The Securitisation Law Review: United Arab Emirates
Securitisations are a viable alternative source of funding for financial institutions and corporates in the United Arab Emirates (UAE) and the Kingdom of Saudi Arabia (Saudi Arabia), but the take-up remains slow. The scarcity of securitisations in the region is driven by a number of factors, including:
- the existing legal environment (e.g., a lack of legal certainty with respect to enforcement of contracts and security);
- plentiful liquidity within many financial institutions (e.g., banks in Saudi Arabia have good liquidity – typically funded by current account deposits on which they pay little or no return to customers – and they hold to maturity the financial products they originate rather than securitising them);
- financial institutions are smaller and do not face the same concentration risk issues compared with the larger international financial institutions;
- the investor base is more focused on sponsor creditworthiness (rather than the creditworthiness of a segregated pool of assets and related cash flows);
- that same investor base has a need to acquire shariah-compliant (and not conventional) securitised products, which can be more complicated and expensive to structure; and
- the requirement for any person who wishes to provide financing to be licensed (i.e., the activity of lending is in general prohibited unless the person doing the lending has the requisite licence).
Instances where material securitisations have been successfully bought to market in the UAE and Saudi Arabia include HANCO Rent A Car (Saudi Arabia 2004), Tamweel ABS Sukuk (2005), Kingdom Instalment Company (Saudi Arabia 2006), Tamweel ABS Sukuk (UAE 2007), Sun Finance Sukuk (UAE 2009), Salik Sukuk (UAE 2009) and the TRS Sukuk (UAE 2012), which failed. However, all these securitisations took place either before or shortly after the global financial crisis and, since that time, few large-scale securitisations have come to market. More recently, the Tata Group securitised receivables from 11 African subsidiaries of Tata International Limited (India) and Tata International Singapore Pte Ltd through a special purpose vehicle established in the ADGM (defined in Section II). The impact of the covid-19 pandemic has forced companies in the UAE and Saudi Arabia to look again at how they finance their working capital. Monetising receivables whether by way of a securitisation or a more traditional receivables purchase agreement (with or without recourse) is a viable way to raise liquidity as proven by the Tata Group securitisation.
The securitisations that are currently being undertaken in the UAE and Saudi Arabia are on a smaller scale (US$10 million to US$50 million) and are typically being privately placed. Examples include financial institutions securitising pools of financial products they have originated, with the notes (which are called sukuk) placed privately, in many instances with high-net-worth individuals who are customers of the financial institutions' private wealth management arms. The privately placed notes (or sukuk) are not rated and the financial products (that have been securitised) will typically continue to be serviced by the financial institutions that originated them.
It is also not uncommon for financial institutions in the UAE and Saudi Arabia (in particular banks) to acquire receivables from the originators of those receivables (e.g., automobile lease receivables). A leasing company will originate lease receivables, which are then acquired by a bank (often on a non-recourse basis). Because banks are prepared to acquire such receivables, there is no business case for setting up securitisation programmes.
Because many of the financial institutions in the UAE and Saudi Arabia operate on a shariah-compliant basis and because those same financial institutions are often the investors who participate in regional securitisations, most securitisations in the region are structured on a shariah-compliant basis. This requires the issuer of the notes (or sukuk) to own a pool of tangible assets (not intangible assets, such as receivables). The holders of the sukuk own an undivided interest in that pool of tangible assets with returns generated by that pool of tangible assets funding coupon and principal payments to the sukuk holders. To understand the material difference between a sukuk offering and the offering of notes in a conventional securitisation programme, take as an example the securitisation of a pool of residential mortgages. Many residential mortgage programmes in the UAE and Saudi Arabia are structured on a lease-to-own basis: the financial institution owns the property, which it leases to its customer; the rent payable under the lease provides the financial institution with the repayment of its capital (equivalent to loan principal) plus a financing return (equivalent to interest); and upon the final capital payment, the financial institution transfers the property to its customer. To securitise such a residential mortgage programme in accordance with shariah principles, the entity that issues the sukuk must own the properties that are the subject of the leases (therefore the financial institution has to transfer the properties to the issuer as part of the securitisation). The sukuk holders then own an undivided share in the properties and the returns generated from leasing the properties are used to fund payments under the sukuk. Payments to sukuk holders are generated by tangible assets, which distinguishes a sukuk offering from an offering of conventional notes (which typically rely on a pool of receivables to fund payments to noteholders).
