Toll securitization shows how to tap retail demand

The Hong Kong government recently completed Asia''s first asset-backed deal sold to retail buyers. Clifford Chance lawyers examine how the transaction was structured.

The Hong Kong Link deal, the government's securitization of toll revenues generated by five tunnels and a bridge, is unparalleled in Asia .

This is the first Asian securitization of sovereign assets, the first public Asian securitization of infrastructure, the region's first securitization to be offered to retail investors, the first asset-backed transaction to be listed on the Stock Exchange of Hong Kong Limited (SEHK) for some years, and the first public debt offering in Hong Kong to be distributed through placing banks, the Hong Kong Securities Clearing Company Limited (CCASS) and securities brokers .

The structure of the transaction, which closed on May 7, could only be finalized after the government had obtained approval for the deal. Under section 27 of the Public Finance Ordinance (Cap 2), the government may not generally borrow money except in accordance with an ordinance. But section 3(1) of the Loans Ordinance (Cap 61) permits the government to borrow funds in a manner and from lenders approved by the Hong Kong Legislative Council (LegCo) on such terms and subject to such conditions as the parties agree .

On February 18 2004 LegCo passed a resolution under section 3(1) authorizing a borrowing of up to HK$6 billion ($769 million) by securitizing the toll revenue from the designated bridges and tunnels .

The transaction combines facets of a standard secured loan securitization with an asset package that is more closely related to a whole-business securitization .

Special purpose company Hong Kong Link 2004 Limited was incorporated to issue the notes and the retail bonds. Unusually for a securitization, the originator (in this case the government acting through the Financial Secretary Incorporated) owns the issuer .

It was necessary to analyze both the unconventional structure and the nature of the parent company. The government's control over the issuer had to be consistent with the security granted to the trustee for the investors and with the degree of administrative control normally exercised by a transaction administrator or corporate service provider .

The issuer's obligations under its notes and retail bonds are serviced by payments it receives under a revenue-linked bond, the Toll Revenue Bond, issued by the government .

After a detailed legal and political analysis of the bridges and tunnels, the operating arrangements and the toll revenues, it became clear that a traditional true sale or trust structure was not practical to alienate the toll revenues. Instead, the transaction uses a covenant package under the Toll Revenue Bond to replicate the toll receipts .

The terms of this bond had to fall within the terms of LegCo's February 18 resolution and of the Loans Ordinance. In the ordinary course, the terms of the bond work like a conventional revenue-linked obligation: to the extent that toll revenue is paid, net of operating expenses, by the operators of the bridges and tunnels to the government, the amounts related to the cost of operating the bridges and tunnels, but is then obliged to make a payment under the Toll Revenue Bond in an amount equal to the net toll revenue .

The Toll Revenue Bond's interest rate is variable and formulated so that over the course of an interest period the issuer should receive enough income to pay the fees and expenses due to its agents and contractors, to maintain its cash reserves and to pay interest on the notes and the retail bonds .

The critical feature of the Toll Revenue Bond is its ability to replicate the toll cashflows if the revenues are interrupted or reduced by factors other than natural changes in road use and traffic volume .

The repayment risk that was disclosed to investors applied historic traffic volumes and toll levels to show the issuer's ability to cover its obligations. If in future the traffic volumes change because motorists use different routes or different modes of transport, the investors bear the risk that the net toll revenue will not be sufficient to service the notes and retail bonds .

However, if the toll revenues are reduced below a specified amount by external factors, for example increases or decreases in the toll levels, events that reduce the operational capacity of the bridges or tunnels for a specified period, or increases in the cost of the operation of the bridges or tunnels, under the terms of the Toll Revenue Bond the government must make direct payments from its general funds to make up the shortfall .

The direct payment obligations were drafted as integral to the Toll Revenue Bond, to take advantage of both the LegCo resolution and section 6 of the Loan Ordinance, which validates ancillary undertakings given in respect of a primary borrowing .

Retail distribution

To make the retail bonds more widely available, the government placed them through retail banks in Hong Kong, CCASS and securities brokers. This was unusual for two reasons. First, publicly offered securitizations in any part of the world are rare. Secondly, in other recent retail debt offerings in Hong Kong only placing banks were used to distribute the bonds .

