This paper examines a major obstacle to structured finance from an Asian perspective. There is in the writer’s view, never a shortage of capital. There is however an acute shortage of the willingness on the part of financiers to take risk. The cost of financing in relation to the collateral required, reflect the financiers’ perception of the degree of risks inherent in a transaction. The focus of this paper is on collaterals, more specifically, the real security in structured finance. It contends that it is the financier’s inventiveness, knowledge and experience coupled with the borrowers’ ability to deliver and get paid together with the necessary support from various relevant third parties that provide the ‘true collateral’. This is the essence of a structured finance transaction.
Unless one is well established or connected, the discussions in Asia with one’s financiers over the collaterals to be furnished for the facilities sought to support one’s trade or project can be long and difficult. The borrower and his financier often part ways, divided over the sufficiency, type, quality and amount of assets to be provided as collaterals rendering the project or trade a non-starter. The financier’s concerns are not without justification; particularly when the capital sought is to be deployed in a politically intricate country with nascent laws and regulations. There is in the writer’s view never a shortage of capital, but there is an acute shortage of the willingness to take risks. The cost of financing in relation to the collaterals required reflects the financiers’ perception of the degree of the risks inherent in a transaction.
This paper contends that it is the financier’s inventiveness, knowledge and experience coupled with the borrowers’ ability to deliver and get paid together with the necessary support from various relevant third parties that provide the ‘true collateral’ to a structured finance transaction.
We begin with the financiers. For it is they from whom a need for inventiveness is first called for.
Imagine for one moment that one is able to peep into the mind of the traditional Asian financier. Tangible assets are his first targets. The higher the perceived value of the tangible assets, the happier he is. Never mind the overkill. For one should, in his mind err on the side of caution. Never mind also that the borrower carries little long-term stocks and may be a believer in first-in-time management principles, or is now outsourcing most of its business process so that it can focus more on its core competence in order to become better at it. The borrower knows that he has to stay focused on his core competence not least because globalisation will force him to be more competitive to stay in business.
The facility is further structured and priced by the traditional Asian financiers as if the doomsayers are already right. If this does not take the cake, the sheer weight of the documentation relating to the deal, which sometimes defy comprehension, may.
The sophistication and purchasing power of the borrowers in the developed countries today, are but warning signs that such specie of traditional Asian financier described above may soon be a vanishing breed. The borrowers in the developed countries are no longer content with their financiers offering off-the-shelf products. They demand customisation. They even engage specialists (never mind the availability or lack thereof, of expertise provided by the financiers) to prescribe the products they want and choose the price that they are willing to pay without compromising one iota the assurances and comforts any diligent financier will need. They compel the financier to be price competitive and give them reasons to be. In another sense, they supplement even supplant, the expertise that some financiers lack in-house.
The structured financiers in Asia, on the other hand look to the transaction to be financed, in particular the receivables and stock in trade, which will generate the specific receivables and not the borrower’s balance sheet. He is not overly concerned with the extent of the political or country risk. His concern is after all the integrity of the specific transaction in question. He leaves no stone un-turned in this respect. He has to, because his payback depends on the transaction proceeds. As a last resort he turns to the tangible assets, usually only those directly related to the transaction. He applies a special blend of knowledge and experience to his analysis which requires him to have a broad view of the transaction from start to finish as well as depth in some specialised aspects for he knows that the devil is always in the details.
Where then do the structured financier in Asia find the security for their loan? The specific assets charged and its proceeds of sale. Are these after all not the very source from where payments to any financiers would come from?
Such are the qualities needed of the structured financiers in Asia. Inventiveness, knowledge and experience on the part of the structured financiers in Asia, is not enough to bring about financing. We must now examine the parts the borrowers and other third parties must play.
We begin as we did with the financiers, by examining the traditional Asian borrowers and the non-traditional Asian borrowers.
