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70. U.S. delegation memorandum on railway rolling stock finance protocol (March 2007)

UNIDROIT DIPLOMATIC CONFERENCE AT LUXEMBOURG FEBRUARY 12-23, 2007 ADOPTED A PROTOCOL TO THE CAPE TOWN CONVENTION ON RAILWAY ROLLING STOCK FINANCE

USG positions and objectives

Over 40 States participated representing all regions, plus the World Bank, the Hague Conference, the Southern African Development Community (SADAC), the European Investment Bank, the European Commission, and industry-based NGOs including the Unidroit-sponsored Railroad Working Group (RWG), the International Rail Transport Committee, the International Union of Railways, and others. The negotiation concluded (the first of several milestones as noted below before US ratification can be considered) a four-year project to bring to railroad finance the benefits we have already secured for aircraft and air transportation under the new UNIDROIT treaty system (the “Cape Town Convention”) for international equipment finance.

The principle effects expected of the Luxembourg Protocol, consistent with US objectives going into the final negotiation, are: (a) significant enhancement in global financing of rail equipment and increase of exports of rail equipment, (b) boosting domestic rail improvements, and especially capacity of developing countries to obtain modern rail facilities, (c) boosting potential regional rail development where geography and political circumstances permit, (d) reaffirming the trend toward modern US-style secured finance laws and economics, begun in 2001 with the UNIDROIT Cape Town Convention and the concurrently negotiated UNCITRAL Convention on assignments financing, and (e) protecting the North American (US, Canada, Mexico) rail system so that it would only come under the Protocol’s new international finance registry system if North American rail industry interests (rail operators, manufacturers, financers and regulators) agree to that.

The 2001Cape Town Convention, which established the framework for the Luxembourg Protocol, requires a separate protocol for each type of equipment. The first protocol to that Convention covered aircraft, aircraft engines and helicopters, came into force in 2006, and is already covering over fifty (50) percent of the worldwide aircraft transaction market, a major achievement. The circumstances of the two international industries, aircraft and rail, are substantially different and the dynamics of the negotiations therefor were quite different.

First, the international organizational framework was different. All protocols to the Cape Town Convention are negotiated under UNIDROIT auspices, a small intergovernmental body headquartered in Rome which is highly productive in the private transactional law field, and which in some cases partners with other international bodies in each relevant sector. For aircraft, that was an obvious connection with ICAO (International Civil Aviation Organization, a UN specialized agency) which now serves as the Supervisory Authority for the new aircraft transaction registry system, and the USG as a member of the ICAO Council is adequately positioned there. Rail however has no comparable UN body or other organization which has jurisdiction over transportation. The largest multilateral rail transportation body is the Bern, Switzerland-based OTIF (Intergovernmental Organization for International Carriage by Rail), which has taken an active role in the process and was selected to become the Secretariat for the new Registry system as well as the Preparatory Commission of 20 states that will establish the rail registry. While we have no issue at this juncture with how OTIF manages its affairs, it remains a regional body, largely composed of European states, with some additional membership from North Africa and the Middle East (its role in this rail protocol is expected to expand its membership). Neither the US, Canada or Mexico are parties to OTIF, thus making the optional carve-out for national or regional rail systems vis-a-vis the new registry system an important US objective, which was met.

In addition, the markets themselves are different. US rail markets already benefit from UCC asset -based finance law (which the treaty incorporates) and are already largely integrated in the three NAFTA states, whereas European markets lack both an equally modern commercial law and sufficient integration of their practices to achieve efficiencies. US rail is largely freight-based and largely private sector, unlike European and some other systems which rely more on passenger service and are more often government-related, which is reflected in differing financing and registration practices. For the cost of a new international finance registry to be reasonably amortized, air finance needed the entry of the US aircraft markets into that system to avoid substantial delay. The opposite may be true for rail, where either European rail interests or a combination of large developing countries with significant rail service can result in sufficient transactional filings to amortize such costs. Moreover, it is expected that at least in the near term US rail may seek a carve-out from the new registry system even if the US ratifies the Protocol. For these various reasons the negotiating capacity of the USG and US interests were different in the context of rail transportation than for air.

Finally, it is worth noting that, unlike the aircraft protocol, US rail manufacturers and financing interests may obtain some, tho not all, benefits of a new treaty-based rail finance system without the US becoming a party. Since the Convention itself is already in force, US based parties can sell or lease to entities located in a country party to the rail finance protocol and obtain some of the protections afforded by the protocol without the US being a party thereto. The circumstances for aircraft were different. There, since the Convention and the aircraft protocol were the first international instruments to promote a system based on UCC asset-based concepts, absence of US ratification would have made it unlikely that many other countries would have ratified it. The new rail protocol is likely to move forward even if the US does not ratify it.

As noted above, more milestones need to be met following the negotiation for the US to consider ratification. First, private commercial law treaties require, unlike most public law treaties, very specific language carefully interwoven as to all parties’ rights and interests, each provision of which is then assessed closely by capital markets analysts and international credit risk raters as to the effect in transactions (a process that sets credit and transaction costs up front). This leads to extended informal negotiations, after conclusion of the protocol treaty text, as to the wording of an official commentary on the text, which fills in a number of factors important to transactions and credit ratings.

Assuming that is concluded satisfactorily, detailed negotiations are required (and are already planned to be underway later in 2007) to work out the technical and policy issues surrounding the setting up of a new international computer-based finance registry for rail interests. This type of transparent system, built into the Convention itself, tracks market-tested concepts in the Uniform Commercial Code (UCC) in force in all states of the US and comparable to law in all provinces of Canada. Setting up and funding a new system accessible worldwide which permits accurate searching for prior financing interests recorded against any rail equipment, when the underlying national registry systems are widely different, is quite challenging.

Only when these next two phases are complete can the potential value and benefit for US rail interests and US export and development assistance programs be assessed. We have given assurance to the US rail industry that any future consideration by DOT, Commerce, EXIM Bank and others as to possible USG interest in ratification would be premised on deference to the US rail industry as to whether or under what conditions US rail would be linked in any way to the new registry.

The U.S. delegation was co-headed by representatives from the State Department Legal Adviser’s Office, Harold Burman, and the Department of Transportation’s General Counsel’s Office, Peter Bloch, and included US Export-Import Banks’ structured finance counsel Louis Emery and commercial finance law expert Steven Harris, Chicago Kent -Illinois institute of Technology Law school. The delegation was supported by industry experts represented through NGO’s. UNIDROIT, as a private law body, recognizes the important role of industry and NGO participation and unlike public law bodies, allows full participation of industry at all levels of the negotiation.

Following the successful conclusion of this second equipment protocol under the new Cape Town treaty system, it is expected that negotiations will be restarted on a third protocol on outer space commercial asset finance, with a focus on financing of satellites and space-based commercial services.

Mar 15, 2007


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