LOAN COLLATERAL POOLING UNDER THE STERLING MONETARY FRAMEWORK AND FUNDING FOR LENDING SCHEME: EXPLANATORY NOTE

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1 10 June 2014 LOAN COLLATERAL POOLING UNDER THE STERLING MONETARY FRAMEWORK AND FUNDING FOR LENDING SCHEME: EXPLANATORY NOTE Introduction Purpose 1. This note explains: (a) the structure of the Bank s documentation for accepting portfolios of loans as collateral to cover exposures to counterparties arising under: (i) the Bank s Sterling Monetary Framework (SMF), including the Discount Window Facility (DWF) (within the DWF pool ) and the rest of the SMF (currently the Indexed Long-Term Repo operations (ILTR) and Contingent Term Repo Facility (CTRF)) being the main collateral pool ); and (ii) the Bank s Funding for Lending Scheme (FLS) (within the FLS pool ); and (b) the legal mechanism for the provision of loan collateral under the FLS and SMF. 2. This note is intended for information purposes only and is subject to agreeing all facility documentation with the Bank in connection with the pre-positioning of loan collateral. The Bank makes no representation or warranty regarding the accuracy or completeness of the information contained in this note. 3. Terms which are defined in the applicable facility documentation have the same meanings in this note. Transfer of Loans 4. Loans can be transferred to the Bank by one of two methods: equitable assignment or declaration of trust. 1 The Bank will determine which of these alternatives should be used for each loan portfolio (although the Bank s preference is for collateral to be transferred by equitable assignment whenever possible). 1 The Bank may consider in extraordinary circumstances the grant of security over (as opposed to the transfer of title to) a loan collateral portfolio by way of first fixed charge. The Bank would in such a case provide the Participant with detailed terms as to the required security arrangements at the time and such a mechanism for the provision of loan collateral by a counterparty is therefore not considered in this note.

2 5. The SMF Terms and Conditions (which apply to liquidity advanced under the DWF, ILTR and CTRF, being the facilities under the SMF for which loan portfolios presently constitute eligible collateral) are supplemented by a number of annexes (Annexes) which contain specific provisions for different types of loans and the different transfer methods outlined above. 6. Under the collateral pooling structure, advances (of cash or DWF Swap Securities in accordance with the terms of the applicable facility) under the ILTR, CTRF and DWF are made against the provision of eligible loan collateral which is delivered to the Bank and then allocated to the appropriate pool or pools (with such loan collateral being provided pursuant to the Annexes as further described below). Similarly, the FLS Terms and Conditions (which apply to liquidity advanced under the FLS) use the same Annexes such that advances (of Treasury bills) can be made by the Bank under the FLS against the provision of eligible loan collateral to the Bank and allocation to the FLS pool. 7. The Participant will need to provide details of loan portfolios offered as collateral to enable the Bank to undertake due diligence on the portfolios and, once approved, the portfolio will be allocated to the pre-positioned pool for loan collateral so that its transfer can take place without delay. 8. The transfer of loan collateral from the pre-positioned pool for loan collateral 2 to the Bank pursuant to the Annexes will be triggered in each case under both the SMF and the FLS by the counter-signature by the Bank of a Loan Collateral Transfer Request Notice received from the Participant following a collateral call by the Bank, or in circumstances where the Participant wishes to increase the collateral allocated to (i) the main collateral pool, (ii) the DWF pool or (iii) the FLS pool under the FLS (even though no collateral is then required by the Bank, for example), to cover an anticipated advance under a facility (with, in each case, further requirements for Scottish loans and English loans transferred by a declaration of trust as outlined below). Overview of Documentation Annexes, Declarations of Trust and Trust Asset Designations 9. As described above, there are a number of different Annexes which are tailored to the particular types of loan and method of transfer, including: (a) assignment Annex; (b) declaration of trust Annex; and 2 For a further description of the loan pre-positioning process, see below. 2

