Introduction

On these pages:

These pages are updated when there is any significant development.  

For further information please contact our Securitisation group:


*  This statutory instrument has itself been amended by further statutory instruments:

On these pages:

These pages are updated when there is any significant development.  

For further information please contact our Securitisation group:


*  This statutory instrument has itself been amended by further statutory instruments:

Regulation (EU) 2017/2402 of the European Parliament and of the Council

of 12 December 2017

laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC [the UCITS Directive], 2009/138/EC [Solvency II] and 2011/61/EU [AIFM Directive] and Regulations (EC) No 1060/2009 [Credit Rating Agencies Regulation] and (EU) No 648/2012 [EMIR]

The European Parliament and the Council of the European Union,

Having regard to the Treaty on the Functioning of the European Union, and in particular Article 114 thereof,

Having regard to the proposal from the European Commission,

After transmission of the draft legislative act to the national parliaments,

Having regard to the opinion of the European Central Bank (1),

Having regard to the opinion of the European Economic and Social Committee (2),

Acting in accordance with the ordinary legislative procedure (3),

Whereas:

  1. Securitisation involves transactions that enable a lender or a creditor – typically a credit institution or a corporation – to refinance a set of loans, exposures or receivables, such as residential loans, auto loans or leases, consumer loans, credit cards or trade receivables, by transforming them into tradable securities. The lender pools and repackages a portfolio of its loans, and organises them into different risk categories for different investors, thus giving investors access to investments in loans and other exposures to which they normally would not have direct access. Returns to investors are generated from the cash flows of the underlying loans.
  1. In its communication of 26 November 2014 on an Investment Plan for Europe, the Commission announced its intention to restart high-quality securitisation markets, without repeating the mistakes made before the 2008 financial crisis. The development of a simple, transparent and standardised securitisation market constitutes a building block of the Capital Markets Union (CMU) and contributes to the Commission’s priority objective of supporting job creation and a return to sustainable growth.
  1. The Union aims to  strengthen the legislative framework implemented after the financial crisis to address the risks inherent in highly complex, opaque and risky securitisation. It is essential to ensure that rules are adopted to better differentiate simple, transparent and standardised products from complex, opaque and risky instruments and to apply a more risk-sensitive prudential framework.
  1. Securitisation is an important element of well-functioning financial markets. Soundly structured securitisation is an important channel for diversifying funding sources and allocating risk more widely within the Union financial system. It allows for a broader distribution of financial-sector risk and can help free up originators’ balance sheets to allow for further lending to the economy. Overall, it can improve efficiencies in the financial system and provide additional investment opportunities. Securitisation can create a bridge between credit institutions and capital markets with an indirect benefit for businesses and citizens (through, for example, less expensive loans and business financing, and credits for immovable property and credit cards). Nevertheless, this Regulation recognises the risks of increased interconnectedness and of excessive leverage that securitisation raises, and enhances the microprudential supervision by competent authorities of a financial institution’s participation in the securitisation market, as well as the macroprudential oversight of that market by the European Systemic Risk Board (ESRB), established by Regulation (EU) No 1092/2010 of the European Parliament and of the Council  (4), and by the national competent and designated authorities for macroprudential instruments.
  1. Establishing a more risk-sensitive prudential framework for simple, transparent and standardised (‘STS’) securitisations requires that the Union clearly define what an STS securitisation is, since otherwise the more risk-sensitive regulatory treatment for credit institutions and insurance companies would be available for different types of securitisations in different Member States. This would lead to an unlevel playing field and to regulatory arbitrage, whereas it is important to ensure that the Union functions as a single market for STS securitisations and that it facilitates cross-border transactions.
  1. In line with the existing definitions in Union sectoral legislation, it is appropriate to provide definitions of all the key concepts of securitisation. In particular, a clear and encompassing definition of securitisation is needed to capture any transaction or scheme whereby the credit risk associated with an exposure or pool of exposures is tranched. An exposure that creates a direct payment obligation for a transaction or scheme used to finance or operate physical assets should not be considered an exposure to a securitisation, even if the transaction or scheme has payment obligations of different seniority. 
  1. A sponsor should be able to delegate tasks to a servicer, but should remain responsible for risk management. In particular, a sponsor should not transfer the risk-retention requirement to his servicer. The servicer should be a regulated asset manager such as an undertaking for the collective investment in transferable securities (UCITS) management company, an alternative investment fund manager (AIFM) or an entity referred to in Directive 2014/65/EU [MiFID II] of the European Parliament and of the Council (5) (MiFID entity).
  1. This Regulation introduces a ban on resecuritisation, subject to derogations for certain cases of resecuritisations that are used for legitimate purposes and to clarifications as to whether asset-backed commercial paper (ABCP) programmes are considered to be resecuritisations. Resecuritisations could hinder the level of transparency that this Regulation seeks to establish. Nevertheless, resecuritisations can, in exceptional circumstances, be useful in preserving the interests of investors. Therefore, resecuritisations should only be permitted in specific instances as established by this Regulation. In addition, it is important for the financing of the real economy that fully supported ABCP programmes that do not introduce any re-tranching on top of the transactions funded by the programme remain outside the scope of the ban on resecuritisation.

Resecuritisations are forbidden (Article 20(9) and 24(8)) from meeting STS standards, and even non-STS resecuritisations are only permitted where:

  • they are done for “legitimate purposes”, typically in context of a winding up or resolution or
  • the deal was done before effective date of the Securitisation Regulation;

and there are further provisions regarding permissible non-STS ABCP programmes.

The wording used in all three places in the Securitisation Regulation is odd - a securitisation's exposures "shall not include securitisation positions".  Does this forbid EU investors buying resecuritisations, or does it just forbid EU sponsors and issuers from issuing resecuritisation paper?  EU investors will presumably be cautious.

The prohibition is by reference to "securitisation" - which as defined requires there to be contractually-established tranching of debt. Query whether parties may be tempted to structure around this.

Paragraph 31 of the EBA Guidelines refers darkly to pre-2009 days when resecuritisations were structured in a highly leveraged way, with a small change in the credit performance of the underlying assets having a severe impact on the credit quality of the bonds.  The EBA considered that this made the modelling of the credit risk very difficult.  It would certainly have required more time and analysis than the average buy-side professional would have had, making reliance on the rating all the more tempting.

  1. Investments in or exposures to securitisations not only expose the investor to credit risks of the underlying loans or exposures, but the structuring process of securitisations could also lead to other risks such as agency riskmodel risk, legal and operational risk, counterparty risk, servicing risk, liquidity risk and concentration risk. Therefore, it is essential that institutional investors be subject to proportionate due-diligence requirements ensuring that they properly assess the risks arising from all types of securitisations, to the benefit of end investors. Due diligence can thus also enhance confidence in the market and between individual originators, sponsors and investors. It is necessary that investors also exercise appropriate due diligence with regard to STS securitisations. They can inform themselves with the information disclosed by the securitising parties, in particular the STS notification and the related information disclosed in this context, which should provide investors with all the relevant information on the way STS criteria are met. Institutional investors should be able to place appropriate reliance on the STS notification and the information disclosed by the originator, sponsor and securitisation special purpose entity (SSPE) on whether a securitisation meets the STS requirements. However, they should not rely solely and mechanistically on such a notification and such information.

EBA 2015 Report (page 7)

  1. It is essential that the interests of originators, sponsors, original lenders that are involved in a securitisation and investors be aligned. To achieve this, the originator, sponsor or original lender should retain a significant interest in the underlying exposures of the securitisation. It is therefore important for the originator, sponsor or original lender to retain a material net economic exposure to the underlying risks in question. More generally, securitisation transactions should not be structured in such a way so as to avoid the application of the retention requirement. That requirement should be applicable in all situations where the economic substance of a securitisation is applicable, whatever legal structures or instruments are used. There is no need for multiple applications of the retention requirement. For any given securitisation, it suffices that only the originator, the sponsor or the original lender is subject to the requirement. Similarly, where securitisation transactions contain other securitisations positions as underlying exposures, the retention requirement should be applied only to the securitisation which is subject to the investment. The STS notification should indicate to investors that the originator, sponsor or original lender is retaining a material net economic exposure to the underlying risks. Certain exceptions should be made for cases in which securitised exposures are fully, unconditionally and irrevocably guaranteed in particular by public authorities. Where support from public resources is provided in the form of guarantees or by other means, this Regulation is without prejudice to State aid rules.
  1. Originators or sponsors should not take advantage of the fact that they could hold more information than investors and potential investors on the assets transferred to the SSPE, and should not transfer to the SSPE, without the knowledge of the investors or potential investors, assets whose credit-risk profile is higher than that of comparable assets held on the balance sheet of the originators. Any breach of that obligation should be subject to sanctions to be imposed by competent authorities, though only when such a breach is intentional. Negligence alone should not be subject to sanctions in that regard. However, that obligation should not prejudice in any way the right of originators or sponsors to select assets to be transferred to the SSPE that ex ante have a higher-than-average credit-risk profile compared to the average credit-risk profile of comparable assets that remain on the balance sheet of the originator, as long as the higher credit-risk profile of the assets transferred to the SSPE is clearly communicated to the investors or potential investors. Competent authorities should supervise compliance with this obligation by comparing the assets underlying a securitisation and comparable assets held on the originator’s balance sheet.

    The comparison of performance should be made between assets that are ex ante expected to have similar performances, for example between non-performing residential mortgages transferred to the SSPE and non-performing residential mortgages held on the balance sheet of the originator.

    There is no presumption that the assets underlying a securitisation should perform similarly to the average assets held on the originator’s balance sheet.
  1. The ability of investors and potential investors to exercise due diligence and thus make an informed assessment of the creditworthiness of a given securitisation instrument depends on their access to information on those instruments. Based on the existing acquis, it is important to create a comprehensive system under which investors and potential investors will have access to all the relevant information over the entire life of the transactions, to reduce originators’, sponsors’ and SSPEs’ reporting tasks and to facilitate investors’ continuous, easy and free access to reliable information on securitisations. To enhance market transparency, a framework for securitisation repositories to collect relevant reports, primarily on underlying exposures in securitisations, should be established. Such securitisation repositories should be authorised and supervised by the European Supervisory Authority (European Securities and Markets Authority) (‘ESMA’), established by Regulation (EU) No 1095/2010 of the European Parliament and of the Council (6). In specifying the details of such reporting tasks, ESMA should ensure that the information required to be reported to such repositories reflects as closely as possible existing templates for disclosures of such information
  1. The main purpose of the general obligation for the originator, sponsor and the SSPE to make available information on securitisations via the securitisation repository is to provide the investors with a single and supervised source of the data necessary for performing their due diligence. Private securitisations are often bespoke. They are important because they allow parties to enter into securitisation transactions without disclosing sensitive commercial information on the transaction (e.g. disclosing that a certain company needs funding to expand production or that an investment firm is entering a new market as part of its strategy) and/or related to the underlying assets (e.g. on the type of trade receivable generated by an industrial firm) to the market and competitors. In those cases, investors are in direct contact with the originator and/or sponsor and receive the information necessary to perform their due diligence directly from them. Therefore, it is appropriate to exempt private securitisations from the requirement to notify the transaction information to a securitisation repository.
  1. Originators, sponsors and original lenders should apply to exposures to be securitised the same sound and well-defined criteria for credit-granting which they apply to non-securitised exposures. However, to the extent that trade receivables are not originated in the form of a loan, credit-granting criteria need not be met with respect to trade receivables.
  1. Securitisation instruments are generally not appropriate for retail clients within the meaning of Directive 2014/65/EU [MiFID II].

  1. Originators, sponsors and SSPEs should make available in the investor report all materially relevant data on the credit quality and performance of underlying exposures, including data allowing investors to clearly identify delinquency and default of underlying debtors, debt restructuring, debt forgiveness, forbearance, repurchases, payment holidays, losses, charge offs, recoveries and other asset performance remedies in the pool of underlying exposures. The investor report should include in the case of a securitisation which is not an ABCP transaction data on the cash flows generated by underlying exposures and by the liabilities of the securitisation, including separate disclosure of the securitisation position’s income and disbursements, namely scheduled principal, scheduled interest, prepaid principal, past due interest and fees and charges, and data relating to the triggering of any event implying changes in the priority of payments or replacement of any counterparties, as well as data on the amount and form of credit enhancement available to each tranche. Although securitisations that are simple, transparent and standardised have in the past performed well, the satisfaction of any STS requirements does not mean that the securitisation position is free of risks, nor does it indicate anything about the credit quality underlying the securitisation. Instead, it should be understood to indicate that a prudent and diligent investor will be able to analyse the risks involved in the securitisation.

    In order to allow for the different structural features of long-term securitisations and of short-term securitisations (namely ABCP programmes and ABCP transactions), there should be two types of STS requirements: one for long-term securitisations and one for short-term securitisations corresponding to those two differently functioning market segments. ABCP programmes rely on a number of ABCP transactions consisting of short-term exposures which need to be replaced once matured. In an ABCP transaction, securitisation could be achieved, inter alia, through agreement on a variable purchase-price discount on the pool of underlying exposures, or the issuance of senior and junior notes by an SSPE in a co-funding structure where the senior notes are then transferred to the purchasing entities of one or more ABCP programmes. However, ABCP transactions qualifying as STS should not include any resecuritisations. In addition, STS criteria should reflect the specific role of the sponsor providing liquidity support to the ABCP programme, in particular for fully supported ABCP programmes.

  1. At both the international and Union level, much work has already been done to identify STS securitisation. In Commission Delegated Regulations (EU) 2015/35 (7) [Solvency II Delegated Act] and (EU) 2015/61 (8) [the LCR Delegated Act made under the CRR], criteria have already been set out for STS securitisation for specific purposes to which a more risk-sensitive prudential treatment is given.

  1. SSPEs should only be established in third countries that are not listed as high-risk and non-cooperative jurisdictions by the Financial Action Task Force (FATF). If a specific Union list of third-country jurisdictions that refuse to comply with tax good-governance standards has been adopted by the time a review of this Regulation is conducted, that Union list should be taken into account and could become the reference list for third countries where SSPEs are not allowed to be established.

  1. It is essential to establish a general and cross-sectorally applicable definition of STS securitisation based on the existing criteria, as well as on the criteria adopted by the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) on 23 July 2015 for identifying simple, transparent and comparable securitisations in the framework of capital sufficiency for securitisations, and in particular based on the opinion on a European framework for qualifying securitisation published on 7 July 2015, published on 7 July 2015 by the European Supervisory Authority (European Banking Authority)(EBA) established by Regulation (EU) No 1093/2010 of the European Parliament and of the Council (9).

  1. Implementation of the STS criteria throughout the Union should not lead to divergent approaches. Divergent approaches would create potential barriers for cross-border investors by obliging them to familiarise themselves with the details of the Member State frameworks, thereby undermining investor confidence in the STS criteria. The EBA should therefore develop guidelines to ensure a common and consistent understanding of the STS requirements throughout the Union, in order to address potential interpretation issues. Such a single source of interpretation would facilitate the adoption of the STS criteria by originators, sponsors and investors. ESMA should also play an active role in addressing potential interpretation issues.

  1. In order to prevent divergent approaches in the implementation of the STS criteria, the three European Supervisory Authorities (ESAs) should, in the framework of the Joint Committee of the European Supervisory Authorities, coordinate their work and that of the competent authorities to ensure cross-sectoral consistency and assess practical issues which could arise with regard to STS securitisations. In doing so, the views of market participants should also be requested and taken into account to the extent possible. The outcome of those discussions should be made public on the websites of the ESAs so as to help originators, sponsors, SSPEs and investors assess STS securitisations before issuing or investing in such positions. Such a coordination mechanism would be particularly important in the period leading up to the implementation of this Regulation.

  1. This Regulation only allows for ‘true-sale’ securitisations to be designated as STS. In a true-sale securitisation, the ownership of the underlying exposures is transferred or effectively assigned to an issuer entity which is a SSPE. The transfer or assignment of the underlying exposures to the SSPE should not be subject to clawback provisions in the event of the seller’s insolvency, without prejudice to provisions of national insolvency laws under which the sale of underlying exposures concluded within a certain period before the declaration of the seller’s insolvency can, under strict conditions, be invalidated.

  1. A legal opinion provided by a qualified legal counsel could confirm the true sale or assignment or transfer with the same legal effect of the underlying exposures and the enforceability of that true sale, assignment or transfer with the same legal effect under the applicable law.
  1. In securitisations which are not true-sale, the underlying exposures are not transferred to an issuer entity which is a SSPE, but rather the credit risk related to the underlying exposures is transferred by means of a derivative contract or guarantees. This introduces an additional counterparty credit risk and potential complexity related in particular to the content of the derivative contract. For those reasons, the STS criteria should not allow synthetic securitisation.

    The progress made by the EBA in its report of December 2015, identifying a possible set of STS criteria for synthetic securitisation and defining ‘balance-sheet synthetic securitisation’ and ‘arbitrage synthetic securitisation’, should be acknowledged. Once the EBA has clearly determined a set of STS criteria specifically applicable to balance-sheet synthetic securitisations, and with a view to promoting the financing of the real economy and in particular of SMEs, which benefit the most from such securitisations, the Commission should draft a report and, if appropriate, adopt a legislative proposal in order to extend the STS framework to such securitisations. However, no such extension should be proposed by the Commission in respect of arbitrage synthetic securitisations.

  1. The underlying exposures transferred from the seller to the SSPE should meet predetermined and clearly defined eligibility criteria which do not allow for active portfolio management of those exposures on a discretionary basis. Substitution of exposures that are in breach of representations and warranties should in principle not be considered active portfolio management.

  1. Underlying exposures should not include exposures in default or exposures to obligors or guarantors that, to the best of the originator’s or original lender’s knowledge, are in specified situations of credit-impairedness (for example, obligors that have been declared insolvent).

    The ‘best knowledge’ standard should be considered to be fulfilled on the basis of information obtained from debtors on origination of the exposures, information obtained from the originator in the course of its servicing of the exposures or in the course of its risk-management procedure or information notified to the originator by a third party.

    A prudent approach should apply to exposures which have been non-performing and have subsequently been restructured. However, the inclusion of the latter in the pool of underlying exposure should not be excluded where such exposures have not presented new arrears since the date of the restructuring, which should have taken place at least one year prior to the date of transfer or assignment of the underlying exposures to the SSPE. In such cases, adequate disclosure should ensure full transparency.

  1. To ensure that investors perform robust due diligence and to facilitate the assessment of underlying risks, it is important that securitisation transactions are backed by pools of exposures that are homogenous in asset type, such as pools of residential loans, or pools of corporate loans, business property loans, leases and credit facilities to undertakings of the same category, or pools of auto loans and leases, or pools of credit facilities to individuals for personal, family or household consumption purposes. The underlying exposures should not include transferable securities, as defined in point (44) of Article 4(1) of Directive 2014/65/EU [MiFID II] . To cater for those Member States where it is common practice for credit institutions to use bonds instead of loan agreements to provide credit to non-financial corporations, it should be possible to include such bonds, provided that they are not listed on a trading venue.

  1. It is essential to prevent the recurrence of ‘originate to distribute’ models. In those situations lenders grant credits applying poor and weak underwriting policies as they know in advance that related risks are eventually sold to third parties. Thus, the exposures to be securitised should be originated in the ordinary course of the originator’s or original lender’s business pursuant to underwriting standards that should not be less stringent than those the originator or original lender applies at the time of origination to similar exposures which are not securitised. Material changes in underwriting standards should be fully disclosed to potential investors or, in the case of fully supported ABCP programmes, to the sponsor and other parties directly exposed to the ABCP transaction. The originator or original lender should have sufficient experience in originating exposures of a similar nature to those which have been securitised. In the case of securitisations where the underlying exposures are residential loans, the pool of loans should not include any loan that was marketed and underwritten on the premise that the loan applicant or, where applicable intermediaries, were made aware that the information provided might not be verified by the lender. The assessment of the borrower’s creditworthiness should also meet where applicable, the requirements set out in Directive 2008/48/EC (10) [Credit Agreements Directive] or 2014/17/EU [the Mortgage Credits Directive(11) of the European Parliament and of the Council or equivalent requirements in third countries.

  1. A strong reliance of the repayment of securitisation positions on the sale of assets securing the underlying assets creates vulnerabilities, as illustrated by the poor performance of parts of the market for commercial mortgage-backed securities (CMBS) during the financial crisis. Therefore, CMBS should not be considered to be STS securitisations.

  1. Where data on the environmental impact of assets underlying securitisations are available, the originator and sponsor of such securitisations should publish them.

    Therefore, the originator, the sponsor and the SSPE of an STS securitisation where the underlying exposures are residential loans or auto loans or leases should publish the available information related to the environmental performance of the assets financed by such residential loans or auto loans or leases.

  1. Where originators, sponsors and SSPEs would like their securitisations to use the STS designation, investors, competent authorities and ESMA should be notified that the securitisation meets the STS requirements. The notification should include an explanation on how each of the STS criteria has been complied with. ESMA should then publish it on a list of notified STS securitisations made available on its website for information purposes. The inclusion of a securitisation issuance in ESMA’s list of notified STS securitisations does not imply that ESMA or other competent authorities have certified that the securitisation meets the STS requirements. Compliance with the STS requirements remains solely the responsibility of the originators, sponsors and SSPEs. This should ensure that originators, sponsors and SSPEs take responsibility for their claim that the securitisation is STS and that there is transparency on the market.

  1. Where a securitisation no longer meets the STS requirements, the originator and sponsor should immediately notify ESMA and the relevant competent authority. Moreover, where a competent authority has imposed administrative sanctions with regard to a securitisation notified as being STS, that competent authority should immediately notify ESMA for their inclusion on the STS notifications list allowing investors to be informed about such sanctions and about the reliability of STS notifications. It is therefore in the interest of originators and sponsors to make well-considered notifications in order to avoid reputational consequences.

  1. Investors should perform their own due diligence on investments commensurate with the risks involved but they should be able to rely on the STS notification and on the information disclosed by the originator, sponsor and SSPE on whether a securitisation meets the STS requirements. However, they should not rely solely and mechanistically on such notifications and information.

  1. The involvement of third parties in helping to check compliance of a securitisation with the STS requirements could be useful for investors, originators, sponsors and SSPEs and contribute to increasing confidence in the market for STS securitisations. Originators, sponsors and SSPEs could also use the services of a third party authorised in accordance with this Regulation to assess whether their securitisation complies with the STS criteria. Those third parties should be subject to authorisation by competent authorities. The notification to ESMA and the subsequent publication on ESMA’s website should mention whether STS compliance was confirmed by an authorised third party. However, it is essential that investors make their own assessment, take responsibility for their investment decisions and do not mechanistically rely on such third parties. The involvement of a third party should not in any way shift away from originators, sponsors and institutional investors the ultimate legal responsibility for notifying and treating a securitisation transaction as STS.

  1. Member States should designate competent authorities and provide them with the necessary supervisory, investigative and sanctioning powers. Administrative sanctions should, in principle, be published. Since investors, originators, sponsors, original lenders and SSPEs can be established in different Member States and supervised by different sectoral competent authorities, close cooperation between relevant competent authorities, including the European Central Bank (ECB) with regard to specific tasks conferred on it by Council Regulation (EU) No 1024/2013 (12), and with the ESAs should be ensured by the mutual exchange of information and assistance in supervisory activities. Competent authorities should apply sanctions only in the case of intentional or negligent infringements. The application of remedial measures should not depend on evidence of intention or negligence. In determining the appropriate type and level of sanction or remedial measure, when taking into account the financial strength of the responsible natural or legal person, competent authorities should in particular take into consideration the total turnover of the responsible legal person or the annual income and net assets of the responsible natural person.

  1. Competent authorities should closely coordinate their supervision and ensure consistent decisions, especially in the event of infringements of this Regulation. Where such an infringement concerns an incorrect or misleading notification, the competent authority identifying that infringement should also inform the ESAs and the relevant competent authorities of the Member States concerned. In the event of disagreement between the competent authorities, ESMA, and, where appropriate, the Joint-Committee of the European Supervisory Authorities, should exercise their binding mediation powers.

  1. The requirements for using the designation ‘simple, transparent and standardised’ (STS) securitisation are new and will be further specified by EBA guidelines and supervisory practice over time. In order to avoid discouraging market participants from using that designation, competent authorities should have the ability to grant the originator, sponsor and SSPE a grace period of three months to rectify any erroneous use of the designation that they have used in good faith. Good faith should be presumed where the originator, sponsor and SSPE could not know that a securitisation did not meet all the STS criteria to be designated as STS. During that grace period, the securitisation in question should continue to be considered STS-compliant and should not be deleted from the list drawn up by ESMA in accordance with this Regulation.

  1. This Regulation promotes the harmonisation of a number of key elements in the securitisation market without prejudice to further complementary market-led harmonisation of processes and practices in securitisation markets. For that reason, it is essential that market participants and their professional associations continue working on further standardising market practices, and in particular the standardisation of documentation of securitisations. The Commission should carefully monitor and report on the standardisation efforts made by market participants.

  1. Directives 2009/65/EC [UCITS Directive(13)2009/138/EC [Solvency II(14) and 2011/61/EU [AIFM Directive(15) of the European Parliament and of the Council and Regulations (EC) No 1060/2009 [Credit Rating Agencies Regulation(16and (EU) No 648/2012 [EMIR(17) of the European Parliament and of the Council are amended accordingly to ensure consistency of the Union legal framework with this Regulation on provisions related to securitisation the main object of which is the establishment and functioning of the internal market, in particular by ensuring a level playing field in the internal market for  all institutional investors.

  1. As regards the amendments to Regulation (EU) No 648/2012 [EMIR], over-the-counter (‘OTC’) derivative contracts entered into by SSPEs should not be subject to the clearing obligation provided that certain conditions are met. This is because counterparties to OTC derivative contracts entered into with SSPEs are secured creditors under the securitisation arrangements and adequate protection against counterparty credit risk is usually provided for. With respect to non-centrally cleared derivatives, the levels of collateral required should also take into account the specific structure of securitisation arrangements and the protections already provided for therein.

  1. There is a degree of substitutability between covered bonds and securitisations. Therefore, in order to prevent the possibility of distortion or arbitrage between the use of securitisations and covered bonds because of the different treatment of OTC derivative contracts entered into by covered bond entities or by SSPEs, Regulation (EU) No 648/2012 [EMIR] should be amended to ensure consistency of treatment between derivatives associated with covered bonds and derivatives associated with securitisations, with regard to the clearing obligation and to the margin requirements on non-centrally cleared OTC derivatives.

  1. In order to harmonise the supervisory fees that are to be charged by ESMA, the power to adopt acts in accordance with Article 290 of the Treaty on the Functioning of the European Union (TFEU) should be delegated to the Commission in respect of further specifying the type of fees, the matters for which fees are due, the amount of the fees and the manner in which they are to be paid. It is of particular importance that the Commission carry out appropriate consultations during its preparatory work, including at expert level, and that those consultations be conducted in accordance with the principles laid down in the Interinstitutional Agreement of 13 April 2016 on Better Law-Making (18). In particular, to ensure equal participation in the preparation of delegated acts, the European Parliament and the Council receive all documents at the same time as Member States’ experts, and their experts systematically have access to meetings of Commission expert groups dealing with the preparation of delegated acts.

  1. In order to specify the risk-retention requirement, as well as to further clarify the homogeneity criteria and the exposures to be deemed homogenous under the requirements on simplicity, while ensuring that the securitisation of SME loans is not negatively affected, the Commission should be empowered to adopt regulatory technical standards developed by the EBA with regard to the modalities for retaining risk, the measurement of the level of retention, certain prohibitions concerning the retained risk, the retention on a consolidated basis and the exemption for certain transactions, and the specification of homogeneity criteria and of which underlying exposures are deemed to be homogeneous. The Commission should adopt those regulatory technical standards by means of delegated acts pursuant to Article 290 TFEU and in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010. The EBA should consult closely with the other two ESAs.

  1. In order to facilitate investors continuous, easy and free access to reliable information on securitisations, as well as to specify the terms of the cooperation and exchange of information obligation of competent authorities, the Commission should be empowered to adopt regulatory technical standards developed by ESMA with regard to: comparable information on underlying exposures and regular investor reports; the list of legitimate purposes under which resecuritisations are permitted; the procedures enabling securitisation repositories to verify the completeness and consistency of the details reported, the application for registration and simplified application for an extension of registration; the details of the securitisation to be provided for transparency reasons, the operational standards required for the collection, aggregation and comparison of data across securitisation repositories, the information to which designated entities have access and the terms and conditions for direct access; the information to be provided in the case of STS notification; the information to be provided to the competent authorities in the application for the authorisation of a third-party verifier; and the information to be exchanged and the content and scope of the notification obligations. The Commission should adopt those regulatory technical standards by means of delegated acts pursuant to Article 290 TFEU and in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010. ESMA should consult closely with the other two ESAs.

  1. In order to facilitate the process for investors, originators, sponsors and SSPEs, the Commission should also be empowered to adopt implementing technical standards developed by ESMA, with regard to: the templates to be used when making information available to holders of a securitisation position; the format of the application for registration and of the application for an extension of registration of securitisation repositories; template for the provision of information; the templates to be used to provide information to the securitisation repository, taking into account solutions developed by existing securitisation data collectors; and the template for STS notifications that will provide investors and competent authorities with sufficient information for their assessment of compliance with the STS requirements. The Commission should adopt those implementing technical standards by means of implementing acts pursuant to Article 291 TFEU and in accordance with Article 15 of Regulation (EU) No 1095/2010. ESMA should consult closely with the other two ESAs.

  1. Since the objectives of this Regulation, namely laying down a general framework for securitisation and creating a specific framework for STS securitisation, cannot be sufficiently achieved by the Member States given that securitisation markets operate globally and that a level playing field in the internal market for all institutional investors and entities involved in securitisation should be ensured but can rather, by reason of their scale and effects, be better achieved at Union level, the Union may adopt measures, in accordance with the principle of subsidiarity as set out in Article 5 of the Treaty on European Union. In accordance with the principle of proportionality, as set out in that Article, this Regulation does not go beyond what is necessary in order to achieve those objectives.

  1. This Regulation should apply to securitisations the securities of which are issued on or after 1 January 2019.

  1. For securitisation positions outstanding as of 1 January 2019, originators, sponsors and SSPEs should be able to use the designation ‘STS’ provided that the securitisation complies with the STS requirements, for certain requirements at the time of notification and for other requirements at the time of origination. Therefore, originators, sponsors and SSPEs should be able to submit an STS notification to ESMA pursuant to this Regulation. Any subsequent modification to the securitisation should be accepted provided that the securitisation continues to meet all of the applicable STS requirements.

  1. The due-diligence requirements that are applied in accordance with existing Union law before the date of application of this Regulation should continue to apply to securitisations issued on or after 1 January 2011, and to securitisations issued before 1 January 2011 where new underlying exposures have been added or substituted after 31 December 2014. The relevant provisions of Commission Delegated Regulation (EU) No 625/2014 [RTS relating to risk retention made under CRR] (19that specify the risk-retention requirements for credit institutions and investments firms within the meaning of Regulation (EU) No 575/2013 [CRR] of the European Parliament and of the Council (20) should remain applicable until the moment that the regulatory technical standards on risk retention pursuant to this Regulation apply. For reasons of legal certainty, credit institutions or investment firms, insurance undertakings, reinsurance undertakings and alternative investment fund managers should, for securitisation positions outstanding as of the date of application of this Regulation, continue to be subject to Article 405 of Regulation  (EU) No 575/2013 [CRR] and to Chapters I, II and III and Article 22 of Delegated Regulation (EU) No 625/2014 [RTS relating to risk retention made under CRR] , Articles 254 and 255 of Delegated Regulation Commission Delegated Regulations (EU) 2015/35 (7) [Solvency II Delegated Act] and Article 51 of Commission Delegated Regulation (EU) No 231/2013 [supplementing the AIFM Directive]  (21respectively.

In order to ensure that originators, sponsors and SSPEs comply with their transparency obligations, until the regulatory technical standards to be adopted by the Commission pursuant to this Regulation apply, the information referred to in Annexes I to VIII of Commission Delegated Regulation Commission Delegated Regulations (EU) 2015/35 (7) [Solvency II Delegated Act](22) should be made publicly available,

HAVE ADOPTED THIS REGULATION:

Chapter 1

General Provisions

Article 1

Subject matter and scope

1.  This Regulation lays down a general framework for securitisation. It defines securitisation and establishes due-diligence, risk-retention and transparency requirements for parties involved in securitisations, criteria for credit granting, requirements for selling securitisations to retail clients, a ban on re-securitisation, requirements for SSPEs as well as conditions and procedures for securitisation repositories. It also creates a specific framework for simple, transparent and standardised (‘STS’) securitisation.

2.  This Regulation applies to institutional investors and to originators, sponsors, original lenders and securitisation special purpose entities.

Article 2

For the purposes of this Regulation, the following definitions apply:

7. ‘asset-backed commercial paper programme’ or ‘ABCP programme’ means a programme of securitisations the securities issued by which predominantly take the form of asset-backed commercial paper with an original maturity of one year or less;


8. ‘asset-backed commercial paper transaction’ or ‘ABCP transaction’ means a securitisation within an ABCP programme;

[UK version only:  (A4). ‘competent authority’ means an authority designated or required to be designated for the purpose of supervising compliance by an entity with obligations set out in this Regulation; and in relation to an entity, means the authority designated for the purpose of supervising compliance with such obligations by that entity;]

[EU version only: 

(26)        “credit protection agreement” means an agreement concluded between the originator and the investor to transfer the credit risk of securitised exposures from the originator to the investor by means of credit derivatives or guarantees, whereby the originator commits to pay an amount, known as a credit protection premium, to the investor and the investor commits to pay an amount, known as a credit protection payment, to the originator in the event that one of the contractually defined credit events occurs;

(28)        “credit protection payment” means the amount the investor has committed to pay to the originator under the credit protection agreement in the event that a credit event defined in the credit protection agreement occurs;

(27)        “credit protection premium” means the amount the originator has committed to pay to the investor under the credit protection agreement for the credit protection promised by the investor;]


17. ‘early amortisation provision’ means a contractual clause in a securitisation of revolving exposures or a revolving securitisation which requires, on the occurrence of defined events, investors’ securitisation positions to be redeemed before the originally stated maturity of those positions;


18. ‘first loss tranche’ means the most subordinated tranche in a securitisation that is the first tranche to bear losses incurred on the securitised exposures and thereby provides protection to the second loss and, where relevant, higher ranking tranches.


21. ‘fully- supported ABCP programme’ means an ABCP programme that its sponsor directly and fully supports by providing to the SSPE(s) one or more liquidity facilities covering at least all of the following:

(a)  all liquidity and credit risks of the ABCP programme;

(b)  any material dilution risks of the exposures being securitised;

(c)  any other ABCP transaction-level and ABCP programme-level costs if necessary to guarantee to the investor the full payment of any amount under the ABCP;

22. ‘fully supported ABCP transaction’ means an ABCP transaction supported by a liquidity facility, at transaction level or at ABCP programme level, that covers at least all of the following:

(a)  all liquidity and credit risks of the ABCP transaction;

(b)  any material dilution risks of the exposures being securitised in the ABCP transaction;

(c)  any other ABCP transaction-level and ABCP programme-level costs if necessary to guarantee to the investor the full payment of any amount under the ABCP;

12. ‘institutional investor’ means an investor which is one of the following

(a)  an insurance undertaking as defined in point (1) of Article 13 of  [EU version: Directive 2009/138/EC [Solvency II]] [UK version: section 417(1) of the 2000 Act];

(b)  a reinsurance undertaking as defined in point (4) of Article 13 of [EU version:  Directive 2009/138/EC [Solvency II]] [UK version: section 417(1) of the 2000 Act];

[EU version:

(c)  an institution for occupational retirement provision falling within the scope of Directive (EU) 2016/2341[IORPs Directive (recast)] of the European Parliament and of the Council in accordance with Article 2 thereof, unless a Member States has chosen not to apply that Directive in whole or in parts to that institution in accordance with Article 5 of that Directive; or an investment manager or an authorised entity appointed by an institution for occupational retirement provision pursuant to Article 32 of Directive (EU) 2016/2341 [IORPs Directive (recast)] ;

(d)  an alternative investment fund manager (AIFM) as defined in point (b) of Article 4(1) of Directive 2011/61/EU[AIFM Directive] that manages and/or markets alternative investment funds in the Union;

(e)  an undertaking for the collective investment in transferable securities (UCITS) management company, as defined in point (b) of Article 2(1) of Directive 2009/65/EC [UCITS Directive];

(f)  an internally managed UCITS, which is an investment company authorised in accordance with Directive 2009/65/EC [UCITS Directive] and which has not designated a management company authorised under that Directive for its management; 

(g)  a credit institution as defined in point (1) of Article 4(1) of Regulation (EU) No 575/2013 [CRR] for the purposes of that Regulation or an investment firm as defined in point (2) of Article 4(1) of that Regulation];

[UK version:

(c)  an occupational pension scheme as defined in section 1(1) of the Pension Schemes Act 1993 that has its main administration in the United Kingdom, or a fund manager of such a scheme appointed under section 34(2) of the Pensions Act 1995 that, in respect of activity undertaken pursuant to that appointment, is authorised for the purposes of section 31 of the 2000 Act; 

(d)  an AIFM (as defined in regulation 4(1) of the Alternative Investment Fund Managers Regulations 2013) which markets or manages AIFs (as defined in regulation 3 of those Regulations) in the United Kingdom;

(e)  a management company as defined in section 237(2) of the 2000 Act;

(f)  a UCITS as defined by section 236A of the 2000 Act, which is an authorised open ended investment company as defined in section 237(3) of that Act;

(g)  a CRR firm as defined by Article 4(1)(2A) of Regulation (EU) No 575/20;

11. ‘investor’ means a natural or legal person holding a securitisation position;


14. ‘liquidity facility’ means the securitisation position arising from a contractual agreement to provide funding to ensure timeliness of cash flows to investors;

[EU version only:

‘(24)       “non-performing exposure” or “NPE” means an exposure that meets any of the conditions set out in Article 47a(3) of Regulation (EU) No 575/2013 [CRR];

(31)        “non-refundable purchase price discount” means the difference between the outstanding balance of the exposures in the underlying pool and the price at which those exposures are sold by the originator to the SSPE, where neither the originator nor the original lender are reimbursed for that difference.

(25)        “NPE securitisation” means a securitisation backed by a pool of non-performing exposures the nominal value of which makes up not less than 90 % of the entire pool’s nominal value at the time of origination and at any later time where assets are added to or removed from the underlying pool due to replenishment, restructuring or any other relevant reason;]

20. ‘original lender’ means an entity which, itself or through related entities, directly or indirectly, concluded the original agreement which created the obligations or potential obligations of the debtor or potential debtor giving rise to the exposures being securitised;


3. ‘originator’ means an entity which:

(a)  itself or through related entities, directly or indirectly, was involved in the original agreement which created the obligations or potential obligations of the debtor or potential debtor giving rise to the exposures being securitised; or

(b)  purchases a third party’s exposures on its own account and then securitises them;

[UK version only:

[(A1). ‘Regulation (EU) No 575/2013’ means Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012;

(A2). ‘Regulation (EU) No 648/2012’ means Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories;]

4. ‘resecuritisation’ means securitisation where at least one of the underlying exposures is a securitisation position;


15. ‘revolving exposure’ means an exposure whereby borrowers’ outstanding balances are permitted to fluctuate based on their decisions to borrow and repay, up to an agreed limit;


16. ‘revolving securitisation’ means a securitisation where the securitisation structure itself revolves by exposures being added to or removed from the pool of exposures irrespective of whether the exposures revolve or not;


1. ‘securitisation’ means a transaction or scheme, whereby the credit risk associated with an exposure or a pool of exposures is tranched, having all of the following characteristics:

(a)  payments in the transaction or scheme are dependent upon the performance of the exposure or of the pool of exposures;

(b)  the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme;

(c)  the transaction or scheme does not create exposures which possess all of the characteristics listed in Article 147(8) of Regulation (EU) No 575/2013 [CRR].

[EU version only:

(30)        “sustainability factors” mean sustainability factors as defined in point (24) of Article 2 of Regulation (EU) 2019/2088 of the European Parliament and of the Council [Sustainable Finance Disclosure Regulation];

(29)        “synthetic excess spread” means the amount that, according to the documentation of a synthetic securitisation, is contractually designated by the originator to absorb losses of the securitised exposures that might occur before the maturity date of the transaction;]

 

Introduction

So-called specialised lending exposures include many exposures arising in respect of commercial real estate, project finance, ship and aircraft, and the like, which might be caught if the definition of "securitisation" covered any situation where the credit risk was tranched, payments were dependent upon the performance of the exposure or of the pool of exposures, and the subordination of the tranches determines the distribution of losses - which had been the definition of "securitisation" in article 4(61) of the CRR.  

So, to avoid catching financings which nobody would regard as being "securitisations", and which involve exposures which are only assumed by specialist lenders which need no protection when considering whether or not to commit themselves, the Securitisation Regulation adopted the definition of "securitisation" in article 4(61) of the CRR but then added a third limb - sub-paragraph (c) - which excludes any transaction or scheme which creates exposures which possess all the characteristics listed in Article 147(8) of the CRR, i.e. specialised lending exposures.  We comment further below on the history of this defintion.   

What are specialised lending exposures?

Article 147(8) specifies the following characteristics:

  1. "the exposure is to an entity which was created specifically to finance or operate physical assets or is an economically comparable exposure;
  2. the contractual arrangements give the lender a substantial degree of control over the assets and the income that they generate;

  3. the primary source of repayment of the obligation is the income generated by the assets being financed, rather than the independent capacity of a broader commercial enterprise"

Limb (c) of the definition thus emphasises the related recital (6) (which itself repeats the final sentence of recital (50) of the CRR):

"An exposure that creates a direct payment obligation for a transaction or scheme used to finance or operate physical assets should not be considered an exposure to a securitisation, even if the transaction or scheme has payment obligations of different seniority".

It is generally understood that limb (c) is capable of encompassing:

  • project finance

  • object finance (e.g. ship, aircraft, rail)

  • commodities finance

  • commercial real estate

  • some types of ABL.

It may be that Recital (6) applies over and above limb (c), although the more prudent approach is probably to assume that the Recital would not exclude a securitisation that did not fall within limb (c).

So, for example, take the common case of a JPUT set up to raise finance to fund the acquisition and holding of some commercial property by way of a mixture of equity and mezzanine and senior debt.  It holds no other assets of note and there is no broader commercial purpose, just the holding of this one asset, and the lenders take the usual comprehensive security package over the asset and the rent derived from it.  This should, absent any unusual characeristics, satisfy the three requirements of article 147(8) and so fall outside the definition, and so outside the scope of the Securitisation Regulation. 

