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Reprints of articles written by or about Jones Day lawyers.

New Securitization Legislation in Taiwan: A Comprehensive Review

By William E. Bryson, ESQ and Shirlie Pai, ESQ. (Jones Day, Taipei) As was reported in the July 31, 2002 issue of International Securitization & Structured Finance Report, new securitization legislation in Taiwan is expected to spark the securitization market. The history of this new legislation as well as a review of some of its most important features is presented below.

Introduction

For the past few years, there has been a lot of talk about securitization in Taiwan, but little action. Securitization activity was sporadic (and hopeful) at best, and an urban renewal law that would have permitted a form of securitization was largely ignored, mainly because other desirable legal structures (single-shareholder companies, trust enterprises) were not available. The talk ended in late 2001, when the ROC Ministry of Finance (“MOF”) issued its first draft of the ROC Financial Asset Securitization Law (“FASL”). The first draft of the FASL, which was based on the Japanese ABS law, drew comments from scholars, arrangers, rating agencies and the Capital Markets Com- mittee of the American Chamber of Commerce. The draft was submitted to the Legislative Yuan (“LY”), Taiwan’s legislature, seminars were held, and the mar- ket expected the legislation to pass in January, 2002, prior to the LY’s election recess. The legislation did not pass, mainly because of political wrangling between the LY and the executive branch of the government. It is just as well that the earlier version did not pass. During the ensuing five months, a new LY was elected which included many of the same scholars who had commented on the earlier version. The FASL underwent a substantial re-draft at the hands of both the ROC Min- istry of Finance and Norman Yin, a professor who had joined the LY in January. The FASL was re-submitted to the LY and was passed into law shortly afterward on June 21, 2002. While it is possible that deals could have been done under the original version of the FASL, it is just as well that they did not have to be. The amendments represent a substantial improvement in the versatility and viability of the statute. While there are some issues that still need to be resolved in the Implementing Guidelines that are ßexpected by the end of September. The basic principles and structures provided for under the FASL are described in more detail below.

Special Purpose Vehicles

The FASL permits the securitization of financial assets through use of either a special purpose trust (“SPT”) or a special purpose company (“SPC”). This is a substan- tial improvement over the original draft of the FASL, which did not contemplate the use of SPCs. Since the SPT provisions were in the original draft, they are better developed and more detailed than the SPC provisions. Many of the provisions that are applicable to SPTs, especially as to incentives, are also applicable to SPCs. There are, however, enough differences that they bear separate examination.

Special Purpose Trust

A SPT must be a trust that has been established under the ROC Trust Law. A foreign law trust would there- fore not qualify as an SPT, and is therefore unavailable as a structuring option under the FASL. The trustee of the SPT must be a “trust enterprise” within the meaning of the ROC Trust Enterprise Law. Since there are no companies in Taiwan that have been established as dedicated trust enterprises, the only “trust enterprises” which qualify in the current market are the

trust departments of banks that have a trust business

• license. The good news is that this includes most of the

large local banks in Taiwan, as well as many of the larger foreign banks. The bad news is that the Trust Law has been in force for less than a decade, the Trust Enterprise Law has been in force for only a little over three years, and there has been virtually no activity under either Law since they were adopted. Any securitization structures utilizing SPTs will therefore be breaking new ground under both the T rust Law and the Trust Enterprise Law.

Special Purpose Companies

Special purpose companies, on the other hand, are well- grounded in the ROC Company Law, though some

• f the provisions which make SPCs possible (e.g.,

the provisions permitting single-shareholder companies) are less than a year old. SPCs can be either onshore or off- shore, and the special purpose company must have a single shareholder. The single shareholder must be a financial institution, which is defined in the FASL to include banks, insurance companies and securities houses. While the requirement that the shareholder be a financial institution appears to be aimed at making sure that there is substance to the SPC, the financial institu- tions contemplated by the definition in the FASL appear to be only financial institutions established in the ROC. Indeed, the requirement that the financial institution be one which is organized under local law, when read with the prohibition under local law against the ownership of shares by the ROC branches of foreign banks, suggests that a foreign bank may not establish an SPC in Taiwan. This appears to be an over- sight in the drafting of the FASL. The FASL does, however, give the MOF the ability to approve foreign banks as SPC shareholders on an ad hoc basis. The details of corporate governance for SPCs are still being determined. As a single-purpose, single-share- holder company, an SPC is exempt from many of the corporate governance provisions of the ROC Company

• Law. Since the SPC provisions were clearly drafted with

ROC companies in mind, however, there is some uncertainty about how potential disconnects between the Company Law and foreign company laws will be addressed. Of even more importance, however, will be the implementing guidelines that govern the manner in which the SPC can be used for securitization. If the implementing guidelines retain the breadth and flexibil- ity of the language of the FASL, and are drafted with a view towards filling the gaps in the FASL language, then the SPC provisions in the FASL will represent a marked improvement on the flexibility of the statute. If, on the other hand, the implementing guidelines are used to interpret the FASL in a very conservative man- ner, then the SPC provisions in the FASL will become so inflexible as to be useless in the development of securitization structures. For example, it is not clear whether the use of an

