Journal of Applied Corporate Finance
F A L L
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V O L U M E
Securitization: A Financing Strategy for Emerging Markets Firms
by Claire A. Hill,
Boston University School of Law
11 . 3
SECURITIZATION:
A FINANCING STRATEGY
FOR EMERGING MARKETS
FIRMS
by Claire A. Hill,
Boston University School of Law*
ith emerging markets now in crisis, companies in emerging markets countries
are finding it difficult to obtain financing.
Securitization, a transaction structure in
which securities backed by a company’s receivables
are sold to investors, is one of the few vehicles
potentially offering financing at attractive rates.
While securitization cannot meet all the financing
needs of emerging markets companies, it may nevertheless play an important role in coaxing investors
back to emerging markets.
The first securitization transactions in emerging
markets were in Latin America. After the debt crisis
of the mid-1980s, Latin American firms needed new
ways to appeal to foreign investors fearful of political
risk. Securitization was well-suited for this purpose.
Since the first Latin American securitization issue by
the Mexican telephone company Telmex in 1988,
many others have followed in Brazil and Argentina
as well as Mexico. There also have been transactions
by companies in Chile, Venezuela, Peru, Colombia,
Costa Rica, Honduras, and El Salvador.
In emerging markets in Asia, securitization has
taken a somewhat different path. Whereas most of
the Latin American deals have involved firms in
countries with less than investment-grade ratings,
most of the Asian emerging markets deals involved
countries whose ratings were investment grade at
the time of issuance. Transactions began in earnest
in 1994, in Hong Kong, with four mortgage
securitizations and an issue backed by credit card
receivables. Since then, transactions have been done
in Thailand, China, Indonesia, Pakistan, Turkey, the
Philippines, and Hong Kong, with Thailand and
Hong Kong representing much of the transaction
volume. Unlike in the case of the Latin American
issues, the foreign investors purchasing most of the
Asian securitization issues did not require much
coaxing. And, for Asian firms in the then-investmentgrade countries, the transactions simply added to the
menu of choices available to them.
Until the Asian crisis began in the summer of
1997, Latin American firms had been broadening
their access to foreign capital markets.1 Foreign
investors had become more comfortable investing in
the region, and firms were enjoying more financing
options as well as more favorable terms. Indeed, in
early 1997, Endesa, a Chilean energy firm, was able
to issue a 100-year bond on the Yankee bond market,
priced at 127 basis points over U.S. Treasuries. Chile
has long been a darling of foreign investors; still,
Latin American firms in other countries also were
obtaining favorable terms.
The Asian crisis and its global aftermath have
dramatically affected the climate for emerging markets investment, with the spread for emerging markets instruments occasionally reaching 1500 basis
points. Asian countries such as Indonesia, Thailand,
Malaysia, and South Korea have been downgraded
below investment grade. As a consequence, companies in such countries—and in Hong Kong as well,
even though it remains investment grade—now
have far fewer financing options. Latin American
markets, which appeared at first to have been spared
the worst of the contagion, are now experiencing
tremendous volatility as well.
*This article draws on my earlier article, “Latin American Securitization: The
Case of the Disappearing Political Risk,” Virginia Journal of International Law, Vol.
38 (1998), pp. 293-329.
1. There was, however, an interruption during the Mexican peso crisis in 1994.
The crisis proved short-lived, as rescue efforts (including a large package by the
United States) helped forestall panic and contagion. For some time afterward,
investors were still skittish, but they became progressively less so until the Asian
crisis.
W
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FINANCE
The Asian crisis has sharply reduced new
issuance by Latin American companies for all types
of financing transactions. But, at the same time, the
volume of securitization issues appears to have
declined less precipitously than other types of
transactions geared to foreign investors. While exact figures are hard to obtain, there are accounts of
Latin American firms choosing securitization as the
most viable financing technique in the present
climate. And, in Asian emerging markets, where
overall financings on the international capital markets have also plummeted, there is considerable
interest in securitization transactions—and a few
transactions backed by the highest-quality receivables are continuing to get done. But broader
issuance will resume only when volatility in the
region subsides.
Securitizations under consideration include those
backed by the following:
power company receivables (in Brazil);
mining receivables (also in Brazil); and
oil receivables (in Mexico).
Deals backed by credit card receivables and foreignworker remittances are also presently being considered in both Latin America and Asia. Moreover, now
that Japan is having financial difficulties, Japanese
companies are increasingly finding securitization to
be an attractive option. In particular, troubled Japanese banks are issuing securities backed by their
loan portfolios.
Why is there now so much interest in
securitization by emerging markets firms? Because,
in this environment, securitization issues may be
saleable at relatively low rates to foreign investors
who would otherwise be unwilling (without the lure
of much higher rates) to invest in emerging markets.
The appeal of such securities is that they can be
structured to minimize investors’ exposure to political risk. Companies with hard-currency receivables
generated (or to be generated in the future) outside
their home countries can sell securities backed by
those receivables. Typically, Latin American (and,
increasingly, Asian emerging market) securitizations
involve “future flows”—that is, receivables not yet in
existence at the time of issuance, but expected to be
generated in the future. Foreign investors’ fears of
political risk are allayed, mainly because the receiv-
ables are never in the politically risky country or
denominated in its currency.