It is possible of course to come up with debt structures which are difficult to classify with the same degree of confidence, no matter how much analysis is done.  In the last analysis, if a client is faced with such a case, and in the absence (possibly) of its being able to discuss the matter with its regulator, it may need to proceed on the basis of good faith on the basis that, if subsequently its regulator disagreed with its classification, it could expect leniency on the basis that this arose from a simple honest mistake.  In case it is necessary to consider a case which is less than clear-cut, what follows examines the history of this category.

Background

The term “specialised lending” is defined in Article 147(8) of the CRR (quoted above). Conceptually, it encompasses lending where the systemic component of the credit risk is largely linked to the source of income which is generated by the holding of assets rather than an exposure to an active business; see also the EBA's 20th December 2013 commentary on the final draft RTS regarding identification of an exposure for CRD IV purposes; and, as regards UK-regulated banks, Rule 4.5.3 of the FCA's BIPRU Rulebook. Its application in any particular case may be a matter of debate and degree, depending on the circumstances and the relative importance of the income generated - largely passively - by the assets being financed compared to the "independent capacity of a broader commercial enterprise". It is possible to come up with examples which are clearly one or the other, but there are inevitably some where the analysis is more nuanced.

The distinction was made in Article 86 of the Banking Consolidation Directive, which required regulated institutions to sub-divide corporate credits into those which possessed the three characteristics which are now identified in Article 147(8) from those which did not. This left it unclear whether financings which possessed the twin characteristics that payment was dependent on the performance of underlying exposures and ongoing losses were distributed via the tranching of different categories of debt fell within securitisation or within specialised lending. Accordingly, when the distinction was continued in the CRR, recital (50) explained that an exposure that creates a direct payment obligation for a transaction or scheme used to finance or operate physical assets should not be considered an exposure to a securitisation, even if the transaction or scheme has payment obligations of different seniority.  The Securitisation Regulation continued this with Recital (6) but at a trilogue meeting on 17th June 2017 it was agreed to add limb (c) - presumably for added emphasis - to provide that specialised lending exposures were by definition outside the meaning of "securitisation".

By way of further background, the rationale for the distinction goes back to the Basel Committee's approach to assessing corporate exposures i.e. those where the source of repayment of the loan is based primarily on the operations of the borrower, and any security taken over assets is a secondary risk mitigant: see the BCBS’s Working Paper on the Internal Ratings-Based Approach to Specialised Lending Exposures of 2001. The BCBS's task force distinguished these from what it described as "specialised lending exposures", i.e. loans which are structured in such a way that repayment depends principally on the cash flow generated by the asset rather than the credit quality of the borrower. It explained that this type of loan had certain characteristics, either in legal form or economic substance:

  • the economic purpose of the loan was to acquire or finance an asset;

  • the cash flow generated by the collateral was the loan’s sole or almost exclusive source of repayment;

  • the subject loan represented a significant liability in the borrower’s capital structure; and

  • the primary determinant of credit risk was the variability of the cash flow generated by the collateral rather than the independent capacity of a broader commercial enterprise.

The BCBS task force identified categories of loan with these characteristics  (each described in more detail in the 2001 paper):

  • project finance

  • object finance (e.g. ship, aircraft, rail)

  • commodities finance

  • income-producing real estate, and high-volatility commercial real estate.

This distinction was made for two primary reasons: firstly, because such loans possess unique loss distribution and risk characteristics, and in particular, display greater risk volatility (in times of distress, banks are likely to be faced with both high default rates and high loss rates); and secondly, because most banks using the IRB have different risk rating criteria for such loans. In addition, the 2001 paper addressed other forms of ABL i.e. loans where a company:

"uses its current assets (e.g., accounts receivable and inventory) as collateral for a loan. The loan is structured so that the amount of credit is limited in relation to the value of the collateral. The product is differentiated from other types of lending secured by accounts receivable and inventory by the lender’s use of controls over the borrower’s cash receipts and disbursements and the quality of collateral. This form of lending can be extended to both solvent and bankrupt borrowers. Debtor in possession (DIP) financing is a type of asset-based lending activity where banks extend credit to bankrupt borrowers based upon their accounts receivable and inventory which is taken as collateral";

and expressed its "preliminary view" that this kind of loan may also fall under the IRB framework for specialised lending.


[UK version only:

(A3). ‘the 2000 Act’ means the Financial Services and Markets Act 2000;

(A5). ‘the FCA’ means the Financial Conduct Authority;

(A6). ‘the FCA Handbook’ means the Handbook of Rules and Guidance published by the
FCA containing rules made by the FCA under the 2000 Act (as that Handbook has effect on exit day);

(A7). ‘the PRA’ means the Prudential Regulation Authority;

(A8). ‘third country’ means a country other than the United Kingdom;]

19. ‘securitisation position’ means an exposure to a securitisation;


23. ‘securitisation repository’ means a legal person that centrally collects and maintains the records of securitisations.

[EU version only: For the purpose of Article 10 of this Regulation, references in Articles 61, 64, 65, 66, 73, 78, 79 and 80 of Regulation (EU) No 648/2012 [EMIR] to ‘trade repository’ shall be construed as references to ‘securitisation repository’.]


2. ‘securitisation special purpose entity’ or ‘SSPE’ means a corporation, trust or other entity, other than an originator or sponsor, established for the purpose of carrying out one or more securitisations, the activities of which are limited to those appropriate to accomplishing that objective, the structure of which is intended to isolate the obligations of the SSPE from those of the originator;


13. ‘servicer’ means an entity that manages a pool of purchased receivables or the underlying credit exposures on a day-to-day basis;


5. [EU version:  sponsor means a credit institution, whether located in the Union or not, as defined in point (1) of Article 4(1) of Regulation (EU) No 575/2013 [CRR], or an investment firm as defined in point (1) of Article 4(1) of Directive 2014/65/EU [MiFID II] other than an originator, that:

(a)  establishes and manages an asset-backed commercial paper programme or other securitisation that purchases exposures from third-party entities, or

(b)  establishes an asset-backed commercial paper programme or other securitisation that purchases exposures from third-party entities and delegates the day-to-day active portfolio management involved in that securitisation to an entity authorised to perform such activity in accordance with Directive 2009/65/EC [UCITS Directive], Directive 2011/61/EU [AIFM Directive] or Directive 2014/65/EU [MiFID II];]

[UK version:  ‘sponsor’ means a credit institution as defined in point (1) of Article 4(1) of Regulation (EU) No 575/2013 or an investment firm as defined in paragraph 1A of Article 2 of Regulation 600/2014/EU [onshored MIFIR], whether located in the United Kingdom or in a third country, which -

(a) is not an originator; and

(b) either - 

(i) establishes and manages an asset-backed commercial paper programme or other securitisation that purchases exposures from third party entities; or

(ii) establishes an asset-backed commercial paper programme or other securitisation that purchases exposures from third party entities and delegates the day-to-day active portfolio management involved in that securitisation to an entity which is authorised to manage assets belonging to another person in accordance with the law of the country in which the entity is established.]

A seemingly welcome development for the securitisation market - which occurred towards the end of the trilogues during the passage of the original Securitisation Regulation  - was the apparent widening of the definition of “sponsor” in the Securitisation Regulation, although doubts persist in some quarters over its precise scope.  The original draft had followed the old CRR Rules and had required (by way of a cross-reference to the Capital Requirements Regulation definition) that the sponsor had to be a credit institution or fully-approved MIFID investment firm (as is the case for CRR purposes), and this would have caused problems for many CLO managers wanting to hold the risk retention, because the risk retention can only be held by the sponsor, the originator or the original lender and, since CLO managers would rarely qualify as a sponsor if it referred to the CRR definition of fully-approved investment firm (because few, if any, have the “super authorisations” allowing them to hold client money and perform client custody and so on under paragraphs 6-8 of Annex 1 of MIFID) the only option left would have been the “originator manager” option.  The definition was expanded during the trilogues in two ways: by adding "whether located in the Union or not" after the reference to "credit institution" and by changing the definition from the CRR definition to the much wider MIFID definition, where an "investment firm" is defined as:

“any legal person whose regular occupation or business is the provision of one or more investment services to third parties and/or the performance of one or more investment activities on a professional basis”.

Doubts exist because, although on its face the definition does not have any geographical limitation, the phrase "whether located in the Union or not" appears after "credit institution" but before "investment firm", which is ambiguous and perhaps - so some observers worry - suggestive.  The MIFID definition is usually taken - in the context of the operation of MIFID II itself - to refer to EU-organised firms, and there is a separate definition of "third-country firm" which means "a firm that would be a credit institution providing investment services or performing investment activities or an investment firm if its head office or registered office were located within the Union", and the wording suggests that such a firm is not an "investment firm" - rather, it would be one is it were organised in the EU.  However, in the context of the Securitisation Regulation, article 5(1)(d) clearly envisages the possibility of the sponsor being established in a third country.  No official interpretation or guidance has yet been provided, and a cautious reading is that post-Brexit, UK investment firms, which have certainly fallen out of scope of the EU MIFID II, have consequently also fallen outside of the definition.  On this more cautious analysis, if a pre-Brexit securitisation had been structured so that a UK-organised investment firm were holding the retention as sponsor, the ramifications would require consideration.

The UK post-Brexit onshored version of this definition, contained in section 4 of the Securitisation (Amendment) (EU Exit) Regulations 2019, places "whether located in the United Kingdom or in a third country" after the reference to "investment firm" so that it clearly applies to non-UK firms.  In passing, the UKSR refers to the definition which appears in paragraph 1A of Article 2 of Regulation 600/2014/EU, which may be unfamiliar to many lawyers: this is because it is referring to the onshored version of MIFIR, as amended by section 26 of the Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018; the definition is, broadly speaking, a person whose regular occupation or business is the provision of one or more investment services to third parties or the performance of one or more investment activities on a professional basis.

There is an anomaly here in part (b) as regards non-STS securitisations, which the EC has acknowledged to be unintentional.  Non-STS securitisations may have their sponsor located anywhere in the world.  However, if that sponsor  establishes the securitisation (or ABCP programme) but then delegates the day to day active portfolio management, because the manager is defined by reference to the UCITS Directive, the AIFMD or MIFID, the manager must - as drafted - be in the EU.  The UK post-Brexit onshoring version of this definition, contained in section 4 of the Securitisation (Amendment) (EU Exit) Regulations 2019, has already corrected the wording in point (b) and allows delegation to be to any entity "which is authorised to manage assets belonging to another person in accordance with the law of the country in which the entity is established".

AIFMs

The ESAs' Joint Opinion of 25 March 2021 noted potential inconsistencies between the provisions of the EUSR and the requirements of Directive 2011/61/EU [the AIFM Directive], especially the lack of clarity regarding how the due diligence obligations on AIFMs in respect of securitisations in Article 17 ("Investment in securitisation positions") meshes with the EUSR, and which national regulator should ensure compliance with the relevant due diligence obligations.  The ESAs recommended various clarifications and changes (see further our commentary on investor due diligence) including amending the EUSR definition of “sponsor” to clarify that AIFM sponsors may only delegate day-to-day active portfolio management involved with a securitisation to a servicer which is an EU authorised investment firm, AIFM or UCITS management company, and not to third country AIFMs or sub-threshold AIFMs).


10. ‘synthetic securitisation’ means a securitisation where the transfer of risk is achieved by the use of credit derivatives or guarantees, and the exposures being securitised remain exposures of the originator;


9. ‘traditional securitisation’ means a securitisation involving the transfer of the economic interest in the exposures being securitised through the transfer of ownership of those exposures from the originator to an SSPE or through sub-participation by an SSPE, where the securities issued do not represent payment obligations of the originator;


6. ‘tranche’ means a contractually established segment of the credit risk associated with an exposure or a pool of exposures, where a position in the segment entails a risk of credit loss greater than or less than a position of the same amount in another segment, without taking account of credit protection provided by third parties directly to the holders of positions in the segment or in other segments;

Article 2

For the purposes of this Regulation, the following definitions apply:

[UK version only:

(A1). ‘Regulation (EU) No 575/2013’ means Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012;

(A2). ‘Regulation (EU) No 648/2012’ means Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories;

(A3). ‘the 2000 Act’ means the Financial Services and Markets Act 2000;

(A4). ‘competent authority’ means an authority designated or required to be designated for the purpose of supervising compliance by an entity with obligations set out in this Regulation; and in relation to an entity, means the authority designated for the purpose of supervising compliance with such obligations by that entity;

(A5). ‘the FCA’ means the Financial Conduct Authority;

(A6). ‘the FCA Handbook’ means the Handbook of Rules and Guidance published by the
FCA containing rules made by the FCA under the 2000 Act (as that Handbook has effect on exit day);

(A7). ‘the PRA’ means the Prudential Regulation Authority;

(A8). ‘third country’ means a country other than the United Kingdom;]

(1)  ‘securitisation’ means a transaction or scheme, whereby the credit risk associated with an exposure or a pool of exposures is tranched, having all of the following characteristics:

(a)  payments in the transaction or scheme are dependent upon the performance of the exposure or of the pool of exposures;

(b)  the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme;

(c)  the transaction or scheme does not create exposures which possess all of the characteristics listed in Article 147(8) of Regulation (EU) No 575/2013 [CRR].

Introduction

So-called specialised lending exposures include many exposures arising in respect of commercial real estate, project finance, ship and aircraft, and the like, which might be caught if the definition of "securitisation" covered any situation where the credit risk was tranched, payments were dependent upon the performance of the exposure or of the pool of exposures, and the subordination of the tranches determines the distribution of losses - which had been the definition of "securitisation" in article 4(61) of the CRR.  

So, to avoid catching financings which nobody would regard as being "securitisations", and which involve exposures which are only assumed by specialist lenders which need no protection when considering whether or not to commit themselves, the Securitisation Regulation adopted the definition of "securitisation" in article 4(61) of the CRR but then added a third limb - sub-paragraph (c) - which excludes any transaction or scheme which creates exposures which possess all the characteristics listed in Article 147(8) of the CRR, i.e. specialised lending exposures.  We comment further below on the history of this defintion.   

What are specialised lending exposures?

Article 147(8) specifies the following characteristics:

  1. "the exposure is to an entity which was created specifically to finance or operate physical assets or is an economically comparable exposure;
  2. the contractual arrangements give the lender a substantial degree of control over the assets and the income that they generate;

  3. the primary source of repayment of the obligation is the income generated by the assets being financed, rather than the independent capacity of a broader commercial enterprise"

Limb (c) of the definition thus emphasises the related recital (6) (which itself repeats the final sentence of recital (50) of the CRR):

"An exposure that creates a direct payment obligation for a transaction or scheme used to finance or operate physical assets should not be considered an exposure to a securitisation, even if the transaction or scheme has payment obligations of different seniority".

It is generally understood that limb (c) is capable of encompassing:

  • project finance

  • object finance (e.g. ship, aircraft, rail)

  • commodities finance

  • commercial real estate

  • some types of ABL.

It may be that Recital (6) applies over and above limb (c), although the more prudent approach is probably to assume that the Recital would not exclude a securitisation that did not fall within limb (c).

So, for example, take the common case of a JPUT set up to raise finance to fund the acquisition and holding of some commercial property by way of a mixture of equity and mezzanine and senior debt.  It holds no other assets of note and there is no broader commercial purpose, just the holding of this one asset, and the lenders take the usual comprehensive security package over the asset and the rent derived from it.  This should, absent any unusual characeristics, satisfy the three requirements of article 147(8) and so fall outside the definition, and so outside the scope of the Securitisation Regulation. 

It is possible of course to come up with debt structures which are difficult to classify with the same degree of confidence, no matter how much analysis is done.  In the last analysis, if a client is faced with such a case, and in the absence (possibly) of its being able to discuss the matter with its regulator, it may need to proceed on the basis of good faith on the basis that, if subsequently its regulator disagreed with its classification, it could expect leniency on the basis that this arose from a simple honest mistake.  In case it is necessary to consider a case which is less than clear-cut, what follows examines the history of this category.

Background

The term “specialised lending” is defined in Article 147(8) of the CRR (quoted above). Conceptually, it encompasses lending where the systemic component of the credit risk is largely linked to the source of income which is generated by the holding of assets rather than an exposure to an active business; see also the EBA's 20th December 2013 commentary on the final draft RTS regarding identification of an exposure for CRD IV purposes; and, as regards UK-regulated banks, Rule 4.5.3 of the FCA's BIPRU Rulebook. Its application in any particular case may be a matter of debate and degree, depending on the circumstances and the relative importance of the income generated - largely passively - by the assets being financed compared to the "independent capacity of a broader commercial enterprise". It is possible to come up with examples which are clearly one or the other, but there are inevitably some where the analysis is more nuanced.

The distinction was made in Article 86 of the Banking Consolidation Directive, which required regulated institutions to sub-divide corporate credits into those which possessed the three characteristics which are now identified in Article 147(8) from those which did not. This left it unclear whether financings which possessed the twin characteristics that payment was dependent on the performance of underlying exposures and ongoing losses were distributed via the tranching of different categories of debt fell within securitisation or within specialised lending. Accordingly, when the distinction was continued in the CRR, recital (50) explained that an exposure that creates a direct payment obligation for a transaction or scheme used to finance or operate physical assets should not be considered an exposure to a securitisation, even if the transaction or scheme has payment obligations of different seniority.  The Securitisation Regulation continued this with Recital (6) but at a trilogue meeting on 17th June 2017 it was agreed to add limb (c) - presumably for added emphasis - to provide that specialised lending exposures were by definition outside the meaning of "securitisation".

By way of further background, the rationale for the distinction goes back to the Basel Committee's approach to assessing corporate exposures i.e. those where the source of repayment of the loan is based primarily on the operations of the borrower, and any security taken over assets is a secondary risk mitigant: see the BCBS’s Working Paper on the Internal Ratings-Based Approach to Specialised Lending Exposures of 2001. The BCBS's task force distinguished these from what it described as "specialised lending exposures", i.e. loans which are structured in such a way that repayment depends principally on the cash flow generated by the asset rather than the credit quality of the borrower. It explained that this type of loan had certain characteristics, either in legal form or economic substance:

  • the economic purpose of the loan was to acquire or finance an asset;

  • the cash flow generated by the collateral was the loan’s sole or almost exclusive source of repayment;

  • the subject loan represented a significant liability in the borrower’s capital structure; and

  • the primary determinant of credit risk was the variability of the cash flow generated by the collateral rather than the independent capacity of a broader commercial enterprise.

The BCBS task force identified categories of loan with these characteristics  (each described in more detail in the 2001 paper):

  • project finance

  • object finance (e.g. ship, aircraft, rail)

  • commodities finance

  • income-producing real estate, and high-volatility commercial real estate.

This distinction was made for two primary reasons: firstly, because such loans possess unique loss distribution and risk characteristics, and in particular, display greater risk volatility (in times of distress, banks are likely to be faced with both high default rates and high loss rates); and secondly, because most banks using the IRB have different risk rating criteria for such loans. In addition, the 2001 paper addressed other forms of ABL i.e. loans where a company:

"uses its current assets (e.g., accounts receivable and inventory) as collateral for a loan. The loan is structured so that the amount of credit is limited in relation to the value of the collateral. The product is differentiated from other types of lending secured by accounts receivable and inventory by the lender’s use of controls over the borrower’s cash receipts and disbursements and the quality of collateral. This form of lending can be extended to both solvent and bankrupt borrowers. Debtor in possession (DIP) financing is a type of asset-based lending activity where banks extend credit to bankrupt borrowers based upon their accounts receivable and inventory which is taken as collateral";

and expressed its "preliminary view" that this kind of loan may also fall under the IRB framework for specialised lending.

The definition of "securitisation" takes the old CRR definition and adds sub-paragraph (c) to clarify that specialised lending exposures are not securitisations (for much more on this, see our commentary on Specialised Lending Exposures).  So the definition is not significantly changed. 

However, the definition is now more significant because of the scope of the Securitisation Regulation, and there are traps for the unwary.  The emphasis on contractual tranching of credit risk is capable of applying to structuring arrangements that the parties concerned may not think of as being securitisation.  The precise wording of the definition, and the related definition of "tranching", can be pored over if the parties are aware of the risk that their deal could accidentally be caught, but not if they are not.  When are payments "dependent on the performance" of exposures?  If there is full recourse to the original seller then the performance of the exposures may be incidental.  But what if recourse is partial; or if the credit of the seller is dubious?  And why is a division of risk between equity and debt, or via structural subordination, permitted, but a "contractually established" subordination possibly not?  Level 3 guidance would be helpful, and meanwhile commentaries and references back to the meaning of "specialised lending exposures" may provide some degree of clarity.

In passing, we might add that, given the many references to "exposure" in the Regulation, and bearing mind Recital (6) ("it is appropriate to provide definitions of all the key concepts of securitisation") it is surprising that "exposure" is not defined.  The CRR does have a definition of it in article 5, although for the limited purpose of calculating capital requirements for credit risk (articles 107 et seq.) as "an asset or off-balance sheet item".


(2)  ‘securitisation special purpose entity’ or ‘SSPE’ means a corporation, trust or other entity, other than an originator or sponsor, established for the purpose of carrying out one or more securitisations, the activities of which are limited to those appropriate to accomplishing that objective, the structure of which is intended to isolate the obligations of the SSPE from those of the originator;

(3)  ‘originator’ means an entity which:

(a)  itself or through related entities, directly or indirectly, was involved in the original agreement which created the obligations or potential obligations of the debtor or potential debtor giving rise to the exposures being securitised; or

(b)  purchases a third party’s exposures on its own account and then securitises them;

(4)  'resecuritisation’ means securitisation where at least one of the underlying exposures is a securitisation position;

[EU version:

(5)  ‘sponsor means a credit institution, whether located in the Union or not, as defined in point (1) of Article 4(1) of Regulation (EU) No 575/2013 [CRR], or an investment firm as defined in point (1) of Article 4(1) of Directive 2014/65/EU [MiFID II] other than an originator, that:

(a)  establishes and manages an asset-backed commercial paper programme or other securitisation that purchases exposures from third-party entities, or

(b)  establishes an asset-backed commercial paper programme or other securitisation that purchases exposures from third-party entities and delegates the day-to-day active portfolio management involved in that securitisation to an entity authorised to perform such activity in accordance with Directive 2009/65/EC [UCITS Directive], Directive 2011/61/EU [AIFM Directive] or Directive 2014/65/EU [MiFID II];]

[UK version: 

(5)  ‘sponsor’ means a credit institution as defined in point (1) of Article 4(1) of Regulation (EU) No 575/2013 or an investment firm as defined in paragraph 1A of Article 2 of Regulation 600/2014/EU [onshored MIFIR], whether located in the United Kingdom or in a third country, which -

(a) is not an originator; and

(b) either - 

(i) establishes and manages an asset-backed commercial paper programme or other securitisation that purchases exposures from third party entities; or

(ii) establishes an asset-backed commercial paper programme or other securitisation that purchases exposures from third party entities and delegates the day-to-day active portfolio management involved in that securitisation to an entity which is authorised to manage assets belonging to another person in accordance with the law of the country in which the entity is established.]

References

A seemingly welcome development for the securitisation market - which occurred towards the end of the trilogues during the passage of the original Securitisation Regulation  - was the apparent widening of the definition of “sponsor” in the Securitisation Regulation, although doubts persist in some quarters over its precise scope.  The original draft had followed the old CRR Rules and had required (by way of a cross-reference to the Capital Requirements Regulation definition) that the sponsor had to be a credit institution or fully-approved MIFID investment firm (as is the case for CRR purposes), and this would have caused problems for many CLO managers wanting to hold the risk retention, because the risk retention can only be held by the sponsor, the originator or the original lender and, since CLO managers would rarely qualify as a sponsor if it referred to the CRR definition of fully-approved investment firm (because few, if any, have the “super authorisations” allowing them to hold client money and perform client custody and so on under paragraphs 6-8 of Annex 1 of MIFID) the only option left would have been the “originator manager” option.  The definition was expanded during the trilogues in two ways: by adding "whether located in the Union or not" after the reference to "credit institution" and by changing the definition from the CRR definition to the much wider MIFID definition, where an "investment firm" is defined as:

“any legal person whose regular occupation or business is the provision of one or more investment services to third parties and/or the performance of one or more investment activities on a professional basis”.

Doubts exist because, although on its face the definition does not have any geographical limitation, the phrase "whether located in the Union or not" appears after "credit institution" but before "investment firm", which is ambiguous and perhaps - so some observers worry - suggestive.  The MIFID definition is usually taken - in the context of the operation of MIFID II itself - to refer to EU-organised firms, and there is a separate definition of "third-country firm" which means "a firm that would be a credit institution providing investment services or performing investment activities or an investment firm if its head office or registered office were located within the Union", and the wording suggests that such a firm is not an "investment firm" - rather, it would be one is it were organised in the EU.  However, in the context of the Securitisation Regulation, article 5(1)(d) clearly envisages the possibility of the sponsor being established in a third country.  No official interpretation or guidance has yet been provided, and a cautious reading is that post-Brexit, UK investment firms, which have certainly fallen out of scope of the EU MIFID II, have consequently also fallen outside of the definition.  On this more cautious analysis, if a pre-Brexit securitisation had been structured so that a UK-organised investment firm were holding the retention as sponsor, the ramifications would require consideration.

The UK post-Brexit onshored version of this definition, contained in section 4 of the Securitisation (Amendment) (EU Exit) Regulations 2019, places "whether located in the United Kingdom or in a third country" after the reference to "investment firm" so that it clearly applies to non-UK firms.  In passing, the UKSR refers to the definition which appears in paragraph 1A of Article 2 of Regulation 600/2014/EU, which may be unfamiliar to many lawyers: this is because it is referring to the onshored version of MIFIR, as amended by section 26 of the Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018; the definition is, broadly speaking, a person whose regular occupation or business is the provision of one or more investment services to third parties or the performance of one or more investment activities on a professional basis.

There is an anomaly here in part (b) as regards non-STS securitisations, which the EC has acknowledged to be unintentional.  Non-STS securitisations may have their sponsor located anywhere in the world.  However, if that sponsor  establishes the securitisation (or ABCP programme) but then delegates the day to day active portfolio management, because the manager is defined by reference to the UCITS Directive, the AIFMD or MIFID, the manager must - as drafted - be in the EU.  The UK post-Brexit onshoring version of this definition, contained in section 4 of the Securitisation (Amendment) (EU Exit) Regulations 2019, has already corrected the wording in point (b) and allows delegation to be to any entity "which is authorised to manage assets belonging to another person in accordance with the law of the country in which the entity is established".

AIFMs

The ESAs' Joint Opinion of 25 March 2021 noted potential inconsistencies between the provisions of the EUSR and the requirements of Directive 2011/61/EU [the AIFM Directive], especially the lack of clarity regarding how the due diligence obligations on AIFMs in respect of securitisations in Article 17 ("Investment in securitisation positions") meshes with the EUSR, and which national regulator should ensure compliance with the relevant due diligence obligations.  The ESAs recommended various clarifications and changes (see further our commentary on investor due diligence) including amending the EUSR definition of “sponsor” to clarify that AIFM sponsors may only delegate day-to-day active portfolio management involved with a securitisation to a servicer which is an EU authorised investment firm, AIFM or UCITS management company, and not to third country AIFMs or sub-threshold AIFMs).

(6)  ‘tranche’ means a contractually established segment of the credit risk associated with an exposure or a pool of exposures, where a position in the segment entails a risk of credit loss greater than or less than a position of the same amount in another segment, without taking account of credit protection provided by third parties directly to the holders of positions in the segment or in other segments;

(7)  ‘asset-backed commercial paper programme’ or ‘ABCP programme’ means a programme of securitisations the securities issued by which predominantly take the form of asset-backed commercial paper with an original maturity of one year or less;

(8)  ‘asset-backed commercial paper transaction’ or ‘ABCP transaction’ means a securitisation within an ABCP programme;

(9)  ‘traditional securitisation’ means a securitisation involving the transfer of the economic interest in the exposures being securitised through the transfer of ownership of those exposures from the originator to an SSPE or through sub-participation by an SSPE, where the securities issued do not represent payment obligations of the originator;

(10)  ‘synthetic securitisation’ means a securitisation where the transfer of risk is achieved by the use of credit derivatives or guarantees, and the exposures being securitised remain exposures of the originator;

(11)  ‘investor’ means a natural or legal person holding a securitisation position;

(12)  ‘institutional investor’ means an investor which is one of the following:

(a)  an insurance undertaking as defined in point (1) of Article 13 of [EU version: Directive 2009/138/EC [Solvency II]] [UK version: section 417(1) of the 2000 Act];

(b)  a reinsurance undertaking as defined in point (4) of Article 13 of [EU version: Directive 2009/138/EC [Solvency II]] [UK version: section 417(1) of the 2000 Act];

[EU version:

(c)  an institution for occupational retirement provision falling within the scope of Directive (EU) 2016/2341[IORPs Directive (recast)] of the European Parliament and of the Council (23) in accordance with Article 2 thereof, unless a Member States has chosen not to apply that Directive in whole or in parts to that institution in accordance with Article 5 of that Directive; or an investment manager or an authorised entity appointed by an institution for occupational retirement provision pursuant to Article 32 of Directive (EU) 2016/2341 [IORPs Directive (recast)] ;

(d)  an alternative investment fund manager (AIFM) as defined in point (b) of Article 4(1) of Directive 2011/61/EU[AIFM Directive] that manages and/or markets alternative investment funds in the Union;

(e)  an undertaking for the collective investment in transferable securities (UCITS) management company, as defined in point (b) of Article 2(1) of Directive 2009/65/EC [UCITS Directive];

(f)  an internally managed UCITS, which is an investment company authorised in accordance with Directive 2009/65/EC [UCITS Directive] and which has not designated a management company authorised under that Directive for its management;

(g)  a credit institution as defined in point (1) of Article 4(1) of Regulation (EU) No 575/2013 [CRR] for the purposes of that Regulation or an investment firm as defined in point (2) of Article 4(1) of that Regulation];

[UK version:

(c)  an occupational pension scheme as defined in section 1(1) of the Pension Schemes Act 1993 that has its main administration in the United Kingdom, or a fund manager of such a scheme appointed under section 34(2) of the Pensions Act 1995 that, in respect of activity undertaken pursuant to that appointment, is authorised for the purposes of section 31 of the 2000 Act;

(d)  an AIFM (as defined in regulation 4(1) of the Alternative Investment Fund Managers Regulations 2013) which markets or manages AIFs (as defined in regulation 3 of those Regulations) in the United Kingdom;

(e)  a management company as defined in section 237(2) of the 2000 Act;

(f)  a UCITS as defined by section 236A of the 2000 Act, which is an authorised open
ended investment company as defined in section 237(3) of that Act;

(g)  a CRR firm as defined by Article 4(1)(2A) of Regulation (EU) No 575/2013;]

(13)  ‘servicer’ means an entity that manages a pool of purchased receivables or the underlying credit exposures on a day-to-day basis;

(14)  ‘liquidity facility’ means the securitisation position arising from a contractual agreement to provide funding to ensure timeliness of cash flows to investors;

(15)  ‘revolving exposure’ means an exposure whereby borrowers’ outstanding balances are permitted to fluctuate based on their decisions to borrow and repay, up to an agreed limit;

(16)  ‘revolving securitisation’ means a securitisation where the securitisation structure itself revolves by exposures being added to or removed from the pool of exposures irrespective of whether the exposures revolve or not;

(17)  ‘early amortisation provision’ means a contractual clause in a securitisation of revolving exposures or a revolving securitisation which requires, on the occurrence of defined events, investors’ securitisation positions to be redeemed before the originally stated maturity of those positions;

(18)  ‘first loss tranche’ means the most subordinated tranche in a securitisation that is the first tranche to bear losses incurred on the securitised exposures and thereby provides protection to the second loss and, where relevant, higher ranking tranches.

(19)  ‘securitisation position’ means an exposure to a securitisation;

(20)  original lender’ means an entity which, itself or through related entities, directly or indirectly, concluded the original agreement which created the obligations or potential obligations of the debtor or potential debtor giving rise to the exposures being securitised;

(21)  ‘fully- supported ABCP programme’ means an ABCP programme that its sponsor directly and fully supports by providing to the SSPE(s) one or more liquidity facilities covering at least all of the following:

(a)  all liquidity and credit risks of the ABCP programme;

(b)  any material dilution risks of the exposures being securitised;

(c)  any other ABCP transaction-level and ABCP programme-level costs if necessary to guarantee to the investor the full payment of any amount under the ABCP;


(22)  ‘fully supported ABCP transaction’ means an ABCP transaction supported by a liquidity facility, at transaction level or at ABCP programme level, that covers at least all of the following:

(a)  all liquidity and credit risks of the ABCP transaction;

(b)  any material dilution risks of the exposures being securitised in the ABCP transaction;

(c)  any other ABCP transaction-level and ABCP programme-level costs if necessary to guarantee to the investor the full payment of any amount under the ABCP;

(23)  ‘securitisation repository’ means a legal person that centrally collects and maintains the records of securitisations.

[EU version only, not in UK version: For the purpose of Article 10 of this Regulation, references in Articles 61, 64, 65, 66, 73, 78, 79 and 80 of Regulation (EU) No 648/2012 [EMIR] to ‘trade repository’ shall be construed as references to ‘securitisation repository’.]

[EU version only, not in UK version:

(24)      “non-performing exposure” or “NPE” means an exposure that meets any of the conditions set out in Article 47a(3) of Regulation (EU) No 575/2013 [CRR];

(25)      “NPE securitisation” means a securitisation backed by a pool of non-performing exposures the nominal value of which makes up not less than 90 % of the entire pool’s nominal value at the time of origination and at any later time where assets are added to or removed from the underlying pool due to replenishment, restructuring or any other relevant reason;

(26)      “credit protection agreement” means an agreement concluded between the originator and the investor to transfer the credit risk of securitised exposures from the originator to the investor by means of credit derivatives or guarantees, whereby the originator commits to pay an amount, known as a credit protection premium, to the investor and the investor commits to pay an amount, known as a credit protection payment, to the originator in the event that one of the contractually defined credit events occurs;

(27)      “credit protection premium” means the amount the originator has committed to pay to the investor under the credit protection agreement for the credit protection promised by the investor;

(28)      “credit protection payment” means the amount the investor has committed to pay to the originator under the credit protection agreement in the event that a credit event defined in the credit protection agreement occurs;

(29)      “synthetic excess spread” means the amount that, according to the documentation of a synthetic securitisation, is contractually designated by the originator to absorb losses of the securitised exposures that might occur before the maturity date of the transaction;

(30)      “sustainability factors” mean sustainability factors as defined in point (24) of Article 2 of Regulation (EU) 2019/2088 of the European Parliament and of the Council [the Sustainable Finance Disclosure Regulation];

(31)      “non-refundable purchase price discount” means the difference between the outstanding balance of the exposures in the underlying pool and the price at which those exposures are sold by the originator to the SSPE, where neither the originator nor the original lender are reimbursed for that difference.]

Article 3

Selling of securitisations to retail clients

1.  The seller of a securitisation position shall not sell such a position to a retail client, as defined in [EU version: point 11 of Article 4(1) of Directive 2014/65/EU [MiFID II]][UK version: rule 3.4.1 of the Conduct of Business sourcebook of the FCA Handbook (retail clients)] unless all of the following conditions are fulfilled:

(a)  the seller of the securitisation position has performed a suitability test in accordance with [EU version: Article 25(2) of Directive 2014/65/EU [MiFID II]] [UK version: rules 9A.2.1 and 9A.2.16 of the Conduct of Business sourcebook of the FCA Handbook (assessing suitability to buy and hold an investment);

(b)  the seller of the securitisation position is satisfied, on the basis of the test referred to in point (a), that the securitisation position is suitable for that retail client;

(c)  the seller of the securitisation position immediately communicates in a report to the retail client the outcome of the suitability test.

2.  Where the conditions set out in paragraph 1 are fulfilled and the financial instrument portfolio of that retail client does not exceed EUR 500 000, the seller shall ensure, on the basis of the information provided by the retail client in accordance with paragraph 3, that the retail client does not invest an aggregate amount exceeding 10 % of that client’s financial instrument portfolio in securitisation positions, and that the initial minimum amount invested in one or more securitisation positions is EUR 10 000.

3.  The retail client shall provide the seller with accurate information on the retail client’s financial instrument portfolio, including any investments in securitisation positions.

4.  For the purposes of paragraphs 2 and 3, the retail client’s financial instrument portfolio shall include cash deposits and financial instruments, but shall exclude any financial instruments that have been given as collateral.

Article 4

Requirements for SSPEs

SSPEs shall not be established in a third country to which any of the following applies:

[UK version: (a)  the third country is listed as a high-risk and non-cooperative jurisdiction by the FATF;]

[EU version:  (a)  the third country is listed as a high-risk third country that has strategic deficiencies in its regime on anti-money laundering and counter terrorist financing, in accordance with Article 9 of Directive (EU) 2015/849 [Money Laundering Directive] of the European Parliament and of the Council;]

[EU version only: (aa)      the third country is listed in Annex I of the EU list of non-cooperative jurisdictions for tax purposes;]

(b)  the third country has not signed an agreement with [EU version: a Member State] [UK version: the United Kingdom] to ensure that that third country fully complies with the standards provided for in Article 26 of the Organisation for Economic Cooperation and Development (OECD) Model Tax Convention on Income and on Capital or in the OECD Model Agreement on the Exchange of Information on Tax Matters, and ensures an effective exchange of information on tax matters, including any multilateral tax agreements.

[EU version only:  For an SSPE established, after 9 April 2021, in a jurisdiction mentioned in Annex II for the reason of operating a harmful tax regime, the investor shall notify the investment in securities issued by that SSPE to the competent tax authorities of the Member State in which the investor is resident for tax purposes.]

Chapter 2

Provisions applicable to all Securitisations

Article 5

Due-diligence requirements for institutional investors

1.  Prior to holding a securitisation position, an institutional investor, other than the originator, sponsor or original lender, shall verify that:

(a)  where the originator or original lender established in the [EU version: Union] [UK version: United Kingdom] is not a credit institution or an investment firm as defined in points (1) and (2) of Article 4(1) of Regulation (EU) No 575/2013 [CRR], the originator or original lender grants all the credits giving rise to the underlying exposures on the basis of sound and well-defined criteria and clearly established processes for approving, amending, renewing and financing those credits and has effective systems in place to apply those criteria and processes in accordance with Article 9(1) of this Regulation;

(b)  where the originator or original lender is established in a third country, the originator or original lender grants all the credits giving rise to the underlying exposures on the basis of sound and well-defined criteria and clearly established processes for approving, amending, renewing and financing those credits and has effective systems in place to apply those criteria and processes to ensure that credit-granting is based on a thorough assessment of the obligor’s creditworthiness;

(c)  if established in the [EU version: Union] [UK version: United Kingdom], the originator, sponsor or original lender retains on an ongoing basis a material net economic interest in accordance with Article 6 and the risk retention is disclosed to the institutional investor in accordance with Article 7;

(d)  if established in a third country, the originator, sponsor or original lender retains on an ongoing basis a material net economic interest which, in any event, shall not be less than 5 %, determined in accordance with Article 6, and discloses the risk retention to institutional investors;

(e)  [UK version: if established in the United Kingdom,] the originator, sponsor or SSPE has, where applicable, made available the information required by Article 7 in accordance with the frequency and modalities provided for in that Article.

[UK version only: (f)  if established in a third country, the originator, sponsor or SSPE has, where applicable - 

(i)  made available information which is substantially the same as that which it would have made available in accordance with point (e) if it had been established in the United Kingdom; and

(ii)  has done so with such frequency and modalities as are substantially the same as those with which it would have made information available in accordance with point (e) if it had been so established.]

[EU version only(f)  in the case of non-performing exposures, sound standards are applied in the selection and pricing of the exposures.]

 

 

References

Sound and consistent credit-granting criteria (Article 5(1)(a) and (b))

Consistency of underwriting is an important theme not only in the Securitisation Regulation, but also in the Basel/IOSCO proposals on STC.  In this respect, a useful contribution was made by the European Parliament during the passage of the Securitisation Regulation, by narrowing the scope of the underwriting verification to the credits which give rise to the underlying exposures being securitised - which is consistent with requirement A4 in Basel/IOSCO.  The EC had originally proposed that it should extend to the basis on which the originator or original lender granted "all" its credits, whether they were being securitised or not (consistent with Article 52 of the old  AIFM rules).

This verification requirement does not apply if the originator or original lender is a credit institution or investment firm as defined in Article 4(1)(1) and (2) of the CRR.  Many CLO managers will not be because many are not fully authorised, and so if they are acting as originator of an issue, this would catch the issue if the exposures were not originated by a credit institution or one of the other exempt categories: for example, securitisations of auto loans and leases, and credit or store cards; and post-Brexit, it also catches UK originators which would previously have been authorised institutions, because they would now fall within Article 5(1)(b).  A nice question is whether a securitisation of exposures originated by a UK credit institution before Brexit but securitised after Brexit would fall within (a) - in which case its credit-granting criteria etc. would require not verification by EU27 investors - or (b) - in which case they would.

Verification that risk has been retained (Article 5(1)(c) and (d))

An institutional investor must verify before becoming exposed to a securitisation that the originator, sponsor or original lender meets the risk retention criteria in Article 6 (non-EU originators or original lenders are not themselves directly obliged to do this, but EU investors cannot buy the paper if they do not; because Dodd-Frank has slightly different rules on risk retention, this means EU investors may not be able to buy some US issues).

It is not specified what "verification" a potential investor is supposed to do, and no RTS or guidelines can flesh out any of the detail.

Verification of compliance with the transparency criteria (Article 5(1)(e))

This raises the vexed question of what an EU investor in a non-EU securitisation has to do.  This is analysed here.

Institutional investors' heightened due diligence assessment  for STS (Article 5(3)(c))

As well as the assessments required by Article 5(3) and (4) for any investment, before investing in an STS securitisation, EU institutional investors have to comply with the heightened due diligence requirements in article 5(3)(c) to check that it meets the STS criteria.  When doing this, they can "rely to an appropriate extent" on the STS notification, but must not rely on it "solely or mechanistically".  As of June 2019 it seems that some investors have a preference for non-STS deals in order to avoid having to get into this.

Procedures, regular testing, internal reporting and understanding (article 5(4))

On a point of detail, the wording of Article 5(4)(e) presumably should have, but (seemingly in error) does not, carve out fully-supported ABCP (unlike in Article 5(4)(b)) and so it seems that ABCP investors must be able to demonstrate that they have a comprehensive and thorough understanding of the credit quality of the underlying exposures; which makes no sense at all in the context.

