Operational ExposureThe extent to which a company is exposed to exchange risk and inflation risk. That is, operating exposure is the exposure to the risk that a change in an exchange rate or the inflation rate will negatively impact a company's revenue. For both in-house and retained international counsel, a thorough knowledge of international risk exposure techniques can serve as an effective way to supplement legal strategies for clients involved in international business transactions. While creative and thorough legal drafting can go a long way to reduce some international transactions risks, the financial markets can obviate many business risks in whole or in part. One such area of particular risk is known as transaction risk and is associated with foreign exchange rates. 100.(И.Р.)Foreign Direct Investments: Joint Ventures, wholly owned Subsidiaries Foreign direct investment (FDI) is direct investment by a company in production located in another country either by buying a company in the country or by expanding operations of an existing business in the country. Foreign direct investment is done for many reasons including to take advantage of cheaper wages in the country, special investment privileges such as tax exemptions offered by the country as an incentive to gain tariff-free access to the markets of the country or the region. Foreign direct investment is in contrast to portfolio investment, which is a passive investment in the securities of another country such as stocks and bonds. It usually involves participation in management, joint-venture, transfer of technology and expertise. There are two types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow (positive or negative) and "stock of foreign direct investment", which is the cumulative number for a given period. Direct investment excludes investment through purchase of shares. A JV on a continuing basis is the normal business undertaking. It is similar to a business partnership with two differences: the first, a partnership generally involves an ongoing, long-term business relationship, whereas an equity-based JV comprises a single business activity. Second, all the partners have to agree to dissolve the partnership whereas a finite timehas to lapse before it comes to an end (or is closed by the Court due to a dispute). The term JV refers to the purpose of the entity and not to a type of entity. Therefore, a joint venture may be a corporation, a limited liability enterprise, a partnership or other legal structure, depending on a number of considerations such as tax and tort liability. JVs are normally formed both inside one's own country and between firms belonging to different countries. JVs are usually formed in order to combine strengths or to bypass legal restrictions within a country; for example an insurance company cannot market its policies through a banking company. A subsidiary, in business matters, is an entity that is controlled by a separate higher entity. The controlled entity is called a company, corporation, or limited liability company; and in some cases can be a government or state-owned enterprise, and the controlling entity is called its parent (or the parent company). The reason for this distinction is that a lone company cannot be a subsidiary of any organization; only an entity representing a legal fiction as a separate entity can be a subsidiary. A parent company does not have to be the larger or "more powerful" entity; it is possible for the parent company to be smaller than a subsidiary, or the parent may be larger than some or all of its subsidiaries (if it has more than one). The parent and the subsidiary do not necessarily have to operate in the same locations, or operate the same businesses, but it is also possible that they could conceivably be competitors in the marketplace. Also, because a parent company and a subsidiary are separate entities, it is entirely possible for one of them to be involved in legal proceedings, bankruptcy, tax delinquency, indictment and/or under investigation, while the other is not. The most common way that control of a subsidiary is achieved, is through the ownership of shares in the subsidiary by the parent. These shares give the parent the necessary votes to determine the composition of the board of the subsidiary, and so exercise control. This gives rise to the common presumption that 50% plus one share is enough to create a subsidiary. There are, however, other ways that control can come about, and the exact rules both as to what control is needed, and how it is achieved, can be complex (see below). A subsidiary may itself have subsidiaries, and these, in turn, may have subsidiaries of their own. Subsidiaries are separate, distinct legal entities for the purposes of taxation and regulation. For this reason, they differ from divisions, which are businesses fully integrated within the main company, and not legally or otherwise distinct from it. 101. Securitization (S): creation of ABSs, participants and functions, securitization’s impact and risks, regulators’ concerns. A significant development in the bond markets in recent years has been the growth of securitisation, in which the cash flows from non-tradable assets are transformed into tradable securities. Any type of asset with a reasonably predictable stream of future cash flows can be securitized. In its most basic form, the process involves two steps. In step one, • A company with loans or other income-producing assets—the originator—identifies the assets it wants to remove from its balance sheet and pools them into what is called the reference portfolio. • It then sells this asset pool to an issuer, such as a special purpose vehicle (SPV)—an entity set up, usually by a financial institution, specifically to purchase the assets and realize their off-balance-sheet treatment for legal and accounting purposes. In step two, • the issuer finances the acquisition of the pooled assets by issuing tradable, interest-bearing securities that are sold to capital market investors. The investors receive fixed or floating rate payments from a trustee account funded by the cash flows generated by the reference portfolio. In most cases, • the originator services the loans in the portfolio, collects payments from the original borrowers, and passes them on—less a servicing fee—directly to the SPV or the trustee. In essence, securitization represents an alternative and diversified