But, for all its promise, securitization is not a
panacea for emerging markets ills. For one thing,
lower-quality firms cannot currently use this technique, nor can firms located in countries with very
high levels of political risk such as Indonesia. But
there are some, and perhaps many, emerging markets companies for which securitization is potentially available. Perhaps more significantly, many
potential issuers are improving their disclosure and
accounting procedures, and emerging markets countries are putting into place securitization-encouraging legal and regulatory regimes. Thus, when investors begin returning to emerging markets, as
they almost surely will, the stage will be set for
future transactions with far fewer of the financial,
legal, and regulatory risks and uncertainties that
complicated the structuring of pre-crisis transactions. In short, the market to which investors
return may be on a stronger footing than the one
they left.2
In this article, I begin by describing how future
flows securitization transactions carve out securities
with levels of political risk acceptable to foreign
capital market investors. Next, I trace the history of
emerging markets securitization from its origins in
Latin America to its more recent uses during the Asian
crisis. The article concludes by exploring the longerterm effects of securitization on both domestic
issuers and their economies. It suggests that
securitization could play a pivotal role in restoring
emerging markets firms’ access to global financial
markets and, in the process, encourage legal, regulatory, and other changes that could contribute to a
reduction of overall political risk.
2. See Calvin R. Wong, “Asian Securitization to Grow Despite Turmoil,”
Standard & Poor’s CreditWeek, October 28, 1998.
3. For an account of U.S. securitization and an explanation of its benefits for
issuers and investors, see my article, “Securitization: A Low-Cost Sweetener for
Lemons,” Journal of Applied Corporate Finance, Vol. 10 No. 1 (Spring 1997.)
FUTURE FLOWS SECURITIZATION
In securitization transactions, investors buy
securities backed by a firm’s receivables. The receivables most often securitized in U.S. issues are
mortgages, credit card receivables, and auto loans.3
These receivables are already in existence when
the transaction occurs. Far less common in the U.S.
are “future flows” transactions, in which the receivables being securitized do not yet exist. In such
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The Asian crisis has sharply reduced new issuance by Latin American companies for
all types of financing transactions. But the volume of securitization issues appears to
have declined far less precipitously than other types of transactions geared to
foreign investors.
Structuring Mechanisms
cases, the firm might have contracts to deliver a
commodity or provide a service in the future. The
securities are payable from the receivables to be
generated upon such delivery or provision of the
service.
As mentioned above, securitization issues in
Latin America have typically been backed by hardcurrency- (often dollar-) denominated receivables
expected to be generated in the future.4 Because
the transactions are structured to minimize investors’ exposure to the countries’ governments, future flows transactions tend to be cost-effective
primarily for high-quality firms in countries of somewhat lesser quality—“good companies with bad zip
codes.” For example, in 1995, when Mexico’s foreign currency rating was BB, the Mexican bank
Banamex received a BBB rating on its securitization
of money order receivables generated in the U.S.
Commonly securitized future receivables include those expected to be generated by the sale of
commodities such as oil, copper, and pulp; those to
be produced by services such as telephone and air
travel services; and future money transfer (and credit
card) receivables. Also sometimes securitized are
receivables to be generated by manufactured goods.
For example, the Mexican firm MABE, S.A. de C.V.
issued securities backed by receivables expected
from gas ranges it manufactures for General Electric
for resale in the U.S.
As mentioned above, emerging markets companies in Asia have historically securitized existing
receivables, such as auto loans, credit cards, and
mortgages, often denominated in the domestic currency. Although typically packaged with currency
swaps if sold to foreign investors, such transactions
were not designed primarily to overcome foreign
investors’ fears of political risk. Nevertheless, some
future flows securitizations backed by hard-currency receivables have been done in lower-rated
countries such as the Philippines and Pakistan, and
present and contemplated transactions in Asian
emerging markets countries increasingly involve
future flows.
Investors in securitization transactions buy securities backed by a discrete repayment source, a
pool of receivables conveyed to a separate entity.
Thus, insulating the pool is critical. The pool assets
must be available to the investors, and to no one
else.5 The conveyance of the receivables to the pool
must be respected under the applicable regulatory
regime (including commercial and bankruptcy laws).
The payments of the receivables to the pool also
must be respected, as must the payments from the
pool to the investors. And the receivables must be as
represented as to quality, amount, and other matters.
Moreover, the flow of funds from the pool to the
investors must be arranged within the logistical and
regulatory constraints.6
Structuring the transaction to minimize investors’ exposure to political risk presents a daunting
challenge. Political risk is a large, amorphous category. It contains “sovereign risk,” which in this
context means the possibility that the sovereign will
interfere with a firm’s ability to pay its investors as
promised. It also contains various political, economic, and country-specific risks, such as the possible imposition of currency and exchange rate
restrictions, and failure to enforce or respect agreedupon property and contract rights.
The securitization transaction structure minimizes investors’ exposure to political risk in several
ways.7 First, payments on the securitization securities come from cash flows that never enter the
emerging market country’s borders, thus making the
risk of sovereign interference smaller and easier to
quantify. For export receivables securitization, the
sovereign’s only means of interference may be to
restrict export of the product or service that is to
generate the future receivable. If the receivables are
generated by credit cards, airline tickets, electronic
worker remittances, or telephone settlement payments, sovereign interference should be still more
difficult. How would a sovereign interfere with, for
instance, wire money transfers by workers in the U.S.
4. Some of the transactions use local-currency denominated receivables and
swaps. However, in the present climate, such transactions are difficult to
consummate, in large part because the swaps are often prohibitively expensive.
