In the context of the modern reality, instruments that were previously widely used in a familiar form can be seen from a different perspective. It is interesting to note that the testing of various types of transactions (and, consequently, the assets transferred), which are currently at the peak of popularity, did not begin instantaneously or this year, but occurred gradually over the past several years. In this article, we want to trace the path that repack transactions have taken before achieving popularity.
Russian legislation does not contain the term "securitization," which is why practice has developed a rather free interpretation of what is actually understood by "securitization." In the most general terms, securitization refers to transactions involving the raising of financing through the issuance of securities backed by assets generating stable cash flows, with the issuers of such securities being specialized financial societies (established in accordance with the Federal Law "On the Securities Market") and special purpose companies (simple LLCs, but with charter-limited competence).
Before the appearance of provisions on structured bonds in the Securities Market Law in 2018, only its most classical manifestations were called securitization – the assignment of a pool of rights of claim to a specialized financial society and the issuance of bonds secured by a pledge of these claims. The structured bond construct allowed for the use of a wider pool of instruments and the implementation of an almost limitless palette of transactions, with some of them still continuing to be securitization in the broad sense of the word.
Repack transactions are implemented using a specialized financial society and the issuance of structured bonds, allowing to solve two conceptually different tasks: (1) assign the originator's existing debt to a specialized financial society and issue bonds secured by a pledge of this debt; or (2) provide new "money" through the originator's purchase of bonds and the extension of a loan from the specialized financial society to the borrower. Thus, by their nature, these transactions continue to be securitization, as the assets pledged against the bonds generate a regular cash flow.
The need for "repackaging" arose even before the advent of structured bonds. Thus, in 2017, a transaction was implemented through SFO Lokoservis Finance LLC, where the asset was rights of claim under a single contract – a contract for locomotive maintenance services concluded by TMH-Service LLC (the originator). This transaction was the first example of a departure from classical securitizations of asset pools, such as mortgages, auto loans, consumer loans, NPLs, etc. The experience of SFO Lokoservis Finance LLC was extremely useful at the time when structured bonds appeared in Russian legislation.
The main feature of structured bonds is the possibility of not paying the full nominal value upon redemption if a predefined list of events occurs, which opened new opportunities for "repackaging." Structured bonds allowed for the full synchronization of bond payments with payments received into the pledge account of the specialized financial society for the asset pledged against the bonds, including negative scenarios, for example, a default on the asset, which automatically leads to a "write-down" of the nominal value and the redemption of the structured bonds. Such full synchronization was impossible before the advent of structured bonds and only worked through the mechanism of foreclosure on the pledged item and, consequently, the bankruptcy of the specialized financial society, which certainly extended the time for bondholders to receive funds and did not fully meet the goals of "repackaging."
From 2018 to 2022, a number of public and private transactions, essentially "repacks," were implemented. As one public example of this type of transaction, one can cite the deal of SFO RUSOL 1 LLC, where the company attracted a loan to refinance credit taken for the construction of two solar power plants, or the ESG securitization deal of SFO Sotsialnogo Razvitiya LLC, where monetary claims under one loan and one borrowings were assigned, which acted as collateral. Refinancing was the main task among all deals of this type during the specified period; there were even successes in securitizing rights under a syndicated loan (with the allocation of a share in such a loan to a specialized financial society). Unfortunately, most of the transactions were private, making it difficult to assess the number of such stories implemented before 2022, but, one way or another, the work of project teams on them, the modernization of various mechanisms from deal to deal, and the detailed elaboration of wording allowed project teams in 2022 to quickly optimize and adapt to new realities, requirements, and current demands based on existing developments.
In this article, we do not aim to cover the entire list of reasons why repack transactions have become in high demand and popular since 2022, but rather would like to highlight current issues that we, and we believe our colleagues, face during their implementation. Below are just a few of them.
Bondholder Control over the Asset
In a "repack," regardless of whether an existing loan is assigned or new "money" is lent, the cornerstone is the issue of bondholder control over the asset pledged against the bonds. Typically, in such transactions, for decisions regarding:
Assignment, transfer, alienation in any other way of any rights of the specialized financial society to the asset;
Increase/decrease of the availability period, namely an extension of the principal repayment term for an asset that is a loan/credit;
Change in the composition of obligors for an asset that is a loan/credit;
Amendments to the terms of an asset that is a loan/credit, including changes to the amount of interest, fees, or other payments under such asset;
the specialized financial society, acting as the issuer, is obliged to preliminarily convene a general meeting of bondholders (GMB), as the listed issues directly affect the need to make similar changes to the issuance documentation.