There have been some recent legal developments in the UAE and Saudi Arabia that should make it easier to structure securitisations in that the procedure for taking, perfecting and enforcing security has seen some recent positive developments and new laws on insolvency have been enacted in both the UAE and Saudi Arabia.
Finally, while the issuance of sukuk in Saudi Arabia and the UAE remains robust, nearly without exception those sukuk issuances are asset based and not asset backed and therefore those issuances do not involve the securitisation of pools of assets (i.e., securitisations may involve the issuance of sukuk, but not all sukuk issuances are securitisations). In an asset-based sukuk issuance, the holders of the sukuk are ultimately looking to the originator of the sukuk for repayment, and not to the assets of the underlying sukuk programmes. Of the more than 60 sukuk traded on Nasdaq Dubai, all are asset based (and not asset backed) and most include provisions that restrict sukuk holders from enforcing rights against specific assets of the originator. Enforcement rights are limited to enforcing contractual rights, therefore if sukuk holders wanted to enforce against the assets of the originator, they would first have to obtain a judgment for damages resulting from a breach of contract by the originator and then use that judgment to attach the assets of the originator.
A majority of the large-scale securitisations in the region (specifically transactions seeking to attract investors from outside the region) have been structured in part through either the Dubai International Financial Centre (DIFC) or the Abu Dhabi Global Market (ADGM), and the issuing vehicles have typically been incorporated in the Cayman Islands (the issuing vehicle for the Tata Group securitisation was set up in the ADGM, see Section I).
The DIFC and the ADGM are free zones within the UAE that have adopted English common law as the governing law and whose courts have their own jurisdiction. The DIFC and ADGM are commonly referred to as offshore jurisdictions (notwithstanding the fact that they sit within the UAE).
The driver behind structuring as much of a securitisation transaction as is possible in the DIFC or the ADGM is to gain access to legal systems that international investors are more familiar with (i.e., the English common law system). Having transactions governed by English law provides greater certainty and makes it more straightforward for clear legal opinions to be provided (e.g., with respect to the sale of an asset and the enforcement of security), which in turn provides the necessary comfort to rating agencies and international investors.
However, moving transactions into the DIFC or the ADGM does in some cases lead to tax issues, specifically in relation to withholding tax. For example, incorporating an issuing vehicle in the DIFC that is reliant on an income stream from Saudi Arabia to fund payments to sukuk holders will trigger a 5 per cent withholding tax on certain types of payments made from Saudi Arabia to the DIFC, and this has to be priced into any transaction. Similarly, in the case of transfer taxes, if assets such as real estate have to be transferred as part of the securitisation programme (which is often the case with any shariah-compliant securitisation programme), that may result in transfer taxes.
A further issue that has to be factored into securitisations in the region is that if they are to be structured on a shariah-compliant basis, the issuing vehicle must have an ownership interest in the underlying assets (tangible assets) (see Section I). Both the UAE and Saudi Arabia have laws restricting foreigners from owning certain assets (e.g., land unless it is in a designated area), which means any assets transferred to the issuing vehicle may not be able to be owned by foreigners (either non-nationals of a particular country, such as the UAE, or non-nationals of a Gulf Cooperation Council country). Therefore, unless the securitisation transaction is structured in a particular manner (or the assets owned by the issuer are not subject to foreign-ownership restrictions), the persons able to acquire the sukuk will be limited (i.e., the owners of the sukuk are deemed to own an undivided share in the assets of the issuing vehicle, but if the assets are of a type whose ownership is restricted to a certain class of persons, only persons of that restricted class will be able to own the sukuk – unless the sukuk is properly structured).
