September 2001 | A publication of the European offices of Mayer, Brown & Platt www.mayerbrown.com
www.securitization.net
Auto Finance Securitisation
in the UK
By Steven P. Janes | Partner, Mayer, Brown & Platt, London
Consumer Finance Securitisation in the UK
When the UK market for securitisation was precedents. However, in the context of the
in its infancy, in the late 1980’s/early ‘90s, aim of this note to provide a general guide
there were some observers who considered only, and not to be a substitute for specific
the prospects for securitising any UK legal advice, it should be assumed - unless
consumer-based receivables to be very otherwise stated - that the legal issues
questionable. The impact of UK consumer affecting auto securitisations are
credit laws, together with laws and substantially the same, and/or the locally-
regulation concerning sale of goods, unfair adapted structural solutions produce similar
contract terms, data protection and more outcomes, in each part of the UK. Indeed,
was felt to pose too great a threat to the UK auto securitisations commonly include
predictability of income streams. A decade assets from all the constituent parts of the
or so later, there is a thriving sector of the UK (though not the Channel Islands or the
UK securitisation market focussed on Isle of Man).
consumer receivables, of which auto finance
is just one - albeit one of the more
significant constituents. The market has 1. The Auto Finance
learned to assess the true effects of UK
conditions, such as consumer protection Market in the UK
legislation, and the historic data from many
successful transactions has allowed these, 1.1 Size/value
along with other risk factors, to be deal with UK new motor vehicle sales have averaged
in the most effective ways in terms of deal around 2.2 million units for the past 2 years
structure and pricing. (2000, 1999) - in addition to which there is
a large market for used vehicles. According to
The legal systems in Scotland and Northern the UK Finance and Leasing Association
Ireland are based on different principles to around 57% of all new car registered in the
those applicable in England and Wales and in UK is achieved through various finance
some areas of economic and social activity arrangements, with consumer credit for car
have unique statutory rules or case law finance worth around £20 billion. The
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figures for 2000 suggest that “point of sale” Under HP and Lease Agreements as well as
consumer finance (that is, taken out at a car Conditional Sales, the finance provider
dealership) for new and used cars is worth retains legal title in the car until full payout
around £9.5 billion. Personal (unsecured) of the financing, thus giving collateral
loans comprise the majority of the backing for the payment obligations. The
remainder, with this form of finance being HP contract involves a nominal final
especially suited to small business payment to acquire title, whereas the lease
customers.
purchase may have a more substantial final
The UK has probably the most developed instalment. The “personal contract
business fleet market in Europe, with many purchase” (PCP) arrangement is a popular
employees receiving a “company car” as a hybrid form of a lease purchase contract
feature of their total salary and benefits (see Sections 1.4 and 3.3).
package. Vehicles coming out of company
• contract hire agreements - these are
car schemes also impact the size of the UK
similar to an “operating lease” concept,
used car market and residual value levels.
although customarily the lease company
1.2 Providers also includes a vehicle maintenance
UK car/motor vehicle finance is provided service in the “package”. The customer
through a variety of sources, but the most normally has no right to acquire title,
significant are: unless a separate option has been
• manufacturer-tied finance units - most, if not negotiated.
all the car ‘majors’ have their own financing 1.4 Trends/Future Changes
division; The key trend in car finance market in the
• banks - a number of retail banks offer loan UK in recent years has been the growth of
products specifically targeted at consumer “low-cost” consumer finance products from
car finance; the finance departments of car manufacturer
groups based upon expected future values -
• specialist finance houses - these institutions i.e. the value of the vehicle that remains at
often target particular sectors of the the end of the finance period. These
consumer/small business vehicle finance financing programs initially assumed a fairly
market, such as employees exiting company high level of residual value, with lower
car schemes or “sub-prime” customers; monthly payments, and therefore a more
• “contract hire”/business leasing - these are attractive deal for the consumer. The so-
specialist providers of new vehicles, with called “personal contract purchase” (“PCP”)
service/maintenance packages, to (mainly) arrangement has become a highly popular
business users. mode of consumer car financing: some
estimates suggest over a third of new cars are
1.3 Products
now sold under some form of PCP
The main financing products available in the
arrangement.