5. There may actually be an additional pot from which the investors can be
repaid: the firm itself. In the United States, various constraints severely limit the
issuer’s ability to effectively guarantee the securities; in many Latin American and
other emerging markets transactions, these constraints operate with less force. (If
there is an insurer, the insurer will be able to recover from the pool and the firm
as well.)
6. For a detailed explanation of the mechanics of these transactions, see
Douglas Doetsch, “Emerging Market Cash Flow Securitizations Take Off,” International Financial Law Review, Nov. 1996, pp. 16-23.
7. If securitization securities are insured, the investor may not be exposed to
political risk, but the insurer remains exposed, since the insurer’s payment
obligation can be triggered by events resulting from political risk. For ease of
exposition, I collapse here the situation of the investor and the insurer.
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to their relatives in Mexico—or with net amounts
payable by AT&T to the Mexican telephone company for handling cross-border calls?
Other features of the transaction also make
sovereign interference more difficult. Because the
transaction specifies in detail each step involved in
generating the receivables and paying the investors,
sovereign interference is likely to be quite visible.
Furthermore, sovereign interference might require
pursuing funds in foreign jurisdictions that pride
themselves on being commerce-and-investor friendly.
Indeed, the pools—the obligors on the securitization
securities—are often located in one of the offshore
havens, such as the Cayman Islands. A sovereign is
likely to conclude that attempting to recover funds
located in such a jurisdiction would be costly, and
probably futile.
In sum, emerging markets future flows
securitization is designed in large part to minimize
investors’ exposure to political risk. (Investors in
issues backed by export receivables may still be
more exposed to one particular component of
political risk—namely, export-related risks. Nevertheless, their remaining exposure is less than it
would be with a direct obligation of the firm.)
But if investors’ exposure to political risk is
minimized, it is not eliminated. A sovereign still
could interfere with the transaction, even though
interference was costly. And circumstances could
arise under which recourse to the sovereign’s courts
might be necessary. In this regard, some emerging
markets countries—Argentina, Chile, Colombia, Peru,
Indonesia, Korea, Brazil, Thailand, and Hong Kong—
have made legal and regulatory changes designed to
encourage securitization. Some of the changes are
directed more toward transactions that involve domestic assets and investors. Still, the general effect is
to send a positive signal for securitization in whatever form. Other emerging market countries have
also enacted or are considering enactment of laws
that will foster securitization. But recently enacted
laws offer less certainty than a more expansively
developed regime that, as in the U.S, has been
interpreted and affirmed many times by the courts.
Many other emerging markets countries’ laws are
silent about securitization; how securitization will be
treated is not clear.8
Moreover, even the most careful structuring
cannot provide sufficient certainty if a regime is
sufficiently unfamiliar or unstable. Sovereign interference remains possible and, indeed, seems more
likely now than it did before the Asian crisis. Strong
pressures to interfere with contractual bargains
between firms and their investors may be brought to
bear, perhaps stemming from political forces or
financial distress. For example, a sovereign might see
a short-term payoff to disrupting a transaction by,
say, taxing prohibitively the exports generating the
receivables securitized in the transaction. Or a new
government unable or unwilling to abide by the
previous government’s commitments might come
into power. In sum, although there has been no
appreciable sovereign interference to date, the specter of such interference remains.9
Another complexity in structuring future flows
securitizations involves appraisal of the receivables.
Receivables appraisal is a crucial part of securitization
transactions. Indeed, development of sophisticated
appraisal methodology has helped fuel securitization’s
explosive growth in the U.S. In the most common
types of U.S. transactions, such as mortgages, the
pooled receivables can be valued with considerable
precision. In emerging markets transactions, however, both the nature of the receivables and the lack
of historical data make the appraisal process both
more costly and less accurate.10
Moreover, selling interests in assets not yet in
existence, as future flows securitization does, is a
challenge even in regimes with more developed
bodies of commercial law; the challenge is exacerbated exponentially in emerging market countries.
Apart from the legal hurdles, carving out interests in
cash flows to be generated in the future still presents
daunting challenges. The most critical challenge
involves generation of the receivables. In future
flows transactions, the receivables might never come
into existence in a variety of circumstances: What if
the firm becomes unable or unwilling to satisfactorily
8. For a description of the legal regime governing securitization in Asia, see
Neil Campbell, “Receivables Can Play a Role in Region’s Recovery,” National Law
Journal, September 14, 1998, Vol. 21, C14 col. 1.
9. Non-governmental actors could also create difficulties for a transaction. For
instance, the pipelines of Ecopetrol, the Colombian oil company that securitized
oil receivables in 1997, have been bombed by rebels 64 times in 1998. Until the
most recent bombings, repairs had been easy, and the transaction had not been
significantly affected. But this may change after the the last few, and more serious,
bombings. The transaction was structured to share some the of the oil production
risk, including that resulting from incessant guerilla attacks, with investors;
however, Ecopetrol retained the transportation risk.
10. However, as I discuss in this article, the appraisal process, and the caliber
of financial reporting generally, should improve as a byproduct of the crisis. Before
the crisis, with investors more eager, the firms could contiue shoddy accounting
and disclosure practices. Now, investors are demanding, and receiving, more
information, pushing firms to new levels of financial transparency.
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Because the transactions are structured to minimize investors’ exposure to the
countries’ governments, future flows transactions tend to be cost-effective primarily
for high-quality firms in countries of somewhat lesser quality—“good firms with bad
zip codes.”
