Thus, revenues from air ticket sales, electricity sale, telephone rentals, and export receivables from natural resources have been the subject of future flows securitization. However, in an apparent overdrive, sometimes, even something as integrally performance-based as the sales of goods or services are considered out of businesses that require continued performance.

It is important to completely understand the answer to these questions, as it also highlights the proper application of future flows transactions. Conceptually, future flows transactions would make sense for the originator if it helps the originator to reduce its overall cost of funding. This would be possible only if (1) the transaction helps the originator to borrow more; and/or (2) the transaction helps the originator to borrow at less costs.

The extent of borrowing possible in future flows deals is determined by the cash flows and the level of overcollateralization required. A traditional lender, in contrast, is mostly concerned with values of assets on the balance sheet. For example, a typical working capital financing bank looks at the current assets on the balance sheet. If the balance sheet assets are four months of cash flow, a bank might provide 75% thereof, or three months of working capital. A securitization investor looks at cash flows for a regular servicing: with a collateralization of two times, a securitization transaction might result in funding of even 20 months of cash flow. Therefore, it is quite possible for a future flow deal to result in an increased extent of borrowing.

On the cost of borrowing, the essential question is: Does future flow securitization remove any of the risks of traditional lending? All traditional lending is subject to the performance risk of the originator. If the originator does not perform or function at all, a lender would face default. The same is true for securitization. However, future flows transactions remove two significant risks—credit risk and sovereign risk.

Credit risk, divested from the performance risk of the originator, implies a situation where the originator has cash flow, but does not pay up investors. This problem would be resolved in securitization if the transaction gives the special purpose vehicle (SPV) a legal right over the cash flow that is trapped at the source.

Another important objective of future flow transactions has been to remove sovereign risk. This applies for cross-border lending, as several of the future flows transactions in the past have been targeted at cross-border investments. If an external lender gives a loan to a borrower, say, from an emerging market country, the risk the investor faces is that in the event of an exchange crisis the sovereign may either impose a moratorium on payments to external lenders or may redirect foreign exchange earnings. A future flow deal tries to eliminate this risk by giving investors a legal right over cash flow arising from countries other than the originator’s, thereby trapping cash flow before it comes under the control of the sovereign.

As such, one of the motives in future flow securitization is to allow the originator, individually a strong company but based in a country with a poor sovereign rating, to pierce the sovereign rating.

Take the instance of a typical transaction by, say, a Mexican originator. The Mexican company has an option of borrowing from international markets, but the lenders would be concerned with currency risk and sovereign risks. This originator, say, exports crude oil to the United States. The cash flow emanating out of the United States will be securitized and transferred to the SPV set up in the United States. The importers buying the crude oil from this originator would sign a notice and acknowledgement of assignment so as to subject them to U.S. law and force them to make payments to the SPV.

Now, the investors are secured against exchange risk, as the export receivables are in U.S. dollars. The investors are secured against sovereign risk as the cash flows are payable by U.S. companies which are not subject to the sovereign’s controls. The only risk the investors face is if the company is not producing and exporting at all, or the company redirects its exports to some other countries not covered by the legal rights of the investors.

While the above is a typical future flows deal based on sales of goods or services, the future flows transactions may be classified into the following broad categories:

If the originator’s rating were to serve as a cap, subordination, which is basically intended to provide a rating upliftment, does not work for future flows.

In addition, the excess of the inflows over the required debt service is typically pooled into a few months’ cash reserve. The cash reserve helps smooth the temporary periods of volatility in the cash flow.