UK market are:
The UK’s relatively high level of new car
• personal loans - these consist of unsecured
monetary obligations of the relevant sales - including those sold via business
customers. No security has normally been fleets and resold “used” within a year - has
given by a customer for any such to some extent flooded the market. This has
obligations and therefore the finance meant that residual values have tended to
provider will have no interest (and therefore fall, which has posed problems for car
cannot transfer the benefit of any interest) in financing operations, whether manufacturer,
any property acquired by a customer with bank-owned or independent. Some finance
the proceeds of any loan made to him providers have had to make write-downs
pursuant to a Personal Loan Agreement. or augment their reserves to handle
the problem.
• title retention products - these comprise
hire purchase (“HP”) contracts, lease The phenomenon of lower guaranteed
purchase and conditional sales contracts. residual values under PCP contracts has also
led some UK consumers away from this with transferring title to vehicles, or creating
product and back to more traditional hire other interests in a vehicle, such as a right of
purchase agreements. Loan finance deals possession (i.e., lease) or a security interest
have also become more commonplace, (e.g. a mortgage). Among the consequences
including some which seek to ‘mimic’ PCP of this are:
cash flows by including a large final loan • A lease over a vehicle does not give the
instalment. lessee a legal interest in the vehicle, so if the
In Europe in general and the UK in vehicle were to be sold by the owner/lessor
particular, there is uncertainty for the car before being delivered to the lessee, the
industry as to what effect, if any, the change lessee could sue the lessor for breach of
in European Union’s “block exemption” contract, but could not compel the new
from the EU’s normal competition rules will owner to recognise the lease;
have. This allows manufacturers to sell their
• A mortgage of a vehicle is only possible by
cars only through exclusive licensed dealers.
the transfer of legal title to the mortgagee,
Once the exemption expires, new sales
leaving the original owner with a right to
channels will open up, and it is difficult to
determine what the effect on residual values recover title through the “equity of
will be. One predicted effect of this change redemption”. It is, however, perfectly
will be carmakers wanting to exercise possible to create a charge or equitable
greater control over their new and used car mortgage over a vehicle, which will be
sales, and therefore, their residual values. enforceable subject to the risks mentioned
Whether through the introduction of buy- in the next paragraph;
back deals or other finance incentives, the • In the absence of special protection of
aim will be to stabilize used car values and
vehicle ownership (e.g. through a title
give peace of mind about new car
registration system) there will always be a
depreciation. Not least among those
risk of rights of ownership or security
concerned about exposure to residual value
being diluted, postponed or lost through
risks will be participants in UK consumer
auto finance securitisation deals. the wrongful actions of the owner or
person in possession of the vehicle.
For practical purposes, all motor vehicles in
2. UK Laws on the UK are required to be registered under
Motor Vehicles a government maintained, national vehicle
registration/licensing regime. This is
2.1 Vehicle Ownership/Registration essentially an administrative and tax
An English law definition of a motor vehicle (known as “Vehicle Excise Duty”) collection
is any “mechanically propelled vehicle system.
intended or adapted for use on roads to
which the public has access” (Hire Purchase A vehicle is identified by a registration
Act 1964 s. 29(1)). However, given the number, and a person is recorded as its
importance of the motor vehicle in a modern “registered keeper”. Confusingly, in some of
economy and society, it is surprising - but the relevant legislation, the registered keeper
true - that there is almost no special body of is occasionally referred to as the “owner” of
law [in the UK] dealing with their ownership the vehicle. However, the register is neither a
or how they are financed. Cars, trucks, record nor proof of title or ownership in the
motor-cycles and other motor vehicles are legal sense. In particular, the registration
treated in the same way as any other system aims to identify the person who has
moveable physical asset: that is, as a “chattel” actual or constructive possession or control of
in legal parlance. the vehicle, not who may have legal
There is no equivalent of any system of ownership. Thus a finance company which
registration of title to vehicles in the UK. This owns a car that is hired to a customer under
means that there are no special rules for an HP contract will not appear as the
proving ownership of a vehicle, nor dealing registered keeper/owner; the customer will.
