As a FinTech do you have everything you need to issue debt?

Do you have everything you need to issue debt?

Most FinTechs do not anticipate securitisation to be an accessible form of funding. Traditionally, securitisation in the Australian market has been largely driven by originators securitising asset-backed securities, such as Residential Mortgage Backed Securities. These are usually funded by large financiers such as the Big Four Australian banks, non-bank financial institutions and large private equity funds. However, with investors’ growing understanding and recognition of FinTech, securitisation is now a viable option.

Getting the assets right from the start

The underlying assets (e.g., a loan receivable) are of critical importance in a securitisation. Accordingly, when starting out, it is important to ensure that the lending documents comply with all regulatory requirements. Securitisation funders will often require a legal opinion on the loan terms confirming that the relevant loan receivable is legally enforceable, complies with consumer credit and unfair terms legislation and is able to be transferred under the securitisation programme.

Securitisation funders will often also conduct due diligence on a FinTech’s credit and collection policies.

In the past 12 months, we have seen an increasing number of FinTechs accessing securitisation warehouse funding in the wholesale debt market with relatively small underlying receivables pools (e.g., less than A$10 million). Often, these facilities are established with subordinated and mezzanine funding first, with senior funding introduced once the pool is a critical size.

How does securitisation work?

Securitisation can be understood as realising the future value of assets in the present. Securitisation allows FinTechs that originate loans to pool these loan assets and sell them to investors in search of yield and to use the proceeds to grow the business.

We have recently acted on several FinTech securitisation transactions for personal loans and small-business loan providers. In these cases, the FinTech sells a pool of loans to a special purpose vehicle (SPV) — usually a trust — that has been established for the sole purpose of raising funds.

Investors contribute funds by subscribing for notes issued by the SPV (or, alternatively, investors directly lending funds to the SPV). In each case, the repayment of the notes or loans is dependent on the cash flows from the pool of assets held by the SPV. The proceeds of the notes or financier loans are used by the SPV to acquire the pool of loans from the FinTech.

During an initial period known as the ‘revolving period’, the SPV applies collections on the pool of receivables held by it to acquire more receivables from the FinTech originator. After the revolving period ends, the SPV funding is either refinanced (by transfer of the pool to another funding structure) or the SPV applies collections on the pool of receivables to repay the notes or funding on a pass-through amortising basis. The notes and loan funding provided to the SPV are limited recourse to the pool of receivables held by the SPV (and there usually is no recourse to the FinTech originator).

Getting ready to negotiate

The following points often come up in negotiations with potential FinTech financiers. Although many of these financier requests are difficult to resist in early funding stages when funding certainty and tenor of availability are critical, the implication of these points should be considered carefully in the context of future growth.

• Security and guarantees: FinTech financiers may ask for security or a guarantee from the FinTech or its related companies; however, in a typical securitisation an originator will not provide security or a guarantee in respect of the SPV’s obligations because the deal is primarily an asset-backed deal. Where a FinTech has few assets and little credit history, however, such security or guarantee may be required in initial funding stages.
• Change of control/key person: FinTech financiers will often seek to include a change of control or change of key persons clause, which, if triggered, may stop the revolving period of funding. The rationale for this is that the FinTech is young and its success to date is often tied to the founders and initially equity holders. If possible, it is better to resist change of control and key person triggers to preserve flexibility for corporate growth and potential exits.
• Right of first refusal: FinTech financiers may ask for a right to provide future funding, provided the financier can match the terms and pricing of its competitors. This is understandable on the basis that the financier was willing to provide funding at an early stage in the FinTech’s growth. However, agreeing to a right of first refusal needs to be subject to clear parameters, such as dollar limits and time periods, at which point the right falls away.
• Refinancing risk: FinTechs need to be aware of refinancing risk where financiers are proposing bullet repayment of debt that is shorter in tenor than the underlying pool of loans sold to the SPV. This can become especially problematic if there are restrictions in the facility that prevent the transfer of the SPV’s receivables in connection with a refinancing. Such transfer restrictions should not apply after the revolving period has ended, because time will be needed to arrange for refinancing if the facility is not extended.
• Equity asks: FinTech financiers may seek to combine an offer to provide securitisation or debt funding with equity rights such as options and, at times, may look to have the right to appoint a representative to the board of directors. The correct balance of equity rights to give up in the context of debt funding is a point for careful negotiation, and legal advice on this matter should be obtained.

Authors:  Jennifer Schlosser, Partner and Alexandra Rennie, Lawyer.