One final issue to be considered with any securitisation programme in the region is whether the issuing vehicle will require a special licence to be able to acquire the financial products being securitised. In the UAE and Saudi Arabia, both the lending of money and the taking of deposits is a regulated activity, therefore if the issuing vehicle is held to be in the business of lending (because it owns a portfolio of residential mortgages), it may have to be licensed to be able to conduct that activity. In practice however that does not appear to be the case (e.g. the issuing vehicle in the recent Tata Group securitisation, which acquired receivables, was not required to be licensed). Because of the regulatory regime in the UAE and Saudi that, as a general rule, restricts lending to entities that have the requisite licence, structured finance solutions may provide an alternative. For example, notes or sukuk issued by a special purchase vehicle which uses the proceeds to acquire a pool of receivables originated by a third party, such an arrangement (provided it was approved by the applicable regulatory authority in the UAE or Saudi Arabia) should enable the issuer to become the owner of the receivables but without the requirement to have a lending licence.
Security and guarantees
Historically the taking of security and the provision of guarantees in the UAE and Saudi Arabia has not been straight forward and security packages have typically been limited to mortgages over land and personal guarantees (with security over other types of assets and corporate guarantees having been viewed as being of limited value). Until recently most security had to be granted in favour of a financial institution licensed in the jurisdiction of the situs of the asset subject to the security, and enforcement of security was a court-sanctioned process (i.e., self-help remedies, such as a sale at a public auction arranged by lender or its nominee outside court, were not available). Further issues that have caused problems included the inability to take security over a floating pool of assets (such as cash in a bank account, receivables and inventory) and the lack of any procedure for perfecting security.
Because of the issues around taking a robust security package, it has not been uncommon for lenders to require all or a part of a transaction to be structured through the DIFC or the ADGM to obtain access to a better security package. For example, take the case of a limited liability company incorporated in onshore UAE or Saudi Arabia (Opco) that requires financing. The lender, as a condition to providing the financing, may require the owners of the business to swap their shares in the Opco for shares in a DIFC holding company (with the DIFC holding company then acquiring the shares in the Opco). The lender will then require the owners of the business to grant English law security over their shares in the DIFC holding company. Following the restructuring, the lender will have a good security package over the shares in the DIFC holding company (which can be enforced outside a court-sanctioned process) even if its onshore security package (such as a pledge over the shares in the Opco) contains some weaknesses.
However, some of the perceived weakness of UAE and Saudi Arabian onshore security packages (specifically in relation to taking security over moveable property) have been addressed through Federal Law No. 4/2020 On Guaranteeing Rights Related to Movables (which replaced and repealed UAE Federal Law No. 20/2106 on Mortgaging of Movable Assets as Security for Debt) (the UAE Mortgage Law) and Saudi Arabia Royal Decree No. M/86 (as amended in 2019 and April 2020) and the Law on Securing Rights with Moveable Assets and implementing regulations of April 2020 (together the Saudi Mortgage Law).
The UAE Mortgage Law and the Saudi Mortgage Law now make it possible to take security over fluctuating pools of assets, and security can be granted in favour of unlicensed financial institutions. The UAE Mortgage Law and Saudi Mortgage Law also set out a process for enforcing security outside a court-sanctioned process; for example, in the UAE it is now possible to enforce security over a bank account without having to resort to a court-sanctioned process. While a lender could exercise a right of set-off, there had always been some doubt as to whether exercising such a right was a self-help remedy and therefore prohibited, but that doubt has now been removed by the UAE Mortgage Law.
Both the UAE Mortgage Law and the Saudi Mortgage Law provide a procedure for perfecting security interests (by registering the security in a public register). The registration (perfection) of security has become more important following the implementation of new insolvency laws in both the UAE and Saudi Arabia, as failure to perfect security will now mean that the security will be void against the bankruptcy trustee in any insolvency process.
The developments in the area of taking security over fluctuating pools of assets (such as cash in a bank account and receivables) can only help with structuring securitisation transactions.