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2.2 Recognition of It is, of course, a universal requirement of
Financing Interests motor finance contracts to place upon the
The UK vehicle registration regime has no customer the obligation to obtain not
facility to register (or even “note” on an only statutory third-party insurance but
informal basis) the legal interests of finance also cover against damage to or theft of
parties, whether owners (under a lease or HP the vehicle.
contract) or secured lenders. Thus, there is not in the UK at present the
It is standard practice for finance providers same degree of exposure as exists in the
who operate through products that leave US to vicarious tort liability for falling
them as legal owner (HP contracts, leases, upon finance providers for harm caused
conditional sales) but otherwise unprotected by the vehicle.
by registration of their interest to file a note
of their status with a private company, HPI
Group Limited, which maintains an 3. Structural Issues for
industry-recognised database of vehicle
financing interests. The organizations that UK Auto Securitisations
provide information to HPI include the
DVLA, Police, Vehicle Inspectorate, 3.1 Asset Types/Limits
Independent Mileage Verification The categories of finance product commonly
Association and RMI, many of the UK’s local offered in the UK auto finance market have
authorities and the majority of UK finance been outlined at Section 1.3.
and insurance companies, motor
manufacturers, motor dealers and auction Receivables deriving from Hire Purchase
houses. HPI was established in 1938 to Agreements, PCP Agreements, Personal Loan
prevent financing fraud in the motor Agreements and Lease Agreements that have
industry. HPI has evolved into the pre- been generated for the finance of new or
eminent UK source of information for used vehicles for consumers and small
manufacturers, dealers, auction houses, businesses are all capable of being
finance and insurance companies who buy, securitised.
sell, finance and insure motor vehicles.
Special conditions in some transactions place
It is also common practice among motor limits on some categories - for example:
traders, dealerships and finance providers to
carry out a search with HPI against any • The percentage of Receivables which relate
vehicle they propose to acquire (e.g. through to the finance of used, as opposed to, new
“trade-in”) or finance to reveal any vehicles will not exceed [x] per cent;
outstanding finance. The HPI check reduces
• Personal Loan Receivables will not represent
risk by giving information on the current
more than [y] per cent. of total acquired
status of over 57 million UK registered
receivables; and
vehicles. The HPI register does not, however,
have any formal legal status, and details of a • Lease Receivables will not represent more
financing interest recorded with HPI are not than [z] per cent. of acquired Receivables.
deemed to be notified to the public at large.
These limits normally apply at closing or (in a
2.3 Liability Issues revolving deal) immediately following any
Under UK law, any person using a motor further substitution.
vehicle on-road must have, as a minimum, a
valid insurance in place against third-party 3.2 Transfer of Assets
liability. It is a criminal offence - and may be The originator will normally transfer to a
the basis of a claim for damages by an special purpose entity (SPE), commonly but
injured party - to “cause or permit” another not universally located in a low-tax
person to use a vehicle without the statutory jurisdiction:
minimum insurance. However, under UK
case law a finance provider will not normally • The benefit of the Receivables, which will
run a risk of liability for “permitting” an generally consist of unsecured monetary
uninsured driver unless it has specific obligations of customers under the
knowledge of its customer’s affairs. Receivables Agreements;
• Proceeds of related credit protection • Deal arrangers will become more
insurance policies; and sophisticated in analysing an originator’s
residual value loss experience, and in
• The proceeds (net of associated expenses)
imposing receivables criteria and
of contracts for the sale (or lease, hire
operational requirements that maintain a
purchase, use or other disposition) of any
strong management incentive on the
vehicles following their repossession.
originator to minimize such losses.
