June 2018

A panel discussion at the Global ABS 2018 conference looked at the role of trustees in an ever changing landscape

The primary driving force dictating the actions and activities of any trustee overseeing an asset securitisation transaction is investor protection. Asset securitisations are complex undertakings and each transaction will typically involve multiple intermediaries and parties with different roles and responsibilities.

The vast majority of capital markets transactions are set up so trustees passively monitor transactions. Therefore, if the trustee receives annual accounts and unqualified certificates of no default, the trustee is entitled to assume the transaction is performing and that there are no issues. “Trustees will typically take on a more active role in the transaction process when something dictates that they should, such as a negative market rumour about a deal, a press article or if the note-holders or other stakeholders approach them,” said Olufemi Oye, Head of Special Situations, Corporate Trust, Deutsche Bank, speaking on a trustees panel at Global ABS.

Despite many industry experts acknowledging this current set-up works reasonably well, some investors urged trustees in the years following the financial crisis to adopt a more active role when overseeing transactions.

“A handful of transactions are set up so that they are actively monitored right from the beginning, but the question needs to be asked as to whether the market could bear it if more transactions are to be actively rather than passively monitored. There would be major cost for the industry if trustees are required to shift from passive to active monitoring, as a result of the added operational overheads and extra legal and financial advice the trustees would need to take. Even in the unlikely event of this happening, I doubt the industry would be able to cope with the additional costs and the extra scrutiny from trustees,” said Oye.

Having indemnity and being pre-funded

To mitigate the risk of a default adversely impacting a trustee’s balance sheet, trustees will typically ask for indemnification and pre-funding from security holders to shield them from the twin threats of potential litigation and the costs associated with the transaction, including exercises of discretion by the trustee. In reality, trustees rarely have uncapped indemnities and prefunding to fall back on, but rather a mix of the two as institutional investors invariably try to limit such protection. While some trustees are content to incur the added risk, others believe the arrangement is unfair and disproportionate relative to the remuneration they receive and their lack of skin in the game.

The emergence of litigation funding

As indemnification gets increasingly difficult to negotiate, a new source of funding in the form of litigation funding has emerged, whereby third parties agree to underwrite the costs of the trustee bringing action and some of the indemnification, in exchange for a share of the financial reward or damages recovered. Some trustees find the concept of litigation funding distasteful. “There is an old English law prohibiting exactly what litigating funders are doing and it is called the Rule against Champerty. It was explicitly designed to prevent people profiteering from other’ misery,” said Oye. 

He continued: “Litigation funders assume control over the deal and control everything the trustee does whether they like it or not. Funders can even put the trustee in a position whereby they must continue with a litigation claim even if there is scope to compromise or reach a settlement. On occasion, litigation funders have been known to balk at paying the trustees’ costs. While there is a place for litigation funders in some parts of the economy, I am not convinced that they belong in our industry,” highlighted Oye.

Managing potential conflicts of interest

A trustee’s role is to look after the interests of all investors, and not just a select few. While it is not unreasonable for an activist investor to be vocal about a transaction as they are perfectly within their rights to escalate issues or concerns, the trustee is not obliged to make or implement any decisions unless they are to benefit investors as a class. One panellist concurred that those who believed otherwise were wholly misguided.

Conflicts of interest at trustees can also occasionally manifest themselves within large banking groups. Such a scenario may occur if a bank either arranges or holds a position in an issuance which its trustee business is overseeing. Admittedly, such conflicts are not regular occurrences but they do happen from time to time.  Managing these conflicts is imperative and most banks will have robust Chinese Walls in place to do exactly that. “We have Chinese Walls in place, which act as an information barrier. The trustee is a separate legal entity with a different board of directors to the bank and decisions are not comingled,” commented one panellist.

In the event of a conflict emerging on a deal, a bank will either resign from its position as trustee or delegate the work to an independent provider. “We take our fiduciary obligations seriously, and we will delegate to an independent third party trustee in circumstances where our trustee business is overseeing a transaction which Deutsche Bank itself may have an interest in. However, delegation should not be used as an excuse by trustees to shirk their responsibilities, and no trustee should ever delegate just because they are facing a difficult issue. Delegation must only be exercised in a genuine conflict of interest situation where the trustee is unable to make a decision that is in the interests of the beneficiaries because its parent institution has skin in the game,” concluded Oye.

Olufemi Oye

Head of Special Situations | Corporate Trust | Deutsche Bank

Olufemi Oye

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