For new audio-visual media companies, intellectual property (IP) is a crucial asset. On 11 April 2018, the State Council issued the Guidelines on Supporting Hainan in Comprehensively Deepening Reform and Opening-up, calling for “encouraging to explore securitisation of IP and improving the credit guarantee mechanism for IP”. iQiyi, one of China’s mainstream video website operators, has launched three IP securitisation products in the two years since December 2018, making itself a trendsetter in the industry.
IP asset-backed securitisation (ABS) can fully unleash the benefits of IP and heighten the level of profit transformation. However, a reasonable deal structure should be designed scientifically to guard against legal risks.
The value chain of the new audio-visual media industry mainly includes the following links: Supply of content (in-house production, purchasing, sub-licensing, distribution, etc.); content services (subject to content service licence or other qualifications); integrated services (subject to the permit for the broadcast of audio-visual programmes via information networks, and the integrated service licence); transmission and distribution (network operators, channels, technical service providers); terminals (manufacturers of televisions, projectors, smartphones, set-top boxes, etc.); and consumption (subscribers).
High-quality content represents the core competence of a new audio-visual media company, and its IP mostly takes the form of copyrights, especially the right to disseminate works through information networks, and also involves computer software copyright, patents and trademarks.
The latest Copyright Law enacted on 11 November 2020 has expanded the scope of “works” to include all “other intellectual achievements that meet the characteristics of works”. In addition, the description of “cinematographic works and works created in a way similar to cinematography” has been replaced with “audio-visual works”. This change reflects the challenge posed to copyrights by the rapid development of new audio-visual media services. The objects of copyright are becoming increasingly diverse, and the assets that can be securitised are constantly evolving.
Selection of underlying assets
Intellectual property ABS is a process in which the originator transfers its IP or derivative claims to a special purpose vehicle (SPV), which uses such assets as collateral and issues negotiable securities in the market after repackaging, credit evaluation and credit enhancement, thereby financing the originator.
Underlying assets are the starter and cornerstone of intellectual property ABS. According to relevant laws and regulations and practical needs, the author believes that the viable underlying assets for intellectual property ABS should at least meet the following requirements: Predictable cash flows; clear credit characteristics; easy valuation; low probability of default; and high liquidating value.
As IP comes as a combination of property rights and personal rights, direct transfer of IP is of low operability. Moreover, given the immature valuation system seen today, it is not feasible to directly take IP as an underlying asset. However, it is advantageous to take the related claims, such as authorised royalties derived from IP rights, as the underlying assets.
Any link in the new audio-visual media industry chain can integrate its upstream and downstream activities, and take the claims on financial lease, accounts receivable and microloans as underlying assets to proceed to the selection, packaging, design, credit enhancement and issuance of assets that can be securitised.
In selecting underlying assets, due care should be taken to spread risks, develop an optimal portfolio out of the asset pool, and avoid the risk of cash flow disruptions caused by the unstable operation of individual IP rights or derivative claims. For this purpose, due diligence should be conducted on underlying assets before their inclusion in the pool.
The design of product structure should be preceded by onsite investigation and data analysis of the target company’s assets, operations, finance, liabilities and other investment matters by such intermediaries as lawyers, certified public accountants, securities firms and IP professionals in an effort to clarify the ownership, term, type, scope and defects of rights in underlying assets, and to create a package in which different types of IP rights are arranged to supplement each other.
SPV design, risk control
In order to protect the common interests of the target company and investors to the maximum extent, and avoid the risk of possible bankruptcy, it is necessary to set up a an SPV to separate and transfer the underlying asset package from the originator and the issuer to the SPV.
Regarding the legal framework, it is the best choice to designate a specific asset plan set up by a securities company and fund management subsidiary as an SPV. Creditors transfer their underlying assets such as IP rights and derivative claims to the original beneficial owner, which enters into an underlying asset purchase agreement with the SPV manager, by which it transfers the underlying assets to the SPV. The SPV manager then sets up an asset-backed special scheme to raise funds from investors, and enters into service agreements with relevant service providers, the custodian bank and the registrar to carry out securities issuance and management.
If the underlying assets are transferred to the SPV, the debtors shall be notified of such transfer. The core debtor in the intellectual property ABS is obligated to repay the due debt, and is usually the main user of proceeds, in practice. The debtor’s timely fulfilment of obligation is critical to the success of securitisation. Therefore, the debtor should be notified in time according to the legal and contractual provisions, so that it can transfer the payables to the custodian bank in time, according to the scheme brochure or investment agreement. The SPV manager should regularly monitor the debtor’s operating conditions and debt service, and guard against the risk of default.
Chen Wei is the managing partner at the Tianjin Office of DOCVIT Law Firm
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