Using both CCASS and brokers enabled the public to apply for retail bonds in a way similar to applying for shares in an initial public offering .

However, before this could happen CCASS had to amend its operational rules on how applications and their proceeds were dealt with. Further, a detailed description of how retail investors could apply for the retail bonds through CCASS directly or through their brokers had to be drafted to include in the prospectus .

Stock exchange listing

One legal challenge of listing all tranches of retail bonds and notes on the SEHK was to agree an approach with the Exchange on the application of the listing rules .

The Exchange took the view that the issuer would be treated as a state corporation and that the rules relating to debt securities issued by such corporations would apply subject to the application of rules relating to the listing of asset-backed securities (ABS). While the Exchange's listing rules contain a section relating to ABS dating from the early 1990s, these rules have only been applied on a few occasions to selectively marketed ABS. Plus, the rules refer to loan assets and not generally to revenues or cashflows generated by any asset .

The Exchange took a practical approach in applying the listing rules by looking at comparable listings of ABS in other jurisdictions .

Similar to other issuers in securitization transactions, Hong Kong Link 2004 Limited is an insolvency remote special purpose entity with no employees and no financial history, and hence no track record or historical financial statements. The Exchange considered this when interpreting the listing rules and granted waivers, where necessary, from compliance with requirements of the State corporation rules, to the extent they are inconsistent with the ABS rules (which require the issuer to be a single purpose undertaking) .

Prospectus requirements

The issuer had to comply with the prospectus requirements of the Companies Ordinance (Cap 32) for purposes of the Hong Kong retail offering. One of these was the need for the issuer to disclose its material contracts in the prospectus and the delivery of such material contracts to the Registrar of Companies for registration together with the prospectus .

The issuer took the view that, since it was a single purpose entity with no other activities, substantially all of the contracts it entered into as part of the transaction were material for purposes of the Companies Ordinance .

However, the transaction documents are complex agreements involving numerous different counterparties, and negotiating and agreeing them took time. The rating agencies also had to review the documents .

In most securitizations, the documents are typically only agreed and signed shortly before the closing. In this deal, the issuer faced a problem. While most of these contracts would be in near final form at the time of registering the prospectus with the Registrar of Companies, the issuer and the counterparties would still not be in a position to execute them at that time .

The issuer applied to the Securities and Futures Commission for an exemption allowing it to deliver only a copy of each executed material contract and forms of those unexecuted material contracts to the Registrar for registration with the prospectus. The Commission granted a waiver but required the issuer to file with the Registrar, as a public record, the executed versions of all the material contracts within a specified time after closing .

Most issuers of retail bonds, unlike Hong Kong Link 2004 Limited, are operating companies whose material contracts would already have been executed before the registration of the prospectus .

Issuer's website

The issuer also set up a website ( containing mainly information extracted from the prospectus .

But before the site could go live, the issuer had to overcome several legal hurdles .

The nature of the information on the internet meant that the website and its contents could arguably constitute: (i) publicity materials in connection with the retail offering under Rule 24.08 of the SEHK listing rules; (ii) an extract or an abridged version of the prospectus under section 38B(1) of the Companies Ordinance; and/or (iii) an advertisement, invitation or document amounting to or containing an invitation to the public under section 103 of the Securities and Futures Ordinance (Cap. 571) .

This Ordinance defines an advertisement, invitation or document that contains an invitation to the public very widely and could potentially catch websites and their contents .

In the context of the Exchange's listing rules, this matter would not normally arise for a corporate issuer undertaking a public offering .

In many cases a corporate issuer would be able to rely on exemptions for information appearing on its corporate website about its business and products. However, as a special purpose vehicle set up only to undertake the securitization, Hong Kong Link 2004 Limited was unable to make use of these exemptions .

Consequently the issuer applied for, and obtained, authorization from the Exchange under Rule 24.08 of its listing rules, section 38B(2A) of the Companies Ordinance and section 103(3)(h) of the Securities and Futures Ordinance. This was the first time the Exchange has been asked to approve a website as an extract or an abridged version of a prospectus under section 38B(1) of the Companies Ordinance .

Stephen Roith and Mary Matson are partners, and Connie Heng and Gareth Old senior associates, in Clifford Chance's Capital Markets Group in Hong Kong .

This article was first published in the June 2004 edition of International Financial Law Review.