In more limited circumstances, the title in the
There remains some uncertainty about the
vehicles which are the subject of the
way that PCP receivables should be treated
Receivables Agreements may be transferred to
for accounting purposes, especially if they
the SPE, or the SPE (or the servicer on its
are to be acquired by a SPE which is
behalf) may have a direct right to repossess a
subject to US GAAP (and FAS 140 in
vehicle if a customer defaults under a
particular).
Receivables Agreement.
There will normally be little practical
credit/collateral value for the SPE in acquiring
title to vehicles. It may in practice, be difficult
4. Legal Issues for UK
to trace and repossess any individual vehicle, Auto Securitisations
and any proceeds arising on the disposal of a
vehicle may be less than the total amount 4.1 Consumer Credit legislation
outstanding under the relevant Receivables The Consumer Credit Act 1974 (“CCA”) will
Agreement. A car may be subject to an apply in relation to any Receivables
existing possessory lien or similar right, for Agreement where the debtor is not a body
example, in respect of repairs carried out for corporate and which is for an amount less
which no payment has yet been made. than (in most cases) £25,000. This will have
several consequences, including the
3.3 Issues Relating to PCP
following:
Contracts/Residual Value Risk
The inclusion in a securitisation of PCP Rights of Early Settlement
Receivables - or more specifically, the final and Termination
“future value” instalment under a PCP Whether under the terms of the agreement
contract, poses a number of additional or (even if it is silent or purports to prevent
difficulties. As a result, it is believed that to this) by exercising his CCA rights, the
date no public/term ABS deals based on UK customer has a right to settle early (or
car finance products have included PCP terminate) a Receivables Agreement before
contract final payments. its scheduled final payment date. This may
occur at any time.
However as PCP contracts come to be a
standard feature of the consumer car finance If he so elects, the customer can settle by
market, and come to represent a significant payment of all outstanding amounts in
portion of their portfolio for many finance advance of their scheduled payment dates less
providers, there is increasing probability that any statutory rebate of charges to which he
solutions will be found to the main issues. may be entitled under the CCA. Early
settlement will entitle the customer to
• Support from the manufacturer may be
exercise his option to acquire title to the
offered, through residual value loss
relevant vehicle.
protection or some form of buy-back for
returned vehicles inevitably, the finance As an alternative to early settlement the
divisions of the more “upmarket” model customer has a right to terminate a CCA-
manufacturers will find it easier to place regulated Receivables Agreement (without
PCP contracts into securitisation, provided acquiring title to the relevant Vehicle)
that the future values are set without completing all payments which
conservatively. would otherwise have been due. In those
circumstances the originator is entitled to
• Finance providers may have to become
recover:
more expert - or arrange access to agents
with this expertise - in the management (a) any interest due and unpaid in respect of
of vehicles returned from PCP contracts. any arrears of payments due;
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(b) amounts payable by way of damages The vehicle ceases to be protected from a
arising from a failure to take reasonable care of repossession action if the customer terminates
the vehicle; the agreement, although this would not
preclude him from applying to the court for a
(c) any arrears due immediately before the
“time order” pursuant to which the court can
termination; and
reschedule the outstanding liabilities.
(d) where at the date of termination the
4.2 Data Protection
customer has paid less than one half of the
Consumer Protection legislation and data
total amount (the “total price”) payable under
protection legislation may also be relevant if
the Receivables Agreement (including any
they proscribe certain methods of dealing
sum payable on the exercise of an option to
with the assets, so that the transaction will
purchase, but excluding any damages for
need to be structured in such a way as to
breach of the agreement), an amount equal to
ensure compliance with the relevant
the difference between (1) one-half of the
regulations. The Consumer Credit Act 1974
total price and (ii) the aggregate of the sums
(the “CCA”) and the Data Protection Act 1998
paid and the sums due under the agreement
(the “DPA”) are the two most relevant statutes
immediately before termination.
in the UK. It is common practice, therefore, in
Liability For Dealer Misrepresentations transactions involving UK assets, for the SPC to
and Breach of Contract obtain a CCA licence and to register itself for
CCA Agreements: Pursuant to Section 56 of the purposes of the DPA. Consideration will
the CCA, the originator may be liable for any also be required as to whether the transaction
misrepresentations, acts, omissions or complies with the requirement for “personal
statements made by a dealer to a customer data” to be processed fairly, as laid down
during negotiations between them prior to within the principles of the DPA.
the execution of the Receivables Agreement.