All this structuring complexity does not come
cheaply. Indeed, the transaction costs for emerging
markets future flows securitization transactions are
quite high. In addition, unlike “plain vanilla”
securitization transactions in the U.S., which require
a front-end expenditure that can be largely amortized over many transactions, the emerging markets
transactions involve sizable transaction-specific investments. Structuring costs will be high. But even
so, the transaction can earn its keep, especially in
times of instability like the present.
provide the product or service? What if the buyer
reneges or is excused from performance? What if
buyer interest in the product or service declines
precipitously? In the typical U.S. securitization transactions involving existing receivables, these problems do not arise. The firm has already done what it
needs to do to generate the receivables, and the
buyer has received the good or service.
Thus, the transaction establishes mechanisms
helping ensure that the receivables will be generated. Some transactions include contracts in which
the firm agrees to sell, and one or more buyers
agree to buy, some quantity of the product or
service at a specified price. There also may be a
hedge against price drops. Other transactions involve commodities for which a liquid spot market
exists. In such cases, the firm typically commits to
sell a certain amount of the commodity on the spot
market at prevailing prices.
Moreover, the investors still need to make an
expansive inquiry into the firm’s long-term stake in
remaining in business. Investors rightly are concerned that the firm’s ability to perform is not
sufficient to ensure that it will perform. After all, the
firm has already received payment for the goods or
services from the securitization investors. If the firm
were in an “end-game,” it could simply pocket the
proceeds from selling the securitization securities
and renege on its obligations to generate the receivables. To reassure investors about its intentions—
and, more generally, to align its interests with those
of investors—a firm making a securitization issue
often “bonds” its performance by taking a residual
interest in the pool of receivables. Such interests are
payable only once the securitization investors have
been paid. A firm also may guarantee the securities—
though such a guarantee is no better than the credit
of the firm that stands behind it.
The additional jurisdictions involved also could
present problems, especially as regards payments to
investors from the pool. For instance, one of the
jurisdictions involved could lay claim to the payments, or assess taxes or other charges on the pool
or investor. For transactions involving multiple jurisdictions, any of these jurisdictions might be able to
complicate investors’ claims to the pool. However,
as discussed above, most of the jurisdictions chosen
as part of the transaction structure are known for
their favorable treatment of securitization. Such
jurisdictions have considerable reputational stake in
respecting agreed-upon investment terms.
The Role of Rating Agencies
Emerging markets future flows transactions are
almost always rated. The agencies involved are the
principal U.S. rating agencies, Standard & Poor’s
Corporation (“S&P”) and Moody’s Investor Services.
Duff and Phelps Credit Rating Co. and Fitch IBCA
have also been active in rating such issues.
Both countries and firms are rated. And both are
assigned foreign currency as well as local currency
ratings. The ratings reflect the agencies’ assessments
of the country’s or firm’s ability and willingness to
repay debts in domestic and foreign currency. In the
U.S. and most countries in Western Europe, the two
ratings tend to be the same or nearly the same. In
many other countries, including countries in emerging markets, the foreign currency ratings are often
lower than the local currency ratings, reflecting the
rating agency’s assessment that foreign currency
repayments may be more uncertain. A firm’s foreign
currency rating reflects the likelihood, in the rating
agency’s estimation, that the firm’s home country
will restrict its ability to exchange funds into foreign
currency or send foreign currency out of the country,
or require the firm, together with other firms, to
reschedule its debts.
Rating agencies generally do not rate a firm’s
debt higher than the debt of the country in which it
is located. This is referred to as the sovereign
“ceiling.” By using securitization, a firm may be able
to exceed the sovereign ceiling and issue higherrated securities. However, exceeding the sovereign
ceiling typically requires a firm to retain a significant
ongoing connection with the transaction. Because
the receivables are not yet generated, their generation depends on the firm’s ability to perform in the
future. The firm’s own local currency rating—which
measures its creditworthiness generally—becomes
the applicable ceiling.
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their loans to Latin America and reluctant to make
new ones. Foreign capital market investors were also
reluctant to invest in Latin America; however, their
reluctance could more easily be overcome.
Foreign capital markets investors could be
attracted with a new financing structure that assuaged their concerns about political risk. However,
it was not just the investors’ concerns that had to be
assuaged. Foreign capital markets investors are often
subject to regulatory restrictions, as well as informal
policies, that effectively discourage them from buying lower-quality or less familiar investments. To
attract these investors, securities had to be not only
of high quality, but also readily appraisable as such.
Moreover, the investors favored readily resalable
securities requiring little, if any, monitoring.
Securitization was well-suited to attract these
investors. Since its U.S. government-subsidized development in the early 1970s, it had come into wide
use. Various credit enhancement techniques had been
developed. Sophisticated technology to appraise cash
inflows and craft cash outflows had been developed;
incremental applications of such technology were
comparatively cheap. Securitization issues were structured to require only scant monitoring and permit
easy resale, and could be tailored to meet investors’
economic, regulatory, and institutional concerns.
As mentioned, securitization offered a significant rate advantage over the firms’ alternative sources.
The rate was favorable for the firms, but also,
perhaps, for investors. The securities were sold using
the same argument Michael Milken used when
selling junk bonds: investor perceptions of risks
were exaggerated, and the securities were therefore
undervalued. Indeed, Milken was one of the first to
consider and discuss securitization as a source of
financing for Latin America. Moreover, the Brady
proposal, which contemplated the use of
securitization-type structuring to transform troubled
defaulted loans into more liquid securities, had
already started the financial community thinking
about securitization in emerging markets.