3 (c) Such other form of annex as the Bank may require if the Annexes set out in paragraph (a) or (b) above are not appropriate for the relevant loan portfolio. 10. As explained further below, where the method of transfer used is a declaration of trust, the Participant will also be required to enter into a Declaration of Trust and provide to the Bank a Trust Asset Designation (in standard form). Separate Scottish Declaration of Trust and Scottish Transfer form are required for Scottish loans. Operating Procedures 11. The SMF Operating Procedures describe the process for submitting loan portfolios to the Bank to determine their eligibility. The FLS Operating Procedures describe the additional procedures to be followed where loans are to be used as collateral under the FLS. 12. Loans must be pre-positioned in accordance with the SMF Operating Procedures and must satisfy the relevant eligibility requirements for use as collateral in an SMF collateral pool for the purposes of the DWF, ILTR or CTRF and as collateral in the FLS pool under the FLS. Other Documentation 13. As part of the eligibility process, a Participant must also provide certain documentation to the Bank before it is able to provide loans as collateral: (a) (b) (c) (d) an executed power of attorney to give the Bank the right to act as agent or in the name of the Participant in relation to the loans. A single power of attorney covering the SMF and FLS will be signed at the time loans are pre-positioned; in relation to Scottish loans, in addition to the Scottish Declaration of Trust referred to above, Scottish Transfer forms (these will be required to be in pre-agreed form to enable them to be signed on drawdown); in relation to English loans to be transferred by a declaration of trust, a Declaration of Trust and a Trust Asset Designation are required to be delivered on drawdown; a legal opinion confirming, among other things, the assignability and enforceability of the loans. It is possible that more than one legal opinion will be required by the Bank if any element of a loan portfolio is in a particular jurisdiction (for instance, an opinion may be required from Participant s counsel: (i) in the jurisdiction in which the Participant is domiciled or incorporated; (ii) in the jurisdiction in which the underlying borrowers are domiciled or residing; (iii) in the jurisdiction in which the laws of that jurisdiction govern the loans in the loan portfolio; and/or (iv) in the jurisdiction in which security is created/perfected by the Participant). A single opinion in the 3

4 Bank s standard form and covering the SMF and FLS will be required at the time loans are pre-positioned; (e) (f) a legal due diligence report to confirm the eligibility of the loan portfolio. The Participant may be required to deliver more than one report where the loans to be used as collateral are governed by the laws of more than one jurisdiction. For instance, if loan collateral is to consist of some loans governed by English law and other loans governed by Scots law (loans governed by Scots law must be provided in a separate portfolio), then an English legal due diligence report and a Scottish legal due diligence report must be delivered to the Bank; and an audit report in relation to the loan portfolio that is to be pre-positioned. 14. All of these documents are to be provided to the Bank in a standard form (which the Bank will provide) other than the audit report, the form of which will be agreed between the Participant and the Bank. Pre-positioning of Loans in the SMF or FLS 15. So that liquidity can be advanced quickly under the SMF and FLS against loan portfolios, a Participant is required to pre-position loan portfolios that are to be provided as collateral in each case, using the current loan pre-positioning process described in this section and set out in more detail in the SMF Operating Procedures. It is a condition precedent for including a loan portfolio in the main collateral pool, DWF pool or the FLS pool that the Participant has completed all the eligibility and pre-positioning requirements. 16. The pre-positioning process is essentially a due diligence process whereby the Bank confirms on pre-positioning that the loan portfolio is eligible and ready to be transferred. The loans are not transferred to the Bank at the pre-positioning stage. 17. The Participant is required to update information relating to pre-positioned portfolios on a monthly basis. 18. Having completed the eligibility process to the Bank s satisfaction (as set out in the SMF Operating Procedures, including completion of the documentation outlined in paragraph 13), prepositioning involves notifying the Bank of a loan portfolio that the Participant wishes to provide as collateral in the future by completing the pre-positioning notice available on the Bank s website. Upon completion of all pre-positioning conditions precedent, the portfolio will be included within the pre-positioned pool for loan collateral (although the Bank does not acquire any rights in the loan collateral at this stage). 4