To save costs on holding a GMB for issues that do not require changes to the issuance documentation, the terms of the issue may either provide for such issues to be resolved by the specialized financial society independently, but according to a pre-formulated instruction, or provide for a unanimous written instruction to the bondholders' representative, to whom the bondholders, in a pre-agreed manner, issue instructions on further actions regarding the asset on their behalf.
Issues falling directly within the competence of the GMB vary from project to project and directly depend on the transaction structure and the need for greater or lesser control by bondholders over the asset. If responsibility for decision-making regarding the asset is transferred to the bondholders, a complete translation of the creditor's rights for the pledged item is created, which corresponds to the goals of "repackaging." The main question, as a rule, is the scope of such translation. For our part, we express hope that some universal solution will be found in the future.
Simplified Foreclosure on the Pledged Item
Typically, in repack transactions, it is important for the bondholder to quickly obtain the asset if something goes wrong. For this, physical settlement of rights of claim to the asset can be provided for upon the occurrence of a credit event, but this construct may prove weak if the issuer, for one reason or another, does not effect such an assignment. And here arises the need for direct foreclosure in the shortest possible time. The most logical would be to use an out-of-court foreclosure procedure via a notary's executive endorsement, but in practice this option is unlikely. Difficulties are due to notaries refusing to certify the text of the terms of the issue. Notaries justify the refusal as follows: in accordance with Article 94.2 of the Fundamentals of the Legislation of the Russian Federation on Notaries, a notarized pledge agreement or a notarized agreement entailing the emergence of a pledge, which contains a condition on the possibility of out-of-court foreclosure on the pledged property, are accepted for the execution of an executive endorsement. According to Article 420 of the Civil Code, a contract is an agreement of two or more persons on the establishment, modification, or termination of civil rights and obligations, while the terms of a securities issue is a unilateral transaction, not a pledge agreement, the certification of which by a notary involves all parties to the agreement being present simultaneously. In this regard, it is not possible to make an executive endorsement on the terms of a securities issue, which is a unilateral transaction, even if the authenticity of the signature on it is certified by a notary.
Thus, we believe it would be extremely useful to legislatively expand the list of transactions under which foreclosure on pledged property can be effected through an executive endorsement and to include, in particular, the possibility of certifying a pledge based on the terms of a securities issue.
Currency of Payment
Lately, there has been a high need to attract funds in foreign currency, but while securities can be denominated in it (under a certain set of conditions), loans in currency between residents are prohibited, which significantly complicates the structuring of repack transactions in currency. Unfortunately, the issue lies in the realm of currency regulation, so hoping for relaxations in this part is not warranted.
Synchronization of Loan Agreement Terms with Bond Payment Terms
Credit agreements and loan agreements, in addition to standard interest payments and principal repayments, often also provide for the accrual of various fees, potential penalties, and other payments, which are not directly translated into the bond structure. As a solution to the synchronization problem in this case, we propose using the instrument of additional income, in which any payments made in excess of standard interest payments translated into coupon income can be stipulated.
Non-Standard Assets Using Investment Units as an Example
To expand companies' opportunities to attract financing through the issuance of bonds secured by a pledge, the legislation introduced the possibility of including investment units in the collateral for bonds. Investment units are in some cases used as an asset for repack transactions. For the purposes of the law, investment units act as securities, and the registration of rights to them is carried out on personal accounts in the register of investment unit owners and, if provided for by the rules of trust management of the unit investment fund, on depot accounts by depositaries, for which purpose personal accounts of nominal holders are opened in the register of investment unit owners. To record the pledge right on investment units, a separate personal account for the pledgee is opened in the register of investment unit owners. The fixation of rights occurs on the basis of a pledge order, which stipulates the terms of the pledge. The use of investment units as the subject of the pledge for bonds significantly increases the variation of potential repack deals, but due to the novelty of the construct, in practice, one can often encounter depositaries lacking the technical capability to pledge investment units according to the provisions of the terms of the issue. We believe that resolving this issue lies in popularizing such transactions and establishing the depositary technical infrastructure.
We see high potential in implementing such transactions; with each new project, we come to an understanding of how to better and more effectively structure certain requests of the current market. We believe that a public exchange of experience on certain issues of structuring private repack transactions could help many market participants who previously did not have a need for such transactions.