The due diligence obligations contain no provision for RTS nor even guidelines to supplement them.  It is to be hoped that the joint committee of the ESAs may be able to issue some clarity (this is particularly an issue as regards the extraterritoriality question).  RTS (Commission Delegated Regulation 625/2014)) were issued to supplement the old Article 406 of the CRR. The Commission seems to have been determined to impose a principles-based obligation so that investors would need to exercise caution in their due diligence. It is clear that regulated investors will need to establish and follow detailed policies and procedures so that they can demonstrate to their regulator that best practice has been followed, and presumably it will then be for their regulator to adopt a common-sense approach in not penalising investors which have done what they reasonably can.

On the positive side, the new requirements do away with some of the existing excessive qualitative due diligence required of insurers by Article 256(3) of Solvency II and of AIFMs by Article 53 of the CRD for AIFMs, and they recognise that in the case of fully-supported ABCP programmes, what counts principally is the quality of the support, not the underlying exposures.

AIFMs

The ESAs' Joint Opinion of 25 March 2021 noted potential inconsistencies between the provisions of the EUSR and the requirements of Directive 2011/61/EU [the AIFM Directive], especially the lack of clarity regarding how the due diligence obligations on AIFMs in respect of securitisations in Article 17 ("Investment in securitisation positions") meshes with the EUSR, and which national regulator should ensure compliance with the relevant due diligence obligations.  The ESAs recommended various clarifications and changes including:

  • amending the EUSR and the AIFMD to ensure that third country AIFMs comply with the due diligence obligations with respect to funds marketed in the EU, and to clarify whether third country AIFMs should be regarded as “institutional investors”;
  • amending the EUSR to clarify the powers of EU national regulators to enforce the due diligence requirements in respect of third country AIFMs, and to clarify whether smaller AIFMs (those below the threshold in article 3(2)) are within the definition of an “institutional investor” or not (the ESAs think they should be);
  • clarification regarding the ability of a fund manager to delegate the due diligence activity to another manager; and
  • amending the EUSR definition of “sponsor” to clarify that AIFM sponsors may only delegate day-to-day active portfolio management involved with a securitisation to a servicer which is an EU authorised investment firm, AIFM or UCITS management company, and not to third country AIFMs or sub-threshold AIFMs).

A major uncertainty about the Securitisation Regulation since its inception has been about what transparency it (indirectly) requires non-EU issuers to provide to potential EU investors so that they can do their due diligence under Article 5(1)(e).  By way of a reminder:

  • Article 5 applies to EU institutional investors in securitisations, and Article 5(1)(e) requires the originator, sponsor or SSPE to have "where applicable, made available the information required by Article 7 in accordance with the frequency and modalities provided for in that Article". 
  • Article 7’s “modalities” include using specific templates issued under the  disclosure ITS and the associated Annexes
  • However, Article 7 cannot apply to non-EU issuers without being extra-territorial (which on first principles it should not be, and other parts of the drafting support this too).  
  • But, even though Article 7 does not apply directly to an issue, does the issue have to comply with it indirectly in order to allow non-EU issuers to invest? 

The key is what “where applicable” means inArticle 5(1)(e), and the problem is that there are two ways to interpret it, neither of which is satisfactory:

  • if it means “in a case where Article 7 applies to the issue directly” then some would argue that you could get round the disclosure requirements easily by having a non-EU issue denominated in EUR with EU assets, which would drive a coach and horses through the regulation.   However, Recital (9) says “it is essential that institutional investors be subject to proportionate due-diligence requirements…” and Article 5(3) and (4) contain general requirements on EU investors to do proper due diligence before investing, and these are not disapplied even if, for non-EU issues, they are not provided with granular loan-level data, so this is not the "coach and horses" that some might argue it was;
  • if it means “as the case may be”, you have an extra-territorial effect that probably stops EU investors buying non-EU issues, thus preventing them diversifying their investments and fragmenting the market.  This would not be supportive of Capital Markets Union.

The first of these interpretations would be preferable, but no law firm had been prepared to provide a clean opinion on the matter, and whilst some EU investors had been prepared to invest regardless, others had been boycotting non-EU issues which did not provide the granular loan level data. 

The big sticking point is whether or not you need to have loan-level data disclosure, as Article 7 requires.  In the USA (and apparently Australia and Japan too) this kind of granular loan level disclosure is not the norm.  In the USA, there is no loan level data disclosure required for issues under Rule 144A, just aggregated data; public (prospectus) issues require asset-level data for RMBS, CMBS, and auto loans/leases, but not for credit cards.

The EC had received several communications, from the likes of AFME (FM Update 26th April 2019), the US-based Structured Finance Association (15th July 2019) and the FMLC (5th November, 2019), requesting it to provide clarity, and the 2020 Work Programme of the joint committee of the ESAs identified "the jurisdictional scope of application" as one of the issues requiring their attention, and on 25 March 2021 the ESAs' Joint Opinion was issued.  Unfortunately for the market, it came to the conclusion that, given the reference to complying with the “frequency and modalities” of disclosure referred to in Article 7, a third country securitisation would have to use ESMA templates or, at a minimum, templates with the same content, and that those be disclosed with the same frequency as that of ESMA’s.  The ESAs therefore concluded that:

"it seems very unlikely, or at least very challenging, that EU-located institutional investors would currently be able to discharge the requirement set out in Article 5(1)(e) of the SECR in relation to third country securitisations, as a result of which they will not be able to invest in them". 

This is disappointing, and the ESAs did admit that "the current verification duty laid out in Article 5(1)(e) of the SECR may be overly inflexible for third country securitisations" and recommended that it "should be reassessed to determine whether more flexibility could be added to the framework without undermining its ultimate objective".  This is of course what the UKSR has already done by its new Article 5(1)(f).  This is however a “level 1” issue i.e. it relates to the text of the Securitisation Regulation itself, not some “level 2” RTS or ITS, and it will inevitably take time to amend it.  This is unlikely to be achieved until after the EC's Article 46 review, which is required by the end of 2021.  Brussels is thought to be disappointed at the muted effect on the securitisation market that has been seen in the first year of the Securitisation Regulation and is apparently keen to improve matters. 

As to how this is done, two possibilities had already been aired before the ESAs' Opinion:

  • one, mooted during 2020 in some quarters, was to promote the idea of "substantive compliance", i.e. that disclosure would be made, even if not on the prescribed official ESMA templates, but the SFA letter (see above) had said that this would still be a problem for its USA-based members;
  • in June 2020, the High Level Forum on Capital Markets Union's final report invited the EC to "allow an EU-regulated investor in third-country securitisations to determine [i.e. for itself] whether it has received sufficient information to meet the requirements of Article 5... to carry out its due diligence obligation proportionate to the risk profile of such securitisation" and suggested "clarification" that Article 5(1)(e) does not apply to securitisations with non-EU originators, sponsors or SSPEs, and that, instead, the EU investor must receive "sufficient information to meet the requirements for due diligence proportionate to the risk profile of the securitisation exposure".

The ESAs' Joint Opinion of 25 March 2021 has suggested a third approach:

  • the EUSR should be amended to include an "equivalence" regime for transparency requirements in relation to third country securitisations i.e. its disclosure obligations should require:
    • "substantially the same information" as that required by Article 7
    • with "sufficient frequency” even if the exact frequency of disclosure is not exactly the same as under Article 7
    • with a “modality” of disclosure in the form of disclosure templates of "similar quality and granularity" as those set out in the Disclosure RTS and the Disclosure ITS
  • an EU institutional investor could then comply with Article 5(1)(e) by verifying disclosure compliance either with Article 7 or the equivalent disclosure regime.

This is in some respects similar to "substantive compliance" and will not satisfy the market because it would require the same granularity of disclosure and so run into the same problem in cases where that is not the market norm in the place where the issue takes place.  The market must hope that the EC, in its Article 45 review, pays more attention to the views of the High Level Forum.

For UK investors, as from 1st January 2021 the problem has diminished to an extent because the legislation which implements the Securitisation Regulation into UK law - The Securitisation (Amendment) (EU Exit) Regulations 2019 - has already improved the drafting in Article 5(1)(e), so that (e) applies in relation to originators, sponsors and SPPEs established in the UK, and a new sub-clause (f) applies to those established elsewhere, requiring "substantially" the same information, which contains some latitude and does not require use of the Article 7 templates.  We await guidance on what "substantially" means, and bear in mind that the EU/UK article 7 disclosure requirements are unmatched by anything in the USA or Japan or elsehwere in the world, and so there is a serious risk that Article 5(1)(f) would at most restrict UK investors to UK assets and EU assets).  The position for UK investors in non-UK issues (such as USA issues) is preferable to that of EU investors wanting to buy those same USA issues, but it would be far better if the UK were to move away from the Article 5(1)(e)and (f) requirements.  AFME's preference would be to replace them with a more general principle that required proportionate due diligence to be done. 

A related issue concerns non-EU subsidiaries of EU regulated institutions.  Those subsidiaries are indirectly subject to article 5 by the parent's obligation to ensure the consolidated application of Article 5 via Article 14 of the CRR by requiring them to "implement arrangements, processes and mechanisms to ensure compliance” with Article 5.  The extent of this obligation is unclear, but if it means subsidiaries have to comply line-by-line, then the problems are obvious, and put them at a competitive disadvantage compared to local investors.  The ESAs recommend the CRR is amended to provide some flexibility, either:

  • by allowing the EU parent to "ring-fence" the subsidiary via some "structural separation" - there is no detail provided for this and query whether the idea has any legs; or
  • allowing some "proportionate investment limits on the subsidiary’s investments in third country securitisations by reference to the consolidated situation of the EU parent" - which sounds much more feasible.

2.  By derogation from paragraph 1, as regards fully supported ABCP transactions, the requirement specified in point (a) of paragraph 1 shall apply to the sponsor. In such cases, the sponsor shall verify that the originator or original lender which is not a credit institution or an investment firm grants all the credits giving rise to the underlying exposures on the basis of sound and well-defined criteria and clearly established processes for approving, amending, renewing and financing those credits and has effective systems in place to apply those criteria and processes in accordance with Article 9(1).

3.  Prior to holding a securitisation position, an institutional investor, other than the originator, sponsor or original lender, shall carry out a due-diligence assessment which enables it to assess the risks involved. That assessment shall consider at least all of the following:

(a)  the risk characteristics of the individual securitisation position and of the underlying exposures;

(b)  all the structural features of the securitisation that can materially impact the performance of the securitisation position, including the contractual priorities of payment and priority of payment-related triggers, credit enhancements, liquidity enhancements, market value triggers, and transaction-specific definitions of default;

(c)  with regard to a securitisation notified as STS in accordance with Article 27, the compliance of that securitisation with the requirements provided for in Articles 19 to 22 or in Articles 23 to 26, and Article 27. Institutional investors may rely to an appropriate extent on the STS notification pursuant to Article 27(1) and on the information disclosed by the originator, sponsor and SSPE on the compliance with the STS requirements, without solely or mechanistically relying on that notification or information;

[UK version:  

(d)  in point (c) - 

(i)  the reference to a securitisation notified as STS in accordance with Article 27 includes a reference to a securitisation notified in accordance with that Article before exit day, or before the expiry of a period of two years beginning with exit day, where the person responsible for the notification (the originator and sponsor or, in the case of an ABCP programme, the sponsor) is established in an EEA State;

(ii)  in relation to any securitisation so notified, the reference to the STS notification is a reference to the notification of that securitisation as STS, and a reference to a numbered Article is a reference to the Article so numbered of this Regulation as it had or has effect in relation to an EEA State at any time on and after the date of the notification and before the end of the period referred to in paragraph (i).]

Notwithstanding points (a) and (b) of the first subparagraph, in the case of a fully supported ABCP programme, institutional investors in the commercial paper issued by that ABCP programme shall consider the features of the ABCP programme and the full liquidity support.

4.  An institutional investor, other than the originator, sponsor or original lender, holding a securitisation position, shall at least:

(a)  establish appropriate written procedures that are proportionate to the risk profile of the securitisation position and, where relevant, to the institutional investor’s trading and non-trading book, in order to monitor, on an ongoing basis, compliance with paragraphs 1 and 3 and the performance of the securitisation position and of the underlying exposures.

Where relevant with respect to the securitisation and the underlying exposures, those written procedures shall include monitoring of the exposure type, the percentage of loans more than 30, 60 and 90 days past due, default rates, prepayment rates, loans in foreclosure, recovery rates, repurchases, loan modifications, payment holidays, collateral type and occupancy, and frequency distribution of credit scores or other measures of credit worthiness across underlying exposures, industry and geographical diversification, frequency distribution of loan to value ratios with band widths that facilitate adequate sensitivity analysis. Where the underlying exposures are themselves securitisation positions, as permitted under Article 8, institutional investors shall also monitor the exposures underlying those positions;

(b)  in the case of a securitisation other than a fully supported ABCP programme, regularly perform stress tests on the cash flows and collateral values supporting the underlying exposures or, in the absence of sufficient data on cash flows and collateral values, stress tests on loss assumptions, having regard to the nature, scale and complexity of the risk of the securitisation position;

(c)  in the case of fully supported ABCP programme, regularly perform stress tests on the solvency and liquidity of the sponsor;

(d)  ensure internal reporting to its management body so that the management body is aware of the material risks arising from the securitisation position and so that those risks are adequately managed;

(e)  be able to demonstrate to its competent [EU version: authorities] [UK version: authority], upon request, that it has a comprehensive and thorough understanding of the securitisation position and its underlying exposures and that it has implemented written policies and procedures for the risk management of the securitisation position and for maintaining records of the verifications and due diligence in accordance with paragraphs 1 and 2 and of any other relevant information; and

(f)  in the case of exposures to a fully supported ABCP programme, be able to demonstrate to its competent authorities, upon request, that it has a comprehensive and thorough understanding of the credit quality of the sponsor and of the terms of the liquidity facility provided.

5.  Without prejudice to paragraphs 1 to 4 of this Article, where an institutional investor has given another institutional investor authority to make investment management decisions that might expose it to a securitisation, the institutional investor may instruct that managing party to fulfil its obligations under this Article in respect of any exposure to a securitisation arising from those decisions. [EU version only: Member States shall ensure that,] where an institutional investor is instructed under this paragraph to fulfil the obligations of another institutional investor and fails to do so, any sanction [EU version: under Articles 32 and 33] [UK version: imposed as a result of the failure] may be imposed on the managing party and not on the institutional investor who is exposed to the securitisation.

 

The due diligence provisions in Article 5 clearly apply to EU investors, and similarly the Article 6 risk retention and Article 7 transparency and credit granting criteria provisions clearly apply to originators, sponsors and original lenders doing business in the EU.  But what about cross-border cases?

The better view is that Articles 6 and 7 do not apply to entities which are established outside the EU. This would be consistent with the fundamental presumption that legislation should not be extra-territorial unless that is its clear intention; and in any event, as regards risk retention, if a non-EU sponsor wants to sell a non-EU securitisation to EU investors, then indirectly, as a result of Article 5(1)(d), it would need to comply with the Article 6 risk retention requirements.  The EC's explanatory memorandum accompanying the original draft of the Securitisation Regulation suggested this was the position, and in the final draft RTS on risk retention (at page 27) the EBA helpfully observed, in respect of comments it received in response to its discussion draft RTS on risk retention, that, although the scope of application and jurisdictional scope of the ‘direct’ retention obligation was outside the scope of the draft RTS, it agreed that a ‘direct’ obligation should apply only to originators, sponsors and original lenders established in the EU; and finally, the ESAs' Joint Opinion of 25 March 2021 expressed the same view i.e. that articles 6, 7 and 9 do not apply directly to non-EU parties on the sell side (if there is a mix of EU and non-EU sell-side parties, the ESAs' view is that those located in the EU have a direct obligation to comply with the rules).

As regards transparency, there is the vexed question whether EU investors can invest in non-EU issues that do not comply with Article 7.  As regards risk retention, the position is clear: Article 5(1)(c) requires investors to verify that Article 6 is complied with if the issue is an EU one, and then Article 5(1)(d) is equally clear that where it is a non-EU issue, the originator, sponsor or original lender must retain 5%, determined in accordance with the Article 6 methodology.  So, the wording acknowledges explicitly that the issue could be EU or non-EU, and deals with both in turn.  The same is true of the requirement to verify that the originator's or original lender's credit-granting criteria were acceptable: Article 5(1)(a) applies where they are EU entities, and Article 5(1)(b) applies where they are not.  In comparison, as regards transparency, instead of having a third pair of requirements, one for EU issues and one for non-EU issues, Article 5(1) just has a single requirement, Article 5(1)(e) which requires an EU investor to verify that the originator, sponsor or SSPE "has, where applicable, made available the information required by Article 7 in accordance with the frequency and modalities provided for in that Article", and those modalities require detailed loan-level data in accordance with the prescribed templates, and not just aggregate data.  The ESAs' Joint Opinion of 25 March 2021 was that, given the reference to complying with the “frequency and modalities” of disclosure referred to in Article 7, a third country securitisation would have to use ESMA templates or, at a minimum, templates with the same content, and that those be disclosed with the same frequency as that of ESMA’s.  The ESAs therefore concluded that "it seems very unlikely, or at least very challenging, that EU-located institutional investors would currently be able to discharge the requirement set out in Article 5(1)(e) of the SECR in relation to third country securitisations, as a result of which they will not be able to invest in them".  This is disappointing, and the ESAs did admit that "the current verification duty laid out in Article 5(1)(e) of the SECR may be overly inflexible for third country securitisations" and recommended that it "should be reassessed to determine whether more flexibility could be added to the framework without undermining its ultimate objective".  This is of course what the UKSR has already done by its new Article 5(1)(f).  

This issue is discussed in detail on another page: "Do EU investors need loan level data to invest in non-EU issues"? 

Consolidated non-EU subsidiaries of EU entities

As of 1st January 2019, there was a temporary hiccup concerning the position of consolidated subsidiaries of EU regulated entities, because of the interplay of the Securitisation Regulation and the CRR (as revised by the 2018 CRR Amendment Regulation).  The actual detail is long and complex but, in short, the old CCR's Article 14 required EU regulated entities to ensure that their non-EU subsidiaries complied with the whole of the old part 5 of the CRR, which imposed due diligence obligations on investors and obligations on originators and sponsors regarding sound credit granting criteria and transparency, but as regards both the indirect retention obligation and investor due diligence, this was moderated by Article 14(2) of the CRR.  Because the old part 5 was replaced by the Securitisation Regulation, Article 14 was amended by the 2018 CRR Amendment Regulation to change the reference to Part 5 to refer to Chapter 2 of the Securitisation Regulation (articles 5 to 9, covering due diligence, risk retention, transparency, the ban on resecuritisation and criteria for credit granting).  At first glance this looked consistent, and it took a while before it was noticed that this went too far, e.g. a non-EU subsidiary acting as an originator, sponsor or original lender outside the EU would be required to comply with EU risk retention rules as well as its own home country ones.

The detailed explanation of all this need not concern us now because Article 1(9) of CRR II has changed the wording of CRR Article 14 so that rather than the whole of Chapter 2 applying to consolidated non-EU subsidiaries, only the Article 5 due diligence requirements will:

"1.  Parent undertakings and their subsidiaries that are subject to this Regulation shall be required to meet the obligations laid down in Article 5 of Regulation (EU) 2017/2402 [i.e. the Securitisation Regulation] on a consolidated or sub-consolidated basis, to ensure that their arrangements, processes and mechanisms required by those provisions are consistent and well- integrated and that any data and information relevant to the purpose of supervision can be produced. In particular, they shall ensure that subsidiaries that are not subject to this Regulation implement arrangements, processes and mechanisms to ensure compliance with those provisions.
2.  Institutions shall apply an additional risk weight in accordance with Article 270a of this Regulation when applying Article 92 of this Regulation on a consolidated or sub-consolidated basis if the requirements laid down in Article 5 of Regulation (EU) 2017/2402 are breached at the level of an entity established in a third country included in the consolidation in accordance with Article 18 of this Regulation if the breach is material in relation to the overall risk profile of the group.”

The RTS on risk retention moderate its application in the same way that CDR 625/2014 previously did as regards the old indirect risk retention requirement.  So not only does Article 14(2) apply (so that a breach of the due diligence requirements at the subsidiary level will not result in a penalty capital charge unless the breach is material in relation to the overall risk profile of the group - this is the old position) but also, Article 2(4) of the new RTS will now apply to prevent it being a breach of Article 14(2) in the first place if a breach of the due diligence requirements occurs at the subsidiary level.

Article 6

Risk retention

1.  The originator, sponsor or original lender of a securitisation shall retain on an ongoing basis a material net economic interest in the securitisation of not less than 5%. That interest shall be measured at the origination and shall be determined by the notional value for off-balance-sheet items. Where the originator, sponsor or original lender have not agreed between them who will retain the material net economic interest, the originator shall retain the material net economic interest. There shall be no multiple applications of the retention requirements for any given securitisation. The material net economic interest shall not be split amongst different types of retainers and not be subject to any credit-risk mitigation or hedging.

For the purposes of this Article, an entity shall not be considered to be an originator where the entity has been established or operates for the sole purpose of securitising exposures.

[EU version onlyWhen measuring the material net economic interest, the retainer shall take into account any fees that may in practice be used to reduce the effective material net economic interest.

In the case of traditional NPE securitisations, the requirement of this paragraph may also be fulfilled by the servicer provided that the servicer can demonstrate that it has expertise in servicing exposures of a similar nature to those securitised and that it has well-documented and adequate policies, procedures and risk-management controls in place relating to the servicing of exposures.]

References

Article 6(1):

“For the purposes of this Article [i.e. Article 6 – risk retention], an entity shall not be considered to be an originator where the entity has been established or operates for the sole* purpose of securitising exposures”

was included in the Securitisation Regulation to plug the perceived loophole the EBA identified in its December 2014 report, which could allow for originate-to-distribute structures under which the “real” originator would be able to sidestep the 5% retention requirement.**

Article 6 does not altogether reflect the EC’s original explanatory memorandum: there is no requirement that “the entity retaining the economic interest has to have the capacity to meet a payment obligation from resources not related to the exposures being securitised”.  However, Article 2(7) of the revised draft RTS on risk retention picks this up, adding some clarificatory principles regarding whether an originator has been established for the “sole purpose” of securitising exposures, requiring “appropriate consideration” to be given to whether:

"(a) the entity has a business strategy and the capacity to meet payment obligations consistent with a broader business enterprise and involving material support from capital, assets, fees or other income available to the entity, relying neither on the exposures being securitised by that entity, nor on any interests retained or proposed to be retained in accordance with this Regulation, as well as any corresponding income from such exposures and interests as its sole or predominant source of revenue;
(b) the responsible decision makers have the required experience to enable the entity to pursue the established business strategy, as well as an adequate corporate governance arrangement."

The EBA accepted that the sole purpose test should be principles-based, and on that basis was disinclined to - and so did not - provide any detail regarding "sole purpose" over and above what is said in Article 3(6).

* This wording was the subject of prior debate; an earlier draft had proposed "primary" rather than "sole".

** The EBA December 2014 report noted:

"As a result of the wide scope of the ‘originator’ definition in the CRR, it is possible to establish an ‘originator SSPE’ with third-party equity investors solely for creating an ‘originator’ that meets the legal definition of the regulation and which will become the retainer in a securitisation. For example, an ‘originator SSPE’ is established solely for buying a third party’s exposures and securitises the exposures within one day. Another example is when an ‘originator SSPE’ has asymmetric exposure to a securitisation and benefits from any ‘upside’ but not ‘downside’ of the retained interest (see Annex I for the possible transaction structure)".

2.  Originators shall not select assets to be transferred to the SSPE with the aim of rendering losses on the assets transferred to the SSPE, measured over the life of the transaction, or over a maximum of 4 years where the life of the transaction is longer than four years, higher than the losses over the same period on comparable assets held on the balance sheet of the originator. Where the competent authority finds evidence suggesting contravention of that prohibition, the competent authority shall investigate the performance of assets transferred to the SSPE and comparable assets held on the balance sheet of the originator. If the performance of the transferred assets is significantly lower than that of the comparable assets held on the balance sheet of the originator as a consequence of the intent of the originator, the competent authority shall impose a sanction [EU version: pursuant to Articles 32 and 33] [UK version: for the contravention].

3.  Only the following shall qualify as a retention of a material net economic interest of not less than 5% within the meaning of paragraph 1:

(a)  the retention of not less than 5% of the nominal value of each of the tranches sold or transferred to investors;

(b)  in the case of revolving securitisations or securitisations of revolving exposures, the retention of the originator’s interest of not less than 5% of the nominal value of each of the securitised exposures;

(c)  the retention of randomly selected exposures, equivalent to not less than 5 % of the nominal value of the securitised exposures, where such non-securitised exposures would otherwise have been securitised in the securitisation, provided that the number of potentially securitised exposures is not less than 100 at origination;

(d)  the retention of the first loss tranche and, where such retention does not amount to 5% of the nominal value of the securitised exposures, if necessary, other tranches having the same or a more severe risk profile than those transferred or sold to investors and not maturing any earlier than those transferred or sold to investors, so that the retention equals in total not less than 5% of the nominal value of the securitised exposures; or

(e)  the retention of a first loss exposure of not less than 5% of every securitised exposure in the securitisation.

[EU version only

3a.   By way of derogation from paragraph 3, in the case of NPE securitisations, where a non-refundable purchase price discount has been agreed, the retention of a material net economic interest for the purposes of that paragraph shall not be less than 5 % of the sum of the net value of the securitised exposures that qualify as non-performing exposures and, if applicable, the nominal value of any performing securitised exposures.

The net value of a non-performing exposure shall be calculated by deducting the non-refundable purchase price discount agreed at the level of the individual securitised exposure at the time of origination or, where applicable, a corresponding share of the non-refundable purchase price discount agreed at the level of the pool of underlying exposures at the time of origination from the exposure’s nominal value or, where applicable, its outstanding value at the time of origination. In addition, for the purpose of determining the net value of the securitised non-performing exposures, the non-refundable purchase price discount may include the difference between the nominal amount of the tranches of the NPE securitisation underwritten by the originator for subsequent sale and the price at which these tranches are first sold to unrelated third parties.]

[EU version:

4.  Where a mixed financial holding company established in the Union within the meaning of Directive 2002/87/EC [Financial Conglomerates Directive] of the European Parliament and of the Council(24), a parent institution or a financial holding company established in the Union, or one of its subsidiaries within the meaning of Regulation (EU) No 575/2013 [CRR], as an originator or sponsor, securitises exposures from one or more credit institutions, investment firms or other financial institutions which are included in the scope of supervision on a consolidated basis, the requirements referred to in paragraph 1 may be satisfied on the basis of the consolidated situation of the related parent institution, financial holding company, or mixed financial holding company established in the Union.]

[UK version:

4.  Where - 

(a) a mixed financial holding company,

(b) a UK parent institution,

(c) a financial holding company established in the United Kingdom, or

(d) a subsidiary of such a company or institution,

as an originator or sponsor, securitises exposures from one or more credit institutions, investment firms or other financial institutions which are included in the scope of supervision on a consolidated basis, the requirements set out in paragraph 1 may be satisfied on the basis of the consolidated situation of the mixed financial holding company, UK parent institution or financial holding company concerned.]

The first subparagraph shall apply only where credit institutions, investment firms or financial institutions which created the securitised exposures comply with the requirements set out in Article 79 of Directive 2013/36/EU[CRD IV] of the European Parliament and of the Council (25) and deliver the information needed to satisfy the requirements provided for in Article 5 of this Regulation, in a timely manner, to the originator or sponsor [EU version: and to the Union parent credit institution, financial holding company or mixed financial holding company established in the Union.] [UK version: and, if the originator or sponsor is a subsidiary, to the mixed financial holding company, UK parent institution or financial holding company which is the parent undertaking of the subsidiary].

[UK version only

In this paragraph - 

(a) ‘credit institution’, ‘financial holding company’, ‘financial institution’, ‘investment firm’, ‘subsidiary’ and ‘UK parent institution’ have the meaning given in Article 4(1) of Regulation (EU) No 575/2013; and

(b) ‘mixed financial holding company” has the meaning given in regulation 1(2) of the Financial Conglomerates and Other Financial Groups Regulations 2004.]

5.  Paragraph 1 shall not apply where the securitised exposures are exposures on or exposures fully, unconditionally and irrevocably guaranteed by:

(a)  central governments or central banks;

(b)  regional governments, local authorities and public sector entities within the meaning of point (8) of Article 4(1) of Regulation (EU) No 575/2013 [CRR] [EU version only: of Member States];

(c)  institutions to which a 50 % risk weight or less is assigned under Part Three, Title II, Chapter 2 of Regulation (EU) No 575/2013 [CRR];

(d)  national promotional banks or institutions within the meaning of point (3) of Article 2 of Regulation (EU) 2015/1017 of the European Parliament and of the Council (26); or

(e)  the multilateral development banks listed in Article 117 of Regulation (EU) No 575/2013 [CRR].

6.  Paragraph 1 shall not apply to transactions based on a clear, transparent and accessible index, where the underlying reference entities are identical to those that make up an index of entities that is widely traded, or are other tradable securities other than securitisation positions.

7.  [EU Version: EBA, in close cooperation with the ESMA and the European Insurance and Occupational Pensions Authority (EIOPA) which was established by Regulation (EU) No 1094/2010 of the European Parliament and of the Council(27), shall develop draft regulatory] [UK version: The FCA and the PRA, acting jointly, may make] technical standards to specify in greater detail the risk-retention requirement, in particular with regard to:

(a)  the modalities for retaining risk pursuant to paragraph 3, including the fulfilment through a synthetic or contingent form of retention;

(b)  the measurement of the level of retention referred to in paragraph 1;

(c)  the prohibition of hedging or selling the retained interest;

(d)  the conditions for retention on a consolidated basis in accordance with paragraph 4;

(e)  the conditions for exempting transactions based on a clear, transparent and accessible index referred to in paragraph 6;

[EU version only(f)        the modalities of retaining risk pursuant to paragraphs 3 and 3a in the case of NPE securitisations;]

[EU version only(g)          the impact of fees paid to the retainer on the effective material net economic interest within the meaning of paragraph 1.]

[EU version only:

The EBA shall submit those draft regulatory technical standards to the Commission by 10 October 2021.]

The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.]

 


Risk retention was one of the most controversial aspects during the passage of the Securitisation Regulation, and the eventual agreement to leave it alone was a victory for the market after severe changes had been proposed by Green and Left Wing MEPs who were clearly suspicious of, and often hostile to, the very idea of securitisation.

As a compromise to the strongly-held views of those MEPs who wanted to make it more stringent, Article 31 gives the ESRB a mandate to monitor developments in the securitisation market with respect to the build-up of any excessive risk and, where necessary, in collaboration with the EBA, to issue warnings and recommendations for action, including on the appropriateness of modifying the risk retention levels.

Risk retention – a brief history

The European Parliament had proposed increasing minimum risk retention levels to 10%, except for a first loss tranche, where the minimum would remain at 5%, and retention of a first loss exposure for every securitised exposure, where the minimum would be 7.5%. Further, it had proposed that the EBA and ESRB would have the power to revise retention rates up to 20% on the basis of market circumstances, and that risk retention rates should be reviewed every two years. Rapporteur Tang had been impressed by an academic paper, “Skin-in-the-Game in ABS Transactions: A Critical Review of Policy Options” which highlighted the very different levels of skin in the game represented by horizontal and vertical 5% retention strips.

The Commission put out a non-paper in April 2017 which emphasized the consensus for retaining the current risk retention framework, which is based on the Basel-IOSCO standard and supported by reviews done by CEBS and the EBA, and three public consultations, including the ECB-BOE May 2014 joint paper, “The case for a better functioning securitisation market in the European Union” and the European Banking Authority December 2014 “report on securitisation risk retention, due diligence and disclosure”.  It quoted the European Central Bank’s conclusion in its September 2016 paper, “Issues on risk retention”, that not only was an increase of the 5% minimum retention rate unwarranted, but also a retention rate increase would place European issuers at a disadvantage, and concluded that there was no evidence justifying any change to the risk retention framework, while the proposals to revisit the rates every two years in the future would create excessive uncertainty. Its written response to Rapporteur Tang was worded accordingly.

The outcome was therefore that the position remains unchanged from what we had in the old CRR and Solvency II, and the only remaining vestige of the European Parliament’s failed attempts to change it is a prohibition (Article 6(2) on deliberately adverse selection practices; and even this is much more benign than the original European Parliament’s proposal of an objective test comparing the performance of sold and retained assets.

The risk retention RTS

As of 1st July 2021, the EBA began a fresh consultation, running until 30th September 2021, on the RTS for Article 6.  It had been odd that the final draft RTS on risk retention from July 2018 had never been finalised (and so were not onshored into the UK regime), and the new ones apparently “carry over a substantial amount of provisions” from those.  The new main points are:

  • how the risk retention options apply to NPE securitisations;
  • how to meet the retention requirement through a synthetic or contingent form of retention;
  • requirements for the expertise of servicers acting as a retainers in NPE securitisations
  • the impact of fees payable to the retainer on risk retention
  • risk retention in re-securitisations or in securitisations of own issued debt instruments
  • clarification on the treatment of synthetic excess spread. 

Until we have some implemented risk retention RTS in the EU and in the UK, the old RTS made in 2014 under the CRR continue to apply.  The 8th September 2020 FCA 200 page quarterly consultation, CP20/18, said that the PRA would consult soon about how to adopt risk retention technical standards for the UKSR, but no surprises are likely.

The July 2018 draft RTS contained clarification on points of detail regarding the time when an exposure is taken to have arisen, the measurement of the retention using each of the five permitted methods, and disclosure of the retention.  Notable aspects were:

  • the EBA’s summary of the feedback it received which accompanied the RTS confirms that it did not intend the direct retention obligation in article 6 to apply to parties established outside the EU, in line with normal jurisprudential principles and the view of the EC;
  • clarificatory principles regarding whether an originator had been established for the "sole purpose" of securitising exposures
  • detail regarding synthetic or contingent forms of retention
  • detail on adverse selection of assets
  • a provision regarding circumstances in which a retention originally held by an entity could be transferred to another entity (being where insolvency proceedings in respect of the original retainer have been started, or the original retainer is “unable to continue” holding it either because of a transfer of a holding in the retainer or for “legal reasons beyond its control”). This was an article in the original draft RTS but became a mere recital in the final version, a downgrading of emphasis that may be because it is not referred to at all in the Securitisation Regulation.
  • detail relevant to hedging the retained interest or financing it on a secured basis – it had proposed that it would be permitted so long as the credit risk were not transferred, and the wording had been careful to recognise that this may involve a title transfer arrangement such as a repo, and that what counted was that “the exposure to” the credit risk is retained.
  • it helpfully confirmed that the initial disclosure of the identity of the risk retainer should be considered as evidence of the decision of the eligible retainers with regard to which of them will retain it, in case there was no explicit agreement among them on the point.

Risk retention and non-performing loans securitisations

The risk retention rules are currently unconducive to the securitisation of non-performing loans, because the 5% is calculated on the nominal (par) value of the underlying assets, even though they may have been bought at a considerable discount.  The July 2021 draft RTS address this.  This is discussed in more detail in this commentary.

Fees to be "taken into account"?

The "quick fix" amendments to the EUSR made two unheralded changes to Article 6.  The Article 6(1) amendment which was adopted was essentially the European Council's wording, but a further sub-paragraph was included:

"In measuring the material net economic interest the retainer shall take into account any fees that may in practice be used to reduce the effective material net economic interest";

and then Article 6(7) was amended to require the EBA to produce further RTS to specify in greater detail "the impact of fees paid to the retainer on the effective material net economic interest within the meaning of paragraph 1".  These were required within 6 months of the amendment taking effect, and presumably the revised draft RTS address this.  At a guess the amendment came from that faction in the European Parliament which is generally suspicious of securitisation and sees fees as a way of undermining the principles of "skin in the game", and presumably the intention is that the retention will have to amount to 5% after deducting fees.

What entity should hold the retention?

Article 6(1) is clear that the originator, sponsor or original lender should hold it and they should agree amongst themselves which one will.  Article 6(4) - where its conditions are met - allows the retention to be done by another group company on a consolidated basis.  Article 3 of the draft EU risk retention RTS requires that where the exposures have been created by multiple originators, the retention should be held by each originator or original lender on a pro rata basis, although Article 3(4) (tracking what the old CRR RTS said) permits the retention to be held by a single originator or original lender if it has "established" the securitisation and originated more than 50 % of the total securitised exposures (and there is a provision covering multiple sponsors). 

Somewhat contrary to this, the 1st April 2021 joint opinion of the ESAs “On the Jurisdictional Scope of Application of the Securitisation Regulation” came to the unhelpful view that where some of the relevant entities (originators or whatever) were outside the EU, the risk retention should, under Article 6, be held by a party that was within the EU.  The ESAs' logic is to have it held by an entity within the EU jurisdiction and so subject to the (direct) obligation contained in Article 6, although actually requiring the holding to be by an EU entity goes further than merely requiring an EU entity to be responsible making sure that Article 6 is complied with, and this restrictive interpretation seems contrary to what the level 1 text actually says: Article 5(1)(d) is quite clear that the risk retention may be held by a non-EU party, and it would be bizarre is this only were only to apply where all the relevant parties were non-EU. 

This is just the ESAs' opinion and is not legally binding, and it runs contrary to the basic idea that a risk retention is to ensure alignment of interests and skin in the game; and commercially, it could well make sense for, say, a US parent to hold the retention than its EU27 subsidiary.  Will the EC endorse the ESAs' view in its overall Article 46 review?  The topic highlights the debate between having "Fortress Europe" on the one hand, and making a success of CMU on the other, and developments are likely - such as a statement from the EC - on this during 2021.  Meanwhile, the ESAs have really not helped the market.

Introduction

The EU STS regime for synthetics is a world first:  there is no provision at the Basel/IOSCO level for preferential capital treatment for an STC-qualifying synthetic product.  The 24th July 2020 proposal from the European Commission to enact an STS regime for balance sheet synthetic securitisations by amending the Securitisation Regulation and the CRR (but not, initially at least, Solvency II)  was explicitly in response to the “urgency” of the need to take measures to help the economy recover from the COVID-19 pandemic.  It was broadly welcomed by those who saw it as a way of attracting new risk-takers into the market which would be prepared to take on risk (and be able to do the related due diligence) if the overall package was sufficiently standard, simple and transparent, but not otherwise; the current synthetic market is for the most part, central banks, supranational entities such as the EIB, pension and hedge funds, with monolines having long gone.  

The proposals were adopted in early April 2021 and are effective as from 9th April 2021.  They have been cautiously welcomed, even though they are not the totality of what the market has been asking for, but there are issues  regarding complexity and cost, and one of these issues - the change to Article 248 of the CRR concerning excess spread - applies across the board, not just to STS.  

The EC proposals

When the Securitisation Regulation was enacted, there had been only one, minor, concession to synthetics. Where an institution sold off a junior position in a pool of loans to SMEs via a synthetic structure, it could only apply to the retained position the lower capital requirements available for STS securitisations if the strict criteria set out in Article 270 of the CRR as amended were met, which included that the position was guaranteed by a central government, central bank, or a public sector “promotional entity”, or – but only if fully collateralised by cash on deposit with the originator – by an institution.  Otherwise, originators would have to allocate capital to the retained senior piece on the basis of the higher non-STS rules which, because of the regulatory non-neutrality baked into the regulatory capital requirement for securitisation (i.e. the sum total of capital allocated to all the various tranches of a securitisation will be more than the capital which would be required for a holding of the underlying assets) were, to say the least, discouraging.

Article 45 of the Securitisation Regulation required the EBA to report on the possibility of an STS regime for balance sheet synthetics by 2nd July 2019.  Its "Draft report on STS Framework for Synthetic Securitisation" emerged on 24th September 2019, the delay being due to unresolved differences of opinion among EU regulators about whether or not synthetics should be given any favourable capital treatment or not.  The EBA  considered to what extent buying STS protection should give the protection buyer preferential regulatory capital treatment as regards the portion of risk on the portfolio that it continues to hold (which, post-GFC, is usually the least risky portion, with the first loss risk being transferred to a protection seller).   The EBA envisaged qualifying protection coming from either 0% risk-weighted institutions under the CRR, such as the EIB or, if not, then from entities to which the protection buyer's recourse is fully collateralised in cash or risk-free securities.  It was equivocal about whether STS synthetic securitisations should provide favourable capital treatment for the originator credit institution or not.  Its final proposals for developing a STS framework for synthetic securitisation emerged on 5th May 2020, recommended setting up an STS framework but sat on the fence regarding the capital treatment, merely noting the pros and cons of the introduction of more risk-sensitive regulatory treatment of the STS synthetic product.  The EBA’s summary said:

"On the one hand, developments in the last few years have indicated the potential for the continuing growth of the synthetic sector and have confirmed the technical feasibility of the creation of a prudentially sound STS synthetic securitisation product that is comparable to the STS traditional securitisation product.  In addition, the available performance data do not provide any evidence that the performance of the synthetic securitisation instrument is worse than that of the traditional securitisation instrument.  The introduction of potentially limited and clearly defined differentiated regulatory treatment would match the historical performance of the synthetic securitisation, ensure better alignment with the STS traditional securitisation framework and help overcome the constraints of the current limited STS risk-weight treatment of some SME synthetic securitisations.  

On the other hand, there are limitations of the performance data on which the analysis is based, there is limited experience with the STS traditional framework so far, and the risk of potentially overusing synthetic securitisation, which would potentially lead to a large-scale replacement of regulatory capital by risk mitigation strategies, leading to overleveraging of banks, should be duly taken into account. In addition, the preferential regulatory treatment is not included in the international Basel standards.”

On 12th June 2020, the “High Level Forum on the Capital Markets Union” issued a 129-page “final report” on CMU, the recommendations of which included applying the same regulatory treatment to synthetics as to cash securitisations.  

The new regime for synthetic securitisation

Against this background, the "quick fix" amendments to the Securitisation Regulation have added a new series of articles (Article 26a et seq.) in “Section 2A” to introduce a new regime for synthetics which apply most of the same STS requirements as apply to cash securitisations, plus some others specific to synthetics e.g. requirements mitigating the counterparty credit risk on the protection seller, and the CRR amendments extend the treatment which Article 270 of the CRR had previously allowed to only a limited sub-set of synthetic securitisations.  Some aspects of the proposed regime entail additional cost and complexity over and above what the existing market is used to - for example, protection sellers (which the legislation insists on calling "investors") are required to have recourse to higher-quality collateral to secure repayment of their "investment" than is usual, and that of course comes at a cost.  Some detail has yet to be fleshed out in RTS – those will appear in H1 of 2021 - and there is scope for some level 3 clarification.  There seems to be a lot of devil in the detail and it remains to be seen how this will play out.  

The proposal was enacted after the Brexit transitional period ends, and does not form part of onshored UK law.  The UK had been opposed to the idea of an STS regime for synthetic securitisation, and it was only brought about as a result of Brexit.  It seems unlikely that the UK’s FCA will want to introduce a similar regime under the UKSR.  