5 Transfer of Loan Portfolios 19. Having complied with the eligibility requirements and pre-positioned a provisional loan portfolio in the pre-positioned pool for loan collateral, a Participant may request, by submitting a Loan Collateral Transfer Request Notice to the Bank, that a loan portfolio be used as collateral to cover exposures (which may arise from either anticipated advances of additional liquidity or fluctuations in collateral values) under the SMF or under the FLS from time to time. Such notice will specify the particular loan portfolio that the Participant proposes be transferred to the Bank to cover the anticipated exposure (or actual exposure following a call for additional collateral after a decrease in existing collateral values). Once the loan collateral is transferred to the Bank, the Bank controls movement between the main collateral pool, DWF pool and the FLS pool. The loan collateral can be used to meet an exposure in the main collateral pool, DWF pool or FLS pool as relevant. Participants may also request movements of loan collateral between the main collateral pool and the FLS pool using the process outlined in the SMF Operating Procedures section If the portfolio has already been provided as collateral (for example with respect to liquidity that has been repaid) and has not been re-assigned or re-transferred to the Participant, the Bank may still permit the Participant to use part of the value of that loan portfolio to cover an anticipated or newly arisen actual exposure (and, as outlined below, including where the existing loan portfolio has been allocated to a collateral pool for another facility within the SMF or has been delivered under the FLS for inclusion within the FLS pool). Participants may instruct such changes with respect to SMF and FLS pools from time to time, except in relation to the DWF pool, where only the Bank can instruct the relevant movements, having first agreed them with the Participant. Cross-collateralisation and re-allocation of Loan Portfolios 21. Participants will instruct changes to the collateral composition of the main, DWF and FLS collateral pools from time to time, including for loan portfolios; for the DWF collateral pool any changes must first be agreed with the Bank, and the Bank, not the Participant, will complete the necessary instructions. Economically, loan portfolios provided under the SMF will be allocated to the appropriate pool(s) in line with the changes to composition instructed. A loan portfolio (or part thereof) held in the main collateral pool would therefore be used to cover an ILTR and/or CTRF exposure(s) and a loan portfolio (or part thereof) held in the DWF collateral pool would be used to cover DWF exposure(s). Any collateral shortfall for the ILTR and CTRF will be assessed separately from the DWF by comparing liquidity advanced under each facility with the aggregate value of collateral allocated to the relevant collateral pool, but legally the collateral will be held by the Bank under the SMF. Loan portfolios transferred to the Bank under the SMF or FLS are not allocated to particular advances and therefore the return of loan portfolios will not be triggered by the maturity of a particular advance under either the SMF or the FLS. 5

6 Cross-collateralisation 22. Loan portfolios must be transferred under either the SMF collateral pooling structure i.e. to support liquidity advanced under the ILTR, CTRF and/or DWF (in which case they will be allocated to the main or DWF collateral pools as described above); or the FLS collateral pooling structure (in which case they will be allocated to the FLS collateral pool). However, the ability to crosscollateralise means that a Participant may be able to make a drawing under the SMF against the value of a loan portfolio provided under the FLS (or vice versa) and to use the value of a loan portfolio to cross-collateralise between the FLS and SMF on an ongoing basis (provided that the loan portfolio has sufficient value in the Bank s discretion to cover all required exposures). Absent a reallocation of all or part of the loan portfolio as described in paragraph 23, the loan portfolio will in legal terms remain within either the FLS or the SMF depending on which facility it was originally transferred to support as described above. On a close-out, the loan portfolio will therefore constitute loan collateral for either the FLS or the SMF, according to the original basis of the transfer, and will therefore be valued and applied against the outstanding obligations for the FLS or SMF as relevant. Re-allocation 23. Where a single loan portfolio is being used for cross-collateralisation as described above between the SMF and the FLS, and all outstanding transactions under the relevant structure (SMF or FLS) mature, the loan portfolio may not be re-transferred to the Participant upon the reduction of the Participant s exposures to zero, but may instead be retained by the Bank and will from that point be reallocated to the other pool structure and held by the Bank against outstanding liquidity advances under the other structure. For example, assume a loan portfolio is originally transferred under the SMF and is subsequently used to cross-collateralise FLS drawings. On the maturity of the last SMF advance outstanding to that Participant, the Bank may then re-allocate the loan portfolio to support the FLS. 24. Additionally, where a single loan portfolio is allocated to the main collateral pool or the FLS pool, the Bank reserves the right to split such loan portfolio into two (or more) portfolios and reallocate the new portfolio (or portfolios) within the FLS (or SMF) on an ongoing basis in accordance with the terms and conditions relating to the FLS (or SMF), as applicable. Methods of Transfer 25. As described above, loan collateral may be provided by way of either (1) an assignment and transfer by the Participant of its beneficial interest in the Loans and their Related Security, or (2) a declaration of trust over its beneficial interest in the Loans and Related Security. 26. The Participant retains its legal interest in the loans comprised in a transferred loan portfolio (whether a transfer by assignment or declaration of trust is used), upon providing collateral (and 6