4.3 Tax issues
The customer may make a claim for such
The tax treatment (e.g. tax depreciation, tax on
misrepresentations against a finance provider
gains, income, withholding taxes and VAT and
as well as the dealer. Under the Supply of
stamp duty treatment) of an auto finance
Goods (Implied Terms) Act 1973, he may also
securitisation, as regards each of the parties,
make a claim for breach of contract against the
will need to be explored in depth. For
originator if the vehicle is not of satisfactory
example, it is important to structure the deal
quality. For these purposes, the quality of the
so that the transfer of assets by the originator
vehicle includes its state and condition, its
does not give rise to a taxable profit and that
fitness for all the purposes for which vehicles
all payments routed through the SPC structure
of the type in question are commonly
can be made without withholding taxes.
supplied and its appearance and finish.
An important issue in relation to the
Agreements Not Regulated Under the CCA: If
securitisation of car lease and HP receivables is
the agreement is not regulated, the finance
the tax treatment. It may be necessary to
provider, as a term of the agreement, can
exclude liability for any misrepresentation by investigate the way in which tax depreciation
a dealer and any condition or warranty as to or capital allowances in relation to the
the vehicle’s quality, condition, performance underlying vehicles are calculated and
or fitness. These exclusions are, however, whether, and if so the way in which, the
subject to tests of reasonableness established originator uses these capital allowances in the
by statute and by regulations and unfairness course of its financing business.
and where such tests are not satisfied the If HP or conditional sale receivables are sold
originator could suffer the cost of the liability to an SPC for a price matching the value of
which it sought to exclude. the receivables, the effect would be effectively
Protected Goods: If, under a CCA-regulated tax neutral. However, if the originator sells to
agreement, the customer has paid one third or the SPC a pool of lease receivables for a
more of the total price, the vehicle becomes discounted purchase price the whole of the
“protected goods” and the finance provider is sale proceeds may be characterised as
not entitled to recover possession of the accelerated income from the originator’s
vehicle, except pursuant to an order from the financing/leasing trade and recognised in the
court or with the customer’s consent. accounting year of the sale. The consequence
of this is that there may well be a substantial efficiencies of a medium-term note
tax charge in the year of sale, making the programme with the added advantages of a
securitisation unattractive. There are a presence in the asset-backed market.
number of solutions to this problem. One of The inaugural issue under the programme,
the methods most frequently used is the sale an AAA rated DM1 billion floating rate issue
of both the lease receivables and the backed by US dollar wholesale auto
underlying vehicle as one asset. This is receivables, closed in October 1997. The
because unless the purchase price paid second issue, comprising a senior tranche of
exceeds the cost of the vehicle to the F490,750,000 AAA rated and a junior
originator, the sale proceeds are treated as tranche of F20,500,000 A rated floating rate
proceeds for the sale of the vehicle and not as notes backed by German retail auto
a trading receipt. Depending upon the receivables, closed in March 1999.
originator’s overall capital allowance
The Globaldrive programme gives FCE Bank
position, this may give rise to a tax charge
plc, the pan-European finance arm for Ford,
and an inefficient tax position for the SPC.
as well as other Ford Credit affiliates
One solution which has been used in the past
worldwide, a medium through which they
is to interpose an intermediate company may securitise their assets in many different
which pays for and receives vehicles and jurisdictions, both in Europe and the rest of
receivables and then assigns the receivables to the world. The programme offers gains the
the SPC and sells the vehicles to an benefits of a master trust type structure, in
equipment company. Not only does this have that it can securitise assets by means of a
tax advantages, but it also means that there vehicle capable of issuing successive series of
may well be structural advantages in funding notes, but with the added advantage of being
of the residual value of the vehicles as well as able to securitise separate portfolios of assets
retaining capital allowance benefits. in independent transactions. Rather than
creating undivided interests in a revolving
The impact of the UK trend to aligning tax
pool of assets, “firewalls” in the structure will
and accounting treatment means that
prevent defaults in one securitised portfolio
careful attention will need to be paid to the
having an adverse effect on other transactions
originator’s accounting methodology -
under the programme.