Trusts are not recognised in Saudi Arabia or the UAE and therefore it is not possible to grant security over assets in favour of a trustee who would then hold those assets on trust for a group of beneficiaries (such as a group of lenders or sukuk holders). Instead of a trustee being appointed to hold such assets, a lending syndicate will typically appoint an agent to hold those assets and communicate with the borrower. However, what remains unclear in both the UAE and Saudi Arabia is whether that agent can prove in the insolvency of the borrower. Because the agent is not actually owed any money by the borrower, what right does it have to prove in the insolvency of the borrower? It is therefore not uncommon to see parallel debt language in UAE and Saudi Arabian financing documents. This language states that the borrower owes a debt to both the lending syndicate and the agent; as the debt to the lending syndicate is paid down, the debt owed to the agent is automatically deemed to be paid down and vice versa. If the agent had to prove in the insolvency of the borrower, it could point to the fact it is owed an independent debt and on that basis argue that it has a right to prove in the insolvency of the borrower (any amounts paid to the agent as part of the insolvency process would automatically discharge a corresponding amount of the debt owed by the borrower to the lending syndicate, therefore the borrower would never be in a position of having to pay the debt twice – once to the agent and once to the lending syndicate).
Priority of payments and waterfalls
New insolvency laws have recently come into force in the UAE and Saudi Arabia. Federal Decree-Law No. 9/2016 (the UAE Insolvency Law) and Saudi Royal Decree No. M16/1416 H (the Saudi Arabia Insolvency Law) have both made material changes to the corporate insolvency regime.
The Saudi Arabia Insolvency Law is being used by distressed debtors to restructure their businesses and a number of insolvency cases are now being heard by the Saudi courts. The uptake in the use of the UAE Insolvency Law by debtors in the UAE has been slower (this may be due to many businesses in the UAE being owned by expatriates, often such business owners will leave the UAE (because they may have written cheques, which, if dishonoured, enables the beneficiary of such cheque to file a criminal complaint) rather than work through a restructuring). The primary purpose of both the UAE Insolvency Law and the Saudi Arabia Insolvency Law is to provide a debtor facing financial distress with a period in which to restructure its business and put it on a more secure footing. These laws provide for a moratorium during which time creditors are unable to take enforcement action against the debtor (including a moratorium on secured creditors taking enforcement action without the consent of the courts). The Saudi Arabia Insolvency Law and the UAE Insolvency Law do not apply in the DIFC or the ADGM, which have their own insolvency laws. Recently NMC Healthcare (a London-listed healthcare provider whose principal business is in the UAE and Saudi) successfully applied for an administration order that covers its UAE business. Notwithstanding the companies that have gone into the ADGM administration were not established in the ADGM, the ADGM courts accepted the administration application after the companies continued as ADGM companies following an application to the ADGM Companies Registrar. If the NMC administration proves successful it will set a precedent for restructuring UAE businesses facing financial difficulty (it is likely NMC chose the ADGM as the jurisdiction to handle its restructuring because it sees the insolvency regime in the ADGM as being more favourable to it which in turn should lead to a more successful outcome for the business).
The importance of taking security and ensuring it has been perfected has now become more important because the new insolvency laws, as you would expect, protect the interests of secured creditors, with secured creditors ranking ahead of all other creditors under both insolvency regimes. The Saudi Arabia Insolvency Law and the UAE Insolvency Law both contain provisions to deal with transactions entered into by a debtor prior to the onset of insolvency, with the courts having the power to unwind certain transactions (such as transactions at an undervalue and the granting of security during a time when the grantor was insolvent). Therefore, transactions entered into by a debtor and an issuing vehicle as part of any securitisation transaction will be subject to the provisions in the new insolvency laws and the provisions relating to the unwinding of transactions.
While it is common to structure all or part of a transaction in the DIFC and ADGM (because of the legal certainty that brings, including in connection with matters relating to insolvency and in what circumstances a transaction can be unwound), that is not always going to be possible, and it adds cost and complexity to a transaction. Also, it will not be possible in all circumstances to structure transactions through the DIFC or ADGM. For example, if assets are to be sold by an onshore UAE limited liability company (the originator) to a DIFC company (the issuer) as part of a securitisation programme, the sale agreement will typically be governed by UAE law and will be subject to the laws of the UAE (including the UAE Insolvency Law as it relates to unwinding transactions).
