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The Protected Cell Companies in a Nutshell

 

III. The Protected Cell Company: a new form of investment fund

Protected Cell Companies are also authorized in Guernsey to operate as investment fundsxii. These entities are suitable vehicles for the operation of mutual funds, especially in the form of umbrella funds, having each cell as a sub-fund. A sponsor, for example, may structure a multiple series fund by setting up a PCC, in which case each cell may represent the different group of investments for which the distinct classes or series of shares are offered to the fund's investors. The use of a single entity structure for the different funds ("series fund") -in contrast to a "family of funds" structured with multiple entities in which each separate legal entity represents a particular fund- would eliminate or reduce costs, by using -for example- a single board, the same distributor, custodian, transfer and payment agent, and the same prospectusxiii.

IV. The Protected Cell Company as Conduit for Structured Finance

Although relatively a new instrument, the uses of a PCC have grown and diversified in the past recent years. Since its inception in 1997 this entity have evolved from being an alternative to the rent-a-captive scheme and an investment fund vehicle to become a suitable conduit for insurance risk management.

The PCC may be used for securitizing insurance risk against catastrophic losses, such as natural disasters; thus increasing sources and availability of capital and stabilizing underwriting results of domestic insurance companiesxiv. Securitization of catastrophe risk have taken several forms, which include among the principal ones "contingent surplus notes", catastrophe or "Act of God" bonds (CAT Bonds), CatEPuts, and exchange-traded catastrophe optionsxv. In terms of regulatory developments for these purposes, various States in the United States of America have adopted the PCC concept, looking for ways to generate insurance risks securitization business "onshore". In this regard, for example, sponsored by the National Association of Insurance Commissioners (NAIC) -which approved a model law-, Illinois adopted the Protected Cell Company Law (amending its Insurance Code)xvi, which purpose is the creation of "more efficiency in conducting insurance securitization, to allow domestic companies easier access to alternative sources of capital, and to promote the benefits of insurance securitization generally"xvii. Rhode Island copied the strategy by means of The Protected Cell Companies Act (Chapters 27-64 of Title 27 Insurance of its Code)xviii, and Vermont followed the trend with the concept of the "Sponsored Captive Insurance Company", which is defined in such law as any captive insurance company that segregates each participant's liability through one or more protected cellsxix. Lastly, South Carolina joined also the clubxx.

4.1 Protected Cell Companies and Securitization Corporations: Twin Conduits

It has been reported the introduction of single cell/class fund concepts into Italian company law, "which are at odds with the pari passu principle which treats debtors equally on insolvency"xxi. Law No. 130 of April 30, 1999, approved by the Italian Parliament, provides for the creation of "securitization companies", pursuant to which the receivables assigned to such entities are segregated from other assets of the securitization company and may only be attached by holders of the securitization securities pertaining to those receivables. To the best of my knowledge, the Italian securitization company has as precedent the "sociedad securitizadora" (securitization corporation), which originated in Chile by means of Law 19,301 of 1994 (which amended the Securities Markets Laws)xxii. The PCC concept resembles the Chilean sociedad securitizadora in the sense that it also provides for the segregation of assets, which back the different issued securities. Under Chilean law, the sociedad securitizadora is deemed a special corporation ("anónima especial") whose sole purpose is the acquisition of credits (as defined by law) and rights over cash flows, and the issuance of debt securities (short or long term instruments); therefore, they may act as the assignee of the transferred financial assets and as special purpose issuer of the asset-backed securities. Pursuant to the Chilean law, each issuance originates the formation of separate patrimonies distinct from the common patrimony of the entity, a structural corporate characteristic found in the PCC. The difference among these is that the Chilean law allows for the securitization of various underlying financial assets, to wit: mortgage notes, "mutuos hipotecarios", assets and leasing contracts, credits and rights over cash flows (mainly of public projects) and any other credits documented in writing and that are transferable in naturexxiii, while the PCC American legislation restricts their use to securitizing insurance risks. Other jurisdictions, such as Brazilxxiv, Paraguayxxv, Peruxxvi, and Ecuadorxxvii have followed the trend and adopted -either by law or regulation- similar versions of securitization companies, all of which have brought remarkable progress and innovations to the Latin American asset-backed securities markets. Lastly, with the aim of bringing securitization "onshore" the United States, the National Association of Insurance Commissioners' Insurance Securitization Working Group focused in the adoption of a model law on "special-purpose vehicles"xxviii and on February 6, 2001 agreed -in principle- to such model actxxix, which would facilitate setting up securitization special purpose entities within the United States. This trend shows the increasing and strong competition among jurisdictions to provide the best vehicles to generate structured finance businessxxx.

If properly structured and with the adequate regulatory scheme in place, a PCC may be used for multi-series structured finance transactions, in a similar manner as the Chilean securitizadoras may be utilized. For example, the PCC may act as the special purpose vehicle-issuer for the securitization of different pools of assets, by repackaging them and issuing different types of asset-backed notes, each type of note been backed by the assets forming a separate protected ring-fenced cell (giving rise to "cellular-asset-backed securities"). Even the core assets may be used as a credit enhancement mechanism within the structure. The PCC may be structured in a way in which it would have as many and distinct cells as needed for the different pools of receivables that may be repackaged. In this sense, a bank or finance company may pool and repackage loans per geographic areas, per outstanding balances, per type of loans or by type of security backing such creditsxxxi. A segregated cell "X" would then back the notes "X", cell "Y" would back notes "Y" and so on. In the event of default on the X notes, then the assets backing the Y notes would not be affected, giving complete ring-fencing protection to the different asset-backed securities-holders, enabling the bank or finance company to structure the deal with such flexibility that it may issue ring-fenced multi-series of securities for different markets or type of investors. The segregated cells may provide for a legally strong manner for "tranching"xxxii (thus creating different levels of prioritization or subordination among the securities), in which case each separate cell may represent a tranche and even within such cell different levels of tranches may be established. Obviously, the transaction documentation must clearly set forth the rights and obligations of the parties, including the ones of each protected-segregated cellxxxiii.

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