Private securities: What they are and why they’re popular

Private securities are a popular and enduring element of the investment world. But the securities market can be opaque even for seasoned investors.

To help provide some clarity, we interviewed two experts with over four decades of combined experience in financial markets. Alexandra Nethercott-Parkes is based in Jersey and is director and service delivery lead of capital markets at Vistra. London-based Mahen Surnam is Vistra’s director of loan market solutions.

In this interview, they discuss the nature of private securitisation loans, the kinds of assets that go into private securities, the benefits and risks of private securities and how to manage them, the role of security trustee and more.

At a basic level, what is private securitisation and how are these loans different from collateralised loan obligations or other similar instruments?

Alexandra: Securitisation deals allow for pools of less easily traded assets to be securitised and traded, typically OTC [over the counter] through clearing, that is, through an agency to promote transparency. They can still be listed and rated and allow for investors to receive principal and interest from the underlying collateral.

Within credit markets, we are seeing an uplift in the use of private loan securitisations, similar to CLOs. Significantly, private securities allow investors and asset managers to create bespoke products. Private credit funds are using securitisation vehicles issuing tranches — that is, sections of the pooled securities — collateralised against assets. The market has tripled in the last 10 years, with the US at the forefront.

CDOs are generally used for baskets of debt rather than whole loans, and CLOs are used for leveraged loans. Typically, both are made up of debt already out in the markets that is being repackaged.

Private credit is focused on direct lending or mezz [mezzanine] debt — which combines debt and equity and is generally used for short-term financing — as well as distressed credit. In our current economy, distressed assets are fast becoming a popular investment strategy.

Private securitisations appeal to investors and borrowers as a funding strategy for businesses that have assets over which security can be granted. Using the same framework as traditional ABS [asset-backed securities] deals, investors acquire notes as the form of debt secured by an asset. This allows increased liquidity by virtue of the debt being a tradeable security in the form of a note or certificate.

Unlike funds, where investors are tied to capital commitments, an SPV [special purpose vehicle] acting as a securities issuer can issue further tranches of notes to keep up with demand for the investment or redeem notes when the SPV owners want to sell the asset.

The ability to move in and out of positions gives investors and managers greater flexibility than traditional funds, including more flexible terms than traditional bank loan arrangements permit. Though it’s noteworthy that the level of trades is not the same as in main markets. New investors for private securities are usually sought out by brokers and originators.

It’s also important to understand what makes a securitisation private as opposed to public. Typically, private securities are defined by whether there is a prospectus in place. Publicly traded or direct funding strategies generally do not need a prospectus.

What are some of the assets that typically go into making private securities, and are there any notable new asset types being securitised?

Mahen: We are seeing an increasing number of private credit managers going into the ESG space. Sustainable finance is here to stay and will be a dominant force in the next couple of years.

The transition to net zero economies is high on the agenda for many investors, and we have already seen a number of opportunities in the market. Some existing lenders have expanded their asset-class coverage, in part to meet this investor appetite.

There are other popular asset classes, many of which may not be well known, such as rare whiskey and fine wine, which have performed extremely well over the last decade.

Alexandra: One interesting part of securitisation is that almost any asset can be used as collateral. The assets must have an inherent value, either as a commodity or something that generates income. These include the traditional assets of real estate and stocks, but also as Mahen points out wine, as well as art, digital assets, precious metals and private credit — anything valuable from which a structured trade can be created. It’s important to remember that issuance vehicles are still subject to regulation, which protects investors, so local regulatory approvals will always apply.

Volume is an important factor. To generate high margins, you must cover the initial outlay by raising capital and securing against the asset. This outlay can be substantial, so private credit in the securitisaton world tends to attract mid-level managers and above. It’s notable that issuers can continue to raise capital through further tranches in any one investment. Similar to an open-ended fund, tranches allow more investors in during the life of the trade.

What individuals or groups are looking to enter the private securitisation market, and what are the primary benefits and risks associated with private securities?

Mahen: Depending in the market, one of the risks associated with private securities is that there can be a lack of secondary markets, which can make it hard for an investor to cash in on their transaction. There can also be less transparency and fewer regulations to protect investors, although many authorities around the world are addressing these concerns.

Another factor is that some funds are using untested business models to expand, and that is inevitable as new asset classes come into the frame, including sustainable economy assets, fintech expansion, bitcoins and other digital currency, to name a few. Here as always, investors need to perform rigorous due diligence to minimise risk.

Of course, nearly all financial instruments involve risk, and in recent years private securities have performed relatively well compared to other investment classes.

Alexandra: I mentioned prospectuses earlier. Some private securitisation structures are issued with no prospectus, usually to increase speed to market. This kind of non-traditional approach is part of a larger trend of proliferating alternative investment strategies, including moving away from equities and into private credit. We’ve seen this particularly in Europe and the US. In the US, midsize managers and high-net-worth individuals can access this market, which is below the usual CLO-level markets.