Introduction

2020 saw the European Commission rapidly respond to the consequences of coronavirus by introducing (on 24th July 2020) some "quick fix" proposals to assist with the securitisation of NPLs.  By 16th December these proposals had been through trilogues and reached political agreement, and they completed their legislative journey in April 2021, and our dual-law text incorporates the quick fix amendments to the EU Securitisation Regulation.   

Background

NPL securitisations are different from securitisations of performing assets, where usually, the major risk being transferred to the investors is credit risk.  For NPLs, the main risk is that the workout of the NPLs in question recovers less value than the discounted purchase price at which they were bought, and a major influence on that is the quantum of the discount at which the NPLs have been bought and the success of the workout. Typically, a special servicer is responsible for this and its fees are success-dependent. This produced anomalies, because the CRR and the Securitisation Regulation were both drafted with performing assets in mind, and the anomalies included:

The regulatory capital position produced excessive capital charges (see further below)

The 5% risk retention under Article 6 of the Securitisation Regulation as it was originally enacted, and Article 10(1) of the risk retention RTS, was calculated by reference to nominal values, disregarding the acquisition price of the assets, but in the case of NPLs which have been bought at a substantial discount, this produced an excessive result. If, say, 100 nominal of assets were bought for 12 (88% discount) with the intention of being securitised with a senior piece of 10 and a junior (retained) structure of 2, the required risk retention would nevertheless be 5, which would be 50% of the actual loss risk to the investors, and not 5%.  Further, under the terms of Article 6 as originally enacted, the risk retention could only be held by the originator, sponsor or original lender, and not by the special servicer - but the person with the most skin in the game is the special servicer, which will be on a success fee.

The transparency requirements in Article 7 and the disclosure RTS and related templates require granular, detailed loan-level information. Article 7(1)(a) requires information on the underlying exposures to be produced on a quarterly basis, and Article 2 of the disclosure RTS requires this to be done by completing the Annex IV template (for corporate underlying exposures) and, where the securitisation is more than 50% (in terms of outstanding principal) made up of exposures which are non-performing or credit-impaired, also the Annex X template. This is a laborious amount of detail, assuming it is available, but some of it may not be, because it was never collected, or because the originator is not the original lender and so does not have it, and may not be able to get it, either because it has no contractual or other relationship with the original lender or because the original lender no longer exists. This is partially mitigated to the extent that the “no data” (“ND”) option is available, but as our commentary on Article 7 explains, there are limits to its use.

The criteria for credit-granting in Article 9(3) require an originator which is securitising assets which it has bought to verify that the original lender applied the same “sound and well-defined criteria for credit-granting” to those assets as it did to non-securitised exposures – the mischief being adverse selection, i.e. where originators select poorer quality assets for securitisation than those they conitnue to hold on their balance sheet.  In November 2018, the EBA was asked about the amount of due diligence that needed to be done to verify the original credit-granting criteria in a case such as with NPLs, where the assets were originated some time ago, perhaps by a lender which has gone bust and no longer exists, or which has no incentive to help and no contractual obligation to help.  The EBA’s answer said that the securitising originator should use “adequate resources” and “make reasonable efforts” to obtain “as much information as is available and appropriate for such verification in accordance with sound market standards of due diligence for the class of assets and the nature and type of securitisation”, which helpfully indicates that the EBA views the Article 9(3) requirement with flexibility and is prepared to defer to good market practice.  This is consistent with what we had heard was a general inclination in Brussels to be as helpful as they can (within the confines of level 2 and level 3) because they were aware that securitisation in Europe had not taken off they way they had hoped it would after the Securitisation Regulation came into force. Whilst this was moderately helpful, it was only level 3 guidance and the Article 9(3) verification requirements represent the actual legal position.  As our commentary on “Acquired portfolios” says, Article 9(4) contains two provisions that can help with NPL portfolios:

  • Article 9(4)(a), which disapplies Article 9(3) if the original loan agreements pre-dated the application of the Mortgage Credits Directive (which will vary from country to country but which had to be by 21st March 2016)
  • Article 9(4)(b) permits limb (b) originators to comply instead with Article 21(2) of the RTS relating to risk retention made under CRR (and so "obtain all the necessary information to assess whether the criteria applied in the credit-granting for those exposures are as sound and well-defined as the criteria applied to non-securitised exposures").

Proposals for reform

On 23rd October 2019, the EBA published a 36-page  “Opinion” on the regulatory treatment of securitisations of NPLs.  As it said, securitisation of NPLs was being hampered by the requirements of the CRR, which imposed capital requirements on investor credit institutions under the CRR which overstate the actual risk embedded in the portfolio, and by certain aspects of the risk retention and due diligence requirements under the Securitisation Regulation. The Opinion recommended amendments to the CRR and the Securitisation Regulation, and the coronavirus consequences led the EC to take the bull by the horns, and its 24th July 2020 proposals to amend the Securitisation Regulation and to amend the CRR by adopting the EBA's report came as a welcome surprise.  

The "quick fix" amendments

The amendments to the Securitisation Regulation for the most part addressed the market's requirements, although:

  • the new Article 5(1) due diligence requirement - to verify that "sound standards in the selection and pricing of the exposures are applied" - is not said to be in place of (or "by way of derogarion from" as the legislation tends to put it) the requirement in (a) and (b) (i.e. to verify that the originator or original lender used sound and well-defined credit-granting criteria criteria and clearly established processes, etc. - which make sense for performing loans but not for NPEs).  The intention was surely that this was a replacement - and the point is made as regards the similar amendment to Article 9, but as drafted it does not, awkwardly,  disapply (a) or (b);
  • in article 6, the servicer is permitted to hold the risk retention, but - even though this is irrelevant to the mere holding of the retention - it may only do so if it can demonstrate its expertise in servicing exposures etc.;
  • the new risk retention wording relating to non-refundable purchase price discounts and fees is awkward in places and will require careful reading;
  • no changes have yet been made to the disclosure RTS regarding non-availability of information, and it is to be hoped this will follow
  • the alternative due diligence wording for NPLs in article 9 - to verify that "at the time the originator purchased them from the relevant third party, sound standards shall apply in the selection and pricing of the exposures” - is unhelpfully vague, although capable of being interpreted helpfully by some level 3 guidance.

The CRR regulatory capital adjustments to the NPL prudential calibration were based on the public consultation launched by the Basel Committee on 23rd June 2020, rather than the proposals in the October 2019 EBA opinion.  Originally, the EBA therefore proposed (following Basel) to apply a flat 100% risk weight to the senior tranche and a floor of 100% to the risk weights of any other tranches, even though this could actually increase the risk weights compared to the existing regime (which can produce a risk weight of only 65% for a senior tranche), and even though it must be illogical that the senior tranche would have the same risk weight as the underlying assets despite benefitting from the subordination of the junior tranche(s).  Fortunately, during the trilogues, the risk weight floor was reduced from the proposed 100% to 50%, and the changes to the CRR came into force on 31st March 2012.  

We wait to see whether the amendments will, overall, be enough.  

In the UK

The quick fix changes have effect as from 9th April 2021, and so do not form part of onshored UK law.   The UK PRA’s 4th June 2021 CP10/21 “Implementation of Basel standards: Non-performing loan securitisations” proposes a “more appropriately calibrated NPE securitisation framework” for the required capital allocation against NPLs for UK banks under the UK CRR.  The main one seems to be (following the Basel Committee’s June 2020 consultation) a 100% risk weighting for the senior tranche, which is the same as in the EU CRR following the 31st March 2021 quick fix amendment.  The EU quick fix was seemingly more lenient regarding the EU CRR in its new Article 269a(5) and (6) (the detail is quite technical), but the PRA said that it “does not propose to adopt the EU approach, as it considers there is insufficient evidence to determine that it would be in line with the PRA’s safety and soundness objective”.  Despite its more cautious approach, the PRA thinks that:

“for the securitisation internal ratings based approach ((SEC-IRBA), excluding the foundation approach), and securitisation standardised approach (SEC-SA), there may be a material reduction in capital costs”. 

This is less ambitious than the EU quick fix, and in particular it does not propose any amendment to the UK Securitisation Regulation to deal with the risk retention requirement for NPLs, which in the EU is now based (Article 6(3a)) on the net value of the NPLs rather than their nominal (pre-impairment) value.  Perhaps the issue is less pressing for UK banks, which have lower exposures to NPLs than (particularly) southern European banks.

 

Article 7

Transparency requirements for originators, sponsors and SSPEs

1.  The originator, sponsor and SSPE of a securitisation shall, in accordance with paragraph 2 of this Article, make at least the following information available to holders of a securitisation position, to the competent [EU version: authorities] [UK version: authority]  referred to in Article 29 and, upon request, to potential investors:

(a)  information on the underlying exposures on a quarterly basis, or, in the case of ABCP, information on the underlying receivables or credit claims on a monthly basis;

(b)  all underlying documentation that is essential for the understanding of the transaction, including but not limited to, where applicable, the following documents:

(i)  the final offering document or the prospectus together with the closing transaction documents, excluding legal opinions;

(ii)  for traditional securitisation the asset sale agreement, assignment, novation or transfer agreement and any relevant declaration of trust;

(iii)  the derivatives and guarantee agreements, as well as any relevant documents on collateralisation arrangements where the exposures being securitised remain exposures of the originator;

(iv)  the servicing, back-up servicing, administration and cash management agreements;

(v)  the trust deed, security deed, agency agreement, account bank agreement, guaranteed investment contract, incorporated terms or master trust framework or master definitions agreement or such legal documentation with equivalent legal value;

(vi)  any relevant inter-creditor agreements, derivatives documentation, subordinated loan agreements, start-up loan agreements and liquidity facility agreements;

That underlying documentation shall include a detailed description of the priority of payments of the securitisation;

(c)  [EU version: where a prospectus has not been drawn up in compliance with Directive 2003/71/EC [Prospectus Directive – note: replaced by the Prospectus Regulation  with effect, mainly, from 21 July 2019)] of the European Parliament and of the Council (28)] [UK version: where section 85 of the 2000 Act (prohibition of dealing etc in transferable securities without approved prospectus) and rules made by the FCA for the purposes of Part 6 of the 2000 Act (official listing)(b) do not require a prospectus to be drawn up], a transaction summary or overview of the main features of the securitisation, including, where applicable:

(i)  details regarding the structure of the deal, including the structure diagrams containing an overview of the transaction, the cash flows and the ownership structure;

(ii)  details regarding the exposure characteristics, cash flows, loss waterfall, credit enhancement and liquidity support features;

(iii)  details regarding the voting rights of the holders of a securitisation position and their relationship to other secured creditors;

(iv)  a list of all triggers and events referred to in the documents provided in accordance with point (b) that could have a material impact on the performance of the securitisation position;

(d)  in the case of STS securitisations, the STS notification referred to in Article 27;

(e)  quarterly investor reports, or, in the case of ABCP, monthly investor reports, containing the following:

(i)  all materially relevant data on the credit quality and performance of underlying exposures;

(ii)  information on events which trigger changes in the priority of payments or the replacement of any counterparties, and, in the case of a securitisation which is not an ABCP transaction, data on the cash flows generated by the underlying exposures and by the liabilities of the securitisation;

(iii)  information about the risk retained, including information on which of the modalities provided for in Article 6(3) has been applied, in accordance with Article 6.

(f)  any inside information relating to the securitisation that the originator, sponsor or SSPE is obliged to make public in accordance with Article 17 of Regulation (EU) No 596/2014 [Market Abuse Regulation] of the European Parliament and of the Council (29) on insider dealing and market manipulation;

(g)  where point (f) does not apply, any significant event such as:

(i)  a material breach of the obligations provided for in the documents made available in accordance with point (b), including any remedy, waiver or consent subsequently provided in relation to such a breach;

(ii)  a change in the structural features that can materially impact the performance of the securitisation;

(iii)  a change in the risk characteristics of the securitisation or of the underlying exposures that can materially impact the performance of the securitisation;

(iv)  in the case of STS securitisations, where the securitisation ceases to meet the STS requirements or where [EU version: competent authorities have] [UK version: the competent authority has] taken remedial or administrative actions;

(v)  any material amendment to transaction documents.

The information described in points (b), (c) and (d) of the first subparagraph shall be made available before pricing.

The information described in points (a) and (e) of the first subparagraph shall be made available simultaneously each quarter at the latest one month after the due date for the payment of interest or, in the case of ABCP transactions, at the latest one month after the end of the period the report covers.

In the case of ABCP, the information described in points (a), (c)(ii) and (e)(i) of the first  subparagraph shall be made available in aggregate form to holders of securitisation positions and, upon request, to potential investors. Loan-level data shall be made  available to the sponsor and, upon request, to [EU version: competent authorities] [UK version: the competent authority].

Without prejudice to Regulation (EU) No 596/2014 [Market Abuse Regulation], the information described in points (f) and (g) of the first subparagraph shall be made available without delay.

When complying with this paragraph, the originator, sponsor and SSPE of a securitisation shall comply with [EU version: national and Union law] [UK version: the law applicable in the United Kingdom] governing the protection of confidentiality of information and the processing of personal data in order to avoid potential breaches of such law as well as any confidentiality obligation relating to customer, original lender or debtor information, unless such confidential information is anonymised or aggregated.

In particular, with regard to the information referred to in point (b) of the first subparagraph, the originator, sponsor and SSPE may provide a summary of the documentation concerned.

[EU version: Competent authorities] [UK version:  The competent authority] referred to in Article 29 shall be able to request the provision of such confidential information to them in order to fulfil their duties under this Regulation.


2.  The originator, sponsor and SSPE of a securitisation shall designate amongst themselves one entity to fulfil the information requirements pursuant to points (a), (b), (d), (e), (f) and (g) of the first subparagraph of paragraph 1.

The entity designated in accordance with the first subparagraph shall make the information for a securitisation transaction available by means of a securitisation repository.

The obligations referred to in the second and fourth subparagraphs shall not apply to securitisations [EU version: where no prospectus has to be drawn up in compliance with Directive 2003/71/EC [Prospectus Directive – note: replaced by the Prospectus Regulation with effect, mainly, from 21 July 2019)]] [UK version: for which section 85 of the 000 Act and rules made by the FCA for the purposes of Part 6 of the 2000 Act do not require a prospectus to be drawn up].

Where no securitisation repository is registered in accordance with Article 10, the entity designated to fulfil the requirements set out in paragraph 1 of this Article shall make the information available by means of a website that:

(a)  includes a well-functioning data quality control system;

(b)  is subject to appropriate governance standards and to maintenance and operation of an adequate organisational structure that ensures the continuity and orderly functioning of the website;

(c)  is subject to appropriate systems, controls and procedures that identify all relevant sources of operational risk;

(d)  includes systems that ensure the protection and integrity of the information received and the prompt recording of the information; and

(e)  makes it possible to keep record of the information for at least five years after the maturity date of the securitisation.

The entity responsible for reporting the information, and the securitisation repository where the information is made available shall be indicated in the documentation regarding the securitisation.


3.  [EU version: ESMA, in close cooperation with the EBA and EIOPA, shall develop draft regulatory] [UK version: The FCA and the PRA, acting jointly, may make] technical standards to specify the information that the originator, sponsor and SSPE shall provide in order to comply with their obligations under points (a) and (e) of the first subparagraph of paragraph 1 taking into account the usefulness of information for the holder of the securitisation position, whether the securitisation position is of a short-term nature and, in the case of an ABCP transaction, whether it is fully supported by a sponsor.

[EU version only: 

ESMA shall submit those draft regulatory technical standards to the Commission by 18 January 2019.

The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.]

RTS specifying the information and the details of a securitisation to be made available by the originator, sponsor and SSPE [in force 23rd September 2020]


4.  In order to ensure uniform conditions of application for the information to be specified in accordance with paragraph 3, [EU version: ESMA, in close cooperation with the EBA and EIOPA, shall develop draft] [UK version: the FCA and the PRA, acting jointly, may make] implementing technical standards specifying the format thereof by means of standardised templates.

[EU version only: 

ESMA shall submit those draft implementing technical standards to the Commission by 18 January 2019.

The Commission is empowered to adopt the implementing technical standards referred to in this paragraph in accordance with Article 15 of Regulation (EU) No 1095/2010.]

 ITS with regard to the format and standardised templates for making available the information and details of a securitisation by the originator, sponsor and SSPE [in force 23rd September 2020]

Who and what is caught by Article 7?

The Article 7 transparency requirements apply to all securitisations (and article 22 has some enhanced requirements for STS - see below).  The disclosure obligation is on one of the originator, sponsor and issuer, which should decide among themselves is to do it - presumably the sponsor in most cases, and in the case of STS Article 22(5) designates both the originator and the sponsor to do it.

Full underlying deal documentation (apart from the legal opinions), as well as regular reporting of information on the underlying exposures and their performance is required to be disclosed to a repository (in the case of public issues), and the repository has to provide "direct and immediate access free of charge" to a range of regulators and supervisors, plus "investors and potential investors" (under Article 17(1)).  There are however two cases where disclosure of a transaction summary of the deal documentation may be disclosed:

  • for public issues, the un-numbered penultimate paragraph of Article 7(1), which refers to Article 7(1)(b);
  • Article 7(1)(c), which applies to a securitisation issue where a prospectus is not legally required under applicable EU or UK prospectus regulations 

For public issues, it should be born in mind that the Article 7(1)(b) exemption is narrow.  Article 7(1) is not well-drafted and there had been a view that the penultimate paragraph ("with regard to the information referred to in point (b) of the first subparagraph, the originator, sponsor and SSPE may provide a summary of the documentation concerned") offered a generally-available alternative to full publication.  However, in the Joint Committee Q&A published on 26th March 2021, the ESAs gave a very narrow interpretation of the penultimate paragraph: it only permitted a summary to be provided in cases where full disclosure of the documentation would contravene the pre-penultimate paragraph, which states that, when doing so, a disclosing originator, sponsor or SSPE must not breach any law governing the protection of confidentiality of information and the processing of personal data.  If full disclosure would involve such a breach, then there is the choice of providing the summary or anonymising or aggregating the confidential information.  As regards Article 7(1)(c), the point is less significant, because in a private deal the investors would usually want the underlying documentation and so this would be disclosed in any event.

The disclosure RTS and ITS

The detail regarding transparency is found in the related disclosure RTS and associated Annexes and the disclosure ITS and associated Annexes.  ESMA was given two mandates under the Securitisation Regulation to produce templates:

Article 7(4) authorises it to produce templates which relate to the disclosure obligations under article 7(1)(a) and (e) (covering line-by-line disclosure of information on each of the underlying exposures on a loan-by-loan basis, not aggregate data); and
Article 17(3) authorises it to produce templates which relate to disclosure to a securitisation repository (which is only required for public securitisations).  This mandate extends to all disclosure required under Article 7(1), not just Article 7(1)(a) and (e), and so in particular this extends to Article 7(1)(f) and (g) (relating to inside information and significant events).  

ESMA combined these into a single pair of RTS and ITS.  Because of the bumpy ride these had, the first drafts which were released did not become law, and initially the market had to operate under a non-no action letter issued by the ESAs on 30th November 2018.  The letter recognises that reporting entities face "severe operational challenges" in complying, especially if in the past they had not had to provide using the CRA3 templates (e.g. CLO managers, because CLOs were out of scope for CRA3) and might need to make "substantial and costly adjustments to their reporting systems to comply with the CRA3 templates on a temporary basis, until the ESMA disclosure templates enter into application".  

The application of Article 7 to private deals

A large part of EU securitisation issuance consists of private deals, i.e. deals where no prospectus is drawn up under the Prospectus Regulation.  ABCP (which the European Commission noted made up about 40% of EU issuance) is predominately private.  Private and bilateral transactions were exempted from complying with the detailed disclosure requirements under the old Article 8b, and when ESMA initially consulted on the disclosure RTS that was the position it took: the first draft RTS/ITS, issued in December 2017, had an adjusted standard for private deals which explicitly did not require completion of the data templates (see Recital (3)).  Consequently, originators and sponsors of private issues did not take part in the consultation.  ESMA then surprised everyone by putting private deals in scope, seemingly on the basis of the legal advice it received.  

The disclosure RTS and the disclosure ITS cover two related disclosure requirements:

Articles 7(3) and 7(4), which extend to all securitisations, public and private
Article 17(2)(a) which applies to data held in a securitisation repository, and so only extends to public issues.

Accordingly, the ITS made under Article 7(4) - which deal with the format and templates for making available information - distinguish between public and private: the templates on underlying exposures and investor reports apply to both, but the templates on inside information and significant events are for public only; and the RTS made under Article 7(3) - which deal with the information itself - similarly distinguish between public and private.

In the August 2018 so-called "final" (but since superseded) RTS/ITS, ESMA affirmed its view that Article 7(1)(a) and 7(1)(e), and Recital (13), made no distinction between private and public securitisations as regards reporting requirements and templates (other than a repository being required for public issues).  It stated that it:

"recognises that the application of these draft technical standards may have an impact on private securitisations compared with current practice... However, ESMA considers that using the technical standards as a vehicle for defining different categories of information to be provided for public versus private securitisations, on the basis of "the holder of the securitisation position", would not be within the scope of ESMA's mandate".

ESMA has issued Guidelines on securitisation repository data completeness and consistency thresholds which limit the use of the ‘No-Data’ options in public issues (disclosure via a securitisation repository is only required by Article 7 in the case of a public securitisation).  These do not apply to private issues.  ESMA does not regulate private deals (and its carefully-worded comments in its 10th July Final Report suggest it is happy not to get involved): private deals are a matter for national regulators, which therefore have the scope to be more flexible, subject to the overriding requirement that article 7 of the Securitisation Regulation (as supplemented by the disclosure RTS and the disclosure ITS) is complied with.  Time will tell to what extent national regulators may be inclined to flex the requirements for private issues.  Article 7(3) states that the information to be disclosed should take into account its usefulness to investors.  This arguably permits a distinction to be made between public and private deals, and whilst ESMA did not itself do this when issuing its draft RTS and ITS, national competent authorities may choose to when determining whether or not Article 7 has been complied with. 

How should disclosure be made in respect of private deals?

Private deal disclosure of information on underlying exposures (Article 7(1)(a)) and quarterly investor reports (Article 7(1)(e)) has to be done in accordance with the related RTS/ITS, and so using the specified templates: see further below.  No method for disclosing the information to holders and potential holders is specified, and Q5.1.2.2 of the ESMA Q&A confirms that, as under Article 22 of the old RTS 625/2014 made under the CRR, disclosure can be made (subject to any instructions or guidance provided by national competent authorities) using any arrangements that meet the conditions of the Securitisation Regulation.

How should disclosure be made in respect of private UK deals post Brexit?

On 20th December 2018, the FCA and PRA issued a final Direction under the UK's Securitisation Regulations 2018 specifying the manner disclosure must be made to them in respect of a private securitisation established in the UK.  Annexed to it are short form templates to be used for the purpose.  The 2018 Regulations were routine implementation regulations and not Brexit-related, and do not disapply nor vary Article 7: noteholders and, on request, potential investors, and indeed the regulators themselves, are entitled to the full Article 7 disclosure (save to the extent, if any, that just a summary of the deal documentation to be provided rather than copies of all the bible documentation).  Whilst it would make much sense to have a light-touch (or no touch) regime for private deals, the UK has not - yet at least - deviated from the prevailing EU approach.

Compliance with the RTS and templates

The disclosure RTS and the disclosure ITS were published in October 2019 and should be fully applicable by mid-2020.  Less sophisticated issuers, such as corporates which rely upon private securitisations to finance trade receivables, which do not normally access the public ABS market, had asked for a longer transitional period, because the management of data – especially at the highly granular level prescribed - is difficult, and significant changes to operations, internal processes and information technology may be required; and some banks subject to disclosure obligations may have significant challenges in adapting legacy systems to ensure the collection and faithful reporting of the correct data, and to ensure that it is done correctly for hundreds or thousands of assets (especially where they are sometimes decades-old legacy assets).  Corporate originators may have bigger challenges, as their systems may well not have been designed to produce loan-level data or investor report information at anything like the level of granularity required by the Disclosure RTS.

The templates

Links to the individual templates are below.  These are to the versions produced by ESMA in spreadsheet format.  ESMA says that, to assist analsysis, they include references to the ECB’s asset-backed securities loan-level data template fields, where available, but cautions that the official versions are those on the EC’s website:

Annex 2: Underlying exposures - residential real estate

Annex 3: Underlying exposures - commercial real estate

Annex 4: Underlying exposures - corporate

Annex 5: Underlying exposures - automobile

Annex 6: Underlying exposures - consumer

Annex 7: Underlying exposures - credit cards

Annex 8: Underlying exposures - leasing

Annex 9: Underlying exposures - esoteric

Annex 10: Underlying exposures - add-on non-performing exposures

Annex 11: Underlying exposures - ABCP

Annex 12: Investor report - Non-ABCP securitisation

Annex 13: Investor report - ABCP securitisation

Annex 14: Inside information or significant event information - Non-ABCP securitisation

Annex 15: Inside information or significant event information - ABCP securitisation

Completion of templates - some problematic issues

There are some potentially problematic issues regarding the templates, including:

  • various mandatory template fields
  • the lack of a template for trade receivables
  • points of detail for NPL loan securitisations (the disclosure RTS require not only the specific NPL Annex 10 template but also the routine template required by Article 2(1) for the relevant category of loan, and that could be difficult or impossible) 
  • for CLOs (regarding the corporate template) - now alleviated by an increase in the ability to use "ND" - see further below.    

Two minor anomalies:

  • as regards disclosure of inside information etc.  As noted above, ESMA's mandate under Article 7(3) only extends to producing templates relating to 7(1)(a) and (e), whereas its mandate under Article 17(2) extends the the whole of Article 7.  Consequently, the template it has produced for the disclosure of inside information and significant events under Article 7(1)(f) and (g) only applies to public deals, not private ones.  Article 6 of the RTS misses this point.  It simply says that "inside information that the reporting entity for a non-ABCP securitisation shall make available pursuant to Article 7(1)(f) of Regulation (EU) 2017/2402 is set out in Annex 14", which on the face of it applies to both public and private;
  • for private STS issues where the underlying exposures are residential or auto loans or leases, the "environmental" disclosure (discussed here) required (as a result of pressure from the Green faction in the European Parliament) by Article 22(4) has to be published, "as part of the information disclosed pursuant to Article 7(1)(a)" - a contradiction in terms where Article 7 does not require public disclosure.

Completion of templates - use of ND options 

When completing a reporting template (as required by Article 7 and the disclosure RTS) the relevant template permits some use to be made of a “no data” – or “ND” - answer.  There are five types of “ND” answer, defined in Article 9(3) of the disclosure RTS:

ND1

the required information has not been collected because it was not required by the lending or underwriting criteria at the time of origination of the underlying exposure 

ND2

the required information has been collected at the time of origination of the underlying exposure but is not loaded into the reporting system of the reporting entity at the data cut-off date

ND3

the required information has been collected at the time of origination of the underlying exposure but is loaded into a separate system from the reporting system of the reporting entity at the data cut-off date

ND4-YYYY-MM-DD

the required information has been collected but it will only be possible to make it available at a date taking place after the data cut-off date. ‘YYYY-MM-DD’ shall respectively refer to the numerical year, month, and day corresponding to the future date at which the required information will be made available

ND5

the required information is not applicable to the item being reported

The use of ND options in relation to public securitisations 

Disclosures relating to public deals (where the disclosure is via a securitisation repository) is governed by the RTS on operational standards for securitisation repositories and the related ESMA Guidelines on securitisation repository data completeness and consistency thresholds.  The Guidelines direct securitisation repositories ab out how to determine whether to accept or reject a submission made to them for a public securitisation.  They also contain two types of "threshold" tolerances to permit, within limits, the non-disclosure of information which would otherwise be required, by allowing the use of one of the ‘No Data’ options (where the specific template field allows such options to be entered).  The two types of threshold are:

  • a percentage threshold, which allows ND1-4 to be used in relation to a percentage of the the total number of active underlying exposures (known as "legacy assets"), to address situations where data is not available for a few underlying exposures, perhaps because they were originated far earlier than the remaining underlying exposures;
  • a numerical threshold, which sets a limit on the number of fields in a given underlying exposure data submission that contain one or more ND1-ND4 values.  The rationale for this is that certain categories of information may not be available: perhaps because it being stored in an old database that cannot be accessed in the short run without significant disproportionate expense (these being referred to as “legacy IT systems”). 

Fields demanding disclosure of data where "ND" is a permitted response may be completed with one of the "ND" options, within these limits, although there are other overriding limitations which apply.  In particular as regards public securitisations, Article 4(2)(d) of the RTS on operational standards requires repositories to verify that the ND options are only used where they “do not prevent the data submission from being sufficiently representative of the underlying exposures in the securitisation”.  In addition, there are the requirements noted below (regarding the use of the ND options in the context of private securitisations) set out in Recital (13) and Article 9 of the disclosure RTS, and in Recital (16) of the Securitisation Regulation itself.

ESMA's guidelines contain various limitations on the use of "ND".  In response to the publication of its consultation draft guidelines, ESMA received various industry feedback, which to a degree led to refinements being made in the final guidelines contained in ESMA's Final Report, although the changes fall short of what industry had asked for, and it remains to be seen how problematic the guidelines, and their limits on the use of a "No Data" option, will prove to be.  Some of those industry requests, and ESMA's responses to them, are worth examining here because they illustrate areas where problems for some market participants may arise in the future: 

  • Should there be no specific limit on the use of ND1 (data not collected as not required by the lending or underwriting)?  The argument in favour of there being no limit is that certain data for which the relevant template has a field might not have been collected because it irrelevant (e.g. the earned income of the borrower is irrelevant to the underwriting of a buy to let mortgage loan).  ESMA refused to accommodate this, although its rationale – “understanding the reasons why data is missing is a useful input for securitisation investors when performing due diligence and monitoring of securitisations” – might be said to miss the point, because limiting the use of ND1 does not merely require an explanation for the absence of data: it requires the reporting of that data.
  • Should non-EU disclosing parties be allowed more use of ND1-4?   A particular concern here was that non-EU parties might have local law confidentiality or bank secrecy laws to comply with (e.g. Swiss banks).  Again, ESMA refused: it said that the underlying exposure templates comply with ESMA’s mandate under the Securitisation Regulation, and were based on past experience of disclosures required under the old Article 8b and the ECB templates; which, again, might be said to miss the point, because private and bilateral transactions were exempted from complying with the detailed disclosure requirements under the old Article 8b.
  • Should the maxima differentiate between different types of deal that use the same template?  ESMA would not do this – so, in particular, the thresholds for Annex 4 (Corporate risk assets) apply whatever the deal is – a CLO, or something else – but it did at least say it would keep the matter under review.
  • CLOs: As noted above, there are “tolerance thresholds” applicable in the case of "legacy assets” and “legacy IT systems”.   ESMA had proposed that “ND” would be a permitted answer in the case of “legacy assets” and on account of “legacy IT systems”, but only up to a maximum number.  The LMA and AFME had requested more flexibility as regards the Annex 4 Corporate underlying exposure template given that there is no CLO-specific template, and ESMA has responded by increasing the tolerance thresholds here (with a view to tightening them later).
  • What about CMBS which, as is often the case, only have a small number of underlying exposures?  The tolerances built into the guidelines are of no help if they produce a number less than one, and so, for example, if there are fewer than 10 underlying loans, a percentage threshold of 10% is no help).  ESMA was not persuaded by the logic of this argument, and took the view that in any event the number of fields that would need to be reported is not onerous.

The use of ND options in relation to private securitisations 

As regards disclosures relating to private deals (where a securitisation repository is not involved) ESMA's guidelines do not apply, which allows more flexibility because the limits set out in the guidelines do not apply either.  Disclosing parties are however still subject to other requirements relating to disclosure, including Recital (16) of the Securitisation Regulation itself (which states the investor report t be produced under Article 7(1)(e)) should in any event contain “all materially relevant data on the credit quality and performance of underlying exposures")  and more specifically the disclosure RTS, where particular note should be made of recital (13):

"(13) The set of ‘No data’ (‘ND’) options should only be used where information is not available for justifiable reasons, including where a specific reporting item is not applicable due to the heterogeneity of the underlying exposures for a given securitisation. The use of ND options should however in no way constitute a circumvention of reporting requirements. The use of ND options should therefore be objectively verifiable on an ongoing basis, in particular by providing explanations to competent authorities at any time, upon request, of the circumstances that have resulted in the use of the ND values”;

and of Article 9:

Information completeness and consistency

(1)  The information made available pursuant to this Regulation shall be complete and consistent…

(3) Where permitted in the corresponding Annex, the reporting entity may report one of the following ‘No Data Option’ (‘ND’) values corresponding to the reason justifying the unavailability of the information to be made available:

(a) value ‘ND1’, where the required information has not been collected because it was not required by the lending or underwriting criteria at the time of origination of the underlying exposure;

(b) value ‘ND2’, where the required information has been collected at the time of origination of the underlying exposure but is not loaded into the reporting system of the reporting entity at the data cut-off date;

(c) value ‘ND3’, where the required information has been collected at the time of origination of the underlying exposure but is loaded into a separate system from the reporting system of the reporting entity at the data cut-off date;

(d) value ‘ND4-YYYY-MM-DD’, where the required information has been collected but it will only be possible to make it available at a date taking place after the data cut-off date. ‘YYYY-MM-DD’ shall respectively refer to the numerical year, month, and day corresponding to the future date at which the required information will be made available;

(e) value ‘ND5’, where the required information is not applicable to the item being reported.

For the purposes of this paragraph, the report of any ND values shall not be used to circumvent the requirements in this Regulation.

Upon request by competent authorities, the reporting entity shall provide details of the circumstances that justify the use of those ND values.”

GEM-listed CLOs: disclosure of material breaches, structure, risk characteristics, amendments and material inside information 

Disclosure of material breaches and so on has been the cause of some puzzlement for CLOs, which have to determine how they must report any disclosable information under Articles 7(1)(f) and (g).  This is because Articles 7(1)(f) and (g) differentiate between cases where the Market Abuse Regulation applies - in which case disclosure has to be made under Article 7(1)(f) - and where it does not, in which case Article (7(1)(g)) applies.  Article 2 of the MAR essentially limits its scope to issues of financial instruments admitted to trading on a regulated market, an MTF or an OTF, and so in particular, the MAR would apply to notes listed on the GEM (i.e. the Euronext Dublin Global Exchange Market - a trading name of the Irish Stock Exchange) because the GEM is a regulated market and MTF which the ISE is authorised to operate by the Central Bank of Ireland under MIFID, and this is so even though GEM listings are not subject to a prospectus drawn up in compliance with the Prospectus Regulation, and so are not "public issues" even though these may well have a wide distribution (GEM listings are available for issuers seeking admission of securities which, "because of their nature, are normally bought and traded by a limited number of investors who are particularly knowledgeable in investment matters", and GEM issues are structured so as to avoid the Prospectus Regulation requirements e.g., as an offer solely to qualified investors, or to fewer than 150 offerees per Member State, or in a denomination of at least EUR 100,000).  So in conclusion, many CLOs are private deals, but because they are listed on the GEM, Article 7(1)(f) catches them and so requires reporting of any inside information and significant events. 

The question then arises: how should that disclosure be made?  Annex 14 ("Inside information or significant event information - non-asset backed commercial paper securitisation") is referenced by article 6(1) of the RTS as the template to be used to report "inside information" that must be reported pursuant to Article 7(1)(f) of the Securitisation Regulation, and by article 7(1) of the RTS as the template to be used to report "information on significant events" that must be reported to Article 7(1)(g), but since Annex 14 is produced under ESMA's Article 17 mandate, not its Article 7 mandate, it does not apply to private deals, and consequently, GEM-listed CLOs have to disclose under Article 7(1)(f) and (g) but have flexibility about the format, because Annex 14 does not apply, even though it seems capable of being used if the disclosing entity wants to.

Additional disclosure requirements for STS 

Over and above Article 7, the STS rules have further transparency requirements, in Article 22 for term STS and Article 24(14) for ABCP STS:

  • 5 years of performance data on comparable exposures (or 3 years for short term receivables backing ABCP) must be disclosed before pricing;
  • for term STS but not ABCP, a sample of these must be independently verified and a liability cash flow model must be provided.

The comparable exposures data requirement applies to private deals as well as public ones, which is an unhelpful for ABCP (which is mostly private) and not conducive to sponsors raising ABCP to STS status; and for new asset classes it raises the question what would be comparable.

Disclosure post-Brexit in relation to UK securitisations

To assist firms in preparing to comply with their post-Brexit regulatory obligations, the FCA was given "temporary transitional powers" by HM Treasury to suspend or modify the effect of onshoring changes for a temporary period (known as the "standstill period"), and the FCA has in many cases done this with effect until 31 March 2022 under the FCA Transitional Directions December 2020 made under Part 7 of the Financial Services and Markets Act 2000 (Amendment) (EU Exit) Regulations 2019.  These direct that where, as a result of the operation of a Brexit exit instrument, the post-Brexit obligation is different from the pre-Brexit obligation, during the standstill period the obligation is modified so that it is not breached by a person which instead complies with the pre-Brexit version of the obligation.  Paragraph 32 of Annex A to the December 2020 Directions states that the standstill direction applies to various amendments made to the EUSR by the Securitisation (Amendment) (EU Exit) Regulations 2019, and to the transparency RTS and ITS by the Technical Standards (Specifying the Information and the Details of a Securitisation to be Made Available by the Originator, Sponsor and SSPE (EU Exit) Instrument 2020.  As regards templates, this Instrument made some detailed amendments to the formats as set out in the disclosure ITS.  Paragraph 32 explains that:

“Without relief, originators, sponsors and SSPEs of UK securitisations would have to use UK disclosure templates to satisfy the transparency requirements of article 7 of the Securitisation Regulation, when they would have limited time before IP completion day to modify their systems to take into account the changes made by the Technical Standards (Specifying the Information and the Details of a Securitisation to be Made Available by the Originator, Sponsor and SSPE (EU Exit) Instrument 2020.  Therefore, the FCA is applying the standstill direction so that originators, sponsors and SSPEs of UK securitisations can continue to use the disclosure templates as they had effect prior to IP completion day.”

So, if a notification has to be made under Article 7, during the standstill period, it can continue to be done using the EU disclosure ITS templates rather than the newly-specified UK templates (available here). 

Additional difficulties for ABCP programmes to comply with reporting requirements

Additional difficulties for ABCP programmes include:

(1) the need to provide loan-level data to the sponsoring bank of the ABCP programme and if requested, to the relevant competent authorities, even though information to investors of ABCP can be on an aggregated basis. Getting detailed and structured loan-level data from SMEs in which ABCP issuers often invest is more challenging than from banks which have the systems to deal with it as part of their business; and

(2) the need to provide monthly reports at ABCP programme level, while the underlying securitisation exposures which ABCP transactions invest in only provide reports on a quarterly basis. It is unclear whether the monthly reports for ABCP programme can rely on (and effectively repeat) the information in the previous quarterly reports for the months that there is no securitisation level reporting, or would the ABCP issuer require the underlying securitisation to report on a monthly basis instead?

What was replaced by Article 7?

Article 7 replaced the old rules regarding transparency in the old CRR Article 409 and Articles 22-23 of the related RTS (625/2014) and, as regards "structured finance instruments", in more detailed form in Article 8b of CRA III and the related RTS (2015/3).

Article 8

Ban on resecuritisation

1.  The underlying exposures used in a securitisation shall not include securitisation positions.

By way of derogation, the first subparagraph shall not apply to:

(a)  any securitisation the securities of which were issued before 1 January 2019; and

(b)  any securitisation, to be used for legitimate purposes as set out in paragraph 3, the securities of which were issued on or following 1 January 2019.

2.  A competent authority [EU version only: designated pursuant to Article 29(2), (3) or (4), as applicable,] may grant permission to an entity under its supervision to include securitisation positions as underlying exposures in a securitisation where that competent authority deems the use of a resecuritisation to be for legitimate purposes as set out in paragraph 3 of this Article.

Where such supervised entity is a credit institution or an investment firm as defined in points (1) and (2) of Article 4(1) of Regulation (EU) No 575/2013 [CRR], the competent authority [EU version only: referred to in the first subparagraph of this paragraph] shall consult with the [EU version: resolution authority] [UK version: Bank of England] and any other authority relevant for that entity before granting permission for the inclusion of securitisation positions as underlying exposures in a securitisation. Such consultation shall last no longer than 60 days from the date on which the competent authority notifies the [EU version: resolution authority] [UK version: Bank of England], and any other authority relevant for that entity, of the need for consultation.

[EU version only: Where the consultation results in a decision to grant permission for the use of securitisation positions as underlying exposures in a securitisation, the competent authority shall notify ESMA thereof.]

3.  For the purposes of this Article, the following shall be deemed to be legitimate purposes:

(a)  the facilitation of the winding-up of a credit institution, an investment firm or a financial institution;

(b)  ensuring the viability as a going concern of a credit institution, an investment firm or a financial institution in order to avoid its winding-up; or

(c)  where the underlying exposures are non-performing, the preservation of the interests of investors.

4.  A fully supported ABCP programme shall not be considered to be a resecuritisation for the purposes of this Article, provided that none of the ABCP transactions within that programme is a resecuritisation and that the credit enhancement does not establish a second layer of tranching at the programme level.

5.  In order to reflect market developments of other resecuritisations undertaken for legitimate purposes, and taking into account the overarching objectives of financial stability and preservation of the best interests of the investors, [EU version:  ESMA, in close cooperation with the EBA, may develop draft regulatory] [UK version: the FCA and the PRA, acting jointly, may make] technical standards to supplement the list of legitimate purposes set out in paragraph 3.

[EU version only: ESMA shall submit any such draft regulatory technical standards to the Commission. The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.]

Resecuritisations are forbidden (Article 20(9) and 24(8)) from meeting STS standards, and even non-STS resecuritisations are only permitted where:

  • they are done for “legitimate purposes”, typically in context of a winding up or resolution or
  • the deal was done before effective date of the Securitisation Regulation;

and there are further provisions regarding permissible non-STS ABCP programmes.

The wording used in all three places in the Securitisation Regulation is odd - a securitisation's exposures "shall not include securitisation positions".  Does this forbid EU investors buying resecuritisations, or does it just forbid EU sponsors and issuers from issuing resecuritisation paper?  EU investors will presumably be cautious.

The prohibition is by reference to "securitisation" - which as defined requires there to be contractually-established tranching of debt. Query whether parties may be tempted to structure around this.

Paragraph 31 of the EBA Guidelines refers darkly to pre-2009 days when resecuritisations were structured in a highly leveraged way, with a small change in the credit performance of the underlying assets having a severe impact on the credit quality of the bonds.  The EBA considered that this made the modelling of the credit risk very difficult.  It would certainly have required more time and analysis than the average buy-side professional would have had, making reliance on the rating all the more tempting.

