Securitization

There is an estimated annual global shortfall of USD 2.5 trillion in financing for Sustainable Development Goals (SDGs). Pakistan is no exception and therefore requires out of the box solutions to fund human development. Mobilizing private capital might just be the answer. Here’s how!

Securitization! Many of us have heard about securitizations, more so in the context of the 2008 global financial crisis which was triggered partly by the default of securitized subprime mortgages in the US which were complexly structured. For those unfamiliar with the term, ‘Securitization’ is a transaction structure where an originator pools asset into portfolios which are then sold to issuers. Issuers generate marketable financial instruments by clubbing various financial assets into tranches. Investors buy these securitized products to earn a profit. More simply, securitization refers to the process of converting assets, usually illiquid assets, into securities, which are then invested in, bought, and sold in the financial markets.

In the current day, countries and corporations are making great use of this concept through “Future Flow Securitization” (FFS). FFSs are securitizations of future cash inflows from an originator’s (or government) operations such as terminal fees, tolls from roads, school fees, airline tickets, utility payments or tax receipts. The general process is similar to more traditional loan securitizations: The originator transfers its right to future cash inflows to a Special Purpose Vehicle (SPV); the SPV issues a bond backed by those flows; investors buy the bond; and the proceeds are made available to the originator upfront. And again, just like in simple securitization, the cash flows are ring-fenced and dedicated to paying off the bond, and the originator can make no claims on them once they are sold to the SPV.

FFS has served as an effective financing tool in the emerging market countries of late. For example, Nigeria securitized receivables from the sale of its Expatriate Resident Permits into three series of five-year bonds to raise USD 65 million. In 2019, Nigeria also securitized bus ticket receivables of its state-owned transportation company in Lagos to finance fleet expansion. Indonesia securitized a toll road receivable to finance its extensive infrastructure needs. In 2018, the Indonesian airline securitized cash flows from one of its major routes. Brazil securitized future receipts from water and electric utilities. Mexico securitized future flows from telephone receivables raising USD 6 billion.

However, the instances most impressive and pertinent to Pakistan can be found in Ghana where the government securitized petroleum tax receivables to pay off legacy debts in the energy sector. Ghana recently also securitized a component of Value Added Tax (VAT) receivables to fund its education infrastructure. The latter is called the Daakye Bond Program and is worth USD 1 billion. Using proceeds of the bond issuance, the educational development and financing arm of the government has been able to support delivery of education to the people of Ghana. The massive pool of dedicated funds generated is used for this purpose, which would not have been available otherwise. The bonds in concern have tenures of 7 and 10 years, and are market-tradable. One of the big 4 accounting firms has been appointed as administrator of the SPV, further ensuring transparency and stakeholders’ confidence.

A similar model can be replicated in Pakistan. Future flows of the government, or its arms, such as municipal authorities’ property transfer fees, Petroleum Development Levy, NADRA fees, and numerous other government levy receivables with performance histories, can be securitized. The proceeds from them can then be used to finance development projects, including quality health facilities in the underprivileged areas, primary education infrastructure, universities, or cutting-edge research centers. Securitization provides access to substantial funds through FFS right away, which the government would otherwise receive in bits and pieces over several years. That could be the game changer for the government towards its aims of developing health and educational facilities.

Another benefit of securitization is that the investors, apart from earning interest on their investments, get to channel their funds to an area with positive externalities for society. The securities that come into being as a result are tradable on the market which can help local-underdeveloped debt market to grow and provide diversified investment opportunities to the institutional investors and pension funds, while attracting foreign investment as well. Growing debt market with steady supply of new debt instruments is highly desirable for the investors, government, borrowers, intermediaries and so on, and FFS can provide the right impetus for that. Sovereign FFS can be a good starting point for promoting securitization in the domestic market. It can offer sizable, low-risk transactions with exemplary role for the overall market.

Pakistan formulated a legal framework governing securitizations long time ago; as the Companies (Asset-backed Securitization) Rules, 1999. However, the country has only seen a handful of transactions, and the securitization market has not taken off to any appreciable extent. Reasons for this are multi-fold; including but not limited to the lack of simple replicable government-based and -backed issuances, dearth of external credit enhancement facilities, lack of awareness, limitations of those at the helm, stamp duty and tax anomalies etc. The importance of simple transactions to build the market can be noted from the fact that the recent EU regulation on securitization stipulates criteria for a securitization to be termed as ‘Simple, Transparent and Standardized’ (STS). STS securitizations enjoy numerous preferential treatments, regulatory advantages, exemptions and greater investor confidence. With the establishment of credit enhancement facility in Pakistan, brought jointly by GuarantCo and InfraCo Asia, and with more dynamic and receptive regulators than ever, the landscape is ripe for unlocking this untapped mode of finance.

Securitization market built through government’s simple and replicable FFS structures will not only help in financing human development in the country, but it might also result in the establishment of a robust and dynamic debt market.

(The writer is a Milken scholar and a Chartered Accountant, serves as Deputy Director at the Securities & Exchange Commission of Pakistan (SECP) and can be reached at [email protected]. The views and opinions expressed are author’s personal.)

Copyright Business Recorder, 2021