The new insolvency laws in the UAE and Saudi Arabia, coupled with the new laws relating to the taking of security, provide more certainty when structuring transactions in onshore UAE and Saudi Arabia (including securitisation programmes).
Isolation of assets and bankruptcy remoteness
One of the critical components of any securitisation programme is ensuring the pool of assets that will be used to fund payments to note holders (or, as the case may be, sukuk holders) will not form part of the estate of the originator of the securitisation programme in the event of an insolvency. Following the introduction of new laws relating to insolvency and the taking of security in both the UAE and Saudi Arabia, there is now much greater certainty around what will and what will not form part of the estate of an insolvent entity.
In the UAE and Saudi Arabia, the most robust method of transferring rights or assets from one person to another person is a tripartite agreement. For example, an assignment of rights (such as a right to receive payment from a debtor under a contract) is typically documented under a tripartite agreement between seller, buyer and debtor. If the underlying agreement (governing the rights being assigned) does not contain a prohibition on assignment, then the consent of the debtor will not be required and, provided the debtor is not required to pay to the buyer (i.e., the seller continues to service the agreement that is the subject of the assignment), then no notice will have to be served on the debtor.
Notwithstanding the passing of new laws in the UAE and Saudi Arabia with respect to insolvency and security, it remains common for issuing vehicles to be incorporated in either the DIFC, ADGM or the Cayman Islands. While it is certainly possible to incorporate bankruptcy-remote vehicles in onshore UAE and Saudi Arabia, there are challenges, the most obvious one being that for a UAE limited liability company, 51 per cent of the shares in such an entity must be owned by a UAE national; similar restrictions apply in Saudi Arabia. For that reason, setting up an entity owned by a purpose trust or charitable trust (the typical shareholder of an issuing vehicle in a securitisation programme) will not be possible. It is for that reason that issuing vehicles are set up offshore (i.e., in the DIFC, ADGM or the Cayman Islands). The other advantage of having the issuing vehicle incorporated in a common law jurisdiction is that a trust can be created over the assets of that vehicle for the holders of the notes (or, as the case may be, the sukuk).
Therefore, a typical securitisation structure in the UAE involves assets being transferred by an originator (in onshore UAE) to an entity incorporated in the DIFC or the ADGM (in offshore UAE). That transfer would typically be documented under a sale and purchase agreement (or an absolute assignment). That sale and purchase agreement (or assignment, as applicable) will now be subject to the UAE Insolvency Law (see Section IV).
A similar structure would also be possible for a Saudi Arabian securitisation (i.e., a sale of assets by a Saudi originator to a DIFC or ADGM issuing vehicle); however, the issue of withholding tax would have to be considered. Certain payments made from Saudi Arabia to the DIFC or the ADGM will be subject to withholding tax (unless the issuing vehicle can obtain Saudi Arabian tax residency, in which case the withholding tax would not apply).
It has become common for all or parts of a transaction in the UAE and Saudi Arabia to be structured in the DIFC or the ADGM for the reasons that have been set out in this chapter.
Because the assets that back a securitisation will typically have been originated onshore (i.e., outside the DIFC and ADGM), there is always going to be onshore risk factored into any securitisation programme. For example, any residential mortgage programme that is securitised will have customers (borrowers) who are onshore and the property (over which the mortgage is granted) will also be onshore. Therefore, any enforcement of security and related recoveries will be subject to the laws of the UAE (or Saudi Arabia, as the case may be).
Local investors have a better appetite for securitisation structures where local law risk is more pronounced (i.e., they are more comfortable with the onshore risk). However, that mentality is often driven by the perceived creditworthiness of the originator of the securitisation programme. For example, where a financial institution securitises financial products and sells the resulting notes (or sukuk, as applicable) to high-net-worth individuals who are customers of that financial institution, the high-net-worth individuals are likely to be looking at the creditworthiness of the originator with whom they have a relationship (even if they are going to get repaid solely from the financial products that have been securitised). Privately placed securitised products are also bought up by regional banks and, again, those banks are less inclined to have an adverse reaction to the local law risk because they operate in the local market and understand the risks better. What looks acceptable to a local investor may not be acceptable to an international investor.