Article 9

Criteria for credit-granting

1.  Originators, sponsors and original lenders shall apply to exposures to be securitised the same sound and well-defined criteria for credit-granting which they apply to non-securitised exposures. To that end, the same clearly established processes for approving and, where relevant, amending, renewing and refinancing credits shall be applied. Originators, sponsors and original lenders shall have effective systems in place to apply those criteria and processes in order to ensure that credit-granting is based on a thorough assessment of the obligor’s creditworthiness taking appropriate account of factors relevant to verifying the prospect of the obligor meeting his obligations under the credit agreement.

[EU version onlyBy way of derogation from the first subparagraph, with regard to underlying exposures that were non-performing exposures at the time the originator purchased them from the relevant third party, sound standards shall apply in the selection and pricing of the exposures.]

2.  Where the underlying exposures of securitisations are residential loans made [EU version: after the entry into force of 2014/17/EU [the Mortgage Credits Directive]] [UK version: on or after 20th March 2014], the pool of those loans shall not include any loan that is marketed and underwritten on the premise that the loan applicant or, where applicable, intermediaries were made aware that the information provided by the loan applicant might not be verified by the lender.

3.  Where an originator purchases a third party’s exposures for its own account and then securitises them, that originator shall verify that the entity which was, directly or indirectly, involved in the original agreement which created the obligations or potential obligations to be securitised fulfils the requirements referred to in paragraph 1.

4.  Paragraph 3 does not apply if:

(a)  the original agreement, which created the obligations or potential obligations of the debtor or potential debtor, was entered into before [EU version:  the entry into force of 2014/17/EU [the Mortgage Credits Directive]] [UK version: 20th March 2014]; and

(b)  the originator that purchases a third party’s exposures for its own account and then securitises them meets the obligations that originator institutions were required to meet under Article 21(2) of Delegated Regulation (EU) No 625/2014 [RTS relating to risk retention made under CRR] before 1 January 2019.

For any securitisation of an acquired portfolio, Article 9(3) requires the originator - which, in such a case, will be a limb (b) originator - to "verify that:

  • the related limb (a) originator (i.e. the entity which was, directly or indirectly, involved in the original agreement which created the obligations or potential obligations to be securitised) applies "the same sound and well-defined criteria for credit-granting" to both the exposures being securitised and those which are not;
  • the limb (a) originator applies "the same clearly established processes for approving and, where relevant, amending, renewing and refinancing credits"
  • the relevant originators, sponsors and original lenders have "effective systems in place to apply those criteria and processes in order to ensure that credit-granting is based on a thorough assessment of the obligor’s creditworthiness taking appropriate account of factors relevant to verifying the prospect of the obligor meeting his obligations under the credit agreement".

art 9(3)

and, if STS is envisaged, the limb (b) originator must also comply with Article 20(11).  Post-securitisation, the Article 7 transparency and reporting obligations apply.

Article 9(3)

In Article 9(3) the obligation is to "verify" that the "entity which was, directly or indirectly, involved in the original agreement which created the obligations or potential obligations to be securitised [in other words, the limb (a) originator of the exposures] fulfils the requirements referred to in paragraph 1".  The standards required to achieve an appropriate "verification" for Article 9(3) purposes are left unstated.  What if seller warranties are unavailable e.g. if the seller is not the original lender, or if the original lender has been wound up?  A limb (b) originator has no current official guidance on this point; perhaps some guidance will eventually be provided (it seems the envisaged joint committee of the ESAs may issue some eventually). 

For NPL portfolios particularly, there are two exemptions that can help:

  • Article 9(4)(a) disapplies Article 9(3) if the original loan agreements pre-dated the application of the Mortgage Credits Directive (which will vary from country to country but which had to be by 21st March 2016)
  • Article 9(4)(b) permits limb (b) originators to comply instead with Article 21(2) of the RTS relating to risk retention made under CRR (and so "obtain all the necessary information to assess whether the criteria applied in the credit-granting for those exposures are as sound and well-defined as the criteria applied to non-securitised exposures").

Chapter 3

Conditions and Procedures for Registration of a Securitisation Repository

Article 10

Registration of a securitisation repository

1.  A securitisation repository shall register with [EU version: ESMA] [ UK version: the FCA] for the purposes of Article 5 under the conditions and the procedure set out in this Article.

2.  To be eligible to be registered under this Article, a securitisation repository shall be a legal person established in [EU version: the Union] [UK version: the United Kingdom], apply procedures to verify the completeness and consistency of the information made available to it under Article 7(1) of this Regulation, and meet the requirements provided for in Articles 78, 79 and 80(1) to (3), (5) and (6) of Regulation (EU) No 648/2012 [EMIR]. For the purposes of this Article, references in Articles 78 and 80 of Regulation (EU) No 648/2012 [EMIR] to Article 9 thereof shall be construed as references to Article 5 of this Regulation.

[EU version only: 3.  The registration of a securitisation repository shall be effective for the entire territory of the Union.]

4.  A registered securitisation repository shall comply at all times with the conditions for registration. A securitisation repository shall, without undue delay, notify [EU version: ESMA] [ UK version: the FCA] of any material changes to the conditions for registration.

5.  A securitisation repository shall submit to [EU version: ESMA] [ UK version: the FCA] either of the following:

(a)  an application for registration;

(b)  an application for an extension of registration for the purposes of Article 7 of this Regulation in the case of a trade repository already registered under Chapter 1 of Title VI of Regulation (EU) No 648/2012 [EMIR] or under Chapter III of Regulation (EU) 2015/2365 [Securities Financing Transactions Regulation] of the European Parliament and of the Council (30).

[UK version only: 5A.  For the purposes of this Article, Articles 78, 79 and 80 of Regulation (EU) No 648/2012 have effect in relation to a securitisation repository as they have effect in relation to a trade repository, but with the following modifications - 

(a) a reference to a trade repository is a reference to a securitisation repository within the meaning given by point (23) of Article 2 of this Regulation; and

(b) a reference to Regulation (EU) No 648/2012 is a reference to this Regulation.]

6.  [EU version: ESMA] [ UK version: The FCA] shall assess whether the application is complete within 20 working days of receipt of the application.

Where the application is not complete, [EU version: ESMA] [ UK version: the FCA] shall set a deadline by which the securitisation repository is to provide additional information.

After having assessed an application as complete, [EU version: ESMA] [ UK version: the FCA] shall notify the securitisation repository accordingly.

7.  In order to ensure consistent application of this Article, [EU version: ESMA shall develop draft regulatory] [UK version: the FCA may make] technical standards specifying the details of all of the following:

(a)  the procedures referred to in paragraph 2 of this Article which are to be applied by securitisation repositories in order to verify the completeness and consistency of the information made available to them under Article 7(1);

(b)  the application for registration referred to in point (a) of paragraph 5;

(c)  a simplified application for an extension of registration referred to in point (b) of paragraph 5.

[EU version only:

ESMA shall submit those draft regulatory technical standards to the Commission by 18 January 2019.

The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.]

8.  In order to ensure uniform conditions of application of paragraphs 1 and 2, [EU version: ESMA shall develop draft implementing] [UK version: the FCA may make] technical standards specifying the format of both of the following:

(a)  the application for registration referred to in point (a) of paragraph 5;

(b)  the application for an extension of registration referred to in point (b) of paragraph 5.

[EU version only:

With regard to point (b) of the first subparagraph, ESMA shall develop a simplified format avoiding duplicate procedures.

ESMA shall submit those draft implementing technical standards to the Commission by 18 January 2019.

The Commission is empowered to adopt the implementing technical standards referred to in this paragraph in accordance with Article 15 of Regulation (EU) No 1095/2010.]


Article 11

[EU version only: Notification and consultation with competent authorities prior to registration or extension of registration

1.  Where a securitisation repository applies for registration or for an extension of its registration as trade repository and is an entity authorised or registered by a competent authority in the Member State where it is established, ESMA shall, without undue delay, notify and consult that competent authority prior to the registration or extension of the registration of the securitisation repository.

2.  ESMA and the relevant competent authority shall exchange all information that is necessary for the registration, or the extension of registration, of the securitisation repository as well as for the supervision of the compliance of the entity with the conditions of its registration or authorisation in the Member State where it is established.]

Article 12

Examination of the application

1.  [EU version: ESMA] [UK version: The FCA] shall, within 40 working days of the notification referred to in Article 10(6), examine the application for registration, or for an extension of registration, based on the compliance of the securitisation repository with this Chapter and shall adopt a fully reasoned decision accepting or refusing registration or an extension of registration.

[EU version only: 2.  A decision issued by ESMA pursuant to paragraph 1 shall take effect on the fifth working day following that of its adoption.]

Article 13

[EU version: Notification of ESMA decisions relating to registration or extension of registration

1.  Where ESMA adopts a decision as referred to in Article 12 or withdraws the registration as referred to in Article 15(1), it shall notify the securitisation repository within five working days with a fully reasoned explanation for its decision.

ESMA shall, without undue delay, notify the competent authority as referred to in Article 11(1) of its decision.

2.  ESMA shall communicate, without undue delay, any decision taken in accordance with paragraph 1 to the Commission.

3.  ESMA shall publish on its website a list of securitisation repositories registered in accordance with this Regulation. That list shall be updated within five working days of the adoption of a decision under paragraph 1.]

[UK version: Publication and notification of decisions 

1.  The FCA must publish on its website a list of securitisation repositories registered in accordance with Article 12 (‘the Register’).

2.  On the adoption of a decision under Article 12 or 13a, the FCA must notify its decision to the securitisation repository concerned. 

3.  A refusal of an application to register under Article 12 comes into effect on the  fifth working day following its adoption.

4.  A withdrawal of registration under Article 13a takes effect:

(a) immediately upon the adoption of the decision if the notice states that is the case;

(b) on such date as may be specified in that notice; or

(c) if no date is specified in the notice, when the matter to which the notice relates is no
longer open to review.

5.  A decision to withdraw registration on the FCA’s own initiative under paragraph 1 or 2 of Article 13a may be expressed to take effect immediately (or on a specified date) only if the FCA, having regard to the ground on which it is exercising its power reasonably considers that it is necessary for the withdrawal or direction to take effect immediately (or on that date).

6.  If the decision referred to in paragraph 2 is -

(a)  to refuse the application for registration made under Article 12,

(b)  to exercise the FCA’s power under paragraph 1 or 2 of Article 13a to withdraw the registration of the securitisation repository on the FCA’s own initiative, or

(c)  to refuse an application made by a securitisation repository under paragraph 3 of Article 13a to withdraw the registration of the securitisation repository, the FCA must give the securitisation repository a written notice. 

7.  A written notice under paragraph 6 must:

(a)  give details of the decision made by the FCA;

(b)  state the FCA’s reasons for the decision;

(c)  state when the decision takes effect;

(d)  inform the securitisation repository that it may either:

(i)  request a review of the decision by the FCA, and make written representations for the purpose of the review, within such period as may be specified in the notice; or 

(ii)  refer the matter to the Upper Tribunal (‘the Tribunal’) within such period as may be specified in the notice; and 

(e)  indicate the procedure on a reference to the Tribunal.

8.  If the securitisation repository requests a review of the decision made by the FCA (‘the original decision’) the FCA must consider any written representations made by the securitisation repository and review the original decision. 

9.  On a review under paragraph 8, the FCA may make any decision (‘the new decision’) it could have made on the application.

10.  The FCA must give the securitisation repository written notice of its decision on the review. 

11.  This paragraph applies to a decision - 

(a)  to maintain a decision to refuse an application for registration, made under Article 12;

(b)  to refuse to revoke a decision made under paragraph 1 or 2 of Article 13a to withdraw the registration of the securitisation repository on the FCA’s own initiative; or

(c)  to maintain a decision to refuse an application from a securitisation repository under paragraph 3 of Article 13a to withdraw the registration of the securitisation repository.

12.  A written notice in relation to a decision to which paragraph 11 applies must:

(a)  give details of the new decision made by the FCA;

(b)  state the FCA’s reasons for the new decision;

(c)  state whether the decision takes effect immediately or on such date as may be specified in the notice;

(d)  inform the securitisation repository that it may, within such period as may be specified in the notice, refer the new decision to the Tribunal; and

(e)  indicate the procedure on a reference to the Tribunal.

[UK version only:  Article 13a
Withdrawal of registration

1.  The FCA may, on its own initiative, withdraw the registration of a securitisation  repository where the securitisation repository:

(a)  expressly renounces the registration or has provided no services for the preceding 6 months;

(b)  obtained the registration by making false statements or by any other irregular means; or

(c)  no longer meets the conditions for registration.

2.  The FCA may also, on its own initiative, withdraw the registration of a securitisation repository where it is desirable to do so to advance one or more of its operational objectives set out in section 1B(3) of the 2000 Act.

3.  The FCA may, on an application by a securitisation repository, withdraw the registration of the securitisation repository.

4.  The decision to withdraw the registration of a securitisation repository under paragraph 1, 2 or 3 must be reflected in the Register.]

Article 14

[EU version: Powers of ESMA

1.  The powers conferred on ESMA in accordance with Articles 61 to 68, 73 and 74 of Regulation (EU) No 648/2012 [EMIR], in conjunction with Annexes I and II thereto, shall also be exercised with respect to this Regulation. References to Article 81(1) and (2) of Regulation (EU) No 648/2012 [EMIR] in Annex I to that Regulation shall be construed as references to Article 17(1) of this Regulation.

2.  The powers conferred on ESMA or on any official of or other person authorised by ESMA in accordance with Articles 61 to 63 of Regulation (EU) No 648/2012 [EMIR] shall not be used to require the disclosure of information or documents which are subject to legal privilege.]

[UK version:  Tribunal

1.  A securitisation repository may, subject to paragraph 2, refer to the Tribunal the FCA’s decision to:

(a)  refuse to register the securitisation repository under Article 12;

(b)  exercise its power under paragraph 1 or 2 of Article 13a to withdraw the  registration of a securitisation repository; or

(c)  refuse the securitisation repository’s application under paragraph 3 of Article 13a to withdraw its registration.

2.  Where there is a review under paragraph 8 of Article 13, paragraph 1 applies only in relation to the FCA’s decision in response to that review.]

Article 15

[EU version:  Withdrawal of registration

1.  Without prejudice to Article 73 of Regulation (EU) No 648/2012 [EMIR], ESMA shall withdraw the registration of a securitisation repository where the securitisation repository:

(a) expressly renounces the registration or has provided no services for the preceding six months;

(b) obtained the registration by making false statements or by other irregular means; or

(c)  no longer meets the conditions under which it was registered.

2.  ESMA shall, without undue delay, notify the relevant competent authority referred to in Article 11(1) of a decision to withdraw the registration of a securitisation repository.

3.  The competent authority of a Member State in which a securitisation repository performs its services and activities and which considers that one of the conditions referred to in paragraph 1 has been met, may request ESMA to examine whether the conditions for the withdrawal of registration of the securitisation repository concerned are met. Where ESMA decides not to withdraw the registration of the securitisation repository concerned, it shall provide detailed reasons for its decision.

4.  The competent authority referred to in paragraph 3 of this Article shall be the authority designated under Article 29 of this Regulation.]

[UK version:  Enforcement provisions relating to securitisation repositories

1.  In this Article ‘the 2019 Regulations’ means the Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2019.

2.  Part 4 of the 2019 Regulations (specific provision for trade repositories) has effect in relation to a securitisation repository as it has effect in relation to a trade repository.

3.  For the purposes of paragraph 2, Part 4 of the 2019 Regulations has effect in relation to a securitisation repository with the following modifications:

(a)  ignore Chapter 1 (preliminary);

(b)  in Chapter 2 and Chapter 3 (application of the 2000 Act for the purposes of this Part), including any modification of the 2000 Act which is made by that Chapter:

(i)  a reference to Part 4 of the 2019 Regulations is a reference to that Part as applied by this Article;

(ii)  a reference to the 2019 Regulations (other than in a reference to Part 4) is a reference to those Regulations as applied by this Article;

(iii)  a reference to the EMIR regulation is a reference to this Regulation and a  reference to a provision of that Regulation is a reference to the provision of this Regulation which has equivalent effect; 

(iv)  a reference to the registration or recognition of a trade repository under a provision of the EMIR regulation is a reference to the registration of a securitisation repository under this Regulation;

(v)  a reference to a trade repository is a reference to a securitisation repository within the meaning given by point (23) of Article 2 of this Regulation;

(vi)  a reference to trade repository activities is a reference to the activities of centrally collecting and maintaining records of securitisations;

(vii)  ignore any reference to the TRATP Regulations; and

(c)  in Chapter 3, including any modification of the 2000 Act which is made by that Chapter:

(i)  a reference to a provision of the 2019 Regulations is a reference to the equivalent provision of the Securitisation (Amendment) (EU Exit) Regulations 2019;

(ii)  in regulation 73 (application of Part 9 of the 2000 Act (hearings and appeals),  ignore paragraph (2);

(iii)  in regulation 78 (application of Part 11 of the 2000 Act (information gathering and investigations)), ignore paragraph (2)(f);

(iv)  in regulation 79 (application of Part 26 of the 2000 Act (notices)), ignore  paragraph (8)(h) and any reference to a supervisory notice.]

Article 16

[EU version only:  Supervisory fees

1. ESMA shall charge the securitisation repositories fees in accordance with this Regulation and in accordance with the delegated acts adopted pursuant to paragraph 2 of this Article.

Those fees shall be proportionate to the turnover of the securitisation repository concerned and shall fully cover ESMA’s necessary expenditure relating to the registration and supervision of securitisation repositories as well as the reimbursement of any costs that the competent authorities incur as a result of any delegation of tasks pursuant to Article 14(1) of this Regulation. Insofar as Article 14(1) of this Regulation refers to Article 74 of Regulation (EU) No 648/2012 [EMIR], references to Article 72(3) of that Regulation shall be construed as references to paragraph 2 of this Article.

Where a trade repository has already been registered under Chapter 1 of Title VI of Regulation (EU) No 648/2012[EMIR] or under Chapter III of Regulation (EU) 2015/2365 [Securities Financing Transactions Regulation], the fees referred to in the first subparagraph of this paragraph shall only be adjusted to reflect additional necessary expenditure and costs relating to the registration and supervision of securitisation repositories pursuant to this Regulation.

2.  The Commission is empowered to adopt a delegated act in accordance with Article 47 to supplement this Regulation by further specifying the type of fees, the matters for which fees are due, the amount of the fees and the manner in which they are to be paid.]

Article 17

Availability of data held in a securitisation repository

1.  Without prejudice to Article 7(2), a securitisation repository shall collect and maintain details of the securitisation. It shall provide direct and immediate access free of charge to all of the following entities to enable them to fulfil their respective responsibilities, mandates and obligations:

[EU version only: 

(a)  ESMA;

(b)  the EBA;

(c)  EIOPA;

(d)  the ESRB;

(e)  the relevant members of the European System of Central Banks (ESCB), including the European Central Bank (ECB) in carrying out its tasks within a single supervisory mechanism under Regulation (EU) No 1024/2013;]

(f)  the relevant authorities whose respective supervisory responsibilities and mandates over transactions, markets, participants and assets which fall within the scope of this Regulation;

(g)  [EU version:  the resolution authorities designated under Article 3 of Directive 2014/59/EU of the  European Parliament and the Council(31)] [UK version:  the Bank of England;]

[EU version only:  (h)  the Single Resolution Board established by Regulation (EU) No 806/2014 of the European Parliament and of the Council (32);]

(i)  the authorities referred to in Article 29;

(j)  investors and potential investors.

2.  [EU version:  ESMA shall, in close cooperation with the EBA and EIOPA and taking into account the needs of the entities referred to in paragraph 1, develop draft regulatory] [UK version:  The FCA, taking into account the needs of the entities referred to in paragraph 1, may make] technical standards specifying:

(a)  the details of the securitisation referred to in paragraph 1 that the originator, sponsor or SSPE shall provide in order to comply with their obligations under Article 7(1);

(b)  the operational standards required, to allow the timely, structured and comprehensive:

(i)  collection of data by securitisation repositories; and

(ii)  aggregation and comparison of data across securitisation repositories;

(c)  the details of the information to which the entities referred to in paragraph 1 are to have access, taking into account their mandate and their specific needs;

(d)  the terms and conditions under which the entities referred to in paragraph 1 are to have direct and immediate access to data held in securitisation repositories.

[EU version only:  ESMA shall submit those draft regulatory technical standards to the Commission by 18 January 2019.]

[EU version only:  The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.]

3.  In order to ensure uniform conditions of application for paragraph 2, [EU version:  ESMA, in close cooperation with the EBA and EIOPA shall develop draft implementing] [UK version:  the FCA may make] technical standards specifying the standardised templates by which the originator, sponsor or SSPE shall provide the information to the securitisation repository, taking into account solutions developed by existing securitisation data collectors.

[EU version only:  ESMA shall submit those draft implementing technical standards to the Commission by 18 January 2019.]

[EU version only:  The Commission is empowered to adopt the implementing technical standards referred to in this paragraph in accordance with Article 15 of Regulation (EU) No 1095/2010.]

Chapter 4

Simple, Transparent and Standardised Securitisations

Article 18

Use of the designation ‘simple, transparent and standardised securitisation’

[UK version is numbered "1"]:  Originators, sponsors and SSPEs may use the designation ‘STS’ or ‘simple, transparent and standardised’, or a designation that refers directly or indirectly to those terms for their securitisation, only where:

[UK version:  (a)  the securitisation meets all the requirements of Section 1 or Section 2 of this Chapter, and the FCA has been notified pursuant to Article 27(1); and]

[EU version(a) the securitisation meets all the requirements set out in Section 1, 2 or 2a of this Chapter, and ESMA has been notified pursuant to Article 27(1); and]

(b)  the securitisation is included in the list referred to in Article 27(5).

[EU version only:  The originator, sponsor and SSPE involved in a securitisation considered STS shall be established in the Union.]

[UK version only:

2.  The originator and sponsor involved in a securitisation which is not an ABCP programme or an ABCP transaction and is considered STS must be established in the United Kingdom.

The sponsor involved in an ABCP programme considered STS must be established in the United Kingdom. 

The sponsor involved in an ABCP programme which is not considered STS must be established in the United Kingdom if an ABCP transaction within that programme is considered STS.

3.  This Article has effect in relation to a relevant securitisation without the amendments made by regulation 18 of the Securitisation (Amendment) (EU Exit)  Regulations 2019.

A ‘relevant securitisation’ is a securitisation - 

(a)  which meets all the requirements of Section 1 or Section 2 of this Chapter, and of which ESMA was notified pursuant to Article 27(1) before exit day, or is notified pursuant to Article 27(1) after exit day but before the expiry of a period of two years beginning with exit day; and 

(b)  which is included in the list referred to in Article 27(5).

In this paragraph a reference to Section 1 or Section 2 of this Chapter or to Article 27 is a reference to that Section or Article as it had or has effect in relation to an EEA State at any time on and after the date of the notification and before the end of the period referred to in the second subparagraph.]

References

Securitisation remains one of the most effective and efficient forms of financing to support business growth and development.  In spite of years of regulatory interference, delay and badly developed regulation the market continues to operate, admittedly at significantly reduced levels. The UK now has the opportunity to re-establish a securitisation regulatory regime that is effective and more appropriate to the risk and structures involved.  This is however likely to be some way off as participants initially continue to operate within the current regulatory framework.

With effect from 1 January 2021, businesses looking to use securitisation to fund activities have been faced with a challenging interplay of EU and UK regulation as the UK establishes its framework outside the European Union. Activity within the European securitisation market transcends national European boundaries, and participants need to evaluate the consequences, for existing issuances and new issuances, of the UK leaving the EU and becoming a “third country” from a European securitisation perspective. 

Historic European issuance EUR bn
The European market has not rebounded after 2008, with no obvious uplift from STS.  

Source: AFME Securitisation Data Report Q3 2020, Q4 data grossed up by reference to average 2010-19 European Q4 issuance

This paper aims to assist potential issuers and other participants work through the complex interaction of EU and UK legislation.

The new UK legislative regime adopts the position of the EU Securitisation Regulation as at 31 December 2020 and develops that position for the purposes of the UK securitisation market.  We look at what has changed, and at what sponsors, originators, issuers and investors will need to know in order to comply with the requirements applying in the UK whilst continuing to comply with the rules now applying in the EU.   

A dual securitisation regime

With effect from 1 January 2021, regulation of the European securitisation market has been bifurcated into two sets of rules:

  • the EU Securitisation Regulation ((EU) 2017/2402) (the “EUSR”), to be amended sometime in the next couple of months by the “quick fix” amendments introduced in 2020; and
  • the UK Securitisation Regulation (the “UKSR”), made up of the text of the EUSR as it stood on 31 December 2020, as amended in accordance with section 8 of the European Union (Withdrawal) Act 20181 (”EU Withdrawal Act”) (itself as amended by the European Union (Withdrawal Agreement) Act 2020) and by the Securitisation (Amendment) (EU Exit) Regulations 2019 (which themselves have been amended three times since they were originally issued).

The need to apply two sets of regulations to a market that had operated as a single market up until 1 January 2021 will present some complexity as participants from each of the UK and EU continue to operate on a cross border basis reflecting the operations of the market rather than the operation of newly erected jurisdictional boundaries.  The fact that neither the EU regulatory rules nor the new UK regulatory framework are in a complete state leads to further requirements to remain watchful of the developing regulatory positions.

2020 placed issuance by country of collateral
During 2020 the major segments were RMBS, ABS and CLOs, often pan-European and managed from London

Source: AFME Securitisation Data Report Q3 2020, Q4 data grossed up by reference to average 2010-19 European Q4 issuance

The EU Withdrawal Act onshored all level 2 rules which were legally binding at the end of the Brexit transition period.  The expectation is that any regulatory technical standards or implementing technical standards that were not in force on 31st December 2020 will be adopted - in some form or another - by the Financial Conduct Authority (“FCA”) in due course.  The most important regulatory technical standards that were not in effect on 31st December 2020 were the final draft regulatory technical standards specifying the requirements for originators, sponsors and original lenders relating to risk retention pursuant to Article 6(7) of Regulation (EU) 2017/2402, the final text of which was adopted by the EBA on 31st July 2018 and submitted to the European Commission, but which has still not yet been officially published.

Level three guidance – particularly, the EBA Guidelines on STS requirements2 and the ESMA Q&A on the EUSR– is not onshored by the EU Withdrawal Act, but the Bank of England and the Prudential Regulation Authority (“PRA”) in their 2019 joint policy statement, “Interpretation of EU Guidelines and Recommendations” said that they expected UK-regulated firms to continue to make every effort to comply with them “to the extent that they remain relevant when the UK leaves the EU”.

The inadequacies of the existing regulatory framework have been well documented and the new interplay between two separate regulatory regimes will make for even greater implementation and operational challenges for participants to follow.  For these reasons we recommend readers to bookmark our dual law Securitisation Regulation text, which shows the similarities and differences between the two regimes, and which will be amended as necessary from time to time – for example, to accommodate the EU “quick fix” amendments once they have gone through the jurist/linguist process.  These materials also contain links to relevant level 2 and 3 texts and indeed much more background and related materials which will be helpful in understanding why the market has adopted certain regulatory positions.

UK risk retention holders in EU securitisations

Article 6(1) of the EUSR requires the risk retention holder to be the originator, sponsor or original lender.  “Originator” and “original lender”, as defined in Article 2 of the EUSR, are simply required to be “entities”, whether or not established in the EU (a point emphasised by Article 5(1)(b) of the EUSR), and if a UK-based risk retention holder falls into one of these two categories, the requirements of Article 6(1) EUSR should continue to be met.  However, if a UK-based risk retention holder has been holding as “sponsor”, it needs to examine if it continues to fall within the definition of “sponsor” for the purposes of the EUSR to make sure it can continue to fulfil this role on EU securitisations.

As readers will probably know, this definition is not unambiguous as regards investment firms.  Credit institutions “whether located in the Union or not”, are clearly within the definition of “sponsor”, but the fact that, in the definition of “sponsor”, this phrase appears after "credit institution" but before "investment firm", has created doubt and no little discussion as to whether or not non-EU investment firms are included.  Although the definition in Article 4(1)(1) of MIFID does not have any geographical limitation, in the context of MIFID itself, “investment firm” is usually taken to refer to EU-organised firms3.  However, in the context of the EUSR, Article 5(1)(d) clearly envisages the possibility of the sponsor being established in a third country.The first draft of the EUSR had defined “investment firm” so as to require a fully-authorised MIFID firm (as was the case under the previous Capital Requirements Regulation (“CRR”) rules) and this would certainly have caused problems for many UK CLO managers, which do not usually have the MIFID super-authorisations.  The point then went away – until Brexit revived it - after the definition was switched during one of the trilogues to what we now have in the EUSR, although there was no official commentary explaining why this was done, nor what the legislators intended by it.  Some official interpretation or guidance on this point would be very welcome, but none has yet been provided.  The corresponding definition in the UKSR has no equivalent ambiguity because of the amendment to it made by the Securitisation (Amendment) (EU Exit) Regulations 20194.

This means that for UK investment firms wishing to hold or continue holding the risk retention in European CLOs and which are able to come within the definition of “originator”, the approach which provides most certainty is to do so as an originator rather than as sponsor, unless and until there is any official EU guidance on the point.

Risk retention on a consolidated basis may be affected

Article 6(4) of the EUSR recognises and permits the practice of having one entity within a financial group being permitted to hold the risk retention for securitisations which another group company has originated or sponsored.  This can be convenient for obvious reasons, because the flexibility avoids any need to examine the extent of the definition of “originator”.  That flexibility no longer applies where the group has a UK parent, because Article 6(4) of the EUSR only permits this where the parent or holding company is EU-organised.  Article 6(4) of the UKSR is broadly consistent with this, requiring a UK holding company or parent.

Reduced access to STS issuances for EU investors, but not for UK investors

The UK securitisation regime does not require EU investors to cease to hold securitisations which have a UK originator, sponsor or SSPE, but issuances which had been classified as “STS” prior to 1 January 2021, and had an originator, sponsor or SSPE established in the UK, ceased to qualify as EU-STS with effect from 1 January 2021 because EU-STS status requires all of them to be established in the EU. The European Securities and Markets Authority (“ESMA”) wasted no time in amending its list of STS deals on Tuesday 5 January 2021, to exclude 81 UK-related issues accordingly.  Loss of the STS label for these securities meant that any EU regulated institutions which were still holding them would correspondingly lose the preferential treatment available for STS labelled securities under the CRR and the Liquidity Coverage Ratio (where STS labelled securities are classed as level 2B). It is likely that EU investors would have transferred those assets to UK investment entities or become forced sellers of those assets. 

The UK FCA’s list of issues which qualify as UK-STS was established on 1 January 2021.  In addition to these, so as to maintain an accessible pool of STS labelled  product for UK institutional investors, the FCA grandfathered all EU securitisations which were notified to ESMA before the end of the transition period as meeting the EU STS criteria, and announced it would accept any EU-STS issues which were notified to ESMA in the first two years after Brexit (seemingly this means legal Brexit – 31 January 2020, rather than the transition period end date of 31 December 2020).  The result is that so long as these remain on ESMA’s list, they will also qualify as UK STS for the life of the transaction.

EU due diligence and information disclosure requirements: no significant changes

EU institutional investors are permitted to acquire securities even where the relevant  securitisation special purpose entity (“SSPE”), sponsor, originator or original lender is located in the UK.  These EU investors are required to conduct due diligence in accordance with Article 5 of the EUSR prior to holding a securitisation position, and if that issuance has a UK originator or original lender, the legal obligation on the EU investors to verify credit granting criteria and risk retention switches from the provisions of Article 5(1)(a) and (c) of the EUSR to the provisions of Article 5(1)(b) and (d) of the EUSR, but these are not qualitatively very different. 

EU investors however need to consider Article 5(1)(e) of the EUSR, and the vexed question of what information EU investors are required to receive from the originator, sponsor or SSPE (as the case may be) under Article 7 of the EUSR.  This topic is problematic for EU investors wanting to buy into securitisations which are not structured to align with Article 7 of the EUSR; for example, securitisations originating from markets like the US which do not require granular loan level information like that prescribed by Article 7 (a point discussed in more detail in our commentary, “Do EU investors need loan level data to invest in non-EU issues?”).  For UK issuances this distinction should not make a difference because of the similarity of the practices of disclosure under both regimes.

Positions we are seeing being taken in early 2021 deals include requirements for parties such as sponsors or originators to provide information on a reasonable efforts basis to assist EU-based investors (in UK securitisations) or UK-based investors (in EU securitisations) in complying with the requirements of Article 5 of the EUSR or UKSR, as applicable.  We are also seeing requirements for parties, in the event that the regimes diverge, to enter into negotiations to agree amendments or waivers to transaction documents and, if no agreement can be reached, triggering a redemption of the securities held by the affected investor. 

UK due diligence and information disclosure requirements

For UK investors, the position is largely the same as is outlined above for EU investors.  The UKSR has divided Article 5(1)(e) into sub-articles (e) and (f) – usefully correcting a drafting deficiency in the EU text – but as noted above, the practices regarding disclosure under the EUSR and the UKSR are currently the same in any event, as are the substantive provisions of Article 7 of the UKSR and the related EU regulatory technical standards, which came into force on 23 September 2020 and have been adopted as part of retained EU law by the UK under the EU Withdrawal Act.  As such, a UK investor should be able to satisfy itself that it has the information it needs to perform its due diligence under Article 5 of the UKSR even for an issuance structured principally with the EUSR in mind.

UK sponsors and originators might have hoped that the Securitisation (Amendment) (EU Exit) Regulations 2019 would have disapplied the Article 7 disclosure requirements in respect of private securitisations, but for the time being the UK has not done this.  On 31 January 2019, the FCA and PRA issued a final Direction under the UK's Securitisation Regulations 2018 specifying the manner in which disclosure should be made to them in respect of a private securitisation established in the UK, annexed to which were short form templates to be used for the purpose.  The 2018 Regulations were routine implementation regulations and not Brexit-related and, whilst administratively convenient, they did not disapply nor vary Article 7 of the EUSR: noteholders and, on request, potential investors, and indeed the regulators themselves, are entitled to the full Article 7 disclosure (subject to Article 7(1), which has a paragraph that permits just a summary of the deal documentation to be provided rather than copies of all the bible documentation).

UK CLO asset managers for European CLO’s?

From January 2021, UK-based collateral managers with no EU27 offices will need to examine whether they can legally provide management services to an EU27-incorporated CLO entity (European CLO issues are typically done through an Irish DAC particularly as the Dutch CLO market has largely disappeared). Prior to January 2021, any UK collateral manager would have been a MIFID-authorised “investment firm”, but that authorisation has of course now lapsed and, since there has not been any MIFID equivalence determination from the EU, UK CLO managers will need to consider whether applicable local law permits them to provide the management services to the SSPE. 

In the case of an issuance where the SSPE is an Irish DAC, a UK collateral manager should be able to provide the collateral management services, even though the UK is now a “third country” for EU MIFID purposes, because MIFIR Article 54(1) permits third country investment firms to provide collateral management services into the EU in accordance with relevant local law “until three years after the adoption by the Commission of a decision in relation to the relevant third country in accordance with Article 47”, and the Irish European Union (Markets in Financial Instruments) Regulations 2017, which implemented MIFID II into Irish law permit certain non-EU investment firms to provide collateral management services into the EU to Irish persons.  There are some detailed requirements to be met (the manager may not have a branch in Ireland and must be subject to authorisation and supervision in the UK), and there must be – as there are – appropriate co-operation arrangements in place between the Central Bank of Ireland and the FCA for the exchange of information.  Subject to this, a UK collateral manager may provide management services to any per se professional clients or eligible counterparties (as defined in MIFID II) .

In some cases however, there is a trap for unwary UK collateral managers.  As a general rule, non-STS securitisations may have their sponsor located anywhere in the world.  However, there is an anomaly in the wording of the EUSR which the EU has acknowledged to be unintentional, which is relevant.  This is that, if a non-EU sponsor establishes the securitisation but then delegates day to day active portfolio management to a manager, then, because limb (b) of the definition of “sponsor” requires the manager to be authorised under the UCITS Directive, the AIFM Directive or MIFID, the manager must - as drafted - be in the EU.  The UK post-Brexit onshoring version of this definition, contained in section 4 of the Securitisation (Amendment) (EU Exit) Regulations 2019, has already corrected the corresponding wording in the definition, and allows delegation to be to any entity "which is authorised to manage assets belonging to another person in accordance with the law of the country in which the entity is established".

Is there any significance for deal documentation governed by English law?

The absence of any UK/EU agreement on continuation of the 2012 Brussels (Recast) Regulation on jurisdiction and the recognition and enforcement of judgments means that, unless and until the EU agrees to the UK becoming a party to the 2007 Lugano Convention, the position regarding the recognition and enforcement of UK judgments in the EU27 is governed by the 2005 Hague Convention (the “Hague Convention”).  The generally held view is that the Hague Convention probably only applies if the jurisdiction clause is fully exclusive (i.e. as regards not only the debtor parties but also the trustee, which may not always be the case in legacy documentation).  Having said this, in practice there may be limited circumstances in which litigation on the deal documentation in non-English jurisdictions is likely to arise, save as regards the validity of any transfer of assets by an originator to an issuer (in which event it is likely that the parties would have chosen the laws of the place where the asset is situated) and so, whilst Brexit does have some consequences for the status of English law judgments in the EU27, these should not normally be significant nor necessarily preclude the continuing use of asymmetric clauses.

An uncontroversial point of detail is that the UK and EU now have separate bail-in regimes and so under Article 55 of the EU BRRD and its UK-onshored equivalent, a contractual recognition of bail-in clause is likely to be required in mixed UK/EU securitisations.  The wording of such a clause is quite standard and, as it merely restores the pre-Brexit status quo ante, its inclusion will be uncontroversial.

Is there any prospect of an equivalence regime for STS issues?

As it stands today, the UK is a non-EU "third country" and, pending the adoption of any "third country regime" under the EUSR – which it is difficult to see happening any time soon -  issuances by any UK party are ineligible for STS status, because under EU STS, all three of the issuer, originator and sponsor must be established in the EU.  Back in 2016, the European Parliament had proposed, in response to the Brexit referendum result, an equivalence regime - a solution which one might have thought would be appealing both to EU investors (because it would have given the post-withdrawal STS market the same depth it had pre-withdrawal) and to EU regulators (because any subsequent competitive loosening of UK regulation would be constrained by the prospect of the equivalence declaration being withdrawn).  However, this was dropped as it was regarded by some EU countries (reports at the time suggested France and Germany) as being too political for resolution except as part of a future UK-EU agreement.  Instead, we are left with Article 46 of the EUSR, which contemplates that within the first 3 years after the EUSR has effect, the European Commission will produce a report examining whether an equivalence regime could be introduced for STS securitisations.

Meanwhile, as regards STS, because Article 19 of the EUSR restricts EU STS status to EU originated securitisations, whilst the equivalent UKSR provision does largely the same for UK STS securitisations (the difference being that the SSPE need not be a UK entity - so that, for example, the familiar Irish law DAC can continue to be used) the consequence is a fragmented market, which is not good for issuers or investors. Once the political dust has settled, perhaps a more pragmatic approach can be adopted.

Conclusion

It is ironic that the impetus to revive the European securitisation market after the Global Financial Crisis – and much of the impetus for Capital Markets Union – came from the City of London.  The development of two regulatory frameworks will certainly make it more complex for participants to manage issuances in the near term on a Europe wide basis.  It is hoped however that the current process can act as a starting point for rationalisation of an ill developed regulatory framework which provides an essential tool for funding businesses that will need to drive growth in a post COVID environment.  Businesses looking to issue and investors looking to invest are likely to find their way to the most rational, liquid and well managed market and regulators in both the UK and EU can learn from improvements that drive efficient capital markets across Europe for the benefit of issuers, investors and consumers alike.

For further information please contact our Securitisation group:


Footnotes

1. Section 8 of the EU Withdrawal Act 2018 permits H.M. Treasury to make amendments to adopted EU law "to prevent, remedy or mitigate (a) any failure of retained EU law to operate effectively, or (b) any other deficiency in retained EU law, arising from the withdrawal of the United Kingdom from the EU", and the Securitisation (Amendment) (EU Exit) Regulations 2019 have done this.  In many cases the changes are straightforward updates to reflect this now being UK law - changing "the Union" to "the United Kingdom" for example - but there are some more interesting ones, such as improving the definition of "sponsor", clarifying the due diligence requirements for UK regulated investors in non-UK securitisations, and permitting non-UK SSPEs.  It may be questioned whether all of these fall strictly within the scope of section 8, but it is unlikely that anybody would challenge such helpful changes.

2. Guidelines on the STS criteria for ABCP securitisation, and Guidelines on the STS criteria for non-ABCP securitisation, each published on 12 December 2018.

3. This is because there is a separate definition (Article 4(1)(57)) of "third-country firm" which means (italics added) "a firm that would be… an investment firm if its head office or registered office were located within the Union", which suggests that in the context of MIFID, such a firm is not an "investment firm".

4. The UK text refers to the definition which appears in paragraph 1A of Article 2 of Regulation 600/2014/EU, this is because it is referring to the onshored version of MIFIR, as amended by section 26 of the Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018; the definition is, broadly speaking, a person whose regular occupation or business is the provision of one or more investment services to third parties or the performance of one or more investment activities on a professional basis.

Article 19

Section 1

Requirements for simple, transparent and standardised non-ABCP [EU version only: traditional] securitisation

Simple, transparent and standardised non-ABCP [EU version only: traditional] securitisation

[UK version:  1.  Securitisations, except for ABCP programmes and ABCP transactions, that meet the requirements set out in Articles 20, 21 and 22 shall be considered STS.]

[EU version:  1.   Traditional securitisations, except for ABCP programmes and ABCP transactions, that meet the requirements set out in Articles 20, 21 and 22, shall be considered to be STS.]

[EU version only:  2.  By 18 October 2018, the EBA, in close cooperation with ESMA and EIOPA, shall adopt, in accordance with Article 16 of Regulation (EU) No 1093/2010, guidelines and recommendations on the harmonised interpretation and application of the requirements set out in Articles 20, 21 and 22.]

Article 20

Requirements relating to simplicity

1.  The title to the underlying exposures shall be acquired by the SSPE by means of a true sale or assignment or transfer with the same legal effect in a manner that is enforceable against the seller or any other third party. The transfer of the title to the SSPE shall not be subject to severe clawback provisions in the event of the seller’s insolvency.