Investors can effectively manage risks by partnering with regulated transaction counterparties and investment managers with good track records. We [at Vistra] work with sophisticated professional and institutional investors who understand investor risk warnings related to credit and liquidity.

Basically, investors should thoroughly understand the quality of the underlying investment and track its performance. As more regulatory regimes promote transparency around sustainability — such as in the EU with the SFDR — and as technology evolves, reporting will keep pace to better inform investors.

Could you speak to how private securities are used as a means of off-balance sheet de-risking and why that’s important in today’s economic environment?

Alexandra: Significant risk transfers, or SRTs, are transactions used by banks and credit funds to free up capital. This type of structuring allows for de-leveraging by moving the debt off the balance sheet and into SPVs, though the loan servicing requirement remains.

The importance for banks in today’s economy is the optimisation of balance sheets to satisfy capital requirements. SRTs also provide for cheaper borrowing in a time when uncertainty over interest rates and inflation has investors looking at ways to effectively structure portfolios and allocate cash reserves.

Use of SPVs allows for the segregation of assets and is set up on a limited recourse basis. This allows for multiple notes or certificates to be issued, with each holding separate assets on a remote bankruptcy basis. We are seeing more programmes being established to allow for a wider spread of investments, such as with AMCs [actively managed certificates], where each certificate can be managed by different investment managers working across a variety of asset classes.

Could you give an example or two of a private securitisation deal, including the parties and assets involved?

Mahen: We’ve recently been working with a buy now, pay later [BNPL] firm to set up and maintain a structure. In this case, an SPV, as a purchaser, has been set up to acquire receivables from merchants on Europe’s online marketplace platforms.

This type of structure is commonly used by UK and European businesses that operate under a BNPL model. The roles we are undertaking, through various offices, include security trustee, data trustee, SPV administration, cash manager and backup servicer. We’re seeing many of our clients turning to this kind of ongoing, day-to-day outsourcing to lower their administrative burdens and take advantage of our technology.

Alexandra: Other deals we have seen include the securitisation of UK social housing. These types of structures often involve institutional banks and asset manager working together to create sustainable investments.

What are some reporting requirements and reporting best practices associated with managing private securities?

Alexandra: Transparency, market abuse and compliance are key pillars that drive regulation and reporting across the markets. The global financial crisis had a tremendous influence, leading ESMA [the European Securities and Markets Authority] and the UK FCA [Financial Conduct Authority] to develop and continuously improve market regulation in their markets.

Within the UK, the FCA have published new, more flexible rules for securitisation, which come into effect 1 November 2024. We expect to see further distinctions between private and public securitisations as a result.

Trading across the UK and Europe requires following regulations such as the EU’s Markets in Financial Instruments Directive [MiFID II], which increases transparency and standardises regulatory disclosures. It works alongside the Markets in Financial Instruments Regulation [MiFIR], encompassing OTCs [over the counter derivatives] more widely. These complement the relatively new Markets in Crypto-Asset Regulation [MiCA] in the digital asset space. The UK and EU also have market abuse regulation, or MAR. Also, certain issuer activities may fall within the scope of transparency directives .

Additional ongoing obligations apply in the jurisdictions where the securities are listed. Whether the Vienna MTF or SIX Swiss Exchange, different stock exchanges require differing ongoing obligations and levels of compliance.

The ultimate lesson here is that it’s important for managers to work with experienced teams to lower their risks.

Mahen: I’d add that it’s important to account for any reporting requirements agreed to between the parties of a transaction. These are supplemental reports that, although not required by law, are put in place to meet investor demand.

What is the role of security trustee in a private securities deal, and why is it important?

Mahen: Having an independent security trustee in a transaction is one of the key considerations that investors will consider before committing funds to a borrower. A security trustee will typically hold a security package for the benefit of the lenders. A security package can vary from one deal to another and may consist of a charge over bank account, receivables, a share pledge, property or other assets. A package is typically documented by entering into a security trust deed.

The importance of a security trustee is even more marked when there are multiple lenders, in which case the trustee can act as point of contact for the borrower. This ensures a coordinated approach and makes it more efficient when it comes to registering the securities or seeking consent from the lenders.

Security trustees provide other efficiencies, for example in transactions where the lenders are likely to change over the life of the deal. There’s no need to transfer the underlying security from the outgoing lender to the incoming one when using a security trustee. This can lead to significant cost savings in addition to reducing administrative burdens.

Another important aspect of the role relates to enforcement. A security trustee has no financial interest in the transaction, which enables the trustee to act impartially when enforcing the security agreement and distributing proceeds.