While the DIFC and ADGM remain important jurisdictions for structuring securitisation programmes, the new insolvency and security laws in the UAE and Saudi Arabia should make it more straightforward to structure onshore securitisations that are understood by and acceptable to international investors.
To bring greater certainty in the enforcement of financial transactions, Saudi Arabia has established a number of specialised committees to hear disputes regarding financial transactions. One such committee is the Committee for the Resolution of Securities Disputes and the Appeal Committee for Securities Disputes (the Securities Disputes Committee). The Securities Disputes Committee has been set up to settle disputes relating to the offering of securities. In the event that a dispute relating to the offering of securities comes before the courts in Saudi Arabia, the courts are required to refer the matter to the Securities Disputes Committee. The purpose of these specialised committees (including the Securities Disputes Committee) is to ensure that disputes are settled by judges who have specialised knowledge, disputes are settled quickly and efficiently, and the outcome of disputes become more predictable (i.e., the specialised committees are not going to serve up surprising decisions, which can sometimes occur when a matter is bought before the general courts in Saudi Arabia).
The legal framework to structure securitisation programmes exists in the UAE and Saudi Arabia.
Recent changes to insolvency and security laws in the UAE and Saudi Arabia, together with access to specialised committees in Saudi Arabia (such as the Securities Disputes Committee) to hear disputes related to financial transactions and access to the courts of the DIFC and ADGM, create a positive environment in which to structure the more complicated financial products (such as securitisation programmes).
It is an obvious statement, but a market for securitised products will start to emerge once there is an obvious business case for putting securitisation programmes in place. Specifically, the financing return payable on the securitised notes must be lower than the financing return the originator has to pay to its investors or financiers.
The covid-19 pandemic has required companies in the UAE and Saudi to look at how they finance their working capital. Receivables financing (including securitisation) is one way for a business to fund its working capital and businesses in the UAE and Saudi are looking into such financing resolutions.
Another example of a specific sector that may look to securitisation as an alternative form of financing is the sector providing financing for middle-income housing in Saudi Arabia. There is a shortage of housing for middle-income families in Saudi Arabia and securitisation may have a role in providing financing for building programmes. Finance companies (rather than the banks) could take on the role of providing mortgage finance (perhaps backed by guarantees from the Ministry of Housing) and, in originating loans of this kind, the finance companies might then look to tap into the securitisation market. A set of new laws that came into force in Saudi Arabia in 2012 were intended to promote the growth of the real estate financing sector. These laws provided for the establishment of real estate finance companies, the promotion of a secondary market for real estate loans (including the use of the capital markets to securitise real estate loans) and the option for banks and real estate finance companies to register mortgages over real estate assets. Historically, notaries in Saudi Arabia were reluctant to register mortgages over properties because the registration of a mortgage had connotations of interest-based financing; the notaries therefore took the view that registering a mortgage would be in breach of shariah principles and did not register mortgages. As a result, banks had to take title to real estate assets to secure any financing. The new law has clarified the position, with mortgages now able to be registered. The new laws have not led to a growth in residential real estate financing; however, with the Saudi Arabian government focused on delivering middle-income housing as part of Vision 2030, this market may start to grow, particularly if the Saudi government (through the Ministry of Housing) is prepared to provide financial incentives to real estate finance companies (such as underwriting a percentage of the financing provided by such finance companies).
Other businesses that may in the near future look to securitisation as a form of financing are leasing companies (automobile and aircraft leasing) and toll roads (for which a benchmark has already been set by the Salik Sukuk (UAE 2009)). However, while the banks in the region have liquidity and are prepared to acquire receivables originated by finance companies (such as automobile lease receivables) the incentive to create securitisation programmes will be limited. The market for financial products has to grow such that, in turn, alternative sources of liquidity have to be sourced. At that point, securitisation may become an option for banks and corporates in the UAE and Saudi Arabia.
1 Mike Rainey is a partner at King & Spalding LLP.