source of finance based on the transfer of credit risk (and possibly also interest rate and currency risk) from issuers to investors. Participants: • the originator, • issuer agent (special purpose vehicle), • investors. General description: True sale securitization are typically aimed at isolating assets from a transferor’s (originator) insolvency to enable a purchaser (investor) of tranched securities backed by assets (ABS) to rely solely on (the creditworthiness of) those assets. Asset backed securities are bonds whose interest and principal payments are backed by underlying cash flows from other assets. Examples of asset-backed securities are mortgage-backed securities (“MBSs”), collateralised mortgage obligations (“CMOs”) and collateralised debt obligations (“CDOs”). ABS – financial security backed by a loan, lease or receivables against other than real estate and mortgage-backed security. For investors, assets-backed securities are an alternative to investing in corporate debt. The aim of a typical S. is that the only source of “good” and “bad” for the note holders are the assets “Good” = cash flow: - source of payment generally is the cash flow from a pool of assets, rather than from the ongoing operations of a corporate entity; - typically the notes are limited by their terms in resource to the asset portfolio (ABS); - originator is generally not obligated to cover losses. “Bad” = credit risk: - risk of non-payment is intended to be limited to the credit risk of the asset pool; - credit risk associated with the originator of the assets should not impact the payments under the notes. Impact of S.: banks utilize regulatory loopholes to conserve capital through restricting assets or formally changing risks. Banks can lower capital requirements by simply changing the asset structure and risk disposal arrangements, and then reach the regulatory capital requirements without increasing the bank’s capital burden or risk adjusted total assets. Why S.? - refinancing; -diversify funding sources and liquidity options; - transfer of credit risk; - asset-liability management; -reduce funding costs, esp. for lower rated/unrated companies; -manage regulatory economic capital requirements. Advantages to issuer: -Reduces funding costs - through securitization, a company rated BB but with AAA worthy cash flow would be able to borrow at possibly AAA rates, the difference between BB debt and AAA debt can be multiple hundreds of basis points. -Reduces asset-liability mismatch-depending on the structure chosen, securitization can offer perfect matched funding by eliminating funding exposure in terms of both duration and pricing basis. -Lower capital requirements. -Locking in profits: For a given block of business, the total profits have not yet emerged and thus remain uncertain. Once the block has been securitized, the level of profits has now been locked in for that company, thus the risk of profit not emerging, or the benefit of super-profits, has now been passed on. -Transfer risks S. is achieved by legally isolating the assets so that their credit quality can be analyzed independently of the origination company’s risk. Disadvantages to issuer -May reduce portfolio quality -Increase costs - Securitizations are expensive due to management and system costs -Size limitations: Securitizations often require large scale structuring, -Risks: risks of impairment, such as prepayment, as well as credit loss,
Risks for investors: In a more recent refinement, the reference portfolio is divided into several slices, called tranches, each of which has a different level of risk associated with it and is sold separately. The conventional securitization structure assumes a three-tier security design—junior, mezzanine, and senior tranches. This structure concentrates expected portfolio losses in the junior, or first loss position, which is usually the smallest of the tranches but the one that bears most of the credit exposure and receives the highest return. There are main risks for investors: 1) liquidity risk: 1.1) credit default risk: Default risk is generally accepted as a borrower’s inability to meet interest payment obligations on time. 2) event risk: 2.1) Prepayment/reinvestment/early amortization: The majority of revolving ABS are subject to some degree of early amortization risk. The risk stems from specific early amortization events or payout events that cause the security to be paid off prematurely. 2.2) currency interest rate fluctuations: Like all fixed income securities, the prices of fixed rate ABS move in response to changes in interest rates. Fluctuations in interest rates affect floating rate ABS prices less than fixed rate securities. 3) Contractual agreements. 3.1) Moral hazard: Investors usually rely on the deal manager to price the securitizations’ underlying assets. If the manager earns fees based on performance, there may be a temptation to mark up the prices of the portfolio assets. Conflicts of interest can also arise with senior note holders when the manager has a claim on the deal's excess spread. 3.2) Servicer risk: The transfer or collection of payments may be delayed or reduced if the servicer becomes insolvent. Regulator’s concerns: • The market originated when the Federal National Mortgage Association (FNMA or Fannie Mae) was established to buy mortgages on the secondary market. These are then pooled and bonds are issued as "mortgage-backed securities" to investors. • In the case of Credit Default Swaps, this documentation has been formulated by the International Swaps and Derivatives Association (ISDA). The International Swaps and Derivatives Association (ISDA) is a trade organization of participants in the market for over-the-counter derivatives. It has created a standardized contract (the ISDA Master Agreement) to enter into derivatives transactions. The ISDA Master Agreement is typically used between a derivatives dealer and their counterparty when discussions begin surrounding a derivatives trade. There are two basic forms of Master Agreement: single jurisdiction/currency and multiple jurisdiction/currency. One of these documents is generally combined with a Schedule to set out the basic trading terms between the parties; each subsequent trade is then recorded in a Confirmation which references the Master Agreement and Schedule. The terms of the Schedule are often negotiated, and many firms have preferred versions of the Schedule.
|