Rating agencies use various approaches to
appraise emerging markets securitization transactions. One representative approach is Standard &
Poor’s “weak link” principle: the issue cannot be
rated higher than the weakest link in the payment
chain. The payment chain in securitization transactions is very long. It includes the firm conveying the
receivables, the pool (and the manager of the pool,
typically a trustee) the insurer (and any other provider of credit enhancement, such as a bank providing a letter of credit), and various other parties. It also
includes the various parties counted on to generate
any future receivables. For example, the chain in a
future flow oil receivables transaction would include
the oil buyers, and the chain in a telephone services
transaction would include the people expected to
continue making telephone calls to the emerging
markets country. Any break in the chain can interrupt the payment flow to investors. Thus, each link
must be evaluated, as must the country in which the
firm is located, with its attendant political, legal, and
economic risks.
A SHORT HISTORY OF FUTURE FLOWS
SECURITIZATION
Emerging markets future flows securitization
began in Latin America in the late 1980s. The
structure was intended to attract foreign institutional
investors—in particular, those foreign investors looking to purchase higher-quality securities, and willing
to pay a price commensurate with high quality.
Foreign capital markets investors had been scared
off by the wave of Latin American defaults of the
early and mid-1980s.11 As a result, Latin American
firms had only two main sources of financing at the
time: (1) domestic banks, which were inefficient and
expensive; and (2) foreign investors seeking speculative (high-yielding) investments. Domestic capital
markets had not yet developed sufficiently to be
viable sources of financing.
Before the 1980s, foreign banks and institutional investors had both invested in Latin America,
primarily by making direct loans to the sovereigns.
Both groups had experienced defaults. Indeed, the
defaults had helped trigger a banking crisis. Tough
new capital adequacy standards issued by regulators
in response to the crisis made banks anxious to shed
The First Latin American Securitization
Transaction
The investors to whom securitization issues
were being marketed and sold were seeking qual-
11. Most of the loans had been to the sovereigns themselves; however, some
loans were made to firms, and sovereign action caused the default.
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Securitization is now providing a low-cost financing vehicle for high-quality
emerging markets companies with the right kinds of receivables, helping many such
firms to weather the crisis-driven credit crunch in global financial markets.
American securitizations since that time include gold
to be extracted from a mine in Peru, and oil to be
drilled in Argentina. Investors have generally gotten
their promised returns, though there have been a few
exceptions.12
Until the Asian crisis began, the market for
these transactions had deepened, extending to
more cautious investors, and to investors outside
the United States, mainly in Europe and Japan.
Even the foreign banks, whose troubles with
nonperforming loans inspired the transaction structure, were increasingly buying Latin American and
other emerging markets future flows securitization
issues. Indeed, transaction volume increased
markedly with the 1990 U.S. adoption of Rule
144A and Regulation S—regulations that made
such securities much easier to resell without
costly Securities Act registration. Not surprisingly,
more familiarity and liquidity translated into lower
rates on securitization issues.
In Asia, by contrast, most of the companies
using securitization were located in countries with
investment-grade ratings. Thus, foreign investors
could be attracted without the complexity and
expense of future flows securitization. The firms
securitized existing receivables using simpler structures and sold the securities to domestic and, in some
cases, foreign investors.13
While rates for emerging markets
securitization issues were falling, so were the
rates for firms’ alternative financing choices. As
investors became more accustomed to investing
in emerging markets, spreads declined markedly
and maturities lengthened. The savings
securitization offered over alternative choices
was significantly reduced, especially for firms in
countries with higher ratings.
ity—not of U.S. Treasury caliber but not highly
speculative either. Thus, the first emerging markets
securitization transaction in 1988 was as safe as
such a transaction conceivably could have been. It
involved the securitization of future telephone receivables by the Mexican telephone company,
TelMex. AT&T and TelMex had an agreement to
handle telephone calls made between the U.S. and
Mexico. A phone call between the U.S. and Mexico
necessarily involved the equipment of both firms.
AT&T billed the people who had placed calls to
Mexico from the U.S; TelMex billed the people
who had placed calls to the U.S. from Mexico. Each
firm owed the other the portions of these bills
allocable to the other country and its equipment.
Every month each firm computed what it had billed
on the other’s account; whichever had a net deficit
paid the other. For many years, AT&T had owed
TelMex money each month. At the applicable rates,
the Mexican portion of the U.S.-originated calls
made to Mexico had exceeded, by a sizable amount,
the U.S. portion of the Mexico-originated calls to
the U.S.
TelMex securitized future amounts owed to it by
AT&T under this agreement. The transaction was
especially attractive to U.S. capital markets investors
because the receivables were payable by a U.S. firm
in dollars. Also, TelMex needed only to stay in
business for the receivables to be generated. One
can readily imagine the conversation between an
investment banker and her client (“Do you really
think people in the U.S. will stop calling their
relatives in Mexico?”).
Subsequent Developments
Once this first transaction had been completed,
investors were ready to consider other, less giltedged transactions, where the foreign obligor was a
bit less venerable, or the future goods or services
were perhaps less certain to generate receivables.