EBA Guidelines
Background and rationale para. 16
Guidelines para. 10-12
Q&A 1-2

Introduction

The EU STS regime for synthetics is a world first:  there is no provision at the Basel/IOSCO level for preferential capital treatment for an STC-qualifying synthetic product.  The 24th July 2020 proposal from the European Commission to enact an STS regime for balance sheet synthetic securitisations by amending the Securitisation Regulation and the CRR (but not, initially at least, Solvency II)  was explicitly in response to the “urgency” of the need to take measures to help the economy recover from the COVID-19 pandemic.  It was broadly welcomed by those who saw it as a way of attracting new risk-takers into the market which would be prepared to take on risk (and be able to do the related due diligence) if the overall package was sufficiently standard, simple and transparent, but not otherwise; the current synthetic market is for the most part, central banks, supranational entities such as the EIB, pension and hedge funds, with monolines having long gone.  

The proposals were adopted in early April 2021 and are effective as from 9th April 2021.  They have been cautiously welcomed, even though they are not the totality of what the market has been asking for, but there are issues  regarding complexity and cost, and one of these issues - the change to Article 248 of the CRR concerning excess spread - applies across the board, not just to STS.  

The EC proposals

When the Securitisation Regulation was enacted, there had been only one, minor, concession to synthetics. Where an institution sold off a junior position in a pool of loans to SMEs via a synthetic structure, it could only apply to the retained position the lower capital requirements available for STS securitisations if the strict criteria set out in Article 270 of the CRR as amended were met, which included that the position was guaranteed by a central government, central bank, or a public sector “promotional entity”, or – but only if fully collateralised by cash on deposit with the originator – by an institution.  Otherwise, originators would have to allocate capital to the retained senior piece on the basis of the higher non-STS rules which, because of the regulatory non-neutrality baked into the regulatory capital requirement for securitisation (i.e. the sum total of capital allocated to all the various tranches of a securitisation will be more than the capital which would be required for a holding of the underlying assets) were, to say the least, discouraging.

Article 45 of the Securitisation Regulation required the EBA to report on the possibility of an STS regime for balance sheet synthetics by 2nd July 2019.  Its "Draft report on STS Framework for Synthetic Securitisation" emerged on 24th September 2019, the delay being due to unresolved differences of opinion among EU regulators about whether or not synthetics should be given any favourable capital treatment or not.  The EBA  considered to what extent buying STS protection should give the protection buyer preferential regulatory capital treatment as regards the portion of risk on the portfolio that it continues to hold (which, post-GFC, is usually the least risky portion, with the first loss risk being transferred to a protection seller).   The EBA envisaged qualifying protection coming from either 0% risk-weighted institutions under the CRR, such as the EIB or, if not, then from entities to which the protection buyer's recourse is fully collateralised in cash or risk-free securities.  It was equivocal about whether STS synthetic securitisations should provide favourable capital treatment for the originator credit institution or not.  Its final proposals for developing a STS framework for synthetic securitisation emerged on 5th May 2020, recommended setting up an STS framework but sat on the fence regarding the capital treatment, merely noting the pros and cons of the introduction of more risk-sensitive regulatory treatment of the STS synthetic product.  The EBA’s summary said:

"On the one hand, developments in the last few years have indicated the potential for the continuing growth of the synthetic sector and have confirmed the technical feasibility of the creation of a prudentially sound STS synthetic securitisation product that is comparable to the STS traditional securitisation product.  In addition, the available performance data do not provide any evidence that the performance of the synthetic securitisation instrument is worse than that of the traditional securitisation instrument.  The introduction of potentially limited and clearly defined differentiated regulatory treatment would match the historical performance of the synthetic securitisation, ensure better alignment with the STS traditional securitisation framework and help overcome the constraints of the current limited STS risk-weight treatment of some SME synthetic securitisations.  

On the other hand, there are limitations of the performance data on which the analysis is based, there is limited experience with the STS traditional framework so far, and the risk of potentially overusing synthetic securitisation, which would potentially lead to a large-scale replacement of regulatory capital by risk mitigation strategies, leading to overleveraging of banks, should be duly taken into account. In addition, the preferential regulatory treatment is not included in the international Basel standards.”

On 12th June 2020, the “High Level Forum on the Capital Markets Union” issued a 129-page “final report” on CMU, the recommendations of which included applying the same regulatory treatment to synthetics as to cash securitisations.  

The new regime for synthetic securitisation

Against this background, the "quick fix" amendments to the Securitisation Regulation have added a new series of articles (Article 26a et seq.) in “Section 2A” to introduce a new regime for synthetics which apply most of the same STS requirements as apply to cash securitisations, plus some others specific to synthetics e.g. requirements mitigating the counterparty credit risk on the protection seller, and the CRR amendments extend the treatment which Article 270 of the CRR had previously allowed to only a limited sub-set of synthetic securitisations.  Some aspects of the proposed regime entail additional cost and complexity over and above what the existing market is used to - for example, protection sellers (which the legislation insists on calling "investors") are required to have recourse to higher-quality collateral to secure repayment of their "investment" than is usual, and that of course comes at a cost.  Some detail has yet to be fleshed out in RTS – those will appear in H1 of 2021 - and there is scope for some level 3 clarification.  There seems to be a lot of devil in the detail and it remains to be seen how this will play out.  

The proposal was enacted after the Brexit transitional period ends, and does not form part of onshored UK law.  The UK had been opposed to the idea of an STS regime for synthetic securitisation, and it was only brought about as a result of Brexit.  It seems unlikely that the UK’s FCA will want to introduce a similar regime under the UKSR.  

Articles 20 and 24 do not allow deals to qualify as STS if the asset sale is subject to "severe clawback".  Article 20(2) and (3) for term STS, and Article 24(2) and (3) for ABCP STS, explain that this includes a simple liquidator's power to invalidate a sale within a certain period regardless of the circumstances, but they make it clear that laws on fraudulent transfers (actio Pauliana), unfair prejudice and unfair preference are permitted.  The intent seems clearly not to overturn market expectations or undermine prevailing practices.  The EBA Guidelines envisage one or more legal opinions being obtained in respect of the insolvency aspects relating to a transfer, which is normal practice in any event.

It may be noted that the European Commission’s November 2016 proposal for a European Insolvency Directive explicitly ducked the possibility of harmonising clawback provisions, because although this would be useful for achieving cross-border certainty, “the current diversity in Member States' legal systems over insolvency proceedings seems too large to bridge”.


2.  For the purpose of paragraph 1, any of the following shall constitute severe clawback provisions:

(a)  provisions which allow the liquidator of the seller to invalidate the sale of the underlying exposures solely on the basis that it was concluded within a certain period before the declaration of the seller’s insolvency;

(b)  provisions where the SSPE can only prevent the invalidation referred to in point (a) if it can prove that it was not aware of the insolvency of the seller at the time of sale.

References

EBA Guidelines
Background and rationale para. 18-19
Q&A 2

3.  For the purpose of paragraph 1, clawback provisions in national insolvency laws that allow the liquidator or a court to invalidate the sale of underlying exposures in the case of fraudulent transfers, unfair prejudice to creditors or transfers intended to improperly favour particular creditors over others shall not constitute severe clawback provisions.

4.  Where the seller is not the original lender, the true sale or assignment or transfer with the same legal effect of the underlying exposures to that seller, whether that true sale or assignment or transfer with the same legal effect is direct or through one or more intermediate steps, shall meet the requirements set out in paragraphs 1 to 3.

References

EBA Guidelines
Background and rationale para. 19

5.  Where the transfer of the underlying exposures is performed by means of an assignment and perfected at a later stage than at the closing of the transaction, the triggers to effect such perfection shall include at least the following events:

(a)  severe deterioration in the seller credit quality standing;

(b)  insolvency of the seller; and

(c)  unremedied breaches of contractual obligations by the seller, including the seller’s default.

References

EBA Guidelines
Background and rationale para. 20
Guidelines para. 13-14
Q&A 4

The Article 20(5) minimum perfection triggers will concentrate minds on STS deals, especially legacy deals which parties wish to elevate to STS status, where Article 43(3) requires parties who would like to have them badged "STS" to make do with the wording they inherit.  The phrase seems reasonably wide in scope. 

art 20_5

Section 4 of the EBA Guidelines suggests that the documentation should identify "credit quality thresholds that are objectively observable and related to the financial health of the seller".  This replaces the reference in the draft guidelines to "credit quality thresholds generally used and recognised by market participants" to include a wider range than simply credit ratings, so long as they are objectively observable.

"Insolvency of the seller" should be straightforward, both for new and for legacy deals.

"Unremedied breaches of contractual obligations" is less straightforward.  Does it imply that even trivial breaches must lead to a perfection trigger being pulled?  Probably not: the word "unremedied" suggests that you could have a remedy period or routine before the trigger was pulled, and our understanding is that the ECB is not expecting this to change market practice.  So, whilst the wording requires these triggers to exist, it does not require them to be hair triggers, and does not preclude protections for the parties against the trigger being pulled in circumstances which would not warrant it commercially, so long as the trigger is not rendered altogether illusory.  Unhelpfully, paragraph 20 of the "Background and rationale" section of the EBA Guidelines refers to Article 20(5) as specifying "a minimum set of events subsequent to closing that should trigger the perfection of the transfer of the underlying exposures", and "should" is less forgiving than a word such as "could", and the Guidelines themselves are silent after this.

Article 43(3)(a) requires the Article 20(5) requirements to have been met at the time of issuance of the securities, and not merely at the time the STS notification is given.  Where Article 43(3)(a) applies, there is no scope for amending the terms of a legacy issue to bring it within the STS regime.


6.  The seller shall provide representations and warranties that, to the best of its knowledge, the underlying exposures included in the securitisation are not encumbered or otherwise in a condition that can be foreseen to adversely affect the enforceability of the true sale or assignment or transfer with the same legal effect.

References

EBA Guidelines
Background and rationale para. 21
Q&A 5

 The required seller warranty is that “to the best of its knowledge” the condition of the assets cannot be foreseen adversely to affect the enforceability of the sale. Article 20(6) does not simply refer to bans on assignment in the underlying debt documentation, but, those aside, it is not obvious how the “condition” of a loan asset could affect the enforceability of its sale.  The EBA Guidelines add nothing to this.  An obvious concern is how the representations and warranties could be provided when there is no direct relationship between the seller and the original lender, and especially for NPLs acquired from insolvency officials or a resolution authority but, in any case, the warranty is "best of knowledge" and not absolute.  "Best of knowledge" is an uncertain standard - whose knowledge is to be attributed to the seller? - but it should usually be clear enough what the seller knows, and the ambit of the represetnation is narrow.


7.  The underlying exposures transferred from, or assigned by, the seller to the SSPE shall meet predetermined, clear and documented eligibility criteria which do not allow for active portfolio management of those exposures on a discretionary basis. For the purpose of this paragraph, substitution of exposures that are in breach of representations and warranties shall not be considered active portfolio management. Exposures transferred to the SSPE after the closing of the transaction shall meet the eligibility criteria applied to the initial underlying exposures.

EBA Guidelines
Background and rationale para. 23-26
Guidelines para. 15-19
Q&A 6-7

8.  The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the specific characteristics relating to the cash flows of the asset type including their contractual, credit-risk and prepayment characteristics. A pool of underlying exposures shall comprise only one asset type. The underlying exposures shall contain obligations that are contractually binding and enforceable, with full recourse to debtors and, where applicable, guarantors.

The underlying exposures shall have defined periodic payment streams, the instalments of which may differ in their amounts, relating to rental, principal, or interest payments, or to any other right to receive income from assets supporting such payments. The underlying exposures may also generate proceeds from the sale of any financed or leased assets.

The underlying exposures shall not include transferable securities, as defined in point [EU version:  (44) of Article 4(1) of Directive 2014/65/EU [MiFID II]] [UK version:  (24) of Article 2(1) of Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 [EMIR]], other than corporate bonds that are not listed on a trading venue.

EBA Guidelines
Background and rationale para. 27-30
Guidelines para. 20-21
Q&A 8-9

The homogeneity requirements (in Article 20(8) for term STS and Article 24(15) for ABCP STS) are easier to state than to define with certainty.  The 31st July 2018 revised draft RTS were a great improvement on the original draft RTS and gave participants guidance beyond the "you know it when you see it" position from which many of them will have started.  The enacted 28th May 2019 homogeneity RTS (Commission Delegated Regulation (EU) 2019/1851) have further changes to the recitals (which have been largely rewritten and reduced in number), and Article 1 has been reworked with a view to greater clarity.  To some extent the RTS have reverted to "you know it if you see it", in a way that may provide some reassurance that it is not intending to change market practice. These have been supplemented by the 12th December 2018 EBA guidelines.  All this shows the difficulty in trying to pin down this slippery concept, and in steering a course between making the test neither too easy to satisfy nor too difficult.

History

The development of the homogeneity concept can been seen by reading various papers put out starting in 2014, and then the various iterations of the Securitisation Regulation itself:

and some guidance on interpretation can perhaps be found by considering how the homogeneity concept developed over this period.   A full review of all these is available here.

Level one text

The starting point for term STS is Article 20(8):

"8.  The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the specific characteristics relating to the cash flows of the asset type including their contractual, credit-risk and prepayment characteristics. A pool of underlying exposures shall comprise only one asset type. The underlying exposures shall contain obligations that are contractually binding and enforceable, with full recourse to debtors and, where applicable, guarantors.
The underlying exposures shall have defined periodic payment streams, the instalments of which may differ in their amounts, relating to rental, principal, or interest payments, or to any other right to receive income from assets supporting such payments. The underlying exposures may also generate proceeds from the sale of any financed or leased assets.
The underlying exposures shall not include transferable securities, as defined in point (44) of Article 4(1) of Directive 2014/65/EU, other than corporate bonds that are not listed on a trading venue."

Article 24(15) for ABCP contains principles which are similar to the first paragraph of Article 20(8) but there is additional detail reflecting the particular rules for ABCP, and in what follows we concentrate on term STS.

Recital (27) explains that the rationale for the homogeneity requirement is to "ensure that investors perform robust due diligence and to facilitate the assessment of underlying risks".  For this reason, securitisation transactions should be "backed by pools of exposures that are homogenous in asset type", and it gives four categories by way of example:

  • residential loans
  • corporate loans, business property loans, leases and credit facilities to undertakings of the same category
  • auto loans and leases
  • credit facilities to individuals for personal, family or household consumption purposes.

It forbids pools which include transferable securities, apart from unlisted bonds issued by non-financial corporations to credit institutions in markets where such bonds are common practice in place of loan agreements, e.g. pfandbriefe.

So a pool may only contain one "asset type", and illustrations of "types" are provided in Recital (27).

But just having the same asset type in the pool is not enough by itself to make the pool homogeneous. The pool assets (of the same asset type) must, taking the wording of Article 20(8), be homogeneous "taking into account the characteristics relating to the cash flows… including their contractual, credit risk and prepayment characteristics".   The cash flow characteristics will include interest payments, the likely incidence of prepayments and whether an asset amortises fully, partly or not at all.

Level two text - the homogeneity RTS

Article 20(8) does not explicitly refer to the rationale from EBA 2015 and Basel 2016 - that investors should not need to analyse and assess materially different credit risk factors and risk profiles when carrying out risk analysis and due diligence checks.  The RTS however do in Recital (3), which explains that since underwriting standards are designed to measure and assess credit risk, exposures sharing similar underwriting standards can be taken to have similar risk profiles and therefore be regarded as homogeneous, whereas dissimilar underwriting standards may result in exposures with "materially different risk profiles", even if the standards are all high quality.

The original draft RTS had clearly struggled trying to define homogeneity, and in its feedback on the public consultation exercise the EBA admitted as much. Whilst there was "strong support" for determining homogeneity by reference to the similarity of the underwriting and servicing standards and the adherence to a single asset category, it noted that:

"A substantial number of respondents have raised concerns with the homogeneity factor requirement… and with respect to the perceived lack of clear guidance on how the homogeneity factor requirement should apply in practice, and how their relevance should be determined for a specific securitisation. Overall, it was noted that the current proposal would have severe negative consequences on the market, would produce excessively concentrated pools, would not allow to recognise the existing well-established securitisations as homogeneous, and would penalise smaller entities that would face difficulties with generating critical portfolio mass".

The EBA's response was to try to be clearer, renaming the former ‘risk factor’ as ‘homogeneity factor’ to avoid misconceptions that the homogeneity is about assessment of the credit risk of the individual exposures in the pool, and reducing the number of the homogeneity factors.  In the 28th May 2019 homogeneity RTS it went further, emphasising the central roles of:

  • similar underwriting standards
  • similar servicing procedures, systems and governance

Recital (2) explains that market practice has already identified well established asset types to determine the homogeneity of a given pool of underlying exposures, and stressing that there was no desire to limit either financial innovation nor existing market practice, so that asset pools that do not correspond to a well-established type should also be allowed "on the basis of the internal methodologies and parameters consistently applied by the originator or sponsor", and Recital (4) identified how sensitive cash flow projections and assumptions about payment and default characteristics were to servicing procedures.

So long as the underwriting and servicing standards are similar, consumer credit assets and trade receivables are sufficiently homogeneous without the need for any further examination - to do otherwise would lead to excessive concentrations.  For other asset types, it was necessary to go further and apply "one or more relevant factors on a case-by-case basis" (Recital (5)).

Article 1 of the RTS accordingly goes on to state that the STS homogeneity requirement will be met if four conditions are met:

  • the assets fall into a single defined "asset type" - broadly speaking, residential mortgage loans, commercial mortgage loans, consumer credit, corporate credit, auto loans and leases, credit cards, trade receivables, or - tracking Recital (2), a group of exposures considered by the originator or the sponsor "to constitute a distinct asset type on the basis of internal methodologies and parameters"
  • similar underwriting standards
  • similar servicing procedures
  • except for consumer credit assets and trade receivables, at least one "homogeneity factor" applies the assets in the pool.

The homogeneity factors vary according to the assets in question and can be summarised by reference to the following table (based on Article 2 of the RTS):

homog table

A related point arises under the RTS/ITS on STS Notification produced by ESMA under Article 27 of the Securitisation Regulation.  Field STSS27 requires the notification to provide:

"a detailed explanation as to the homogeneity of the pool of underlying exposures backing the securitisation.  For that purpose the originator and sponsor shall refer to the EBA RTS on homogeneity (Commission Delegated Regulation (EU) […], and shall explain in detail how each of the conditions specified in the Article 1 of the RTS are met."

There is no need to justify the choice of homogeneity factor.  Examples of how field STSS27 is being completed in practice can be found on the ESMA list of STS notifications.

The emphasis on underwriting standards leads to the conclusion that buy-to-let and owner-occupier credits could not form a homogeneous pool, because the origination criteria would have been different.  However, a loan which was originated as an owner-occupier loan but which subsequently became a BTL loan should be able to form part of the same pool as other owner-occupier loans because they have all been (and assuming that they were in fact) originated according to the underwriting standards.  There had been a proposal (made after the original homogeneity RTS were issued) to allow 5% non-homogeneity to cover anomalies like this, but the EBA rejected this because the much-revised second draft homogeneity RTS (see its answer in the RTS to question 14) amended Article 1(a) and Recitals 4 and 5 in order to clarify that the intention of the requirement was that underwriting standards should apply similar approaches to the assessment of the credit risk, and was not to ensure the uniformity of the underwriting standards, methods and criteria.

Multi-jurisdictional pools

The original draft RTS wording was far from clear regarding the position of multi-jurisdictional pools.  Suppose assets in a pool arose in two different legal systems where the legal processes produced identical results for creditors.  Would their risk profiles be the same or different?  Should sponsors assume that creditors would examine the laws in detail, or would their analysis simply involve a consideration of the likely recovery for creditors in each jurisdiction, and whether the jurisdiction was creditor friendly and quick, or debtor friendly and slow?  Should the focus be on similarity of outcome, regardless of the legal detail?  Fortunately, this has been clarified, and in cases - such as RMBS pools or auto loans and leases - where jurisdiction is a potential differentiator, it is now clear that multi-jurisdictional pools are fine so long as the pool can be demonstrated to be sufficiently homogeneous by reference to one of the other available homogeneity factors; which on the face of it provides plenty of latitude for sponsors and originators assembling pools of assets.

It might be noted that the EBA explicitly rejected calls to replace references to "jurisdiction" with references to "nationality" or "set of jurisdictions" to clarify that England, Scotland and Northern Ireland were one and the same.

Level three text - the EBA guidelines

Paragraph 4.3 of the EBA guidelines provide a small degree of clarification about what "contractually binding and enforceable obligations" means - it refers to "all obligations contained in the contractual specification of the underlying exposures that are relevant to investors because they affect any obligations by the debtor and, where applicable, the guarantor, to make payments or provide security", and examples of exposure types that should be considered to have "defined periodic payment streams" - these include bullet repayments, any credit card exposures, interest-only mortgages, repayment loans, loans where (within the limits of what is permitted by Article 20(13)) repayment is dependent on the sale of an underlying asset, and exposures where temporary payment holidays have been agreed; guidance which is usefully accommodating.

For regulated EU banks which securitise receivables with a view to them being eligible collateral for the ECB, the assets must meet the similar but separate homogeneity requirements provided for in Article 73 of the 19th December 2014 ECB Guidelines (ECB/2014/60) on the implementation of the Eurosystem monetary policy framework.  Article 73 requires all assets backing eligible ABS to be homogenous by reference to one of 8 categories:  (a) residential mortgages; (b) commercial real estate mortgages; (c) loans to small and medium-sized enterprises (SMEs); (d) auto loans; (e) consumer finance loans; (f) leasing receivables; and (g) credit card receivables.

RTS on homogeneity


9.  The underlying exposures shall not include any securitisation position.

References

EBA Guidelines
Background and rationale para. 31-32

Resecuritisations are forbidden (Article 20(9) and 24(8)) from meeting STS standards, and even non-STS resecuritisations are only permitted where:

  • they are done for “legitimate purposes”, typically in context of a winding up or resolution or
  • the deal was done before effective date of the Securitisation Regulation;

and there are further provisions regarding permissible non-STS ABCP programmes.

The wording used in all three places in the Securitisation Regulation is odd - a securitisation's exposures "shall not include securitisation positions".  Does this forbid EU investors buying resecuritisations, or does it just forbid EU sponsors and issuers from issuing resecuritisation paper?  EU investors will presumably be cautious.

The prohibition is by reference to "securitisation" - which as defined requires there to be contractually-established tranching of debt. Query whether parties may be tempted to structure around this.

Paragraph 31 of the EBA Guidelines refers darkly to pre-2009 days when resecuritisations were structured in a highly leveraged way, with a small change in the credit performance of the underlying assets having a severe impact on the credit quality of the bonds.  The EBA considered that this made the modelling of the credit risk very difficult.  It would certainly have required more time and analysis than the average buy-side professional would have had, making reliance on the rating all the more tempting.


10.  The underlying exposures shall be originated in the ordinary course of the originator’s or original lender’s business pursuant to underwriting standards that are no less stringent than those that the originator or original lender applied at the time of origination to similar exposures that are not securitised. The underwriting standards pursuant to which the underlying exposures are originated and any material changes from prior underwriting standards shall be fully disclosed to potential investors without undue delay.

In the case of securitisations where the underlying exposures are residential loans, the pool of loans shall not include any loan that was marketed and underwritten on the premise that the loan applicant or, where applicable, intermediaries were made aware that the information provided might not be verified by the lender.

The assessment of the borrower’s creditworthiness shall meet the requirements set out in Article 8 of Directive 2008/48/EC or paragraphs 1 to 4, point (a) of paragraph 5, and paragraph 6 of Article 18 of 2014/17/EU [Mortgage Credits Directive] or, where applicable, equivalent requirements in third countries.

The originator or original lender shall have expertise in originating exposures of a similar nature to those securitised.


11.  The underlying exposures shall be transferred to the SSPE after selection without undue delay and shall not include, at the time of selection, exposures in default within the meaning of Article 178(1) of Regulation (EU) No 575/2013 [CRR] or exposures to a credit-impaired debtor or guarantor, who, to the best of the originator’s or original lender’s knowledge:

(a)  has been declared insolvent or had a court grant his creditors a final non-appealable right of enforcement or material damages as a result of a missed payment within three years prior to the date of origination or has undergone a debt-restructuring process with regard to his non-performing exposures within three years prior to the date of transfer or assignment of the underlying exposures to the SSPE, except if:

(i)  a restructured underlying exposure has not presented new arrears since the date of the restructuring, which must have taken place at least one year prior to the date of transfer or assignment of the underlying exposures to the SSPE; and

(ii)  the information provided by the originator, sponsor and SSPE in accordance with points (a) and (e)(i) of the first subparagraph of Article 7(1) explicitly sets out the proportion of restructured underlying exposures, the time and details of the restructuring as well as their performance since the date of the restructuring;

(b)  was, at the time of origination, where applicable, on a public credit registry of persons with adverse credit history or, where there is no such public credit registry, another credit registry that is available to the originator or original lender; or

(c)  has a credit assessment or a credit score indicating that the risk of contractually agreed payments not being made is significantly higher than for comparable exposures held by the originator which are not securitised.

EBA Guidelines
Background and rationale para. 39-40
Guidelines para. 37-45
Q&A 13-15

12.  The debtors shall, at the time of transfer of the exposures, have made at least one payment, except in the case of revolving securitisations backed by exposures payable in a single instalment or having a maturity of less than one year, including without limitation monthly payments on revolving credits.

References

EBA Guidelines
Background and rationale para. 41-42
Guidelines para. 46-47
Q&A 16

13.  The repayment of the holders of the securitisation positions shall not have been structured to depend predominantly on the sale of assets securing the underlying exposures. This shall not prevent such assets from being subsequently rolled-over or refinanced.

The repayment of the holders of the securitisation positions whose underlying exposures are secured by assets the value of which is guaranteed or fully mitigated by a repurchase obligation by the seller of the assets securing the underlying exposures or by another third party shall not be considered to depend on the sale of assets securing those underlying exposures.

EBA Guidelines
Background and rationale para. 43-46
Guidelines para. 48-50

As the EBA Report explained, to mitigate refinancing risk and the extent to which the securitisation embeds maturity transformation, the exposures to be securitised should be largely self-liquidating. Reliance on refinancing and/or asset liquidation increases the liquidity and market risks to which the securitisation is exposed and makes the credit risk of the securitisation more difficult to model and assess from an investor’s perspective, and so creates model risk.

The EBA envisaged, following the Basel Committee almost to the letter, that partial reliance on refinancing or resale of the assets securing the exposure would be permissible so long as that re-financing was sufficiently distributed within the pool and the residual values on which the transaction relies were sufficiently low, such that reliance on refinancing would not be substantial, and the position in the Securitisation Regulation seems to be essentially the same or perhaps even a little more liberal:

  • Article 20(8) states that:

“underlying exposures may also generate proceeds from the sale of any financed or leased assets”

(and Article 24(15) has the same regarding ABCP)

  • Article 20(13) states that:

“repayment of the holders of the securitisation positions shall not have been structured to depend predominately on the sale of assets securing the underlying exposures. This shall not prevent such assets from being subsequently rolled-over or refinanced. The repayment of the holders of a securitisation position whose underlying exposures are secured by assets the value of which is guaranteed or fully mitigated by a repurchase obligation by the seller of the assets securing the underlying exposures or by another third party shall not be considered to depend on the sale of assets securing those underlying exposures”

(and Article 24(11) has the same statement). 

To take the example of car loans, where it is not uncommon for a new car to be taken by the buyer on a relatively short lease – 3 years perhaps – under which the PV of the rentals is much less than the cost of the car, leaving residual value risk with the lessor, if those assets were transferred to an issuer together with title to the vehicles, the structure could not qualify as STS under the first paragraph in Article 20(13), because the debt is supporting the RV as well as the committed rentals.  Hence the second paragraph, which allows structures - common in Germany - where the RV is underwritten by the manufacturer or its finance company.  The EBA Guidelines have more to say on this (see below).

So, Article 20 is intended to prevent holders taking any significant residual value risk or market risk on asset values, and the focus is on how the deal is structured (Article 20(13)) rather than what actually happens in practice (Article 20(8)).

Paragraphs 43-46 of the EBA Guidelines elaborate on this, particularly that to assess "predominant dependence", three aspects should be taken into account:

(i) the principal balance of the underlying exposures that depend on the sale of assets securing those underlying exposures to repay the balance;

(ii) the distribution of maturities of those exposures across the life of the transaction (a broad distribution will reduce the risk of correlated defaults due to idiosyncratic shocks); and

(iii) how granular the asset pool is.

The Guidelines say that no types of assets will automatically fail this test, but "it is expected" that CMBS, and securitisations where the assets are commodities (e.g. oil, grain, gold), or bonds with maturity dates falling after the maturity date of the securitisation, would not meet these requirements, because then (a) the repayment would be predominantly reliant on the sale of the assets, (b) other possible ways to repay the securitisation positions would be substantially limited, and (c) the granularity of the portfolio would be low.

The second subparagraph of Article 20(13) expressly permits cases where repayment does depend on a sale of the assets but the value "is guaranteed or fully mitigated by a repurchase obligation by the seller".  This is an EU addition, not to be found in Basel, and inserted to permit STS securitisations of German auto loans and leases, where this structure is common.    The Guidelines say that that the guarantor or repurchase entity must not be "an empty-shell or defaulted entity, so that it has sufficient loss absorbency to exercise the guarantee of the repurchase of the assets"; presumably to be tested at the time of the STS notification rather than any later date.  A full put-back or guarantee clearly falls within this but the position of partial or limited guarantees remains uncertain, beyond the general principles to be found in Recital (29) that note how "strong reliance... on the sale of assets securing the underlying assets creates vulnerabilities", singling out CMBS here, and Paragraphs 43-46 of the Guidelines.

For regulated EU banks which securitise lease receivables with a view to them being eligible collateral for the ECB, residual value cannot be included in the securitisation.  Article 73 of the 19th December 2014 ECB Guidelines (ECB/2014/60) on the implementation of the Eurosystem monetary policy framework requires all assets backing eligible ABS to be homogenous by reference to one of 8 categories, one of which is "leasing receivables", which is defined in Article 2 as "the scheduled and contractually mandated payments by the lessee to the lessor under the terms of a lease agreement", and the definition concludes starkly: "Residual values are not leasing receivables". 

CMBS remains excluded from STS despite industry appeals for its rehabilitation on the basis that, although the post-crisis issues showed clear shortcomings in relation to direct real estate finance, European CMBS did not suffer from them. Typically, loans were bifurcated, with only the senior slice being securitised, and the argument is that logically it should be preferable for risk-averse REF investors to be able to buy the highest-rated bonds issued by a CMBS issuer rather than having to seek exposure via direct lending.

However, the Commission was not persuaded. Following the line taken by Basel/IOSCO, it considered CMBS inappropriate for STS status because it entailed too much refinancing risk, and this sentiment is reflected in Recital 29, reflecting similar provisions in the BCBS criteria for STC securitisation.

As such, Article 20(13) applies.  This expressly excludes structures where repayment of the bonds or notes depends predominately on the sale of the underlying assets (as does Recital 29). It does not refer to their refinancing, and in theory a deal could perhaps be structured so that the SPV and its directors would go down a refinancing route ahead of bond maturity, but this would be directly contrary to what Recital (29) says in black and white, and so would be more than a little bold, and Paragraphs 43-46 of the EBA Guidelines, which elaborate on this, say that "it is expected" that CMBS would not meet these requirements.

And for bank investors, CMBS are highly unlikely to qualify as STS for capital treatment purposes because they lack the necessary granularity: in the CRR Amendment Regulation, the new CRR Article 243(2) requirement that no single exposure exceeds 2% (the test being done at the loan level rather than, as commercial logic might suggest, looking at diversification at the rental payment level and the creditworthiness of the underlying tenants).  For example, a CMBS of a shopping centre might involve a handful of anchor tenants and dozens of individual tennts; a more extreme example would be a CMBS where the underlying loan is to a landlord providing private or social housing to several thousands of seprate tenants.


14.  The [EU version:  EBA, in close cooperation with ESMA and EIOPA, shall develop draft regulatory] [UK version: FCA may make] technical standards further specifying which underlying exposures referred to in paragraph 8 are deemed to be homogeneous.

[EU version only: 

The EBA shall submit those draft regulatory technical standards to the Commission by 18 July 2018.]

[EU version only: 

The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.]

Article 21

Requirements relating to standardisation

1.  The originator, sponsor or original lender shall satisfy the risk-retention requirement in accordance with Article 6.

References

EBA Guidelines
Background and rationale para. 47-48

2.  The interest-rate and currency risks arising from the securitisation shall be appropriately mitigated and any measures taken to that effect shall be disclosed. Except for the purpose of hedging interest-rate or currency risk, the SSPE shall not enter into derivative contracts and shall ensure that the pool of underlying exposures does not include derivatives. Those derivatives shall be underwritten and documented according to common standards in international finance.

References

EBA Guidelines
Background and rationale para. 49-52
Guidelines para. 51-56
Q&A 19

3.  Any referenced interest payments under the securitisation assets and liabilities shall be based on generally used market interest rates, or generally used sectoral rates reflective of the cost of funds, and shall not reference complex formulae or derivatives.

References

EBA Guidelines
Background and rationale para. 53-54
Guidelines para. 57-58
Q&A 20

Any referenced interest payments for either the assets or liabilities of an STS securitisation must be based on “generally used market interest rates or generally used sectoral rates reflective of the cost of funds".

This latter wording was intended to allay concerns that mortgage loans based on banks' standard variable rates might otherwise be excluded, but it arguably missed the mark because of the phrase "generally used".  The Basel/IOSCO November 2015 paper addressed this but there are important differences.  Basel/IOSCO explains that examples of “commonly encountered market interest rates” would include "sectoral rates reflective of a lender’s cost of funds, such as internal interest rates that directly reflect the market costs of a bank’s funding or that of a subset of institutions”.  The Securitisation Regulation however only permits "generally used" sectoral rates.  The Basel/IOSCO wording made it clear that mortgage loans based on banks' standard variable rates were included.  However, the standard variable rate for one lender is only used for its products, not by others in the market, and so there is an unhelpful doubt that one lender’s rate is therefore not a “generally used” rate, and that “generally used” might mean only, say, minimum lending rate or base rate of a central bank.  This looks like a drafting error, and paragraph 57 of the EBA Guidelines does its best to rescue matters by explicitly permitting not only usual market benchmarks such as LIBOR and EURIBOR, and official central bank and monetary authority rates, but also:

"(c) sectoral rates reflective of a lender’s cost of funds, including standard variable rates and internal interest rates that directly reflect the market costs of funding of a bank or a subset of institutions, to the extent that sufficient data are provided to investors to allow them to assess the relation of the sectoral rates to other market rates."

4.  Where an enforcement or an acceleration notice has been delivered:

(a)  no amount of cash shall be trapped in the SSPE beyond what is necessary to ensure the operational functioning of the SSPE or the orderly repayment of investors in accordance with the contractual terms of the securitisation, unless exceptional circumstances require that an amount be trapped to be used, in the best interests of investors, for expenses in order to avoid the deterioration in the credit quality of the underlying exposures;

(b)  principal receipts from the underlying exposures shall be passed to investors via sequential amortisation of the securitisation positions, as determined by the seniority of the securitisation position;

(c)  repayment of the securitisation positions shall not be reversed with regard to their seniority; and

(d)  no provisions shall require automatic liquidation of the underlying exposures at market value.

References

EBA Guidelines
Background and rationale para. 55-58
Guidelines para. 59-65
Q&A 21

5.  Transactions which feature non-sequential priority of payments shall include triggers relating to the performance of the underlying exposures resulting in the priority of payments reverting to sequential payments in order of seniority. Such performance-related triggers shall include at least the deterioration in the credit quality of the underlying exposures below a predetermined threshold.

References

EBA Guidelines
Background and rationale para. 59-60
Guidelines para. 66
Q&A 22

6.  The transaction documentation shall include appropriate early amortisation provisions or triggers for termination of the revolving period where the securitisation is a revolving securitisation, including at least the following:

(a)  a deterioration in the credit quality of the underlying exposures to or below a predetermined threshold;

(b)  the occurrence of an insolvency-related event with regard to the originator or the servicer;

(c)  the value of the underlying exposures held by the SSPE falls below a predetermined threshold (early amortisation event); and

(d)  a failure to generate sufficient new underlying exposures that meet the predetermined credit quality (trigger for termination of the revolving period).

References

EBA Guidelines
Background and rationale para. 61-62
Guidelines para. 67
Q&A 23

7.  The transaction documentation shall clearly specify:

(a)  the contractual obligations, duties and responsibilities of the servicer and the trustee, if any, and other ancillary service providers;

(b)  the processes and responsibilities necessary to ensure that a default by or an insolvency of the servicer does not result in a termination of servicing, such as a contractual provision which enables the replacement of the servicer in such cases; and

(c)  provisions that ensure the replacement of derivative counterparties, liquidity providers and the account bank in the case of their default, insolvency, and other specified events, where applicable.

EBA Guidelines
Background and rationale para. 63-64
Q&A 24

8.  The servicer shall have expertise in servicing exposures of a similar nature to those securitised and shall have well-documented and adequate policies, procedures and risk-management controls relating to the servicing of exposures.

References

EBA Guidelines
Background and rationale para. 65-67
Guidelines para. 68-72
Q&A 25-26

9.  The transaction documentation shall set out in clear and consistent terms definitions, remedies and actions relating to delinquency and default of debtors, debt restructuring, debt forgiveness, forbearance, payment holidays, losses, charge offs, recoveries and other asset performance remedies. The transaction documentation shall clearly specify the priorities of payment, events which trigger changes in such priorities of payment as well as the obligation to report such events. Any change in the priorities of payments which will materially adversely affect the repayment of the securitisation position shall be reported to investors without undue delay.

EBA Guidelines
Background and rationale para. 70-71
Guidelines para. 73
Q&A 27

10.  The transaction documentation shall include clear provisions that facilitate the timely resolution of conflicts between different classes of investors, voting rights shall be clearly defined and allocated to bondholders and the responsibilities of the trustee and other entities with fiduciary duties to investors shall be clearly identified.

References

EBA Guidelines
Background and rationale para. 70-71
Guidelines para. 74
Q&A 28
Article 22

Requirements relating to transparency

1.  The originator and the sponsor shall make available data on static and dynamic historical default and loss performance, such as delinquency and default data, for substantially similar exposures to those being securitised, and the sources of those data and the basis for claiming similarity, to potential investors before pricing. Those data shall cover a period of at least five years.

References

EBA Guidelines
Background and rationale para. 72-73
Guidelines para. 75-77
Q&A 29

2.  A sample of the underlying exposures shall be subject to external verification prior to issuance of the securities resulting from the securitisation by an appropriate and independent party, including verification that the data disclosed in respect of the underlying exposures is accurate.

References

EBA Guidelines
Background and rationale para. 74-75
Guidelines para. 78-81
Q&A 30

3.  The originator or the sponsor shall, before the pricing of the securitisation, make available to potential investors a liability cash flow model which precisely represents the contractual relationship between the underlying exposures and the payments flowing between the originator, sponsor, investors, other third parties and the SSPE, and shall, after pricing, make that model available to investors on an ongoing basis and to potential investors upon request.

References

EBA Guidelines
Background and rationale para. 76-77
Guidelines para. 82-83
Q&A 31

4.  In the case of a securitisation where the underlying exposures are residential loans or auto loans or leases, the originator and sponsor shall publish the available information related to the environmental performance of the assets financed by such residential loans or auto loans or leases, as part of the information disclosed pursuant to point (a) of the first subparagraph of Article 7(1).

[EU version onlyBy way of derogation from the first subparagraph, originators may, from 1 June 2021, decide to publish the available information related to the principal adverse impacts of the assets financed by underlying exposures on sustainability factors.]

EBA Guidelines
Background and rationale para. 78-79
Guidelines para. 84
Q&A 32-33

The original Securitisation Regulation had a difficult legislative passage, with some Green/Left factions of the European Parliament seemingly suspicious if not hostile to the very idea of this financial technique, whilst being keen to promote their political preferences for "environmental" issues.  These were largely kept at bay, save for two concessions which were offered as a quid pro quo for their giving up some of their more contentious positions, such as relating to risk retention:

  • Article 22(4), which requires "available information related to the environmental performance" of the houses financed by an STS RMBS or the cars financed by an STS of auto loans and leases to be disclosed to investors quarterly (it only applies to term STS, not ABCP).  The provision has no relationship of course with the "standardisation" pillar of STS or STC, nor the rational interests of prudent investment, but was a necessary expedient.  The EBA Guidelines paragraph 84 require this only if the information on the energy performance certificates for the assets financed by the underlying exposures is available to the originator, sponsor or the SSPE and captured in its internal database or IT systems, and of course it is unlikely that it will be;
  • Article 46(f), which expressly requires the European Commission review under Article 46 (due within the first three years) to review the working of Article 22(4), on the face of it to consider whether the disclosure should be extended to other asset classes.  

Some of the same MEPs represented the Parliament in its examination of the EC's 2020 draft "quick fix" amendments in response to coronavirus, and their efforts have led to more ESG-related positions being conceded for the purpose of getting the EC's package of measures to help with synthetic and NPL securitisations over the line:

  • Article 22(4)  (Requirements relating to transparency) is to be amended to permit (but not require) originators to publish available information related to the "principal adverse impacts on sustainability factors" of the assets financed by the underlying exposures
  • within 3 months after entry into force of the quick fix amendment, the ESAs must develop draft RTS on the content, methodologies and presentation of these principal adverse impacts
  • a new Article 45a - "Development of a sustainable securitisation framework" - will require the EBA to produce a report on developing a specific sustainable securitisation framework for the purpose of integrating sustainability-related transparency requirements into the Securitisation Regulation.  This is required by 1st November 2021.

The UK market will be relieved that, although Article 22(4) in its present form does form part of the onshored UKSR, these new proposals do not.

 

 

5.  The originator and the sponsor shall be responsible for compliance with Article 7. The information required by point (a) of the first subparagraph of Article 7(1) shall be made available to potential investors before pricing upon request. The information required by points (b) to (d) of the first subparagraph of Article 7(1) shall be made available before pricing at least in draft or initial form. The final documentation shall be made available to investors at the latest 15 days after closing of the transaction.

[EU version only6.   By 10 July 2021, the ESAs shall develop, through the Joint Committee of the European Supervisory Authorities, draft regulatory technical standards in accordance with Articles 10 to 14 of Regulations (EU) No 1093/2010, (EU) No 1094/2010 and (EU) No 1095/2010 on the content, methodologies and presentation of information referred to in the second subparagraph of paragraph 4 of this Article, in respect of the sustainability indicators in relation to adverse impacts on the climate and other environmental, social and governance-related adverse impacts.

Where relevant, the draft regulatory technical standards referred to in the first subparagraph shall mirror or draw upon the regulatory technical standards developed pursuant to the mandate given to the ESAs in Regulation (EU) 2019/2088 [Sustainable Finance Disclosure Regulation], in particular in Article 2a and Article 4(6) and (7) thereof.

