On 15 December 2023, the Parliament of Georgia passed the new Law on Securitization (the Law). The Law officially came into effect on April 1, 2024. It provides a legal framework for transforming future receivables from third parties into liquid assets through the issuance of securities.
Definition of Securitization
Under the Law, securitization is defined as a process where the initiator (an entity willing to receive financing) (the Initiator) transfers to the securitization special purpose entity (the Securitization Entity) its underlying assets (any future foreseeable income), in return for which the Initiator receives funds from the Securitization Entity. The Securitization Entity issues securitization instruments (including securities, other financial instruments, unit of a securitization fund (unit), share of a securitization company, etc.), which are obtained by the investors (the Investor), who receive specific income from such instruments. Thus, the Law is applicable to the Initiators, Securitization Entities and the Investors. In some cases, securitization can be carried out without the involvement of the Securitization Entity (as described below).
Securitization Entity and its Role
The Securitization Entity is a legal entity or an organization (without legal entity status) that, by purchasing underlying assets or through other means (such as derivatives), takes on the credit risk associated with these assets. It then issues securitization instruments to raise funds for acquiring this risk. The value and/or profitability of these instruments depend on the mentioned risk. Securitization Entities can take the form of either a securitization company or a securitization fund. These entities are strictly limited to activities directly related to securitization, such as acquiring underlying assets, managing risks, and issuing securitization instruments. The National Bank of Georgia (NBG) regulates the securitization market and oversees Securitization Entities.
Under the Law, a Securitization Entity must be authorized by the NBG if it engages in a public offer or has more than 20 non-qualified investors. The authorization fee for a Securitization Entity is set at GEL 5,000. Entities not requiring NBG authorization must notify the NBG before commencing activities. Initiators conducting securitization without a Securitization Entity’s involvement must also inform the NBG in advance and are limited to private offers with fewer than 20 inexperienced investors.
Investors and their Role in Securitization
The Investor may be an individual, a company, or an organization (without legal entity status) that holds a risk position in securitization through securitization instruments. The law differentiates between inexperienced, experienced and institutional investors. Where the terms inexperienced and experienced investors have already been used in other legislative acts regulating the security markets, the term institutional investor (the Institutional Investor) is a novelty introduced by the Law.
The Law defines an inexperienced investor as one who is not an experienced investor under the Law of Georgia on Securities Market (the Securities Market Law), while an experienced investor, as per the Securities Market Law, is characterized by possessing ample experience, assets, or income to absorb financial losses from investment activities. Experienced investors are individuals secured with substantial assets, and/or financial institutions, directors of such institutions, legal entities with capital surpassing GEL 1,000,000, or those officially recognized as such by the NBG. Under the Law, the Institutional Investor is a type of investor who falls into one of the following categories:
– A commercial bank;
– A microbank;
– A microfinance organization;
– An insurance organization;
– An asset management company or registered/authorized investment fund;
– A brokerage company;
– A person acting on behalf of the pension scheme provided for by the Law of Georgia “On Cumulative Pension.” and
– A person acting on behalf of a voluntary private pension scheme.
The Institutional Investors are supervised by the NBG, and the Law sets forth specific obligations for them, including assessment of the risks associated with the underlying assets and securitization instruments.
Procedure of Securitization
Securitization, in essence, is a financial arrangement where initial assets are pooled together, and securities are issued based on this pool. An overview of securitization procedure is provided below:
– Pooling of Assets: Initially, a collection of income-generating financial assets is gathered. These could be anything from loans to other receivables.
– Transfer to Securitization Entities: Instead of the original owner of these initial assets (Initiator) holding onto them, they are transferred to Securitization Entities set up specifically for this purpose.
– Funding by Issuing Securitization Instruments: The Securitization Entities then finance the acquisition of these initial assets by issuing securitization instruments (i.e. securities). These instruments are essentially shares in the income generated by the pooled initial assets.
– Payment Backed by Asset Proceeds: The principal and interest payments on these instruments are funded by the income generated by the initial assets.
Accordingly, securitization allows for the conversion of diverse income-generating assets into tradable securities, providing Investors with an opportunity to invest in a diversified portfolio of assets while providing the original owner with liquidity.
Under the Law, there are two procedures of securitization:
– Traditional Securitization: This involves transferring ownership of the underlying assets to a Securitization Entity.
– Synthetic Securitization: Here, the credit risk is transferred without transferring ownership of the underlying assets. This can be done through methods like placing a credit derivative or issuing a guarantee. In synthetic securitization, the underlying assets remain with the originator, and credit risk is directly transferred to investors. Synthetic Securitization can be carried out without the participation of a Securitization Entity, by directly transferring credit risk to the Investor(s).
In summary, the Securitization Law in Georgia empowers Securitization Entities to manage credit risks associated with underlying assets by issuing securitization instruments. Investors acquire these instruments to generate specific income, contributing to the liquidity and efficiency of Georgia’s financial markets.