specifically how the sale proceeds relating
to the leasing receivables are brought A number of financial institutions in the UK
into account. specialise in lending for consumer or
business car finance. An example of these
specialists is Paragon Car Finance (PCF)
which was launched in 1997 and provides
5. Examples of UK car financing solutions to a wide range of car
Auto Securitisations users and buyers. Operating in the motor
dealer and corporate markets, PCF offers a
The following are examples of recent range of car finance products, including hire
transactions involving UK auto finance purchase, personal contract purchase,
assets. It should not be inferred that Mayer, contract hire and leasing, for both new and
Brown & Platt represented any parties to second hand vehicles and is among the top 5
such deals - all information has been taken UK lenders in the car finance market.
from published sources. In 2000 Paragon successfully completed a
5.1 ABS Public/Term Issuances £195 million securitisation issue, its thirty-
fourth public securitisation, involving car
A number of European car manufacturers
finance contracts (and some secured personal
and other non-affiliated, specialist car
loans) through a subsidiary company,
finance providers have entered the auto
Paragon Auto and Secured Finance (No. 1)
finance securitisation market, among them
PLC. The assets forming the security for the
Fiat, Volkswagen and Ford.
notes include the benefit of car hire purchase
Ford Credit’s Globaldrive programme was agreements and car conditional sale
the first pan-European asset-backed agreements entered into by PCF and legal and
programme to be set up by a corporate and beneficial ownership of the vehicles that are
seeks to combine the flexibility and the subject of the car finance contracts.
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1.2 “Sub-prime” lenders The auto finance originator’s credit
In early 2001, SPA Holdings, which procedures and systems need to provide
trades as Yes! Car Credit (YCC), a platform on which to structure the
originated the first UK securitisation deal, allowing the parties to track all
structured entirely around UK subprime loan information in detail.
auto loans. The Royal Bank of Scotland 1.3 ABCP Conduit Securitisation
(RBS) arranged the GBP108 million A range of UK auto finance assets are
deal,YCC specialises in the non-standard thought to have been securitised
credit market, and supplies customers through conduits with asset-backed
with both financing and a vehicle. commercial paper programmes -
An SPV named Spartacus, rated P-1/A-1 though, of course, such transactions are
by Moody’s and Standard & Poor’s, not normally in the public domain. As
bought auto loans from Direct Auto well as receivables arising under
Financial Limited, which is the consumer car finance, conduit
subsidiary of YCC which provides loans. securitisations are believed to have
Spartacus funded the purchase of the included contract-hire/business leasing
loans by means of a private placement. receivables originated by some of the
The assets have been put into the TAGS UK “majors” in the car rental/contract
conduit, which will fund the purchase hire sector.
by issuing commercial paper. Spartacus
uses collections on the underlying loans
to repay the facility.
From the originator’s perspective, this
type of securitisation provided it with
cheaper funds in comparison with
straight bank debt, and also provided
access to the capital markets to help
with future fund raising.
It has also been noted that securitisation
instils more discipline in the
organisation owing to additional
reporting requirements and tighter
default triggers, so there is more focus
on cash control.
For further information on European Securitisation Group
Auto Finance Securitisation,
Mayer Brown & Platt have
Kevin Hawken Dr Ralf Hesdahl Steven Janes
published a guide to “Equipment
+44 (0)20 7246 6218 +49 (0) 69 7941 0 +44 (0)20 7246 6243
and Auto Lease Financing”. If you
would like to receive a copy, please
contact a member of the MBP
Jean-Pierre Lee Mark Nicolaides
European Securitisation Group.
+33 1 53 53 43 43 +44 (0)20 7246 6232