Examples of receivables that have backed Latin
THE PRESENT
Starting in July of 1997, when the Asian crisis
began, world markets have been in turmoil. Many
12. See Aaron Elstein, “Investors Wary of Future Flows Securitization,” Am.
Banker, June 26, 1997. Elstein notes that “[s]o far, investors in these deals have
gotten paid for their risk.” One caveat involves regulatory problems. Elstein
describes a deal brought to market by Citicorp backed by future telephone bills
in Pakistan. “But later it turned out the Pakistani phone company was 100% owned
by the national government, which forbade selling what it considered national
assets. The investors and underwriters have been trying to settle the matter ever
since.” Id. Another troubled transaction securitized future Mexican toll road
receipts; the funds were to be used to construct the road. Imagine the difficulty of
estimating the future traffic on a road not yet built. Indeed, the estimators did a bad
job: the Mexican Government is nationalizing the roads to bail them out, and
attempting to negotiate with creditors, including the securitization securities
holders. Also, at present, an auto-loan securitization in Thailand is facing
difficulties, as the insurer and servicer have becomed involved in a legal dispute.
And, as I discuss in this article, the present crisis may very well yield more difficulties
for securitization transactions.
13. However, as noted in the text, firms in below investment-grade countries,
such as Pakistan and the Philippines, have used future flows securitization to attract
foreign investors.
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VOLUME 11 NUMBER 3
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foreign investors who had ventured aggressively
into Euro and Yankee bond markets and localcurrency-denominated bond markets have retrenched, shunning emerging markets altogether,
raising their rates on the riskier instruments, or
making a “flight to quality” to securities such as those
issued in higher-rated securitizations. As the crisis
has deepened and another crisis has erupted in
Russia, the investment climate in emerging markets,
together with investor confidence, has been seriously undermined.
Since the Asian crisis began,14 securitization has
been one of the few financing vehicles that can be
structured for sale to foreign investors.15 Recent
transactions include securitizations of oil receivables
by YPF, an Argentine oil company, Ecopetrol, the
Colombian oil company, and PDVSA, the Venezuelan oil company; equipment loan receivables by a
Peruvian company; export receivables by Inverraz,
a Chilean company; mining receivables by Southern
Peru Copper and Minerva Yancocha (also Peruvian);
auto-loan receivables by Buenas Finance of Indonesia;16 credit card transactions by Garanti Bank in
Turkey; airline ticket receivables by the Philippine
airline; and telephone receivables by Pakistan Telecommunications.
However, several of these transactions are
having difficulties. A few have been downgraded
(Pakistan Telecommunications), or are under review for possible downgraidng (PDVAS, Ecopetrol),
on account of downgrades or potential downgrades of their sovereigns. One unrated transaction, the Philippines Airline transaction, experienced difficulties, because the airline itself came
close to collapsing.17 Nevertheless, the vast majority of securitizations are paying their investors as
scheduled, and Moody’s recently pronounced Latin
American structured finance (that is, securitization)
“quite stable.”18
Latin American issues now reportedly under consideration include those backed by the following:
telephone receivables by Telefonica del Peru;
mining receivables by MBR, a Brazilian mining
company;
power company receivables by Electrobras, the
Brazilian power company;
credit card receivables by Banco Del Istma, S.A., a
Panamanian bank;
oil receivables by Pemex, the Mexican oil
company;
oil receivables by Ecopetrol, the Colombian oil
company;
oil receivables by Petroecuador, the Ecuadoran oil
company.
Other transactions being considered in Latin
America include those backed by credit card receivables, foreign worker remittances, and (existing)
trade receivables.
Transaction issuance is more active in Latin
America than in Asia (with the notable exception
of Japan, where companies are securitizing mainly
existing receivables, in the form of loans, lease
credits, credit card receivables, and trade and
other receivables). Investment banks and rating
agencies are now considering how to structure
future flows transactions (as well as other kinds
of securitization transactions) in emerging markets countries in Asia. However, at this time, all
transactions, including securitizations, are proceeding slowly.19
The transactions that seem likely to proceed
soonest are those backed by the highest-quality
receivables—that is, those receivables that are most
likely to be generated. In Turkey, for example, there
have recently been issues backed by future foreignworker remittances and credit card receivables, and
more are expected to follow. Future flows transactions now being planned include some backed by
14. Because this article deals with securitization as a means of attracting foreign
investors, I don’t consider the securitization transactions geared and marketed to
domestic investors. Such transactions are becoming more viable and, especially in
countries with sizeable domestic savings to tap, might provide a significant source
of financing for firms. For instance, Latin American pension funds are considered
good prospects to buy Latin American domestic securitization issues.
15. An appreciable number of transactions, however, have been abandoned
or postponed, especially in Asia, but in Latin America as well. For instance, a
refinancing of a Venezuelan credit card securitization was recently sold to banks
because foreign investors were wary of Venezuela. Also, a Venezuelan time-share
securitization was postponed until the financing climate improves. And a Peruvian
mining financing is now likely to be structured as a bank loan rather than as a
securitization of mining receivables, as had originally been contemplated.
16. This transaction involved U.S. dollar-denominated bonds backed by
existing receivables in local currency.
17. Another transaction on review for potential downgrading is Japan Leasing’s
securitization of lease receivables. The company recently declared bankruptcy, but
has received court approval to continue as servicer of the receivables, thus
reassuring investors who feared collections could be adversely affected by a lessskilled replacement servicer.
