortgage – it shall be duly certified and registered at the Public Registry.51 Therefore, since mortgage is an agreement, any amendment thereto needs to be made in compliance with the same formal requirements. Based on this, currently the Georgian legislation does not allow for unilateral right of the mortgagor to replace the subject of mortgage or any part thereof. The equivalent regulations are included with regard to contracts of pledge52 (which will be relevant for movable and intangible assets).  The Georgian legislation does not contain any regulations on the quality of assets that can be used for cover pool, neither does it provide for any mitigation or ongoing solvency and/or stress testing obligations of the Covered Bond Issuers.

C. BANKRUPTCY REGIME

1. General Description It is customary to regulate insolvency of the Covered Bond Issuer by specific set of insolvency rules, which supersedes and trumps the general insolvency framework of the country.

47 Introduced by the Luxembourg Law of 22 June 2018 on green covered bonds amending certain provisions of the Luxembourg financial sector act of 5 April 1993, as amended. 48 Law of 24 October 2008 modifying the Luxembourg financial sector act of 5 April 1993, as amended. 49 In Luxembourg the ordinary cover assets may be replaced of up to 20% of the nominal value of the covered bonds of the same category in circulation by substitute cover assets. 50 See Article 286.1 of the Civil Code of Georgia. 51 Ibid., Article 289. 52 Ibid., Articles 254 and 258 of the Civil Code of Georgia.

The most distinct feature of bankruptcy regime applicable to covered bonds is its insolvency remoteness – the covered pool assets shall be at all times be segregated from the insolvency estate of the Covered Bond Issuer and shall be realized solely for satisfaction of the bondholders’ claims. In Luxembourg, cover pools forms a special estate (compartiments patrimoniaux). The special estate will be run and managed as a covered bond bank with limited business activity by a qualified insolvency trustee/bankruptcy receiver, appointed by the competent court. Furthermore, as banking institution, covered bonds issuers are subject to specific banking insolvency proceedings. If the formal insolvency and/or liquidation proceedings are launched, the assets and liabilities forming part of the cover pool are separated (although this pool does not form another legal entity and they remain on the balance sheet of the Issuer). The banking license continues to be operational (subject to the limitations applicable under general banking insolvency rules) until the insolvency proceedings are closed53. As part of such proceedings, the special administrator is appointed for the cover pool. It is noteworthy that this administrator is different from the general liquidator appointed for closing the bank’s activities. Furthermore, the legislation usually allows compartmenting of various cover pools, which means that different cover pools, although they remain on the balance sheet of the same issuer, may be subject to different insolvency treatment. For example, there may be a scenario when the suspension of payment or compulsory liquidation is opened for one set of covered bonds (cover pool), while the other pools are not affected by it and continue to satisfy the bondholders’ claims from the relevant receivables. The assets registered at the cover pool register at the moment of insolvency proceedings shall be considered as forming the cover pool. As noted above, the covered bondholders have preferential claim over the proceeds generated from the sale of the cover pool assets. However, if the sums generated are not sufficient for covering their claims, the bondholders maintain claim vis-à-vis the Issuer for the residual amount and this claim becomes pari passu with other unsecured creditors.

2. Current Regulations of Georgia  Currently there are no special insolvency rules applicable to Covered Bond Issuers, neither are there any regulations segregating the insolvency treatment of separate covered bond programs.  Apart from segregating the cover pool assets and liabilities in the insolvency setting, it is important that the relevant assets shall be shielded from ongoing third party claims initiated against the Covered Bond Issuer. For example, if any third party sues the Covered Bond Issuer and obtains a favorable judgement, the proceeds generated from the assets forming part of the cover pool shall be shielded from the relevant foreclosure proceedings. As of now, the Georgian legislation does not contain any regulations to this effect and the relevant amendments shall be made to the Civil Code of Georgia, as well as the Tax Code of Georgia and the Law of Georgia on Enforcement Proceedings.

53 In Luxembourg, reference is made to proceedings under the Part II of the law of 18 December 2015 on the failure of credit institutions and certain investment firms, as amended.