The traditional Asian borrowers are familiar with the typical secured financing model. Assets, which can be liquidated without difficulty are identified and charged as security for the debt. He knows that if things go wrong the assets charged will go towards satisfying the debt. Many direct and indirect factors have to be considered and in correlation thereof, the related risks, in determining the sufficiency of the collaterals. Since direct and indirect factors are taken into consideration, the economic fortunes of the borrower can impact the transaction as the borrower remains the owner of the charged assets.
Unlike the traditional Asian borrower, the non-traditional Asian borrower knows that if the assets from which a cash flow can be generated can be segregated from his other businesses, the attractiveness of these segregated assets to the financier increase. The isolation of the segregated assets sets it apart from the other risks of the borrower and limits risk considerations to those risks specific to these, and only these assets. The segregated assets, where possible, must be separately owned and/or specifically charged to enable the risks related only to these segregated assets deliberately and consciously addressed in detail. This is not all. The non-traditional Asian borrower knows that the financier’s interest in his ability to manage and transform these assets into cash must never be in doubt. If in doubt, the loan document will require the deposit of the sale proceeds in an escrow account, often called collection account, before any loan monies are disbursed. He has to demonstrate credibility and soundness in his business dealings and risk management techniques if he wishes the loan to be disbursed before the sale proceeds are realised. Even then, it will not be until the assets generating the sales proceeds are effectively charged in favour of the financier.
If again in doubt, a third party or off-taker as he is sometimes called, whose performance credibility can substitute that of the non-traditional borrower, must be found for no monies will be disbursed unless the financier finds comfort in the knowledge that his loan will be repaid. Such a third party is but only one of the supports various third parties must play in order that a structured finance deal can come about.
The Third Parties
Ranking equal if not more important to the off-taker in the line-up of supporting third parties is the government of the country where the assets are located. The governments must provide the appropriate legal, economic, financial, infrastructures and logistical environment to facilitate the transaction.
The laws of a country where the assets are located must not only permit ownership of assets to pass by way of a true sale or charge but also for the assets to be possessed, liquidated and applied in satisfaction of the loan outstanding. The laws must give the financier the unfettered right to re-possess and transform the charged assets into cash in the event that a forced sale is necessary. It is however too simplistic to suggest that securities and insolvency laws are the only concerns. Suffice it to say that the laws of a country play a pivotal role and this paper can do no more than underscore the important role of the government.
Moving down the value chain of a structured finance transaction, one finds a myriad of third parties involved. A convenient classification is to group them into two very broad categories, namely the physical aspects and the other supporting aspects. Included in the former category is availability of secured warehouses, financial markets or exchanges, good and respected carriers and an efficient transportation system, contractors, and literally all the parties whose performance adds to the final realisation of the proceeds of sale. As one would expect the physical aspects alone are insufficient. Third parties comprising the latter include the insurers, technical consultants, derivatives specialists, credit enhancers, underwriters, financial advisers, lawyers and various other professionals.
We are now in a position to provide the answer to the question – what is the true collateral in a structured finance transaction? The answer? Sound execution of the trade involving the charged assets by the financiers and the borrower in concert with and aided by other third parties. The objective? The safe realisation and preservation of the corpus of cash flow generated from the assets charged as security for the repayment of the loan amount and related transaction costs in full.
The Asian Financial Crisis has left in its wake two broad categories of corporations in Asia. The corporations who had demonstrated that they possess sound and prudent business practices, consistently good performance record and a well earned reputation. Based on this – the true collateral – the structured finance route enables such corporations to increase their quantum of loan and/or reduce their cost of financing and boost their competitiveness. The second category comprises those whose past performance did not survive scrutiny and whose performance ability going forward is therefore uncertain. For these corporations, the considerations in this paper may be critical as to whether structured finance, one of the few solutions left for them is even possible. Awareness of and a conscious effort to address the real security or – the true collateral – to enhance one’s credit is an important first step for such corporations in Asia.