Securitization of the future flow-backed receivables is a new phenomenon in developing economies. Future Flow Securitization has grown in emerging markets in response to finding lower cost funding instrument by investment grade firms in the emerging market economies where their abilities were hampered by sovereign rate ceiling. While many of these companies historically relied on bank loans, or straight debts syndicated by major foreign banks in the past, rising volatility of interest rates and foreign exchange rates as well as reduced risk tolerance of major lenders have pushed these institutions (sovereign and private companies) toward an alternative vehicle such as future flow securitization. Future flows, have successfully mitigated a variety of the risks associated with emerging-market investments, and consistently remained the most viable type of rated transactions for funding in emerging-market countries.
Future Flow Securitization Model
Future Flow Securitization involves the borrowing entity to sell future receivables that would have been generated by selling future products directly or indirectly to an off-shore facility known as Special Purpose Vehicle (SPV). The SPV sells asset-backed securities in the global financial markets and channels the funds generated from the sale of securities back to the originating firm. The essence of these transactions is to capture cash flows generated by a sovereign or private company by placing foreign investors on the underlying pool of collaterals in a senior position, legally and practically.
The cash flows from future flow transactions come from a variety of sources to an off shore facility, including foreign importers making payments on receivables, international credit card companies such as Visa, Master Card, American Express and other specialty cards by making settlement payments to local banks and international banks making remittance transfers to local banks.
Furthermore, future flow securitization mitigate many of the common elements of sovereign risks associated with an emerging-market borrower. The originating entity directs its overseas customers (importers) to pay for the export products (from the originating firm) to the off-shore facility managed by a trust. The trust uses proceeds from the sale of the securities to pay to originating entity while servicing the interest and principal to domestic and foreign investors by collecting payments from the sale of future products to domestic and foreign clients. Any excess collection will be channeled to the originating firm less servicing, administrative, and cost of underwriting and credit enhancement.
Future flow securitization are of two types:
- Financial future flows are typically issued by banks and secured by the offshore cash flows generated through the banks’ various lines of business, including credit card vouchers, electronic and paper remittances.
- Corporate-related transactions involving airline ticket receivables, telephone net settlements and, export receivables transactions, including oil, gas, steel, iron ore, soybean, paper, aluminum, coffee and chemicals.
The above transaction allows creditworthy and investment grade firms in developing economies to tap into a cheaper source of financing by accessing wider classes of investors (domestic and foreign) by piercing the sovereign credit rate ceiling through over-collateralization and appropriate credit enhancement of securitized debts in order to secure better credit terms and longer maturity for funding capital as the securitized instruments are rated as investment grade by major rating agencies. Future flow-backed securitization mitigates sovereign risk, thereby allowing a credit rating few notches above that of the sovereign ceiling. Furthermore, once credit history is established for a firm, the cost of future capital is expected to be significantly lower for the borrowing firm in the future.
Risks Involved in Future Flow Securitization
- Sovereign risk: some of the aspects of sovereign risk such as transfer & convertibility are mitigated in a structured deal where foreign obligors are directed to pay for the product to an offshore facility. However, other aspects of sovereign risk, such as severe devaluation of the sovereign currency during periods of liquidity crisis, and the ensuing rampant inflation, may force the sovereign to impose price controls on certain commodities. The effect of devaluation will be unevenly distributed in an economy.
- Performance risk: is related to the ability and the willingness of the originator (sponsor) to produce and deliver the product to the designated party in a timely fashion. This risk is usually captured in the domestic currency rating of the originator.
- Product risk: factors such as price, volatility of price and quantity of demand, likelihood of supply disruption, as well as originator competitive cost advantage or lack of it determines product risk.
- Diversion risk: A sovereign or company’s ability to redirect proceeds from the exports to entities other than the designated offshore trust is classified as diversion risk. The contract should clearly and broadly identify the receivables so that there is no doubt the customers’ pay for the purchased goods from the originator in a future flow-backed securitization to a designated offshore collection facility.