ABS definition

The Circular defines ABS as "securities and certificates of indebtedness representing payment claims against a special purpose vehicle (SPV) serving exclusively the purposes of the ABS transaction". The payment claims are 'backed' by a pool of uncertified receivables ('assets') which are transferred to the SPV as security, principally for the benefit of the holders of the ABS. The qualification 'uncertified' was added to the draft Circular at the behest of the association of foreign banks in order to exclude from the scope of the Circular transactions whereby certificated securities are repackaged in ABS transactions. For banking supervisory purposes the BAK will not distinguish between SPVs with company structures and SPVs with trust structures.

Own funds requirements

In accordance with the EU Directive (89/647/EEC) on a solvency ratio for credit institutions, the Own Funds Principle I (Grundsatz I or Principle I) which amended Sections 10 and 10a of the German Banking Act (Kreditwesengesetz or KWG) requires that at least 8% of a credit institution's risk assets must be backed by own funds. In principle, banking customer receivables are treated as asset items (Principle I Paragraph (3) No. 4). The Circular now makes clear that ABS transactions allow credit institutions to effectively remove customer receivables from their balance sheets and from the application of Principle I, by selling them to an SPV. Such receivables will no longer be treated as risk assets of the selling credit institution, not even as off-balance sheet risk assets, provided no counterparty or market risks regarding such receivables are retained by the selling credit institution (Principle I Paragraph (4) No. 1h).

This will be the case if the following prerequisites are met:

* There must be legally valid transfer of the receivables to the SPV (a 'true sale').

* Recourse against the originator must be limited to liability for the legal existence of the receivables sold or their compliance with eligibility criteria set forth in the purchase agreement -- eg that they are free of rights of third parties.

* There must be no substitution by the originator of receivables sold to the SPV, other than substitutions for non-compliance with the contractually agreed eligibility criteria.

* A repurchase of the receivables sold to the SPV is only permitted for the purposes of finalizing the transaction and is limited to a rest-portfolio of less than 10% of the receivables sold to the SPV at their then current value.

* Subject to the exceptions in the box (see above), neither the originator nor any of its affiliates must participate in the financing of the SPV during the transaction. In this context, 'affiliates' means credit institutions, financial institutions or enterprises engaged in ancillary banking services in which the originator directly or indirectly holds at least 40% of the capital shares or which are controlled subsidiaries of the originator (Section 10a KWG). 'Financing of the SPV' refers to any provision of financial means to the SPV during the transaction in the broadest sense, including the simple obligation to provide the SPV with financial means or the giving of a similar undertaking. The purpose of this regulation is to ensure that the credit risks transferred to the SPV do not fall back onto the originator in a different form.

* If originators assume the placement risk of the ABS in a firm commitment underwriting, relief under Principle I will only be available to the extent that the ABS underwritten by the originator are completely placed on the market, or after the originator's underwriting obligation has expired.

It is unclear whether all ABS must be placed before the originator receives relief under the Own Funds Principle I or whether such relief is granted to the extent that ABS are placed in the market. The latter interpretation would more accurately reflect the risk profile of the originator.

* Purchases of ABS by the originator in the secondary market must be at the current market price and must not involve the granting of credit to the SPV or the investors. Securities purchased by the originator must be backed by own funds in accordance with Principle I.

* Originators must take adequate measures to prevent any de facto obligation to assume economic responsibility for the receivables sold in the ABS transaction from arising, eg in the form of market pressure. In particular, the Circular requires that there be no corporate group, company law, capital or personal connection between the originator and the SPV or the trustee/collateral agent holding title to the receivables and other security in a fiduciary capacity. Nor must the name of the originator be similar to or identical with the name of the SPV. Finally, the ABS sales prospectus must indicate clearly that only the SPV is liable for claims of investors and that a guarantee obligation of the originator exists only to the extent expressly undertaken by it.

Retained market and liquidity risks must be backed by own funds, but it remains unclear which own funds requirements will be applied by the BAK in such cases.

Selection of receivables

On the assumption that the sale and transfer of high quality receivables in an ABS transaction may cause the risk profile of the originator to deteriorate, the BAK requires that the receivables be selected randomly from the originator's receivables portfolio. The random selection may, however, be made from those receivables satisfying certain contractual eligibility criteria. The auditor's report on the audit of the annual accounts of the originator must comment on any material deterioration of the portfolio caused by an ABS transaction and the BAK will assess whether 'special circumstances' (Sonderverhältnisse) within the meaning of paragraph 2 sentence 3 of the preamble of Principle I exist, requiring a revision of the own funds assessment. Because no precedents exist, it is unclear what own funds requirements will be imposed on an originator by the BAK in such cases.

To facilitate ABS transactions by credit institutions, the Circular provides that no consent from the debtor of the receivable is required for the transmission of data:

* which is required to identify and legally enforce the receivable transferred, provided such data are encrypted in the declaration of transfer, the encryption key being deposited under seal with a neutral party, ie either a notary or a domestic credit institution supervised in accordance with the EU Banking Directives and having its seat in another member state of the EU, or in a state party to the Convention on the European Economic Area;

* the transmission of which to a third party (rating agency, auditor, trustee) in connection with the ABS transaction is absolutely indispensable for technical reasons and whereby the identity of the customer is not disclosed. Such third persons must be obliged to ensure confidentiality.

Furthermore, the Circular provides that no consent from the debtor of the receivable is required if the originator itself services (collection by debit authorization) the receivable transferred in the ABS transaction in the capacity of service agent, because in this case customer-related data is not transmitted. The guidance provided by the Circular for cases in which the originator is replaced by a new service agent -- for example because of its insolvency or a serious default of its contractual obligations under the servicing agreement -- is limited to requiring that the new service agent must be a domestic credit institution, an EU credit institution or an EEA credit institution. Clearly customer data must be transmitted in such cases to allow the receivables to be collected; however, the legality of such a data transmission is at present not settled.