APPENDIX: 1 As part of the Gap Analysis for identifying the shortcomings of the existing Georgian legislation to accommodate standard securitization mechanism, the Project Team has elaborated extensive report describing, inter alia, (a) characteristics of standard securitization mechanisms focusing on international best-practices based on Luxembourg model; and (b) analyzing specific provisions of the Georgian civil, insolvency and tax legislation that hinders smooth execution of the standard model. One of the primary issues under the gap analysis was to understand the organizational-legal form of the securitization SPV and whether the relevant changes should have been implemented in the Law of Georgia on Entrepreneurs. As a general note, the Gap Analysis concluded that the SPV, established for the purpose of carrying out one or more securitizations, can be organized in the form of a company or a fund. Securitization undertaking organized in the form of a fund does not have a legal personality, rather it exists as co-ownership or fiduciary estate. Such funds are represented and managed by dedicated management companies. It was further noted that the concept of investment funds, as defined in the Law of Georgia on Investment Funds of 24 July 2013, failed to accommodate the needs of SPV securitization structure. Apart from the fact that there is no clear regulation on creation and activities of investment funds in Georgia, this vehicle is designed to pool the assets (only cash, cash equivalents or securities) of the beneficiaries to carry out various investment activities and provide the fund beneficiaries with return on their investment. The Project Team did however note that investment fund is a sui generis structure envisaged in the Law of Georgia on Investment Funds. Therefore, if SPV is to be organized in the form of a fund, respective legal nature, registration and corporate management details must be statutorily regulated – creation of a fully detached entity (with or without legal personality), with no beneficial ownership and management structure reflecting interests of all stakeholders of securitization and primarily those of the investors. Since the necessity of regulating securitization funds is self-evident, the question arises which legislative act shall contain the relevant regulations. There are two most logical solutions to this matter: (a) regulating the organizational-legal form of a securitization fund in the relevant securitization act (law) itself; or (b) ensuring that the Law on Investment Funds or any equivalent legislative instrument accommodates the relevant peculiarities of a securitization fund.

I. ANALYSIS OF PROPOSED LAW ON CIS As part of our work on the securitization reform, we have been provided with the Draft Law on Collective Investment Funds (the “Law on CIS”) and have been requested to analyze its compliance with the needs the securitization reform faces. According to the proposed edition of the law, the securitization vehicles are entirely excluded from the scope of the Law on CIS. We consider this as a shortcoming of this legislative instrument to the extent that the Law on CIS seems a rather obvious instrument for regulating the peculiarities relevant for establishing and management of securitization fund. Therefore, it is our recommendation to revise this aspect of the Law on CIS and ensure that it also accommodates the securitization fund, as one of the form of an investment fund54. In addition to the comment included here above, given its significance for the financial markets in general, we note that the Law on CIS may have a momentous impact on the development of financial markets in Georgia, including the success of securitization reform. Therefore, we see the room for improvement of the proposed draft from the below listed perspectives: 1. The Law delegates quite extensive rule making authority to the NBG, which is fine in principle. However, the Law also goes ahead and suggest principles for the relevant rules (for example,

54 BLC: We note that in number of developed jurisdictions, including Luxembourg, the securitization funds are regulated in the Securitization Act and not elsewhere. Arguably, there may be certain historical reasons behind (for example, the fact that Luxembourg has separate acts on each form of the investment funds, etc.). However, it is a fact that even where the securitization funds are not regulated through investment fund laws, the Securitization Act cross references number of provisions of the investment fund law to accommodate the relevant requirements (for example, Luxemburg Securitization Act references the reporting and disclose requirements applicable to investment funds). Given the codification structure followed in Georgia, it will be most logical to include securitization funds as one of the forms of investment vehicles.

establishes that there shall be maximum and minimum thresholds of certain benchmarks without actually suggesting one). This puts NBG’s rights and decision making authority into a somewhat ambiguous spot; 2. Although the Law tries to touch the basics of most legal relations characteristic to the activities of investment funds, there will be massive number of sub-normative acts to be enacted by the NBG. Additional scrutiny shall be made on whether this is acceptable; 3. The preface of the Law suggests that it has included the broadest spectrum of funds and it is up to the relevant decision-making authorities to decide whether they want to include all of them. However, certain funds are left out (for example, Exchange Traded Funds, Money Market Funds (although this is mentioned, there are no specific treatment elaborated in the Law itself) and the regulations on AIFs are rather scarce). Therefore, additional consideration shall be given to what extent these need to be regulated; 4. The Law mentions number of financial instruments, which, if adopted, would be mentioned for the first time in the Georgian legislation. Therefore, it is advisable to create the catalogue of such definitions and define them. Otherwise, it may create ambiguity in practice; 5. Certain thresholds seem rather low (case and point – investment policy of UCITS, as well as authorized CISs, etc.), which may be burdensome for the market like Georgia. If we have flexibility in this regard, it may be better to consider making them less stringent; 6. The role of the depositary is overarching in almost all types and forms of the CISs. Maybe we can consider having certain transitional period where the commercial banks, acting as the custodians, can carry out the same or equivalent functions. Otherwise, we may once again end up with a Law that simply will not work in practice. It is further advised to put the capacity building program or assistance in place to enhance the technical and professional know-how of the depositary and prepare this institution for the functions it will eventually be entrusted with; 7. There is certain work to be done for putting this Law into the context of the Georgian legislation. As a matter of essence (as well as legislative technique), we need cross references to neighbouring legislative acts (Law on Entrepreneurs, Law on Securities Market, etc.), to ensure that the Law on Investment Funds fits into the Georgian legislative.

USAID Governing for Growth (G4G) in Georgia Deloitte Consulting Overseas Projects LLP Address: 5 L. Mikeladze Street, Tbilisi Phone: +995 322 240115 / 16 E-mail: [email protected]