18. “Latin American Structured Finance and Energy Project Ratings ‘Quite
Stable’ Despite Sovereign Rating Actions, Moody’s Says,” http://moodys.com/
repldata/ratings/actions/pr.23345.html
19. In this regard, the majority of Asian transactions sold to investors had been
insured. Now insurance is more difficult to obtain. Indeed, an insurer involved in
insuring emerging markets securitization issues recently was downgraded because
of its emerging markets exposure. Latin American transactions, by contrast, were
much less often insured. But, as Asian transactions increasingly are following the
future flows model, a simple “wrap” (as insurance is often called) would not suffice
as it had before the crisis. Then, more complex structuring would be needed.
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Securitization is able to exploit the spread when it is large—that is, when fear of
political risk is high—because it can carve out interests with minimal political risk,
and thereby permit firms to attract foreign investors offering lower rates.
foreign-worker remittances in India20 and the Philippines, and by airline ticket receivables to be generated by Air India.
In sum, securitization provides a low-cost financing vehicle for high-quality emerging markets
companies with the right kinds of receivables. And
although recent downgrades will surely slow transaction volume, considerable pressures in the other
direction should keep momentum going, as investment banks continue their efforts to raise capital for
firms in the region, and investors continue their
search for promising investment opportunities.
security because the security was sufficiently safe;
the sovereign would not attempt to interfere because
the costs of doing so (including the higher rates that
would subsequently be demanded by foreign capital
providers) were high; and the investor would then
invest again, thereby adding to the growing reputation of the sovereign among other foreign investors.
At present, many emerging markets governments are working to restore their stature in global
markets.21 To this end, they are making public
pronouncements and enacting laws signalling their
respect not only for securitization per se,22 but for
commercial bargains in general.23 Moreover, firms,
especially those in Asia, are getting better at acquiring and compiling data about their receivables, while
raising the caliber of their financial disclosure generally and so increasing their “transparency” to
investors. Thus, as the crisis abates, securitization
seems poised to play a role similar to the one it
played in Latin America in the 1980s.
An analogy can be made to arbitrage.
Securitization exploits a spread between the rates
offered by foreign capital markets investors and
other investors—a spread that reflects both political
risk and the inefficiencies of domestic financing
sources. The more the spread is exploited, the
smaller it becomes. Securitization is able to exploit
the spread when it is large—that is, when fear of
political risk is high—because it can carve out
interests with minimal political risk, and thereby
permit firms to attract foreign investors offering
LONGER-TERM EFFECTS OF SECURITIZATION
Although securitization alone will not bring
emerging markets firms or countries back to financial
health, it can play an important role. If a firm is of
sufficient quality and generates suitable receivables,
and if its home country shows satisfactory signs of
respecting firm-investor bargains, it may be able to
obtain financing at attractive rates using securitization.
As conditions improve, securitization should become possible for more firms in more countries.
Assuming the crisis abates, the firms and their
countries should again be able to enjoy more
financing options.
Securitization helped Latin American firms and
governments rebuild credibility and trust after the
defaults of the mid-1980s. A virtuous circle was
created: An investor would buy a securitization
20. This will be India’s first securitization. Thus far, India has been spared
the brunt of the Asian flu, although its rating is not investment grade, nor has
it been. Like many other countries, India is also trying to develop a domestic
securitization market. As part of a push to encourage securitization, the
Indian Ministry of Finance gave the green light to two Indian power
companies to securitize local-currency denominated receivables for sale to
domestic and foreign investors. A large internet service provider in India is
also working on a securitization transaction. However, these transactions
may be difficult to consummate. Indeed, developing such a market presents
difficulties given the legal uncertainties, lack of a secondary market, and,
often, poor credit quality of the receivables. India’s situation in this regard
is a common one faced by emerging markets countries attempting to develop
domestic markets for securitization.
21. In their efforts to improve their firms’ access to financing, they are being
assisted by governmental agencies such as the International Finance Corporation,
The Export-Import Bank, and the Overseas Private Investment Corporation. These
agencies have long been involved in some securitization transactions, effectively
providing subsidies. For instance, Ex-Im might guarantee a transaction. When it
does so, investors are no longer subject to political risk. They look to the Ex-Im
guarantee for payment, and that guarantee is backed by the full faith and credit of
the United States. When OPIC guarantees a loan, investors are no longer subject
to credit risks. OPIC issues certificates of participation in loans initially funded by
it and guarantees the certificates. OPIC also offers political risk insurance. Like ExIm, OPIC’s guaranty and insurance obligations are backed by the full faith and credit
of the United States. The IFC also may lend to emerging markets firms, and offer
participation in its loans to investors. Emerging markets firms would be loath to
default on a loan to the IFC, and emerging markets countries would be loath to
require such a default. The IFC remains lender of record on the loan, notwithstanding its sale of the participation; thus, the investors (loan participants) get the benefit
of the IFC’s clout with the firm and the country.
22. The efforts are directed not only to encouraging securitization to attract
foreign investors, but also to the development of a domestic securitization market,
especially for mortgages. In this regard, several Latin American countries, including
Chile, Argentina, Colombia, and Mexico are moving towards governmentsponsored mortgage securitization programs, like those of Fannie Mae and Freddie
Mac in the United States. A group of banks and agencies recently created such a
program in Brazil as well. Mortgage-backed securities have been issued in
Argentina, Mexico, Brazil, Chile and Colombia.
Secondary mortgage market facilities are not limited to Latin American
countries. The Russian Federation, Malaysia, Hong Kong, Thailand, Indonesia, and,
the Philippines have created, or are considering creating, secondary mortgage
facilities patterned after the U.S.’s Fannie Mae and Freddie Mac government entities.
