Introduction of securitization of future cash flows

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Introduction

Micro, small and medium enterprises have grown exponentially in Egyptian markets and have entered various sectors ranging from telecommunications and health to education. This expansion has warranted the attention of state legislative bodies, namely the Financial Regulatory Authority (the “ENG”), who worked on the development of regulations governing the field of capital markets. An important step in this regard was the introduction of the concept of securitization of expected future cash flows (the “Securitization of future cash flows”) under Law no. 13 of 2022, published on March 13, 2022 (the “Right”). According to the law, securitization companies can now issue negotiable bonds whose returns will be used to finance public and/or private legal persons in exchange for future cash flows. In other words, securitization companies could now issue debt securities whose repayment of principal and interest is guaranteed by payments from future cash flows to be received. The concept aims to facilitate access to liquidity for companies that do not necessarily have a large portfolio of trade receivables by providing an alternative source of financing other than banks or non-banking financial institutions.

To this end, the FRA issued Decree no. 115 of 2022, issued September 27, 2022 (the “Decree”), regulating the issuance of bonds against expected future cash flows to be received.

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This article briefly sheds light on the differences between traditional securitization and future cash flow securitization while specifying the conditions of the latter. It also discusses our view on the importance of securitizing future cash flows in developing countries.

Securitization

Securitization companies are mainly governed by the Capital Market Law no. 95 of 1992 and its executive regulations. These are companies active in the issuance of negotiable bonds on the basis of available and tangible guarantees.

Securitization versus securitization of future cash flows

  • While securitization is typically asset-backed, future cash flow securitization involves securing accounts receivable provided on balance sheets and aims to securitize payments that do not yet exist on corporate balance sheets.
  • While securitization requires a large portfolio of accounts receivable, future cash flow securitization grants do not require one to exist.

Conditions governing the securitization of future flows

The Law and the Decree set forth certain obligations and conditions which must be complied with in connection with the securitization of Future Cash Flows. These included, among otherswhat follows:

  1. Bond Issuance Conditions:Certain conditions apply to the issuance of the aforementioned bonds by securitization companies. This issue is subject to the prior approval of the competent authority and must be made against future cash flows, which will be collected on the account of the offeror in the normal course of business. These future cash flows must be (i) created for the benefit of public or private legal persons; (ii) unrestricted or conditioned; and (iii) free of third party rights.
  2. Obligations of the offeror: The client must prepare an audited study covering- among others – the past revenues realized by the project (if applicable) and the future cash flows expected when the bond is issued. Such a study must also relate to the part of the flows allocated to the securitization company. In addition, the initiator must respect when issuing the bonds:
    1. Obtain a credit rating of at least (BBB-) from a duly approved institution. This rating must be renewed annually during the issue period;
    2. Disclose, in the subscription prospectus or the issue information memorandum, the summary of financial statements and financial data prepared according to Egyptian accounting standards for the three years preceding the issue or since incorporation (if applicable) .
    3. The auditor’s report must also be appended thereto; and
    4. Submit a statement reflecting the net present value of future cash flows, the basis for their valuation, and additional safeguards (if any) ratified by the auditor of the
  3. Obligations of the securitization company: The Decree provides for a set of minimum documents that the securitization company must submit to the depositary as part of the securitization process, in particular: among others- FRA approval for bond issuance. The decree also provides that the securitization company must enter into a number of agreements, including – among others – a transfer agreement with the initiator. A collection agreement must also be concluded between the originator (being a collector) and the securitization company or the party with which it has been agreed to collect the future cash flows (if applicable), provided that it includes assignment to transfer the proceeds to the Custodian immediately upon collection. The decree also regulates the obligations of the depositary regarding the process of securitization of future receivables.

Our point of view

The securitization of future cash flows is a concrete step towards the realization of economic and constitutional principles and objectives, namely:

  • Encouragement of investment;
  • Balanced growth at geographic and sector level;
  • Regulation of market tools; and
  • Balancing the interests of the parties involved.

Future cash flow securitization will help expand the securitization market in Egypt in the coming years. More companies – previously unreadable for traditional securitization – will be able to enter the securitization market and sell future cash flows to investors.

However, it is not without risks. There are mainly two risks regarding the Securitization of Future Cash Flows:

  • Performance risk when the key performance indicators of the originator are not duly achieved, negatively affecting the expected receivables on the basis of which the financing was granted under the securitization of future cash flows.
  • Risk of bankruptcy where the Offeror may become insolvent or otherwise default in its obligations; and, therefore, fail to generate the expected receivables.
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