International finance of ocean-going vessels and other maritime assets such as off-shore oil and gas equipment is currently experiencing what could be described as a perfect storm: Many owners looking to refinance newer assets in their fleet ordered their construction and locked into efficient funding before the global financial crisis of 2007/8. And according to the World Shipping Council, the global container fleet peaked in 2013 at around 34.5 million TEU. At the same time, along with transoceanic freight rates which are widely recognised as a bellwether of international trade flows, residual container ship values in US$ per dead weight tonnage slumped dramatically from the end of 2008 onwards, with ship brokers reporting declines of up to 40% from previous high water marks. What followed in the maritime finance sector, according to the world’s largest shipping lender HSH Nordbank AG, was a “monstrous wave” of loan loss provisions, peaking in 2013. So, when the need of ship owners for new funding was greatest, they found funding taps turned off – at least when investigating traditional sources.
The aircraft finance market had steered its way out of similar storms in the past by heading away from traditional bank lenders and towards increasingly global capital markets. Investors could consider the apotheosis of aviation capital markets financing to be the enhanced equipment trust certificate or “EETC”. EETCs are now a dominant force in aircraft financing, particularly in the United States, with fleet transactions of up to US$ 4.5 billion. In essence, an EETC transaction finances the acquisition and leasing of aircraft and other large equipment through the issuance of a type of asset-backed security by a special purpose vehicle held by a pass-through trust for institutional investors that buy and can potentially trade the relevant trust certificates. The trust certificate securities are said to be “enhanced”, because the special purpose vehicle as registered owner of the aircraft and issuer of the equipment notes backing the certificates is remote from the potential bankruptcy of the plane’s registered owner, typically, an aircraft leasing company. Equity injected for example by the owner / lessee of the aircraft, is thus regarded as credit enhancement for the EETCs, since the trustee for investors is empowered to enforce its security over the plane without getting mixed up in or delayed by corporate bankruptcy or reconstruction proceedings. Similarly, EETCs are so called because they will typically benefit from liquidity support in the form of a standby revolving credit facility from a highly rated financial institution to cover lease payment shortfalls against debt payments due for a period of months in order to avoid an immediate default on the securities.
Nevertheless, the EETC market has possibly been the victim of its own rapid success: Many investors are now facing concentration risk issues in their respective portfolios, with significant relative exposure to certain airlines, lessors, regions, aircraft types and manufacturers. EETC buyers also represent a relatively small part of the investor universe, being in the large part insurance companies and specialist investment funds buying in the U.S. private placement market.
This said, it should be easy to understand the excitement around 2015’s epoch in the development of Malta’s international capital markets sector as well as in ship finance worldwide, as EETC technology was applied for the first time to find a safe harbour for maritime finance deals. In September, the enhanced maritime trust certificate (“EMTC”) financing of MV Al Qibla, a 13,500 TEU ultra-large container vessel owned by United Arab Shipping Company (S.A.G.) (“UASC”) was completed in Malta. Closing in relation to Al Qibla’s sister ship, MV Malik Al Ashtar, was settled in August. The EETCs were privately placed with institutions in the United States of America qualifying as accredited investors under U.S. securities laws and similarly qualified investors in the European Economic Area.
The Equipment Notes cross-collateralizing the EMTCs in this deal were issued by two Malta incorporated special purpose vehicles, one for each vessel, established both as shipping organisations and securitisation vehicles under local legislation. Malta is also the flag of Malik Al Ashtar and Al Qibla. Malta’s Securitisation Act and related statutory instruments establish special regulatory, insolvency and tax regimes that make the jurisdiction uniquely equipped for the establishment of issuers in EMTC transactions. Special purpose vehicles with their centre of main interest in Malta enjoy the highest levels of protection under statute from being brought into the insolvency of a shipping company parent that is also charter party in an EMTC deal. In this deal, further comfort was given to capital markets investors by establishing a purpose foundation, the Tabuk EMTC Foundation, to own “golden shares” in the SPV Equipment Note issuers with rights to veto actions that could be prejudicial to investors, including placing the SPVs into bankruptcy proceedings. In the exercise of those golden share veto rights, the Maltese administrator of the Tabuk EMTC Foundation, Equity Wealth Solutions Limited, follows the instructions of the Subordination Agent in respect of the SPVs it has established. The Subordination Agent appointed for the Al Qibla and Malik Al Ashtar Equipment Notes was Wells Fargo Bank Northwest, N.A.
A particular feature of UASC’s debut EMTC transaction was that it wished as originator to maintain a substantial equity interest in the Equipment Note issuing SPVs and therefore ownership of the vessels. Originator ownership of the asset holding vehicle would ordinarily be anathema to a structured finance transaction – the norm is to “orphan” the vehicle through a charitable trust or purpose foundation. Here, UASC’s continuing ownership of the Vessels by holding ordinary voting shares in the SPVs was requisite. The ultimate concern of investors in relation to the legal structure of an EETC or EMTC transaction is that the assets and liabilities of an SPV will be consolidated with those of the originator on its subsequent insolvency, having been deemed by a court to be substantially those of the originator all along. This doctrine of substantive consolidation exists in policy or statute in many jurisdictions, but it is particularly prevalent as applied by the federal courts under the U.S. Bankruptcy Code. At the same time, a number of foreign ship owners have successfully placed themselves in U.S. bankruptcy proceedings, arguably to the detriment of their long term secured creditors. It was vital therefore to be able to demonstrate to the satisfaction of the investors and credit rating agencies that any bankruptcy or reorganization proceedings in which UASC might possibly be caught up would not affect the SPVs and in particular, the right of investors to enforce their security over the Vessels immediately following an event of default without stay or hindrance. An important element of this bankruptcy remoteness was the “true sale” of the Vessels to the SPVs, i.e., that the alienation from UASC’s estate could not be set aside by the court or an insolvency official recharacterising it as a secured financing, a transaction at undervalue or fraudulent preference. Likewise, the SPVs would be entitled to terminate the charter party agreements with UASC and repossess the Vessels on UASC’s default (including bankruptcy) under the arrangement as a “true lease” rather than a secured financing under the U.S. Federal Bankruptcy Code.