The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulations (EU) No 1093/2010, (EU) No 1094/2010 and (EU) No 1095/2010.]

References

EBA Guidelines
Background and rationale para. 80-81
Q&A 34
Article 23

Section 2

Requirements for simple, transparent and standardised ABCP securitisation

Simple, transparent and standardised ABCP securitisation

1.  An ABCP transaction shall be considered STS where it complies with the transaction-level requirements provided for in Article 24.

2.  An ABCP programme shall be considered STS where it complies with the requirements provided for in Article 26 and the sponsor of the ABCP programme complies with the requirements provided for in Article 25.

For the purpose of this Section, a ‘seller’ means ‘originator’ or ‘original lender’.

[EU version only:  3.  By 18 October 2018, the EBA, in close cooperation with ESMA and EIOPA, shall adopt, in accordance with Article 16 of Regulation (EU) No 1093/2010, guidelines and recommendations on the harmonised interpretation and application of the requirements set out in Articles 24 and 26 of this Regulation.]

Article 24

Transaction-level requirements

1.  The title to the underlying exposures shall be acquired by the SSPE by means of a true sale or assignment or transfer with the same legal effect in a manner that is enforceable against the seller or any other third party. The transfer of the title to the SSPE shall not be subject to severe clawback provisions in the event of the seller’s insolvency.

Articles 20 and 24 do not allow deals to qualify as STS if the asset sale is subject to "severe clawback".  Article 20(2) and (3) for term STS, and Article 24(2) and (3) for ABCP STS, explain that this includes a simple liquidator's power to invalidate a sale within a certain period regardless of the circumstances, but they make it clear that laws on fraudulent transfers (actio Pauliana), unfair prejudice and unfair preference are permitted.  The intent seems clearly not to overturn market expectations or undermine prevailing practices.  The EBA Guidelines envisage one or more legal opinions being obtained in respect of the insolvency aspects relating to a transfer, which is normal practice in any event.

It may be noted that the European Commission’s November 2016 proposal for a European Insolvency Directive explicitly ducked the possibility of harmonising clawback provisions, because although this would be useful for achieving cross-border certainty, “the current diversity in Member States' legal systems over insolvency proceedings seems too large to bridge”.

Introduction

The EU STS regime for synthetics is a world first:  there is no provision at the Basel/IOSCO level for preferential capital treatment for an STC-qualifying synthetic product.  The 24th July 2020 proposal from the European Commission to enact an STS regime for balance sheet synthetic securitisations by amending the Securitisation Regulation and the CRR (but not, initially at least, Solvency II)  was explicitly in response to the “urgency” of the need to take measures to help the economy recover from the COVID-19 pandemic.  It was broadly welcomed by those who saw it as a way of attracting new risk-takers into the market which would be prepared to take on risk (and be able to do the related due diligence) if the overall package was sufficiently standard, simple and transparent, but not otherwise; the current synthetic market is for the most part, central banks, supranational entities such as the EIB, pension and hedge funds, with monolines having long gone.  

The proposals were adopted in early April 2021 and are effective as from 9th April 2021.  They have been cautiously welcomed, even though they are not the totality of what the market has been asking for, but there are issues  regarding complexity and cost, and one of these issues - the change to Article 248 of the CRR concerning excess spread - applies across the board, not just to STS.  

The EC proposals

When the Securitisation Regulation was enacted, there had been only one, minor, concession to synthetics. Where an institution sold off a junior position in a pool of loans to SMEs via a synthetic structure, it could only apply to the retained position the lower capital requirements available for STS securitisations if the strict criteria set out in Article 270 of the CRR as amended were met, which included that the position was guaranteed by a central government, central bank, or a public sector “promotional entity”, or – but only if fully collateralised by cash on deposit with the originator – by an institution.  Otherwise, originators would have to allocate capital to the retained senior piece on the basis of the higher non-STS rules which, because of the regulatory non-neutrality baked into the regulatory capital requirement for securitisation (i.e. the sum total of capital allocated to all the various tranches of a securitisation will be more than the capital which would be required for a holding of the underlying assets) were, to say the least, discouraging.

Article 45 of the Securitisation Regulation required the EBA to report on the possibility of an STS regime for balance sheet synthetics by 2nd July 2019.  Its "Draft report on STS Framework for Synthetic Securitisation" emerged on 24th September 2019, the delay being due to unresolved differences of opinion among EU regulators about whether or not synthetics should be given any favourable capital treatment or not.  The EBA  considered to what extent buying STS protection should give the protection buyer preferential regulatory capital treatment as regards the portion of risk on the portfolio that it continues to hold (which, post-GFC, is usually the least risky portion, with the first loss risk being transferred to a protection seller).   The EBA envisaged qualifying protection coming from either 0% risk-weighted institutions under the CRR, such as the EIB or, if not, then from entities to which the protection buyer's recourse is fully collateralised in cash or risk-free securities.  It was equivocal about whether STS synthetic securitisations should provide favourable capital treatment for the originator credit institution or not.  Its final proposals for developing a STS framework for synthetic securitisation emerged on 5th May 2020, recommended setting up an STS framework but sat on the fence regarding the capital treatment, merely noting the pros and cons of the introduction of more risk-sensitive regulatory treatment of the STS synthetic product.  The EBA’s summary said:

"On the one hand, developments in the last few years have indicated the potential for the continuing growth of the synthetic sector and have confirmed the technical feasibility of the creation of a prudentially sound STS synthetic securitisation product that is comparable to the STS traditional securitisation product.  In addition, the available performance data do not provide any evidence that the performance of the synthetic securitisation instrument is worse than that of the traditional securitisation instrument.  The introduction of potentially limited and clearly defined differentiated regulatory treatment would match the historical performance of the synthetic securitisation, ensure better alignment with the STS traditional securitisation framework and help overcome the constraints of the current limited STS risk-weight treatment of some SME synthetic securitisations.  

On the other hand, there are limitations of the performance data on which the analysis is based, there is limited experience with the STS traditional framework so far, and the risk of potentially overusing synthetic securitisation, which would potentially lead to a large-scale replacement of regulatory capital by risk mitigation strategies, leading to overleveraging of banks, should be duly taken into account. In addition, the preferential regulatory treatment is not included in the international Basel standards.”

On 12th June 2020, the “High Level Forum on the Capital Markets Union” issued a 129-page “final report” on CMU, the recommendations of which included applying the same regulatory treatment to synthetics as to cash securitisations.  

The new regime for synthetic securitisation

Against this background, the "quick fix" amendments to the Securitisation Regulation have added a new series of articles (Article 26a et seq.) in “Section 2A” to introduce a new regime for synthetics which apply most of the same STS requirements as apply to cash securitisations, plus some others specific to synthetics e.g. requirements mitigating the counterparty credit risk on the protection seller, and the CRR amendments extend the treatment which Article 270 of the CRR had previously allowed to only a limited sub-set of synthetic securitisations.  Some aspects of the proposed regime entail additional cost and complexity over and above what the existing market is used to - for example, protection sellers (which the legislation insists on calling "investors") are required to have recourse to higher-quality collateral to secure repayment of their "investment" than is usual, and that of course comes at a cost.  Some detail has yet to be fleshed out in RTS – those will appear in H1 of 2021 - and there is scope for some level 3 clarification.  There seems to be a lot of devil in the detail and it remains to be seen how this will play out.  

The proposal was enacted after the Brexit transitional period ends, and does not form part of onshored UK law.  The UK had been opposed to the idea of an STS regime for synthetic securitisation, and it was only brought about as a result of Brexit.  It seems unlikely that the UK’s FCA will want to introduce a similar regime under the UKSR.  


2.  For the purpose of paragraph 1, any of the following shall constitute severe clawback provisions:

(a)  provisions which allow the liquidator of the seller to invalidate the sale of the underlying exposures solely on the basis that it was concluded within a certain period before the declaration of the seller’s insolvency;

(b)  provisions where the SSPE can only prevent the invalidation referred to in point (a) if it can prove that it was not aware of the insolvency of the seller at the time of sale.

3.  For the purpose of paragraph 1, clawback provisions in national insolvency laws that allow the liquidator or a court to invalidate the sale of underlying exposures in the case of fraudulent transfers, unfair prejudice to creditors or transfers intended to improperly favour particular creditors over others shall not constitute severe clawback provisions.

4.  Where the seller is not the original lender, the true sale or assignment or transfer with the same legal effect of the underlying exposures to the seller, whether that true sale or assignment or transfer with the same legal effect is direct or through one or more intermediate steps, shall meet the requirements set out in paragraphs 1 to 3.

5.  Where the transfer of the underlying exposures is performed by means of an assignment and perfected at a later stage than at the closing of the transaction, the triggers to effect such perfection shall include at least the following events:

(a)  severe deterioration in the seller credit quality standing;

(b)  insolvency of the seller; and

(c)  unremedied breaches of contractual obligations by the seller, including the seller’s default.

6.  The seller shall provide representations and warranties that, to the best of its knowledge, the underlying exposures included in the securitisation are not encumbered or otherwise in a condition that can be foreseen to adversely affect the enforceability of the true sale or assignment or transfer with the same legal effect.

7.  The underlying exposures transferred from, or assigned by, the seller to the SSPE shall meet predetermined, clear and documented eligibility criteria which do not allow for active portfolio management of those exposures on a discretionary basis. For the purpose of this paragraph, substitution of exposures that are in breach of representations and warranties shall not be considered active portfolio management. Exposures transferred to the SSPE after the closing of the transaction shall meet the eligibility criteria applied to the initial underlying exposures.

8.  The underlying exposures shall not include any securitisation position.

References

Resecuritisations are forbidden (Article 20(9) and 24(8)) from meeting STS standards, and even non-STS resecuritisations are only permitted where:

  • they are done for “legitimate purposes”, typically in context of a winding up or resolution or
  • the deal was done before effective date of the Securitisation Regulation;

and there are further provisions regarding permissible non-STS ABCP programmes.

The wording used in all three places in the Securitisation Regulation is odd - a securitisation's exposures "shall not include securitisation positions".  Does this forbid EU investors buying resecuritisations, or does it just forbid EU sponsors and issuers from issuing resecuritisation paper?  EU investors will presumably be cautious.

The prohibition is by reference to "securitisation" - which as defined requires there to be contractually-established tranching of debt. Query whether parties may be tempted to structure around this.

Paragraph 31 of the EBA Guidelines refers darkly to pre-2009 days when resecuritisations were structured in a highly leveraged way, with a small change in the credit performance of the underlying assets having a severe impact on the credit quality of the bonds.  The EBA considered that this made the modelling of the credit risk very difficult.  It would certainly have required more time and analysis than the average buy-side professional would have had, making reliance on the rating all the more tempting.


9.  The underlying exposures shall be transferred to the SSPE after selection without undue delay and shall not include, at the time of selection, exposures in default within the meaning of Article 178(1) of Regulation (EU) No 575/2013 [CRR] or exposures to a credit-impaired debtor or guarantor, who, to the best of the originator’s or original lender’s knowledge:

(a)  has been declared insolvent or had a court grant his creditors a final non-appealable right of enforcement or material damages as a result of a missed payment within three years prior to the date of origination or has undergone a debt restructuring process with regard to his non-performing exposures within three years prior to the date of transfer or assignment of the underlying exposures to the SSPE, except if:

(i)  a restructured underlying exposure has not presented new arrears since the date of the restructuring, which must have taken place at least one year prior to the date of transfer or assignment of the underlying exposures to the SSPE; and

(ii)  the information provided by the originator, sponsor and SSPE in accordance with points (a) and (e)(i) of the first subparagraph of Article 7(1) explicitly sets out the proportion of restructured underlying exposures, the time and details of the restructuring as well as their performance since the date of the restructuring;

(b)  was, at the time of origination, where applicable, on a public credit registry of persons with adverse credit history or, where there is no such public credit registry, another credit registry that is available to the originator or original lender; or

(c)  has a credit assessment or a credit score indicating that the risk of contractually agreed payments not being made is significantly higher than for comparable exposures held by the originator which are not securitised.

10.  The debtors shall, at the time of transfer of the exposures, have made at least one payment, except in the case of revolving securitisations backed by exposures payable in a single instalment or having a maturity of less than one year, including without limitation monthly payments on revolving credits.

11.  The repayment of the holders of the securitisation positions shall not have been structured to depend predominantly on the sale of assets securing the underlying exposures. This shall not prevent such assets from being subsequently rolled over or refinanced.

The repayment of the holders of the securitisation positions whose underlying exposures are secured by assets the value of which is guaranteed or fully mitigated by a repurchase obligation by the seller of the assets securing the underlying exposures or by another third party shall not be considered to depend on the sale of assets securing those underlying exposures.

As the EBA Report explained, to mitigate refinancing risk and the extent to which the securitisation embeds maturity transformation, the exposures to be securitised should be largely self-liquidating. Reliance on refinancing and/or asset liquidation increases the liquidity and market risks to which the securitisation is exposed and makes the credit risk of the securitisation more difficult to model and assess from an investor’s perspective, and so creates model risk.

The EBA envisaged, following the Basel Committee almost to the letter, that partial reliance on refinancing or resale of the assets securing the exposure would be permissible so long as that re-financing was sufficiently distributed within the pool and the residual values on which the transaction relies were sufficiently low, such that reliance on refinancing would not be substantial, and the position in the Securitisation Regulation seems to be essentially the same or perhaps even a little more liberal:

  • Article 20(8) states that:

“underlying exposures may also generate proceeds from the sale of any financed or leased assets”

(and Article 24(15) has the same regarding ABCP)

  • Article 20(13) states that:

“repayment of the holders of the securitisation positions shall not have been structured to depend predominately on the sale of assets securing the underlying exposures. This shall not prevent such assets from being subsequently rolled-over or refinanced. The repayment of the holders of a securitisation position whose underlying exposures are secured by assets the value of which is guaranteed or fully mitigated by a repurchase obligation by the seller of the assets securing the underlying exposures or by another third party shall not be considered to depend on the sale of assets securing those underlying exposures”

(and Article 24(11) has the same statement). 

To take the example of car loans, where it is not uncommon for a new car to be taken by the buyer on a relatively short lease – 3 years perhaps – under which the PV of the rentals is much less than the cost of the car, leaving residual value risk with the lessor, if those assets were transferred to an issuer together with title to the vehicles, the structure could not qualify as STS under the first paragraph in Article 20(13), because the debt is supporting the RV as well as the committed rentals.  Hence the second paragraph, which allows structures - common in Germany - where the RV is underwritten by the manufacturer or its finance company.  The EBA Guidelines have more to say on this (see below).

So, Article 20 is intended to prevent holders taking any significant residual value risk or market risk on asset values, and the focus is on how the deal is structured (Article 20(13)) rather than what actually happens in practice (Article 20(8)).

Paragraphs 43-46 of the EBA Guidelines elaborate on this, particularly that to assess "predominant dependence", three aspects should be taken into account:

(i) the principal balance of the underlying exposures that depend on the sale of assets securing those underlying exposures to repay the balance;

(ii) the distribution of maturities of those exposures across the life of the transaction (a broad distribution will reduce the risk of correlated defaults due to idiosyncratic shocks); and

(iii) how granular the asset pool is.

The Guidelines say that no types of assets will automatically fail this test, but "it is expected" that CMBS, and securitisations where the assets are commodities (e.g. oil, grain, gold), or bonds with maturity dates falling after the maturity date of the securitisation, would not meet these requirements, because then (a) the repayment would be predominantly reliant on the sale of the assets, (b) other possible ways to repay the securitisation positions would be substantially limited, and (c) the granularity of the portfolio would be low.

The second subparagraph of Article 20(13) expressly permits cases where repayment does depend on a sale of the assets but the value "is guaranteed or fully mitigated by a repurchase obligation by the seller".  This is an EU addition, not to be found in Basel, and inserted to permit STS securitisations of German auto loans and leases, where this structure is common.    The Guidelines say that that the guarantor or repurchase entity must not be "an empty-shell or defaulted entity, so that it has sufficient loss absorbency to exercise the guarantee of the repurchase of the assets"; presumably to be tested at the time of the STS notification rather than any later date.  A full put-back or guarantee clearly falls within this but the position of partial or limited guarantees remains uncertain, beyond the general principles to be found in Recital (29) that note how "strong reliance... on the sale of assets securing the underlying assets creates vulnerabilities", singling out CMBS here, and Paragraphs 43-46 of the Guidelines.

For regulated EU banks which securitise lease receivables with a view to them being eligible collateral for the ECB, residual value cannot be included in the securitisation.  Article 73 of the 19th December 2014 ECB Guidelines (ECB/2014/60) on the implementation of the Eurosystem monetary policy framework requires all assets backing eligible ABS to be homogenous by reference to one of 8 categories, one of which is "leasing receivables", which is defined in Article 2 as "the scheduled and contractually mandated payments by the lessee to the lessor under the terms of a lease agreement", and the definition concludes starkly: "Residual values are not leasing receivables". 


12.  The interest-rate and currency risks arising from the securitisation shall be appropriately mitigated and any measures taken to that effect shall be disclosed. Except for the purpose of hedging interest-rate or currency risk, the SSPE shall not enter into derivative contracts and shall ensure that the pool of underlying exposures does not include derivatives. Those derivatives shall be underwritten and documented according to common standards in international finance.

13.  The transaction documentation shall set out, in clear and consistent terms, definitions, remedies and actions relating to delinquency and default of debtors, debt restructuring, debt forgiveness, forbearance, payment holidays, losses, charge-offs, recoveries and other asset-performance remedies. The transaction documentation shall clearly specify the priorities of payment, events which trigger changes in such priorities of payment as well as the obligation to report such events. Any change in the priorities of payments which will materially adversely affect the repayment of the securitisation position shall be reported to investors without undue delay.

14.  The originator and the sponsor shall make available data on static and dynamic historical default and loss performance, such as delinquency and default data, for substantially similar exposures to those being securitised, and the sources of those data and the basis for claiming similarity, to potential investors before pricing. Where the sponsor does not have access to such data, it shall obtain from the seller access to data, on a static or dynamic basis, on the historical performance, such as delinquency and default data, for exposures substantially similar to those being securitised. All such data shall cover a period no shorter than five years, except for data relating to trade receivables and other short-term receivables, for which the historical period shall be no shorter than three years.

15.  ABCP transactions shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the characteristics relating to the cash flows of different asset types including their contractual, credit-risk and prepayment characteristics. A pool of underlying exposures shall only comprise one asset type.

The pool of underlying exposures shall have a remaining weighted average life of not more than one year, and none of the underlying exposures shall have a residual maturity of more than three years.

By way of derogation from the second subparagraph, pools of auto loans, auto leases and equipment lease transactions shall have a remaining weighted average life of not more than three and a half years, and none of the underlying exposures shall have a residual maturity of more than six years.

The underlying exposures shall not include loans secured by residential or commercial mortgages or fully guaranteed residential loans, as referred to in point (e) of the first subparagraph of Article 129(1) of Regulation (EU) No 575/2013 [CRR]. The underlying exposures shall contain obligations that are contractually binding and enforceable, with full recourse to debtors with defined payment streams relating to rental, principal, interest, or related to any other right to receive income from assets warranting such payments. The underlying exposures may also generate proceeds from the sale of any financed or leased assets. The underlying exposures shall not include transferable securities as defined in point [EU version:  (44) of Article 4(1) of Directive 2014/65/EU [MiFID II] other than corporate bonds] [UK version:  (24) of Article 2(1) of Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 [EMIR], other than corporate bonds], that are not listed on a trading venue.

[UK version only:  In the fourth subparagraph the reference to Regulation (EU) No 575/2013 is a reference to Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 [CRR], as it had effect immediately before exit day.]

The homogeneity requirements (in Article 20(8) for term STS and Article 24(15) for ABCP STS) are easier to state than to define with certainty.  The 31st July 2018 revised draft RTS were a great improvement on the original draft RTS and gave participants guidance beyond the "you know it when you see it" position from which many of them will have started.  The enacted 28th May 2019 homogeneity RTS (Commission Delegated Regulation (EU) 2019/1851) have further changes to the recitals (which have been largely rewritten and reduced in number), and Article 1 has been reworked with a view to greater clarity.  To some extent the RTS have reverted to "you know it if you see it", in a way that may provide some reassurance that it is not intending to change market practice. These have been supplemented by the 12th December 2018 EBA guidelines.  All this shows the difficulty in trying to pin down this slippery concept, and in steering a course between making the test neither too easy to satisfy nor too difficult.

History

The development of the homogeneity concept can been seen by reading various papers put out starting in 2014, and then the various iterations of the Securitisation Regulation itself:

and some guidance on interpretation can perhaps be found by considering how the homogeneity concept developed over this period.   A full review of all these is available here.

Level one text

The starting point for term STS is Article 20(8):

"8.  The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the specific characteristics relating to the cash flows of the asset type including their contractual, credit-risk and prepayment characteristics. A pool of underlying exposures shall comprise only one asset type. The underlying exposures shall contain obligations that are contractually binding and enforceable, with full recourse to debtors and, where applicable, guarantors.
The underlying exposures shall have defined periodic payment streams, the instalments of which may differ in their amounts, relating to rental, principal, or interest payments, or to any other right to receive income from assets supporting such payments. The underlying exposures may also generate proceeds from the sale of any financed or leased assets.
The underlying exposures shall not include transferable securities, as defined in point (44) of Article 4(1) of Directive 2014/65/EU, other than corporate bonds that are not listed on a trading venue."

Article 24(15) for ABCP contains principles which are similar to the first paragraph of Article 20(8) but there is additional detail reflecting the particular rules for ABCP, and in what follows we concentrate on term STS.

Recital (27) explains that the rationale for the homogeneity requirement is to "ensure that investors perform robust due diligence and to facilitate the assessment of underlying risks".  For this reason, securitisation transactions should be "backed by pools of exposures that are homogenous in asset type", and it gives four categories by way of example:

  • residential loans
  • corporate loans, business property loans, leases and credit facilities to undertakings of the same category
  • auto loans and leases
  • credit facilities to individuals for personal, family or household consumption purposes.

It forbids pools which include transferable securities, apart from unlisted bonds issued by non-financial corporations to credit institutions in markets where such bonds are common practice in place of loan agreements, e.g. pfandbriefe.

So a pool may only contain one "asset type", and illustrations of "types" are provided in Recital (27).

But just having the same asset type in the pool is not enough by itself to make the pool homogeneous. The pool assets (of the same asset type) must, taking the wording of Article 20(8), be homogeneous "taking into account the characteristics relating to the cash flows… including their contractual, credit risk and prepayment characteristics".   The cash flow characteristics will include interest payments, the likely incidence of prepayments and whether an asset amortises fully, partly or not at all.

Level two text - the homogeneity RTS

Article 20(8) does not explicitly refer to the rationale from EBA 2015 and Basel 2016 - that investors should not need to analyse and assess materially different credit risk factors and risk profiles when carrying out risk analysis and due diligence checks.  The RTS however do in Recital (3), which explains that since underwriting standards are designed to measure and assess credit risk, exposures sharing similar underwriting standards can be taken to have similar risk profiles and therefore be regarded as homogeneous, whereas dissimilar underwriting standards may result in exposures with "materially different risk profiles", even if the standards are all high quality.

The original draft RTS had clearly struggled trying to define homogeneity, and in its feedback on the public consultation exercise the EBA admitted as much. Whilst there was "strong support" for determining homogeneity by reference to the similarity of the underwriting and servicing standards and the adherence to a single asset category, it noted that:

"A substantial number of respondents have raised concerns with the homogeneity factor requirement… and with respect to the perceived lack of clear guidance on how the homogeneity factor requirement should apply in practice, and how their relevance should be determined for a specific securitisation. Overall, it was noted that the current proposal would have severe negative consequences on the market, would produce excessively concentrated pools, would not allow to recognise the existing well-established securitisations as homogeneous, and would penalise smaller entities that would face difficulties with generating critical portfolio mass".

The EBA's response was to try to be clearer, renaming the former ‘risk factor’ as ‘homogeneity factor’ to avoid misconceptions that the homogeneity is about assessment of the credit risk of the individual exposures in the pool, and reducing the number of the homogeneity factors.  In the 28th May 2019 homogeneity RTS it went further, emphasising the central roles of:

  • similar underwriting standards
  • similar servicing procedures, systems and governance

Recital (2) explains that market practice has already identified well established asset types to determine the homogeneity of a given pool of underlying exposures, and stressing that there was no desire to limit either financial innovation nor existing market practice, so that asset pools that do not correspond to a well-established type should also be allowed "on the basis of the internal methodologies and parameters consistently applied by the originator or sponsor", and Recital (4) identified how sensitive cash flow projections and assumptions about payment and default characteristics were to servicing procedures.

So long as the underwriting and servicing standards are similar, consumer credit assets and trade receivables are sufficiently homogeneous without the need for any further examination - to do otherwise would lead to excessive concentrations.  For other asset types, it was necessary to go further and apply "one or more relevant factors on a case-by-case basis" (Recital (5)).

Article 1 of the RTS accordingly goes on to state that the STS homogeneity requirement will be met if four conditions are met:

  • the assets fall into a single defined "asset type" - broadly speaking, residential mortgage loans, commercial mortgage loans, consumer credit, corporate credit, auto loans and leases, credit cards, trade receivables, or - tracking Recital (2), a group of exposures considered by the originator or the sponsor "to constitute a distinct asset type on the basis of internal methodologies and parameters"
  • similar underwriting standards
  • similar servicing procedures
  • except for consumer credit assets and trade receivables, at least one "homogeneity factor" applies the assets in the pool.

The homogeneity factors vary according to the assets in question and can be summarised by reference to the following table (based on Article 2 of the RTS):

homog table

A related point arises under the RTS/ITS on STS Notification produced by ESMA under Article 27 of the Securitisation Regulation.  Field STSS27 requires the notification to provide:

"a detailed explanation as to the homogeneity of the pool of underlying exposures backing the securitisation.  For that purpose the originator and sponsor shall refer to the EBA RTS on homogeneity (Commission Delegated Regulation (EU) […], and shall explain in detail how each of the conditions specified in the Article 1 of the RTS are met."

There is no need to justify the choice of homogeneity factor.  Examples of how field STSS27 is being completed in practice can be found on the ESMA list of STS notifications.

The emphasis on underwriting standards leads to the conclusion that buy-to-let and owner-occupier credits could not form a homogeneous pool, because the origination criteria would have been different.  However, a loan which was originated as an owner-occupier loan but which subsequently became a BTL loan should be able to form part of the same pool as other owner-occupier loans because they have all been (and assuming that they were in fact) originated according to the underwriting standards.  There had been a proposal (made after the original homogeneity RTS were issued) to allow 5% non-homogeneity to cover anomalies like this, but the EBA rejected this because the much-revised second draft homogeneity RTS (see its answer in the RTS to question 14) amended Article 1(a) and Recitals 4 and 5 in order to clarify that the intention of the requirement was that underwriting standards should apply similar approaches to the assessment of the credit risk, and was not to ensure the uniformity of the underwriting standards, methods and criteria.

Multi-jurisdictional pools

The original draft RTS wording was far from clear regarding the position of multi-jurisdictional pools.  Suppose assets in a pool arose in two different legal systems where the legal processes produced identical results for creditors.  Would their risk profiles be the same or different?  Should sponsors assume that creditors would examine the laws in detail, or would their analysis simply involve a consideration of the likely recovery for creditors in each jurisdiction, and whether the jurisdiction was creditor friendly and quick, or debtor friendly and slow?  Should the focus be on similarity of outcome, regardless of the legal detail?  Fortunately, this has been clarified, and in cases - such as RMBS pools or auto loans and leases - where jurisdiction is a potential differentiator, it is now clear that multi-jurisdictional pools are fine so long as the pool can be demonstrated to be sufficiently homogeneous by reference to one of the other available homogeneity factors; which on the face of it provides plenty of latitude for sponsors and originators assembling pools of assets.

It might be noted that the EBA explicitly rejected calls to replace references to "jurisdiction" with references to "nationality" or "set of jurisdictions" to clarify that England, Scotland and Northern Ireland were one and the same.

Level three text - the EBA guidelines

Paragraph 4.3 of the EBA guidelines provide a small degree of clarification about what "contractually binding and enforceable obligations" means - it refers to "all obligations contained in the contractual specification of the underlying exposures that are relevant to investors because they affect any obligations by the debtor and, where applicable, the guarantor, to make payments or provide security", and examples of exposure types that should be considered to have "defined periodic payment streams" - these include bullet repayments, any credit card exposures, interest-only mortgages, repayment loans, loans where (within the limits of what is permitted by Article 20(13)) repayment is dependent on the sale of an underlying asset, and exposures where temporary payment holidays have been agreed; guidance which is usefully accommodating.

For regulated EU banks which securitise receivables with a view to them being eligible collateral for the ECB, the assets must meet the similar but separate homogeneity requirements provided for in Article 73 of the 19th December 2014 ECB Guidelines (ECB/2014/60) on the implementation of the Eurosystem monetary policy framework.  Article 73 requires all assets backing eligible ABS to be homogenous by reference to one of 8 categories:  (a) residential mortgages; (b) commercial real estate mortgages; (c) loans to small and medium-sized enterprises (SMEs); (d) auto loans; (e) consumer finance loans; (f) leasing receivables; and (g) credit card receivables.

RTS on homogeneity


16.  Any referenced interest payments under the ABCP transaction’s assets and liabilities shall be based on generally used market interest rates, or generally used sectoral rates reflective of the cost of funds, but shall not reference complex formulae or derivatives. Referenced interest payments under the ABCP transaction’s liabilities may be based on interest rates reflective of an ABCP programme’s cost of funds.

References

Any referenced interest payments for either the assets or liabilities of an STS securitisation must be based on “generally used market interest rates or generally used sectoral rates reflective of the cost of funds".

This latter wording was intended to allay concerns that mortgage loans based on banks' standard variable rates might otherwise be excluded, but it arguably missed the mark because of the phrase "generally used".  The Basel/IOSCO November 2015 paper addressed this but there are important differences.  Basel/IOSCO explains that examples of “commonly encountered market interest rates” would include "sectoral rates reflective of a lender’s cost of funds, such as internal interest rates that directly reflect the market costs of a bank’s funding or that of a subset of institutions”.  The Securitisation Regulation however only permits "generally used" sectoral rates.  The Basel/IOSCO wording made it clear that mortgage loans based on banks' standard variable rates were included.  However, the standard variable rate for one lender is only used for its products, not by others in the market, and so there is an unhelpful doubt that one lender’s rate is therefore not a “generally used” rate, and that “generally used” might mean only, say, minimum lending rate or base rate of a central bank.  This looks like a drafting error, and paragraph 57 of the EBA Guidelines does its best to rescue matters by explicitly permitting not only usual market benchmarks such as LIBOR and EURIBOR, and official central bank and monetary authority rates, but also:

"(c) sectoral rates reflective of a lender’s cost of funds, including standard variable rates and internal interest rates that directly reflect the market costs of funding of a bank or a subset of institutions, to the extent that sufficient data are provided to investors to allow them to assess the relation of the sectoral rates to other market rates."

17.  Following the seller’s default or an acceleration event:

(a)  no amount of cash shall be trapped in the SSPE beyond what is necessary to ensure the operational functioning of the SSPE or the orderly repayment of investors in accordance with the contractual terms of the securitisation unless exceptional circumstances require that an amount be trapped to be used, in the best interests of investors, for expenses in order to avoid the deterioration in the credit quality of the underlying exposures;

(b)  principal receipts from the underlying exposures shall be passed to investors holding a securitisation position via sequential payment of the securitisation positions, as determined by the seniority of the securitisation position; and

(c)  no provisions shall require automatic liquidation of the underlying exposures at market value.

18.  The underlying exposures shall be originated in the ordinary course of the seller’s business pursuant to underwriting standards that are no less stringent than those that the seller applies at the time of origination to similar exposures that are not securitised. The underwriting standards pursuant to which the underlying exposures are originated and any material changes from prior underwriting standards shall be fully disclosed to the sponsor and other parties directly exposed to the ABCP transaction without undue delay. The seller shall have expertise in originating exposures of a similar nature to those securitised.


19.  Where an ABCP transaction is a revolving securitisation, the transaction documentation shall include triggers for termination of the revolving period, including at least the following:

(a)  a deterioration in the credit quality of the underlying exposures to or below a predetermined threshold; and

(b)  the occurrence of an insolvency-related event with regard to the seller or the servicer.

20.  The transaction documentation shall clearly specify:

(a)  the contractual obligations, duties and responsibilities of the sponsor, the servicer and the trustee, if any, and other ancillary service providers;

(b)  the processes and responsibilities necessary to ensure that a default or insolvency of the servicer does not result in a termination of servicing;

(c)  provisions that ensure the replacement of derivative counterparties and the account bank upon their default, insolvency and other specified events, where applicable; and

(d)  how the sponsor meets the requirements of Article 25(3).

21.  [EU version:  The EBA, in close cooperation with ESMA and EIOPA, shall develop draft regulatory] [UK version:  The FCA may make] technical standards further specifying which underlying exposures referred to in paragraph 15 are deemed to be homogeneous.

[EU version only:  The EBA shall submit those draft regulatory technical standards to the Commission by 18 July 2018.]

[EU version only:  The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.]

Article 25

Sponsor of an ABCP programme

1.  The sponsor of the ABCP programme shall be a [EU version:  credit institution supervised under Directive 2013/36/EU [CRD IV]] [UK version:  person who is a CRR firm as defined by Article 4(1)(2A) of the Capital Requirements Regulation, but is not an investment firm as defined by Article 4(1)(2) of that Regulation].

2.  The sponsor of an ABCP programme shall be a liquidity facility provider and shall support all securitisation positions on an ABCP programme level by covering all liquidity and credit risks and any material dilution risks of the securitised exposures as well as any other transaction- and programme-level costs if necessary to guarantee to the investor the full payment of any amount under the ABCP with such support. The sponsor shall disclose a description of the support provided at transaction level to the investors including a description of the liquidity facilities provided.

3.  Before being able to sponsor an STS ABCP programme, the credit institution shall demonstrate to [EU version: its competent authority] [UK version: the PRA] that its role under paragraph 2 does not endanger its solvency and liquidity, even in an extreme stress situation in the market.

The requirement referred to in the first subparagraph of this paragraph shall be considered to be fulfilled where [EU version: the competent authority] [UK version: the PRA] has determined on the basis of the review and evaluation referred to Article 97(3) of Directive 2013/36/EU [CRD IV] that the arrangements, strategies, processes and mechanisms implemented by that credit institution and the own funds and liquidity held by it ensure the sound management and coverage of its risks.

4.  The sponsor shall perform its own due diligence and shall verify compliance with the requirements set out in Article 5(1) and (3) of this Regulation, as applicable. It shall also verify that the seller has in place servicing capabilities and collection processes that meet the requirements specified in points (h) to (p) of Article 265(2) of Regulation (EU) No 575/2013 [CRR] or equivalent requirements in third countries.

5.  The seller, at the level of a transaction, or the sponsor, at the level of the ABCP programme, shall satisfy the risk-retention requirement referred to in Article 6.

6.  The sponsor shall be responsible for compliance with Article 7 at ABCP programme level and for making available to potential investors before pricing upon their request:

(a)  the aggregate information required by point (a) of the first subparagraph of Article 7(1); and

(b)  the information required by points (b) to (e) of the first subparagraph of Article 7(1), at least in draft or initial form.

7.  In the event that the sponsor does not renew the funding commitment of the liquidity facility before its expiry, the liquidity facility shall be drawn down and the maturing securities shall be repaid.

Article 26

Programme-level requirements

1.  All ABCP transactions within an ABCP programme shall fulfil the requirements of Article 24(1) to (8) and (12) to (20).

A maximum of 5 % of the aggregate amount of the exposures underlying the ABCP transactions and which are funded by the ABCP programme may temporarily be non-compliant with the requirements of Article 24(9), (10) and (11) without affecting the STS status of the ABCP programme.

For the purpose of the second subparagraph of this paragraph, a sample of the underlying exposures shall regularly be subject to external verification of compliance by an appropriate and independent party.

2.  The remaining weighted average life of the underlying exposures of an ABCP programme shall not be more than two years.

3.  The ABCP programme shall be fully supported by a sponsor in accordance with Article 25(2).

4.  The ABCP programme shall not contain any resecuritisation and the credit enhancement shall not establish a second layer of tranching at the programme level.

5.  The securities issued by an ABCP programme shall not include call options, extension clauses or other clauses that have an effect on their final maturity, where such options or clauses may be exercised at the discretion of the seller, sponsor or SSPE.

6.  The interest-rate and currency risks arising at ABCP programme level shall be appropriately mitigated and any measures taken to that effect shall be disclosed. Except for the purpose of hedging interest-rate or currency risk, the SSPE shall not enter into derivative contracts and shall ensure that the pool of underlying exposures does not include derivatives. Those derivatives shall be underwritten and documented according to common standards in international finance.

7.  The documentation relating to the ABCP programme shall clearly specify:

(a)  the responsibilities of the trustee and other entities with fiduciary duties, if any, to investors;

(b)  the contractual obligations, duties and responsibilities of the sponsor, who shall have expertise in credit underwriting, the trustee, if any, and other ancillary service providers;

(c)  the processes and responsibilities necessary to ensure that a default or insolvency of the servicer does not result in a termination of servicing;

(d)  the provisions for replacement of derivative counterparties, and the account bank at ABCP programme level upon their default, insolvency and other specified events, where the liquidity facility does not cover such events;

(e)  that, upon specified events, default or insolvency of the sponsor, remedial steps shall be provided for to achieve, as appropriate, collateralisation of the funding commitment or replacement of the liquidity facility provider; and

(f)  that the liquidity facility shall be drawn down and the maturing securities shall be repaid in the event that the sponsor does not renew the funding commitment of the liquidity facility before its expiry.

8.  The servicer shall have expertise in servicing exposures of a similar nature to those securitised and shall have well-documented policies, procedures and risk-management controls relating to the servicing of exposures.

Article 26a

[EU version only:  SECTION 2a

Requirements for simple, transparent and standardised on-balance-sheet securitisations

Simple, transparent and standardised on-balance-sheet securitisations

1.   Synthetic securitisations that meet the requirements set out in Articles 26b to 26e shall be considered to be STS on-balance-sheet securitisations.

2.   EBA, in close cooperation with ESMA and EIOPA, may adopt, in accordance with Article 16 of Regulation (EU) No 1093/2010, guidelines and recommendations on the harmonised interpretation and application of the requirements set out in Articles 26b to 26e of this Regulation.

Article 26b

[EU version only:  Requirements relating to simplicity

1.   An originator shall be an entity that is authorised or licenced in the Union.

An originator that purchases a third party’s exposures on its own account and then securitises them shall apply policies with regard to credit, collection, debt workout and servicing applied to those exposures that are no less stringent than those that the originator applies to comparable exposures that have not been purchased.

2.   Underlying exposures shall be originated as part of the core business activity of the originator.

3.   At the closing of a transaction, the underlying exposures shall be held on the balance sheet of the originator or of an entity that belongs to the same group as the originator.

For the purposes of this paragraph, a group shall be either of the following:

(a)  a group of legal entities that is subject to prudential consolidation in accordance with Chapter 2 of Title II of Part One of Regulation (EU) No 575/2013 [CRR];

(b) a group as defined in point (c) of Article 212(1) of Directive 2009/138/EC [Solvency II].

4.   The originator shall not hedge its exposure to the credit risk of the underlying exposures of the securitisation beyond the protection obtained through the credit protection agreement.

5.   The credit protection agreement shall comply with the credit risk mitigation rules laid down in Article 249 of Regulation  (EU) No 575/2013 [CRR], or where that Article is not applicable, with requirements that are no less stringent than the requirements set out in that Article.

6.   The originator shall provide representations and warranties that the following requirements have been met:

(a)  the originator or an entity of the group to which the originator belongs has full legal and valid title to the underlying exposures and their associated ancillary rights;

(b)  where the originator is a credit institution as defined in point (1) of Article 4(1) of Regulation  (EU) No 575/2013 [CRR], or an insurance undertaking as defined in point (1) of Article 13 of Directive 2009/138/EC [Solvency II], the originator or an entity which is included in the scope of supervision on a consolidated basis keeps the credit risk of the underlying exposures on its balance sheet;

(c)  each underlying exposure complies, at the date it is included in the securitised portfolio, with the eligibility criteria and with all conditions, other than the occurrence of a credit event as referred to in Article 26e(1), for a credit protection payment in accordance with the credit protection agreement contained within the securitisation documentation;

(d) to the best of the originator’s knowledge, the contract for each underlying exposure contains a legal, valid, binding and enforceable obligation on the obligor to pay the sums of money specified in that contract;

(e) the underlying exposures comply with underwriting criteria that are no less stringent than the standard underwriting criteria that the originator applies to similar exposures that are not securitised;

(f) to the best of the originator’s knowledge, none of the obligors are in material breach or default of any of their obligations in respect of an underlying exposure on the date on which that underlying exposure is included in the securitised portfolio;

(g) to the best of the originator’s knowledge, the transaction documentation does not contain any false information on the details of the underlying exposures;

(h) at the closing of the transaction or when an underlying exposure is included in the securitised portfolio, the contract between the obligor and the original lender in relation to that underlying exposure has not been amended in such a way that the enforceability or collectability of that underlying exposure has been affected.

7.   Underlying exposures shall meet predetermined, clear and documented eligibility criteria that do not allow for active portfolio management of those exposures on a discretionary basis.

For the purposes of this paragraph, the substitution of exposures that are in breach of representations or warranties or, where the securitisation includes a replenishment period, the addition of exposures that meet the defined replenishment conditions, shall not be considered active portfolio management.

Any exposure added after the closing date of the transaction shall meet eligibility criteria that are no less stringent than those applied in the initial selection of the underlying exposures.

An underlying exposure may be removed from the transaction where that underlying exposure:

(a) has been fully repaid or matured otherwise;

(b) has been disposed of during the ordinary course of the business of the originator, provided that such disposal does not constitute implicit support as referred to in Article 250 of Regulation (EU) No 575/2013 [CRR];

(c) is subject to an amendment that is not credit driven, such as refinancing or restructuring of debt, and which occurs during the ordinary course of servicing of that underlying exposure; or

(d) did not meet the eligibility criteria at the time it was included in the transaction.

8.   The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the specific characteristics relating to the cash flows of the asset type including their contractual, credit-risk and prepayment characteristics. A pool of underlying exposures shall comprise only one asset type.

The underlying exposures referred to in the first subparagraph shall contain obligations that are contractually binding and enforceable, with full recourse to debtors and, where applicable, guarantors.

The underlying exposures referred to in the first subparagraph shall have defined periodic payment streams, the instalments of which may differ in their amounts, relating to rental, principal or interest payments, or to any other right to receive income from assets supporting such payments. The underlying exposures may also generate proceeds from the sale of any financed or leased assets.