7 remains the lender of record). On default by a Participant in the case of a transfer by way of equitable assignment, the Bank may acquire legal title to the loans at which point the Bank will become the lender of record. 27. In the case of a declaration of trust, the Participant will declare a trust in favour of the Bank over an initial amount of 100 pursuant to a Declaration of Trust and will designate relevant loans as trust assets by a Trust Asset Designation (the loans referred to in the Trust Asset Designation will be updated on a monthly basis to ensure that the Trust Asset Designation is up to date). 28. The Trust Asset Designation will be provided to the Bank to be held until the time at which such loans are required to collateralise advances under the DWF, ILTR and/or CTRF under the SMF and/or under the FLS at which time the Trust Asset Designation will be endorsed by the Bank and will be deemed to be delivered. Once the Trust Asset Designation is deemed to be delivered the beneficial interest in the relevant loans will be held on trust for the Bank as Trust Assets. 29. With regard to Scottish loans, the Scottish Declaration of Trust and Scottish Transfer forms will be signed by the Participant at the time at which such loans are required to collateralise liquidity advanced under the SMF or the FLS and be delivered to the Bank at which point the beneficial interest in the relevant loans will be held on trust for the Bank. 30. In the case of both a transfer by equitable assignment and by declaration of trust (for both English and Scottish loans), as described above, the Participant will provide a Loan Collateral Transfer Request Notice to the Bank at the time at which the relevant loan portfolio is required to collateralise liquidity advanced under the SMF or under the FLS, at which time the Bank will countersign such notice (and where equitable assignment is being used as the means of transfer, the equitable assignment of the loans to the Bank will take effect at that point). Administration of Loans 31. The Bank appoints the Participant as administrator in respect of loans that have been provided as collateral and may terminate that appointment only in the limited circumstances of the occurrence of an Event of Default or a failure by the Participant to fulfil its obligations as administrator and the Bank considers that termination is necessary to protect its interests. 32. Consistent with the retention of legal title by the Participant, while any transaction supported by a loan portfolio remains outstanding, the Participant holds (a) the title deeds and loan files and related documents for the Bank and (b) all sums received in respect of the loan portfolio, in each case on trust for the Bank. 33. Where the Participant s beneficial interest in loans has been assigned and transferred to the Bank, the Bank will make manufactured payments in respect of income and other distributions arising in respect of such loans. The amount payable by the Bank is offset against the relevant 7

8 amount held for it by the Participant under the trust so that no actual payment is required to be made (and the Participant is therefore effectively collecting and administering the loans for its own account prior to default). Release of Income 34. If, at any time, there are no obligations of the Participant that are outstanding and no event of default (or potential event of default) has occurred in respect of the Participant, the Participant may release any such sums from the trust referred to above. Termination 35. Subject to the return of excess collateral described below and the reallocation process described above, the Bank will only have an obligation finally to re-transfer loan portfolios upon repayment of all advances (in respect of FLS collateral made under the FLS or in respect of SMF collateral provided to the Bank) and any related fees payable to the Bank under the applicable facilities. The Bank will give notice of any such re-transfer to the Participant (and will also deliver any additional notices required for the re-delivery of loans transferred by declaration of trust as outlined above). Any loan portfolios held under the FLS (or SMF) that are also being used to cross-collateralise liquidity advances under the SMF (or FLS) at that point, will not be retransferred but may be re-allocated to the SMF (or FLS) as described above. 36. Where DWF, ILTR or CTRF advances remain outstanding under the SMF or FLS Transactions remain outstanding under the FLS, but the Bank holds excess collateral under the SMF or FLS (whether as a result of the repayment of advances or an increase in the value of collateral allocated to the applicable collateral pools), the Bank may return surplus loan collateral by retransferring a loan portfolio or loan portfolios upon request (although in the case of collateral allocated to the DWF pool, subject always to the prior approval of the Bank). The Bank will give notice of any such re-transfer to the Participant (and will deliver any additional notices required for the re-delivery of loans transferred by declaration of trust as outlined above). The Bank may also at its sole discretion (and only in extraordinary circumstances) agree to the removal of individual loans from loan portfolios allocated to the FLS pool or the main collateral pool. Additional Collateral and Substitution 37. Additional loan portfolios may be transferred under the SMF and/or FLS in the manner outlined above by a Participant (and allocated to the appropriate collateral pool or pools in the case of the SMF) to collateralise exposures arising from time to time in accordance with the collateral maintenance provisions in the FLS and SMF Terms and Conditions. 38. Whilst a loan portfolio has been pre-positioned and has been included in the loan prepositioned pool for loan collateral, the Participant may substitute loans in that portfolio or the 8

9 portfolio itself (provided that the eligibility requirements are met with respect to the new portfolio) at any time before providing that portfolio as collateral under the SMF or FLS. 39. Loan portfolios allocated to main collateral pool may be substituted if the Participant wishes, by providing additional collateral for inclusion within the pool and requesting the withdrawal of the relevant loan portfolio as excess collateral from the main collateral pool in accordance with the SMF Documentation (the same applies to loan portfolios delivered under the FLS where excess collateral is present in the FLS pool). If a loan portfolio has been allocated across both main collateral and FLS pools, then sufficient additional collateral will need to be provided prior to removal of the loan portfolio in respect of both the main collateral pool and the FLS pool. Updated 10 June