Other Asian countries are encouraging mortgage securitization as well.
While many mortgage transactions are sold to domestic investors, not all are.
For instance, the first sizeable non-Japanese Asian securitization was a mortgage
securitization in Hong Kong sold to foreign investors. More recently, Deutsche
Bank securitized Hong Kong mortgages for sale to foreign investors. Indeed, a large
portion of Hong Kong’s securitization volume consists of mortgage-backed
transactions. The Argentine and Chilean transactions were geared and sold to
foreign investors as well.
23. A notable exception is Malaysia, which recently enacted exchange
controls. However, for many years, and continuing into the present, Malaysia has
been making public pronouncements about the desirability of securitization.
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VOLUME 11 NUMBER 3
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emerging markets transaction structure differs from
the structure commonly used in the U.S.; yet the
value-adding mechanism is essentially the same. The
transaction structure extracts a high-quality, readily
appraisable asset (a firm’s receivables) from a lowerquality, or less readily appraisable, mass of assets
and liabilities (the remainder of the firm).
Removing residual-style risks from one portion
of the firm enables the firm to more readily obtain a
high price for that portion. In the U.S., the residualstyle risks removed by securitization pertain to the
firm itself; in emerging markets future flows transactions, the residual-style risks pertain more to the
country and, to a lesser extent, to the region and
emerging markets countries generally. Where the
quality divergence between the residual and other
risks is particularly large, the transaction should offer
the greatest benefits over other structures. The
greater the divergence in value, the better (though
only up to a certain point—if the residual-style risks
threaten to engulf the firm, the transaction likely will
not be possible).
The transaction’s structurers set out to create a
security investors would want to buy, and Latin
American firms would want to sell. The structurers
sought to exploit a spread reflecting a high discount
for political risk. Until the Asian crisis, their activities
may have helped reduce political risk. Indeed,
securitization’s effects may have extended well
beyond the fortunes of its direct clientele—the
emerging markets firms that raise capital from such
securities and the investors who purchase them.
Certainly, Latin American countries themselves, and
emerging markets more broadly, have likely benefitted
from the increasing integration of emerging markets
into the global financial community.
Building trust is difficult. In the late 1980s,
securitization offered Latin American sovereigns a
gradual way to begin the process, helping persuade
investors that history—in the form of the debt crisis
of the early ’80s—was not likely to repeat itself.
Investors’ search for profitable new opportunities,
and their fading memories, would almost certainly
have led them back to Latin American firms. But
future flows securitization made the journey shorter
and, perhaps, less perilous.
lower rates. Once foreign investors become more
comfortable with emerging markets investment, and
are willing to offer appreciable amounts of financing
(by purchasing not only securitization issues but
also, other less exotic issues), the domestic financing
sources’ inefficiencies become harder to sustain, and
the spread narrows.
Continuing the arbitrage analogy, until the
Asian crisis began, the spread seemed to have
narrowed sufficiently in Latin America that future
flows securitization seemed to be on its way to
“putting itself out of business.” Its structuring complexity was often no longer necessary to attract
foreign investors,24 as it had not been necessary in
emerging markets in Asia. But, with the Asian crisis
and its global aftermath, the spread has increased, as
foreign investors have again become wary of emerging markets investment. Structuring complexity to
minimize foreign investors’ exposure to political risk
will again earn its keep. But once the crisis abates,
future flows securitization will again likely “put itself
out of business,” as investor fears of political risk
shrink sufficiently that firms can use less expensive
financing structures. One such structure will likely
be that of the “plain vanilla” credit card and auto loan
securitization issues common in the U.S.—issues that
can be sold not only to domestic investors, but also
perhaps to foreign investors as well.
The ultimate result of limiting investor flight in
times of crisis may be more efficient imposition of
political risk. Political risk has been quite difficult to
price, both for firms and their investors. The valuation range is enormous; the cloud of risk is quite
dispersed. And the dispersion is not typically to good
end; most of the imposers of risk, especially the
sovereign, do not seem to benefit nearly as much as the
firms suffer. Securitization will not deserve full credit for
the increased efficiency in risk-imposition, but it will
have helped the process along at a crucial juncture.
CONCLUSION
Securitization, a transaction structure popular in
the United States, has been adapted by emerging
markets firms to craft investment opportunities attractive to foreign capital markets investors. The
24. Moreover, the conditions giving rise to the spread securitization had
exploited—the inefficiency of domestic banks and the immaturity of domestic
capital markets—had improved, which also reduced the costs of Latin American
firms’ other financing alternatives.
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Removing residual-style risks from one portion of the firm enables the firm to more
readily obtain a high price for that portion. In the U.S., the residual-style risks
removed by securitization pertain to the firm itself; in emerging markets future flows
transactions, the residual-style risks pertain more to the country.
as Latin American firms will again need to lure
back foreign investors, and securitization should
be able to help in this process. At the moment,
Latin America is better situated to attract foreign
investors; still, assuming the crisis abates,
securitization will have helped set the stage for the
return of private foreign capital to emerging
markets in Asia as well.
For firms in many Asian emerging markets
countries, the trajectory has been different. Until
the recent crisis, they had ample access to world
markets because their sovereigns were investment grade. But, with the recent downgrades of
their sovereigns, their situation is somewhat comparable to that of Latin American firms after the
1980s debt crisis (and today). Thus, Asian as well
CLAIRE HILL
is Visiting Associate Professor of Law at Boston University
School of Law.
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FALL 1998
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