It was essential therefore to rely on the specific provisions of the Malta Securitisation Act that preclude an application by on behalf of an originator engaged in insolvency or restructuring proceedings affecting a securitisation vehicle established under the Act. Similarly, absent fraud on the part of the securitisation vehicle, statute prevents the Maltese courts from accepting an application from an insolvency official to reverse or amend the terms of a sale of securitisation assets by the originator effected prior to its insolvency. The statutory bankruptcy remoteness of the SPVs allows UASC to extract excess spread from charter party payments left after debt service by way of nothing more complicated than payment of a dividend. Bolstering this, the Merchant Shipping Act as it applies to shipping organizations such as the SPVs, allows for the enforcement of a Malta registered mortgage outside of any insolvency proceedings. The application of these and related provisions in the Malta Securitisation Act and Merchant Shipping Act were the subject of legal opinions addressed to investors and shown to rating agencies for the purpose of awarding the desired credit rating to the UASC EMTCs.
However, an originator holding an equity stake in a securitistion vehicle is not only problematic from a bankruptcy remoteness perspective:- profits building up in the issuing vehicle and profit extraction by way of dividend payments could obviously threaten the vehicle’s tax neutrality. By the same token, liability of the SPVs to account to the tax authorities in Malta for unpaid tax could threaten the exclusive right of securitisation creditors to manage the Equipment Note issuers’ indebtedness. Broadly speaking, an ordinary Maltese company issuer would be liable to 35% corporation income tax on taxable profits. And whilst interest payments on debt would be deductible, repayments of principal and dividends on shares would not. Hence it was particularly important that unlike in other onshore SPV issuer jurisdictions, the Securitisation Transactions (Deductions) Rules in Malta allow a securitisation vehicle issuer to make a deduction for residual income that would otherwise be taxable, provided that the originator gives its irrevocable consent to this treatment in the SPV’s tax return.
From an investor’s perspective, apart from bankruptcy remoteness and ease and speed of enforcement of security, it is important that shipping securitisation companies are not considered alternative investment funds, particularly if they are investing from Europe. Many European pension funds and insurance companies are limited by their investment policies and / or regulation in their holdings of units in non-UCITS collective investment schemes. Again, legislation in Malta makes it clear that securitisation vehicles are not collective investment schemes and therefore are unable to be considered AIFs as a matter of Maltese law. It is also helpful that all of the SPVs’ voting share capital is issued to UASC and the Tabuk Foundation, whereas the Equipment Notes are clearly debt securities. Similarly, private securitisation vehicles, namely those that do not, as the UASC SPVs do not, issue securities to the public on a continuous basis, are generally not required to be licensed by the competent authority in Malta. The issuers in the UASC transaction were however required to notify the Central Bank of Malta of their existence as financial vehicle corporations under Regulation ECB 2013/40 for collection by the European Central bank of data on FVCs’ activities in the Eurozone.
In short, Malta uniquely allows for originator owned unregulated onshore bankruptcy remote SPVs with profit extraction by way of distributions on equity. For this reason, GANADO Advocates is predicting that as maritime capital markets grow, EMTCs backed by equipment notes issued in Malta should emerge as the classic form of investment security. UASC has itself indicated interest in undertaking further EMTC transactions in the near future and it would be surprising if it remains alone in a large constituency of potential issuers. Moreover, the success of this EMTC transaction could be the harbinger of Maltese EETC issuing vehicles for aircraft deals where European investors or lessors dictate the deal structure. From constituting a fulcrum for Phoenician trade routes in the fourth century BC to becoming the Mediterranean’s first transhipment hub in 1988 with an annual trade volume in 2012 of over 2.5 million TEUs, Malta has been recognized as the region’s pre-eminent freeport. It has now developed the legal, tax and regulatory infrastructure to become the leading safe harbour for maritime capital markets issues.
Lawyers in the London and New York offices of White & Case LLP lead by the firm’s Global Head of Asset Finance, Chris Frampton, acted as Transaction Counsel to UASC and Morgan Lewis Bockius LLP as Investor Counsel. GANADO Advocates acted as Malta Counsel to UASC. The GANADO Advocates’ deal team was made up of Richard Ambery on the securitisation structure, Max Ganado on Maltese corporate and finance law, Stephen Attard on taxation and Karl Grech Orr on shipping. The team also included Associates Nicholas Curmi, Matthew Attard and Amanda Attard, respectively on capital markets, shipping and tax matters.
For further information, contact Dr Max Ganado on +356 2123 5406 or email@example.com