• ffshore SPC also requires the use of an intermediary
• nshore SPC or SPT. While the language of the FASL

would appear to suggest that there is no need for an intermediary, it is possible that the MOF would be loathe to permit a securitization with no substantial

• nshore component, especially in the early days of the
• market. It is to be hoped that the MOF would take a

more enlightened view, permitting direct transfers of fi- nancial assets from onshore originators to offshore SPVs. Even beyond these basic entity issues, there are additional issues as to whether or not the FASL will be interpreted to permit some of the flexible structuring which is common in mature securitization markets. For example, it is unclear whether the FASL will be inter- preted to permit master trusts and conduits, even though the language is clearly broad enough to permit such

• structures. If the Taiwan market is to develop into a

mature securitization market, these structures will have to be addressed at an early stage of the market’s devel-

• pment, just as they are now being addressed in Korea.

Transfer of Financial Assets to the SPV

The FASL provides several tax and fee breaks in con- nection with the sale of financial assets by an originator to a SPV, as more fully described below. The definition

• f “financial assets” in the FASL includes (i) certain

specified assets, such as credit card receivables, chattel mortgages and real estate mortgages, and (ii) any other assets approved by the Ministry of Finance. The ability

• f the MOF to expand the definition of what consti-

tutes “financial assets” makes this legislation very flexible.

The financial assets sold to the SPV must be sold to the SPV by an originator. “Originator” is defined as a financial institution or other institution approved by the MOF. The ability of the MOF to expand the defi- nition of originators suggests that the MOF could approve companies other than financial institutions as

• riginators. This has the potential to substantially

expand the scope of securitizations in Taiwan to include securitizations of accounts receivable generated by large Taiwan corporates, as well as non-performing loans acquired by foreign-invested asset management companies. The FASL encourages arrangers to use the origina- tor as a servicer by providing for exemptions from normal Civil Code transfer requirements in the event that the

• riginator continues to service the assets. In particular,

transfer of the assets under such circumstances can be effected through public announcement. The Civil Code would ordinarily require either notices to, or consents from, financial asset obligors. Asset Management Com- panies and other financial institutions may also service SPV assets, but the ability to transfer by public announce- ment will be lost in such structures. Transfers of financial assets to an SPV will not be valid against third parties unless done so pursuant to an asset securitization plan which has been approved by the

• MOF. While it is a certainty that the MOF will want to

examine and approve the asset securitization plans for the first transactions in the market, the FASL appears to contemplate an eventual switch to a registration sys-

• tem. The MOF has not indicated the timetable for such

a transition.

True Sale

The original draft of the FASL was quite weak in ad- dressing true sale and bankruptcy remoteness issues. Of particular note was the absence of an exemption from an Article of the Trust Law which would permit a court to overturn a trust in the event of the bankruptcy of the settlor (originator) within six months of the establish- ment of the trust. The revised version of the FASL contains some useful language relating to true sale, including:

• Exemption of Special Purpose T

rusts from the ar- ticle of the T rust Law cited above;

• Provisions which address the requirements for trans-

fers to the SPV to be valid as against bona fide third parties; and

• Provisions which address the requirements for trans-

fers to the SPV to be valid as against financial asset

• bligors;
• Provisions addressing the priority of the holders of

Asset-Backed Securities over other creditors and shareholders of the SPC. Since there is no absolute statutory declaration in the FASL as to what constitutes a true sale for legal pur- poses, many of the true sale issues that arise in other jurisdictions will have to be examined in Taiwanese

• structures. The FASL also does not provide accounting

standards for the evaluation of securitization structures by auditors. It is anticipated that the government will publish true sale GAAP guidelines in the near future.

Incentives.

The FASL provides the following incentives and breaks in connection with the transfer of assets pursuant to an approved financial asset securitization plan:

• Exemption from business tax;
• Exemption from deed taxes, except in the context
• f transfers of real estate by the SPV;
• Exemption from stamp duty;
• Exemption from mortgage and other re-registration

fees;

• Exemption (under current regulations) for securi-

ties transaction tax on the sale of securitized products; and

• Deferral of land value increment tax on REO.

The FASL also provides the following additional tax benefits to the SPV and its beneficiaries:

• Pass-through to beneficiaries of taxes on net income
• f the SPV; and
• Withholding tax rate of six percent (6%) on inter-

est distributed to beneficiaries. Taken together, the above incentives create a tax-free transfer of assets from the originator to the SPV, and between SPVs, and for a minimum level of taxation on both the SPV and its beneficiaries. The six percent (6%) withholding tax is particularly significant for foreign investors, as it is substantially lower than the lowest rate (10%) that could be achieved through double-tax agreements. Unfortunately, the FASL is not totally devoid of entity-level taxation on the SPV. The FASL provides that revenues of the assets owned by the SPV are subject to

the same tax as the business tax rate applicable to banks. In Taiwan, this is called Gross Business Receipts Tax, and the current rate is two percent (2%) of gross rev-

• enues. While there is no obvious explanation as to why

this exemption was omitted from the FASL, the tax, by itself, does not seem to be enough to discourage either arrangers or originators. At a more micro level, there are still important tax issues to be resolved. For example, it is not clear whether

• r not the 6% withholding tax will apply to all layers of

a multi-SPV structure. It is anticipated that the Imple- menting Guidelines and future tax rulings will resolve these issues.

Issuance of Securities

The FASL provides that an SPV can issue any type of security which has previously been approved by the ROC Securities and Futures Commission. The FASL also pro- vides that issuances can be either privately placed or publicly listed. Private placement rules are supposed to be issued by the Bureau of Monetary Affairs; public list- ing criteria and procedures are to be issued by the SFC. In terms of disclosure documents, the FASL requires an investment memorandum for private placements and a prospectus for listed issuances. Implementing Guidelines for this section of the FASL have already been issued. As streamlined as this may seem, recent rulings by the SFC suggest that onshore issuances will primarily be listed issuances. The SFC, which has jurisdiction over the regulation of bond funds, recently declared that bond funds can only invest in listed securitization issuances. Since bond funds represent the largest segment of the potential market for these products, the SFC’s ruling virtually guarantees that the majority of issuances will be listed. The purpose of the SFC’s restriction must be political, as there is no commercial or regulatory reason to impose this restriction. Bond funds are sophisticated investors and therefore do not require the level of dis- closure required in a public listing. Requiring that the securities be rated, as is common practice in other securitization markets, would address any counter-party

• risk. The most significant impact of the SFC’s policy

will be to make the first transactions more expensive and complex than they need to be, and to restrict li- quidity in the early days of the market by reducing the scope for negotiated deals with a major segment of the Taiwan market. As this article went to press, there was no indication that this SFC policy would be re-considered. Securitization issuances can only be rated by rating agencies which have been approved by the Ministry of

• Finance. The MOF has not yet promulgated a list of

approved agencies. The FASL places no limits on the ability of the SPV to hedge risks. The simple rule established by the FASL is that the hedging plan has to be submitted, and approved, with the asset securitization plan submitted to the MOF. Approval of the asset securitization plan constitutes approval of the hedging plan.

Market Participants

Much work and study have gone into creating the sup- ply side of the securitization market; somewhat less thought has been given to the demand side. While the size and liquidity of the offshore market is not in doubt, the market for domestic issuances is somewhat less certain. As noted earlier in this article, Taiwan bond funds will only be permitted to invest in listed issuances, and private placements to this segment of the market will therefore not be possible. In addition, the appetite among banks and Taiwan companies for securitized products is not clear, and the ROC Insurance Commis- sion has yet to establish guidelines for investment by insurance companies. If the MOF wants the domestic Taiwan securitization market to mature, the demand side will have to be addressed by the MOF and its agencies. Given the intense level of activity in the market since the FASL became effective, these issues should be addressed sooner rather than later. Any lack of clarity in the ability of potential market participants to invest in securitization products will merely serve to slow down the develop- ment of the market.

Conclusion

It is worth noting that the development of the Taiwan securitization market is a little unusual because it does not follow on the heels of the development of a mature non-performing loan market. While the legal framework

• f the Taiwan NPL market has been established for over

two years, the sale and purchase agreements for the first

deals were only just signed in the second quarter of 2002, the same quarter in which the FASL passed. It therefore appears that the NPL market and the securitization market will develop in parallel, not sequentially. That being said, the legal framework for securitization in Taiwan has been established, and the Taiwan securitization market has already started moving for-

• ward. While some details remain to be worked out, par-

ticularly with regard to cross-border structures and the size of the domestic investor market, the new FASL represents a good start. If current levels of activity con- tinue apace, it is likely that Taiwan will see its first trans- action close sometime during the fourth quarter of 2002

• r the first quarter of 2003, and that many more trans-

actions will follow. Bill Bryson has practiced law in New York and Taipei and has extensive experience in international investment, merg- ers and acquisitions, financing, technology licensing, con- struction, and other corporate transactions. His extensive experience in financial transactions includes syndicated and secured lending, securitization, and distressed asset acqui- sition and servicing in both China and Taiwan. Mr. Bryson is a member of the American Chamber of Commerce in Taipei, where he currently serves as co-chair of the chamber’s Capital Markets Committee and chair of the Publications Policy Committee. Mr. Bryson is active in the chamber’s lobbying efforts with the ROC and U.S. governments, is an advisor to the chamber’s annual Taiwan White Paper (a compilation of position papers describing important issues faced by foreign companies in Taiwan), and is the author of the position papers submitted to the ROC gov- ernment by the Capital Markets Committee. He may be reached via e-mail at webryson@jonesday.com. Shirlie Pai has extensive experience in representing banks, securities firms, and other financial institutions in a wide range of legal matters, including regulatory compliance, structuring and documentation for funding, cash manage- ment, derivative products, trust and custodian services, mergers and acquisitions, loan workouts, and corporate reorganizations and other insolvency-related actions. She may be reached via e-mail at spai@jonesday.com.