The underlying exposures referred to in the first subparagaph of this paragraph shall not include transferable securities as defined in point (44) of Article 4(1) of Directive 2014/65/EU [MIFID II], other than corporate bonds that are not listed on a trading venue.

9.   Underlying exposures shall not include any securitisation positions.

10.   The underwriting standards pursuant to which underlying exposures are originated and any material changes from prior underwriting standards shall be fully disclosed to potential investors without undue delay. The underlying exposures shall be underwritten with full recourse to an obligor that is not an SSPE. No third parties shall be involved in the credit or underwriting decisions concerning the underlying exposures.

In the case of securitisations where the underlying exposures are residential loans, the pool of loans shall not include any loan that was marketed and underwritten on the premise that the loan applicant or, where applicable, intermediaries were made aware that the information provided might not be verified by the lender.

The assessment of the borrower’s creditworthiness shall meet the requirements set out in Article 8 of Directive 2008/48/EC [Consumer Credit Directive] or Article 18(1) to (4), point (a) of Article 18(5) and Article 18(6), of Directive 2014/17/EU [Mortgage Credit Directive], or where applicable, equivalent requirements in third countries.

The originator or original lender shall have expertise in originating exposures of a similar nature to those securitised.

11.   Underlying exposures shall not include, at the time of selection, exposures in default within the meaning of Article 178(1) of Regulation  (EU) No 575/2013 [CRR], or exposures to a credit-impaired debtor or guarantor who to the best of the originator’s or original lender’s knowledge:

(a)  has been declared insolvent or had a court grant his creditors a final non-appealable right of enforcement or material damages as a result of a missed payment within three years prior to the date of the origination or has undergone a debt-restructuring process with regard to his non-performing exposures within three years prior to the date of the selection of the underlying exposures, except where:

(i)  a restructured underlying exposure has not presented new arrears since the date of the restructuring, which must have taken place at least one year prior to the date of the selection of the underlying exposures; and

(ii) the information provided by the originator in accordance with point (a) and point (e)(i) of the first subparagraph of Article 7(1) explicitly sets out the proportion of restructured underlying exposures, the time and details of the restructuring and their performance since the date of the restructuring;

(b)  was at the time of origination of the underlying exposure, where applicable, on a public credit registry of persons with adverse credit history or, where there is no such public credit registry, another credit registry that is available to the originator or the original lender; or

(c) has a credit assessment or a credit score indicating that the risk of contractually agreed payments not being made is significantly higher than for comparable exposures held by the originator which are not securitised.

12.   Debtors shall, at the time of the inclusion of the underlying exposures, have made at least one payment, except where:

(a)  the securitisation is a revolving securitisation, backed by exposures payable in a single instalment or having a maturity of less than one year, including without limitation monthly payments on revolving credits; or

(b) the exposure represents the refinancing of an exposure that is already included in the transaction.

13.   EBA, in close cooperation with ESMA and EIOPA, shall develop draft regulatory technical standards further specifying which underlying exposures referred to in paragraph 8 are deemed to be homogeneous.

EBA shall submit those draft regulatory technical standards to the Commission by 10 October 2021.

The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.

Article 26c

[EU version only:] Requirements relating to standardisation

1.   The originator or original lender shall satisfy the risk-retention requirement in accordance with Article 6.

2.   The interest rate and currency risks arising from a securitisation and their possible effects on the payments to the originator and the investors shall be described in the transaction documentation. Those risks shall be appropriately mitigated and any measures taken to that effect shall be disclosed. Any collateral securing the obligations of the investor under the credit protection agreement shall be denominated in the same currency in which the credit protection payment is denominated.

In the case of a securitisation using a SSPE, the amount of liabilities of the SSPE concerning the interest payments to the investors shall, at each payment date, be equal to or be less than the amount of the SSPE’s income from the originator and any collateral arrangements.

Except for the purpose of hedging interest rate or currency risks of the underlying exposures, the pool of underlying exposures shall not include derivatives. Those derivatives shall be underwritten and documented according to common standards in international finance.

3.   Any referenced interest rate payments in relation to the transaction shall be based on either of the following:

(a) generally used market interest rates, or generally used sectoral rates that are reflective of the costs of funds, and do not reference complex formulae or derivatives;

(b) income generated by the collateral securing the obligations of the investor under the protection agreement.

Any referenced interest payments due under the underlying exposures shall be based on generally used market interest rates, or generally used sectoral rates reflective of the cost of funds, and shall not reference complex formulae or derivatives.

4.   Following the occurrence of an enforcement event in respect of the originator, the investor shall be permitted to take enforcement action.

In the case of a securitisation using a SSPE, where an enforcement or termination notice of the credit protection agreement is delivered, no amount of cash shall be trapped in the SSPE beyond what is necessary to ensure the operational functioning of that SSPE, the payment of the protection payments for defaulted underlying exposures that are still being worked out at the time of the termination, or the orderly repayment of investors in accordance with the contractual terms of the securitisation.

5.   Losses shall be allocated to the holders of a securitisation position in the order of seniority of the tranches, starting with the most junior tranche.

Sequential amortisation shall be applied to all tranches to determine the outstanding amount of the tranches at each payment date, starting from the most senior tranche.

By way of derogation from the second subparagraph, transactions which feature non-sequential priority of payments shall include triggers related to the performance of the underlying exposures resulting in the priority of payments reverting the amortisation to sequential payments in order of seniority. Such performance-related triggers shall include as a minimum:

(a) either the increase in the cumulative amount of defaulted exposures or the increase in the cumulative losses greater than a given percentage of the outstanding amount of the underlying portfolio;

(b) one additional backward-looking trigger; and

(c) one forward-looking trigger.

EBA shall develop draft regulatory technical standards on the specification, and where relevant, on the calibration of the performance-related triggers.

EBA shall submit those draft regulatory technical standards to the Commission by 30 June 2021.

The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in the fourth subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.

As tranches amortise, the amount of the collateral equal to the amount of the amortisation of those tranches shall be returned to the investors, provided the investors have collateralised those tranches.

Where a credit event, as referred to in Article 26e, has occurred in relation to underlying exposures and the debt workout for those exposures has not been completed, the amount of credit protection remaining at any payment date shall be at least equivalent to the outstanding nominal amount of those underlying exposures, minus the amount of any interim payment made in relation to those underlying exposures.

6.   The transaction documentation shall include appropriate early amortisation provisions or triggers for termination of the revolving period, where a securitisation is a revolving securitisation, including at least the following:

(a) a deterioration in the credit quality of the underlying exposures to or below a predetermined threshold;

(b) a rise in losses above a predetermined threshold;

(c) a failure to generate sufficient new underlying exposures that meet the predetermined credit quality during a specified period.

7.   The transaction documentation shall clearly specify:

(a) the contractual obligations, duties and responsibilities of the servicer, the trustee and other ancillary service providers, as applicable, and the third-party verification agent referred to in Article 26e(4);

(b) the provisions that ensure the replacement of the servicer, trustee, other ancillary service providers or the third-party verification agent referred to in Article 26e(4) in the event of default or insolvency of either of those service providers, where those service providers differ from the originator, in a manner that does not result in the termination of the provision of those services;

(c) the servicing procedures that apply to the underlying exposures at the closing date of the transaction and thereafter and the circumstances under which those procedures may be modified;

(d) the servicing standards that the servicer is obliged to adhere to in servicing the underlying exposures during the entire life of the securitisation.

8.   The servicer shall have expertise in servicing exposures of a similar nature to those securitised and shall have well-documented and adequate policies, procedures and risk-management controls relating to the servicing of exposures.

The servicer shall apply servicing procedures to the underlying exposures that are at least as stringent as the ones applied by the originator to similar exposures that are not securitised.

9.   The originator shall maintain an up-to-date reference register to identify the underlying exposures at all times. That register shall identify the reference obligors, the reference obligations from which the underlying exposures arise, and, for each underlying exposure, the nominal amount that is protected and that is outstanding.

10.   The transaction documentation shall include clear provisions that facilitate the timely resolution of conflicts between different classes of investors. In the case of a securitisation using a SSPE, voting rights shall be clearly defined and allocated to bondholders and the responsibilities of the trustee and other entities with fiduciary duties to investors shall be clearly identified.

Article 26d

[EU version only]:  Requirements relating to transparency

1.   The originator shall make available data on static and dynamic historical default and loss performance such as delinquency and default data, for substantially similar exposures to those being securitised, and the sources of those data and the basis for claiming similarity, to potential investors before pricing. Those data shall cover a period of at least five years.

2.   A sample of the underlying exposures shall be subject to external verification prior to the closing of the transaction by an appropriate and independent party, including verification that the underlying exposures are eligible for credit protection under the credit protection agreement.

3.   The originator shall, before the pricing of the securitisation, make available to potential investors a liability cash flow model which precisely represents the contractual relationship between the underlying exposures and the payments flowing between the originator, investors, other third parties and, where applicable, the SSPE, and shall, after pricing, make that model available to investors on an ongoing basis and to potential investors upon request.

4.   In the case of a securitisation where the underlying exposures are residential loans or auto loans or leases, the originator shall publish the available information related to the environmental performance of the assets financed by such residential loans, auto loans or leases, as part of the information disclosed pursuant to point (a) of the first subparagraph of Article 7(1).

By way of derogation from the first subparagraph, originators may, from 1 June 2021, decide to publish the available information related to the principal adverse impacts of the assets financed by the underlying exposures on sustainability factors.

5.   The originator shall be responsible for compliance with Article 7. The information required by point (a) of the first subparagraph of Article 7(1) shall be made available to potential investors before pricing upon request. The information required by points (b) to (d) of the first subparagraph of Article 7(1) shall be made available before pricing, at least in draft or initial form. The final documentation shall be made available to investors at the latest 15 days after the closing of the transaction.

6.   By 10 July 2021, the ESAs shall develop, through the Joint Committee of the European Supervisory Authorities, draft regulatory technical standards in accordance with Articles 10 to 14 of Regulations (EU) No 1093/2010, (EU) No 1094/2010 and (EU) No 1095/2010 on the content, methodologies and presentation of information referred to in the second subparagraph of paragraph 4 of this Article, in respect of the sustainability indicators in relation to adverse impacts on the climate and other environmental, social and governance-related adverse impacts.

Where relevant, the draft regulatory technical standards referred to in the first subparagraph of this paragraph shall mirror or draw upon the regulatory technical standards developed in compliance with the mandate given to the ESAs in Regulation (EU) 2019/2088, in particular in Article 2a, and Article 4(6) and (7) thereof.

The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulations (EU) No 1093/2010, (EU) No 1094/2010 and (EU) No 1095/2010.

Article 26e

[EU version only:]  Requirements concerning the credit protection agreement, the third-party verification agent and the synthetic excess spread

1.   The credit protection agreement shall at least cover the following credit events:

(a) where the transfer of risk is achieved by the use of guarantees, the credit events referred to in point (a) of Article 215(1) of Regulation  (EU) No 575/2013 [CRR];

(b) where the transfer of risk is achieved by the use of credit derivatives, the credit events referred to in point (a) of Article 216(1) of Regulation  (EU) No 575/2013 [CRR].

All credit events shall be documented.

Forbearance measures within the meaning of Article 47b of Regulation  (EU) No 575/2013 [CRR] that are applied to the underlying exposures shall not preclude the triggering of eligible credit events.

2.   The credit protection payment following the occurrence of a credit event shall be calculated based on the actual realised loss suffered by the originator or the original lender, as worked out in accordance with their standard recovery policies and procedures for the relevant exposure types and recorded in their financial statements at the time the payment is made. The final credit protection payment shall be payable within a specified period of time after the debt workout for the relevant underlying exposure where the debt workout has been completed before the scheduled legal maturity or early termination of the credit protection agreement.

An interim credit protection payment shall be made at the latest six months after the occurrence of a credit event as referred to in paragraph 1 in cases where the debt workout of the losses for the relevant underlying exposure has not been completed by the end of that six-month period. The interim credit protection payment shall be at least the higher of the following:

(a) the expected loss amount that is equivalent to the impairment recorded by the originator in its financial statements in accordance with the applicable accounting framework at the time the interim payment is made on the assumption that the credit protection agreement does not exist and does not cover any losses;

(b) where applicable, the expected loss amount as determined in accordance with Chapter 3 of Title II of Part Three of Regulation  (EU) No 575/2013 [CRR].

Where an interim credit protection payment is made, the final credit protection payment referred to in the first subparagraph shall be made in order to adjust the interim settlement of losses to the actual realised loss.

The method for the calculation of interim and final credit protection payments shall be specified in the credit protection agreement.

The credit protection payment shall be proportional to the share of the outstanding nominal amount of the corresponding underlying exposure that is covered by the credit protection agreement.

The right of the originator to receive the credit protection payment shall be enforceable. The amounts payable by investors under the credit protection agreement shall be clearly set out in the credit protection agreement and limited. It shall be possible to calculate those amounts in all circumstances. The credit protection agreement shall clearly set out the circumstances under which investors shall be required to make payments. The third-party verification agent referred to in paragraph 4 shall assess whether such circumstances have occurred.

The amount of the credit protection payment shall be calculated at the level of the individual underlying exposure for which a credit event has occurred.

3.   The credit protection agreement shall specify the maximum extension period that shall apply for the debt workout for the underlying exposures in relation to which a credit event as referred to in paragraph 1 has occurred, but where the debt workout has not been completed upon the scheduled legal maturity or early termination of the credit protection agreement. Such an extension period shall not be longer than two years. The credit protection agreement shall provide that, by the end of that extension period, a final credit protection payment shall be made on the basis of the originator’s final loss estimate that would have to be recorded by the originator in its financial statements at that time on the assumption that the credit protection agreement does not exist and does not cover any losses.

In the event that the credit protection agreement is terminated, the debt workout shall continue in respect of any outstanding credit events that occurred prior to that termination in the same way as that described in the first subparagraph.

The credit protection premiums to be paid under the credit protection agreement shall be structured as contingent on the outstanding nominal amount of the performing securitised exposures at the time of the payment and reflect the risk of the protected tranche. For those purposes, the credit protection agreement shall not stipulate guaranteed premiums, upfront premium payments, rebate mechanisms or other mechanisms that may avoid or reduce the actual allocation of losses to the investors or return part of the paid premiums to the originator after the maturity of the transaction.

By way of derogation from the third subparagraph of this paragraph, upfront premium payments shall be allowed, provided State aid rules are complied with, where the guarantee scheme is specifically provided for in the national law of a Member State and benefits from a counter-guarantee of any of the entities listed in points (a) to (d) of Article 214(2) of Regulation  (EU) No 575/2013 [CRR].

The transaction documentation shall describe how the credit protection premium and any note coupons, if any, are calculated in respect of each payment date over the entire life of the securitisation.

The rights of the investors to receive credit protection premiums shall be enforceable.

4.   The originator shall appoint a third-party verification agent before the closing date of the transaction. For each of the underlying exposures for which a credit event notice is given, the third party verification agent shall verify, as a minimum, all of the following:

(a) that the credit event referred to in the credit event notice is a credit event as specified in the terms of the credit protection agreement;

(b) that the underlying exposure was included in the reference portfolio at the time of the occurrence of the credit event concerned;

(c) that the underlying exposure met the eligibility criteria at the time of its inclusion in the reference portfolio;

(d) where an underlying exposure has been added to the securitisation as a result of a replenishment, that such a replenishment complied with the replenishment conditions;

(e) that the final loss amount is consistent with the losses recorded by the originator in its profit and loss statement;

(f) that, at the time the final credit protection payment is made, the losses in relation to the underlying exposures have correctly been allocated to the investors.

The third-party verification agent shall be independent from the originator and investors, and, where applicable, from the SSPE and shall have accepted the appointment as third-party verification agent by the closing date of the transaction.

The third-party verification agent may perform the verification on a sample basis instead of on the basis of each individual underlying exposure for which credit protection payment is sought. Investors may, however, request the verification of the eligibility of any particular underlying exposure where they are not satisfied with the sample-basis verification.

The originator shall include a commitment in the transaction documentation to provide the third-party verification agent with all the information necessary to verify the requirements set out in the first subparagraph.

5.   The originator may not terminate a transaction prior to its scheduled maturity for any other reason than any of the following events:

(a) the insolvency of the investor;

(b) the investor’s failures to pay any amounts due under the credit protection agreement or a breach by the investor of any material obligation laid down in the transaction documents;

(c) relevant regulatory events, including:

(i) relevant changes in Union or national law, relevant changes by competent authorities to officially published interpretations of such laws, where applicable, or relevant changes in the taxation or accounting treatment of the transaction that have a material adverse effect on the economic efficiency of a transaction, in each case compared with that anticipated at the time of entering into the transaction and which could not reasonably be expected at that time;

(ii) a determination by a competent authority that the originator or any affiliate of the originator is not or is no longer permitted to recognise significant credit risk transfer in accordance with Article 245(2) or (3) of Regulation  (EU) No 575/2013 [CRR] in respect of the securitisation;

(d) the exercise of an option to call the transaction at a given point in time (time call), when the time period measured from the closing date of the transaction is equal to or greater than the weighted average life of the initial reference portfolio at the closing date of the transaction;

(e) the exercise of a clean-up call option as defined in point (1) of Article 242 of Regulation  (EU) No 575/2013 [CRR];

(f) in the case of unfunded credit protection, the investor no longer qualifies as an eligible protection provider in accordance with the requirements set out in paragraph 8.

The transaction documentation shall specify whether any of the call rights referred to in points (d) and (e) are included in the transaction concerned and how such call rights are structured.

For the purposes of point (d), the time call shall not be structured to avoid allocating losses to credit enhancement positions or other positions held by investors and shall not be otherwise structured to provide credit enhancement.

Where the time call is exercised, originators shall notify competent authorities how the requirements referred to in the second and third subparagraphs are fulfilled, including with a justification of the use of the time call and a plausible account showing that the reason to exercise the call is not a deterioration in the quality of the underlying assets.

In the case of funded credit protection, upon termination of the credit protection agreement, collateral shall be returned to investors in order of the seniority of the tranches subject to the provisions of the relevant insolvency law, as applicable to the originator.

6.   Investors may not terminate a transaction prior to its scheduled maturity for any other reason than a failure to pay the credit protection premium or any other material breach of contractual obligations by the originator.

7   The originator may commit synthetic excess spread, which shall be available as credit enhancement for the investors, where all of the following conditions are met:

(a) the amount of the synthetic excess spread that the originator commits to using as credit enhancement at each payment period is specified in the transaction documentation and expressed as a fixed percentage of the total outstanding portfolio balance at the start of the relevant payment period (fixed synthetic excess spread);

(b) the synthetic excess spread which is not used to cover credit losses that materialise during each payment period shall be returned to the originator;

(c) for originators using the IRB Approach referred to in Article 143 of Regulation (EU) No 575/2013 [CRR], the total committed amount per year shall not be higher than the one-year regulatory expected loss amounts on all underlying exposures for that year, calculated in accordance with Article 158 of that Regulation;

(d) for originators not using the IRB Approach referred to in Article 143 of Regulation (EU) No 575/2013 [CRR], the calculation of the one-year expected loss of the underlying portfolio shall be clearly determined in the transaction documentation;

(e) the transaction documentation specifies the conditions laid down in this paragraph.

8.   A credit protection agreement shall take the form of:

(a) a guarantee meeting the requirements set out in Chapter 4 of Title II of Part Three of Regulation  (EU) No 575/2013 [CRR], by which the credit risk is transferred to any of the entities listed in points (a) to (d) of Article 214(2) of Regulation  (EU) No 575/2013 [CRR], provided that the exposures to the investor qualify for a 0 % risk weight under Chapter 2 of Title II of Part Three of that Regulation;

(b) a guarantee meeting the requirements set out in Chapter 4 of Title II of Part Three of Regulation  (EU) No 575/2013 [CRR], which benefits from a counter-guarantee of any of the entities referred to in point (a) of this paragraph; or

(c) another credit protection not referred to in points (a) and (b) of this paragraph in the form of a guarantee, a credit derivative or a credit linked note that meets the requirements set out in Article 249 of Regulation  (EU) No 575/2013 [CRR], provided that the obligations of the investor are secured by collateral meeting the requirements laid down in paragraphs 9 and 10 of this Article.

9.   Another credit protection referred to in point (c) of paragraph 8 shall meet the following requirements:

(a) the right of the originator to use the collateral to meet protection payment obligations of the investors is enforceable and the enforceability of that right is ensured through appropriate collateral arrangements;

(b) the right of the investors, when the securitisation is unwound or as the tranches amortise, to return any collateral that has not been used to meet protection payments is enforceable;

(c) where the collateral is invested in securities, the transaction documentation sets out the eligibility criteria and custody arrangement for such securities.

The transaction documentation shall specify whether investors remain exposed to the credit risk of the originator.

The originator shall obtain an opinion from a qualified legal counsel confirming the enforceability of the credit protection in all relevant jurisdictions.

10.   Where another credit protection is provided in accordance with point (c) of paragraph 8 of this Article, the originator and the investor shall have recourse to high-quality collateral, which shall be either of the following:

(a)  collateral in the form of 0 % risk-weighted debt securities referred to in Chapter 2 of Title II of Part Three of Regulation  (EU) No 575/2013 [CRR] that meet all of the following conditions:

(i) those debt securities have a remaining maximum maturity of three months which shall be no longer than the remaining period up to the next payment date;

(ii) those debt securities can be redeemed into cash in an amount equal to the outstanding balance of the protected tranche;

(iii) those debt securities are held by a custodian independent of the originator and the investors;

(b) collateral in the form of cash held with a third-party credit institution with credit quality step 3 or above in line with the mapping set out in Article 136 of Regulation  (EU) No 575/2013 [CRR].

By way of derogation from the first subparagraph of this paragraph, subject to the explicit consent in the final transaction documentation by the investor after having conducted its due diligence according to Article 5 of this Regulation, including an assessment of any relevant counterparty credit risk exposure, only the originator may have recourse to high quality collateral in the form of cash on deposit with the originator, or one of its affiliates, if the originator or one of its affiliates qualifies as a minim um for credit quality step 2 in line with the mapping set out in Article 136 of Regulation  (EU) No 575/2013 [CRR].

The competent authorities designated pursuant to Article 29(5) may, after consulting EBA, allow collateral in the form of cash on deposit with the originator, or one of its affiliates, if the originator or one of its affiliates qualifies for credit quality step 3 provided that market difficulties, objective impediments related to the credit quality step assigned to the Member State of the institution or significant potential concentration problems in the Member State concerned due to the application of the minimum credit quality step 2 requirement referred to in the second subparagraph can be documented.

Where the third-party credit institution or the originator or one of its affiliates no longer qualifies for the minimum credit quality step, the collateral shall be transferred within nine months to a third-party credit institution with credit quality step 3 or above or the collateral shall be invested in securities meeting the criteria laid down in point (a) of the first subparagraph.

The requirements set out in this paragraph shall be deemed satisfied in the case of investments in credit linked notes issued by the originator, in accordance with Article 218 of Regulation  (EU) No 575/2013 [CRR].

EBA shall monitor the application of the collateralisation practices under this Article, paying particular attention to the counterparty credit risk and other economic and financial risks borne by investors resulting from such collateralisation practices.

EBA shall submit a report on its findings to the Commission by 10 April 2023.

By 10 October 2023, the Commission shall, on the basis of that EBA report submit a report to the European Parliament and to the Council on the application of this Article with particular regard to the risk of excessive build-up of counterparty credit risk in the financial system, together with a legislative proposal for amending this Article, if appropriate.]

Article 27

Section 3

STS notification

STS notification requirements

[EU version:

Originators and sponsors shall jointly notify ESMA by means of the template referred to in paragraph 7 of this Article where a securitisation meets the requirements set out in Articles 19 to 22, Articles 23 to 26 or Articles 26a to 26e (“STS notification”). In the case of an ABCP programme, only the sponsor shall be responsible for the notification of that programme and, within that programme, of the ABCP transactions complying with Article 24. In the case of synthetic securitisation, only the originator shall be responsible for the notification.

The STS notification shall include an explanation by the originator and sponsor of how the STS criteria set out in Articles 20 to 22, Articles 24 to 26 or Articles 26b to 26e have been complied with.

ESMA shall publish the STS notification on its official website pursuant to paragraph 5. Originators and sponsors of a securitisation shall inform their competent authorities of the STS notification and designate amongst themselves one entity to be the first contact point for investors and competent authorities.]

[UK version:  

1.  Where a securitisation which is not an ABCP programme or an ABCP transaction meets the requirements of Articles 19 to 22, the originator and sponsor involved in the securitisation must jointly notify the FCA of that fact by means of the template referred to  in paragraph 7 of this Article.

Where an ABCP programme meets the requirements of Articles 23 to 26, or an ABCP  transaction meets the requirements of Article 24, the sponsor involved in the programme must notify the FCA of that fact by means of the template referred to in paragraph 7 of this Article.

A notice given in accordance with the first or second subparagraph (‘STS notification’) must include an explanation of how the relevant STS criteria set out in Articles 20 to 22 or,  as the case may be, Articles 24 to 26 have been complied with.  The FCA must publish the STS notification on its official website pursuant to paragraph 5.  Where the STS notification is given jointly by the originator and sponsor involved in a securitisation, the STS notification must designate one of them to be the first contact point for investors and the FCA.

2.  [EU versionThe originator, sponsor or SSPE may use the service of a third party authorised under Article 28 to assess whether a securitisation complies with Articles 19 to 22, Articles 23 to 26 or Articles 26a to 26e.]  [UK version:  The originator, sponsor or SSPE may use the service of a third party authorised under Article 28 to check whether a securitisation complies with Articles 19 to 22 or Articles 23 to 26.]  However, the use of such a service shall not, under any circumstances, affect the liability of the originator, sponsor or SSPE in respect of their legal obligations under this Regulation. The use of such service shall not affect the obligations imposed on institutional investors as set out in Article 5.

[EU versionWhere the originator, sponsor or SSPE uses the service of a third party authorised pursuant to Article 28 to assess whether a securitisation complies with Articles 19 to 22, Articles 23 to 26 or Articles 26a to 26e, the STS notification shall include a statement that compliance with the STS criteria was confirmed by that authorised third party.]  [UK version:  Where the originator, sponsor or SSPE use the service of a third party authorised pursuant to Article 28 to assess whether a securitisation complies with Articles 19 to 22 or Articles 23 to 26, the STS notification shall include a statement that compliance with the STS criteria was confirmed by that authorised third party.]   The notification shall include the name of the authorised third party, [EU version:  its place of establishment and the name of the competent authority that authorised it] [UK version:  and its place of establishment].

3.  Where the originator or original lender is not a credit institution or investment firm, as defined in points (1) and (2) of Article 4(1) of Regulation (EU) No 575/2013 [CRR], established in the [EU version: Union] [UK version:  United Kingdom], the notification pursuant to paragraph 1 of this Article shall be accompanied by the following:

(a)  confirmation by the originator or original lender that its credit-granting is done on the basis of sound and well-defined criteria and clearly established processes for approving, amending, renewing and financing credits and that the originator or original lender has effective systems in place to apply such processes in accordance with Article 9 of this Regulation; and

(b)  a declaration by the originator or original lender as to whether credit granting referred to in point (a) is subject to supervision.

[UK version:  4.  The originator and sponsor shall immediately notify [EU version:  ESMA and inform their competent authority] [UK version: the FCA] when a securitisation no longer meets the requirements of either Articles 19 to 22 or Articles 23 to 26.]

[EU version4.   The originator and, where applicable, sponsor, shall immediately notify ESMA and inform their competent authority when a securitisation no longer meets the requirements set out in Articles 19 to 22, Articles 23 to 26, or Articles 26a to 26e.]

[EU version:  

5.  ESMA shall maintain, on its official website, a list of all securitisations which the originators and sponsors have notified it of meeting the requirements set out in Articles 19 to 22, Articles 23 to 26, or Articles 26a to 26e.  ESMA shall add each securitisation so notified to that list immediately and shall update the list where the securitisations are no longer considered to be STS following a decision of competent authorities or a notification by the originator or sponsor. Where the competent authority has imposed administrative sanctions in accordance with Article 32, it shall notify ESMA thereof immediately. ESMA shall  immediately indicate on the list that a competent authority has imposed administrative sanctions in relation to the securitisation concerned.]

[UK version:  

5. The FCA must maintain on its official website a list of all securitisations notified to it as meeting the requirements of Articles 19 to 22 or Articles 23 to 26. The FCA must add each securitisation so notified to that list immediately and must update the list where a securitisation is no longer considered to be STS following a decision of the FCA or a notification by the originator or sponsor concerned.

Where the PRA or the Pensions Regulator, acting as the competent authority, has imposed a relevant sanction in relation to a securitisation, it must notify the FCA of that fact immediately. Where a competent authority has imposed a relevant sanction in relation to a securitisation, the FCA must immediately indicate that fact in relation to the securitisation concerned on the list which it maintains in accordance with the first subparagraph.

In the second subparagraph ‘relevant sanction’ means any sanction imposed or other measure taken where by reason of any act or failure, whether intentional or through negligence - 

(a)  an originator, sponsor or original lender fails to meet the requirements set out in Article 6;

(b)  an originator, sponsor or original lender fails to meet the criteria set out in Article 9;

(c)  an originator, sponsor or SSPE fails to meet the requirements set out in Article 7 or 18;

(d)  a securitisation is designated as STS and an originator, sponsor or SSPE of that securitisation fails to meet the requirements set out in Article 19 to 22 or Articles 23 to 26;

(e)  an originator or sponsor makes a notification pursuant to Article 27(1) which is misleading;

(f)  an originator or sponsor fails to meet the requirements set out in Article 27(4); or 

(g)  a third party authorised pursuant to Article 28 fails to notify a material change to the information provided pursuant to Article 28(1), including any change which could reasonably be considered to affect the competent authority’s assessment of the third party’s competence to assess STS compliance.]

6.  [EU version:  ESMA, in close cooperation with the EBA and EIOPA, shall develop draft regulatory] [UK version: The FCA shall make] technical standards specifying the information that the originator, sponsor and SSPE are required to provide in order to comply with the obligations referred to in paragraph 1.

[EU version only:  ESMA shall submit those draft regulatory technical standards to the Commission by 10 October 2021.]

[EU version only:  The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.]

7.  In order to ensure uniform conditions for the implementation of this Regulation, [EU version:  ESMA, in close cooperation with the EBA and EIOPA, shall develop draft implementing] [UK version: The FCA may make] technical standards to establish the templates to be used for the provision of the information referred to in paragraph 6.

[EU version only:  ESMA shall submit those draft implementing technical standards to the Commission by 10 October 2021.]

[EU version only:  Power is conferred on the Commission to adopt the implementing technical standards referred to in this paragraph in accordance with Article 15 of Regulation (EU) No 1095/2010.]

Article 28

Third party verifying STS compliance

1. [EU versionA third party as referred to in Article 27(2) shall be authorised by the competent authority to assess the compliance of securitisations with the STS criteria provided for in Articles 19 to 22, Articles 23 to 26, or Articles 26a to 26e.]  [UK version:  A third party referred to in Article 27(2) shall be authorised by the FCA to assess the compliance of securitisations with the STS criteria provided for in Articles 19 to 22 or Articles 23 to 26.]  The [EU version:  competent authority] [UK version:  FCA] shall grant the authorisation if the following conditions are met:

(a)  the third party only charges non-discriminatory and cost-based fees to the originators, sponsors or SSPEs involved in the securitisations which the third party assesses without differentiating fees depending on, or correlated to, the results of its assessment;

(b)  the third party is neither a regulated entity as defined in point (4) of Article 2 of Directive 2002/87/EC [Financial Conglomerates Directive] nor a credit rating agency as defined in [EU version only:  point (b) of] Article 3(1) of Regulation (EC) No 1060/2009 [Credit Rating Agencies Regulation], and the performance of the third party’s other activities does not compromise the independence or integrity of its assessment;

(c)  the third party shall not provide any form of advisory, audit or equivalent service to the originator, sponsor or SSPE involved in the securitisations which the third party assesses;

(d)  the members of the management body of the third party have professional qualifications, knowledge and experience that are adequate for the task of the third party and they are of good repute and integrity;

(e)  the management body of the third party includes at least one third, but no fewer than two, independent directors;

(f)  the third party takes all necessary steps to ensure that the verification of STS compliance is not affected by any existing or potential conflicts of interest or business relationship involving the third party, its shareholders or members, managers, employees or any other natural person whose services are placed at the disposal or under the control of the third party. To that end, the third party shall establish, maintain, enforce and document an effective internal control system governing the implementation of policies and procedures to identify and prevent potential conflicts of interest. Potential or existing conflicts of interest which have been identified shall be eliminated or mitigated and disclosed without delay. The third party shall establish, maintain, enforce and document adequate procedures and processes to ensure the independence of the assessment of STS compliance. The third party shall periodically monitor and review those policies and procedures in order to evaluate their effectiveness and assess whether it is necessary to update them; and

(g)  the third party can demonstrate that it has proper operational safeguards and internal processes that enable it to assess STS compliance.

The [EU version:  competent authority] [UK version:  FCA] shall withdraw the authorisation when it considers the third party to be materially non-compliant with the first subparagraph.

2.  A third party authorised in accordance with paragraph 1 shall notify [EU version:  its competent authority] [UK version:  the FCA] without delay of any material changes to the information provided under that paragraph, or any other changes that could reasonably be considered to affect the assessment of [EU version:  its competent authority] [UK version:  the FCA].

3.  [EU version:  The competent authority] [UK version:  The FCA] may charge cost-based fees to the third party referred to in paragraph 1, in order to cover necessary expenditure relating to the assessment of applications for authorisation and to the subsequent monitoring of compliance with the conditions set out in paragraph 1.

4.  [EU version:  ESMA shall develop draft regulatory] [UK version: the FCA may make]  technical standards specifying the information to be provided to [EU version:  the competent authorities] [[UK version:  it] in the application for the authorisation of a third party in accordance with paragraph 1.

[EU version only:  ESMA shall submit those draft regulatory technical standards to the Commission by 18 July 2018.]

[EU version only:  The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.]

A third party can obtain authorisation under Article 28 if it meets the criteria, and is happy with the degree of supervision (which is a "light touch").  Three have been successful - the UK-based PCS, and Germany's True Sale International and STS Verification International, and have been involved in many of the STS issues done since 1st January 2019, but the sponsor, issuer or originator cannot devolve its responsibility for ensuring that the STS label is properly applied, because the ECB was always concerned about moral hazard, and the Commission was concerned not to recreate a pre-crisis kind of over-reliance on external credit rating agencies, with insufficient levels of investor due diligence.  Article 46(g) itemises it as a topic for the EC to cover in its review, due by 1st January 2022.  

Chapter 5

Supervision

Article 29

Designation of competent authorities

[EU version:  

1.  Compliance with the obligations set out in Article 5 of this Regulation shall be  upervised by the following competent authorities in accordance with the powers granted by the relevant legal acts:

(a)  for insurance and reinsurance undertakings, the competent authority designated in accordance with point (10) of Article 13 of Directive 2009/138/EC [Solvency II] ;

(b)  for alternative investment fund managers, the competent authority responsible designated in accordance with Article 44 of 2011/61/EU [AIFM Directive];

(c)  for UCITS and UCITS management companies, the competent authority designated in accordance with Article 97 of Directive 2009/65/EC [UCITS Directive];

(d)  for institutions for occupational retirement provision, the competent authority designated in accordance with point (g) of Article 6 of Directive 2003/41/EC of the European Parliament and of the Council (33);

(e)  for credit institutions or investments firms, the competent authority designated in accordance with Article 4 of Directive 2013/36/EU [CRD IV], including the ECB with regard to specific tasks conferred on it by Regulation (EU) No 1024/2013.

2.  Competent authorities responsible for the supervision of sponsors in accordance with Article 4 of Directive 2013/36/EU [CRD IV], including the ECB with regard to specific tasks conferred on it by Regulation (EU) No 1024/2013, shall supervise compliance by sponsors with the obligations set out in Articles 6, 7, 8 and 9 of this Regulation.

3.  Where originators, original lenders and SSPEs are supervised entities in accordance with Directives 2003/41/EC, 2009/138/EC [Solvency II] , 2009/65/EC [UCITS Directive],  2011/61/EU [AIFM Directive] and 2013/36/EU [CRD IV] and Regulation (EU) No 1024/2013, the relevant competent authorities designated according to those acts, including the ECB with regard to specific tasks conferred on it by Regulation (EU) No 1024/2013, shall supervise compliance with the obligations set out in Articles 6, 7, 8 and 9 of this Regulation.]

[UK version: 

1.  Compliance with the obligations set out in Article 5 of this Regulation is to be supervised as follows - 

(a)  where the institutional investor is an insurance undertaking or a reinsurance undertaking, by the PRA; 

(b)  where the institutional investor is an AIFM which markets or manages AIFs in the United Kingdom, by the FCA;

(c)  where the institutional investor is a management company or a UCITS which is an authorised open ended investment company as defined in section 237(3) of the 2000 Act, by the FCA; 

(d)  where the institutional investor is an occupational pension scheme, by the  pensions Regulator;

(e)  where the institutional investor is a CRR firm - 

(i)  by the PRA, if the investor is a PRA-authorised person;

(ii)  in any other case by the FCA.

2.  Compliance by a sponsor with the obligations set out in Articles 6, 7, 8 and 9 of this Regulation is to be supervised by the PRA, if the sponsor is a PRA-authorised person, and in any other case by the FCA.

3.  Paragraph 3A applies where an originator, original lender or SSPE is an insurance undertaking or a reinsurance undertaking, an AIFM, a management company, a UCITS which is an authorised open ended investment company, an institution for occupational retirement provision or a CRR firm.

3A.  Where this paragraph applies, compliance with the obligations set out in Articles 6, 7, 8 and 9 of this Regulation is to be supervised as follows - 

(a)  where the originator, original lender or SSPE is a PRA-authorised person, by the PRA;

(b)  where the originator, original lender or SSPE is an institution for occupational retirement provision, by the Pensions Regulator; and

(c)  in any other case by the FCA.

3B. In paragraphs (1) to (3A) -

(a)  ‘AIF’ and AIFM’ have the meaning given in regulations 3 and 4(1) of the Alternative Investment Fund Managers Regulation 2013;

(b) ‘CRR firm’ has the meaning given by Article 4(1)(2A) of Regulation (EU) No 575/2013

(c)  ‘occupational pension scheme’ has the meaning given in section 1(1) of the Pension Schemes Act 1993; 

(d)  ‘insurance undertaking’, ‘reinsurance undertaking’ and ‘PRA-authorised person’ have the meaning given in section 417(1) of the 2000 Act;

(e)  ‘management company’ has the meaning given in section 237(2) of the 2000 Act; and

(f)  ‘UCITS’ has the meaning given in section 236A of the 2000 Act.]

4.  For originators, original lenders and SSPEs established in [EU version:  the Union and not covered by the Union legislative acts referred to in paragraph 3, Member States] [UK version:  United Kingdom in relation to which paragraph 3A does not apply, the Treasury] shall designate one or more competent authorities to supervise compliance with the obligations set out in Articles 6, 7, 8 and 9.  [EU version only:  Member States shall inform the Commission and ESMA of the designation of competent authorities pursuant to this paragraph by 1 January 2019.]  That obligation shall not apply with regard to those entities that are merely selling exposures under an ABCP programme or another securitisation transaction or scheme and are not actively originating exposures for the primary purpose of securitising them on a regular basis.

5.  [EU version:  Member States] [ UK version:  The Treasury] shall designate one or more competent authorities to supervise the compliance of originators, sponsors and SSPEs with Articles 18 to 27, and the compliance of third parties with Article 28.  [EU versionMember States shall inform the Commission and ESMA of the designation of competent authorities pursuant to this paragraph by 10 October 2021. Until the designation of a competent authority to supervise the compliance with the requirements set out in Articles 26a to 26e, the competent authority designated to supervise the compliance with the requirements set out in Articles 18 to 27 applicable at 8 April 2021 shall also supervise the compliance with the requirements set out in Articles 26a to 26e.]

 

6.  Paragraph 5 of this Article shall not apply with regard to those entities that are merely selling exposures under an ABCP programme or other securitisation transaction or scheme and are not actively originating exposures for the primary purpose of securitising them on a regular basis. In such a case, the originator or sponsor shall verify that those entities fulfil the relevant obligations set out in Articles 18 to 27.

[EU verson only: 

7.  ESMA shall ensure the consistent application and enforcement of the obligations set out in Articles 18 to 27 of this Regulation in accordance with the tasks and powers set out in Regulation (EU) No 1095/2010. ESMA shall monitor the Union securitisation market in accordance with Article 39 of Regulation (EU) No 600/2014 of the European Parliament and the Council(34) and apply, where appropriate, its temporary intervention powers in accordance with Article 40 of Regulation (EU) No 600/2014.

8.  ESMA shall publish and keep up-to-date on its website a list of the competent authorities referred to in this Article.]

Article 30

Powers of the competent authorities

[EU version only:  1.  Each Member State shall ensure that the competent authority designated in accordance with Article 29(1) to (5) has the supervisory, investigatory and sanctioning powers necessary to fulfil its duties under this Regulation.]

2.  [EU version:  The competent authority] [UK version:  Competent authorities] shall regularly review the arrangements, processes and mechanisms that originators, sponsors, SSPEs and original lenders have implemented in order to comply with this Regulation.

The review referred to in the first subparagraph shall include:

[UK version:  (a)  the processes and mechanisms to correctly measure and retain the material net economic interest on an ongoing basis, the gathering and timely disclosure of all information to be made available in accordance with Article 7 and the credit-granting criteria in accordance with Article 9;]

[EU version(a)       the processes and mechanisms to correctly measure and retain the material net economic interest on an ongoing basis in accordance with Article 6(1) and the gathering and timely disclosure of all information to be made available in accordance with Article 7;]

[EU version only

(aa)     for exposures that are not part of an NPE Securitisation:

(i)            the credit-granting criteria applied to performing exposures in accordance with Article 9;

(ii)           the sound standards for selection and pricing applied to underlying exposures that are non-performing exposures as referred to in the second subparagraph of Article 9(1);]

(b)  for STS securitisations which are not securitisations within an ABCP programme, the processes and mechanisms to ensure compliance with Article 20(7) to (12), Article 21(7), and Article 22; and

(c)  for STS securitisations which are securitisations within an ABCP programme, the processes and mechanisms to ensure, with regard to ABCP transactions, compliance with Article 24 and, with regard to ABCP programmes, compliance with Article 26(7) and (8).

[EU version only:  (d)       for NPE securitisations, the processes and mechanisms to ensure compliance with Article 9(1) preventing any abuse of the derogation provided for in the second subparagraph of Article 9(1);

(e)          for STS on-balance-sheet securitisations, the processes and mechanisms to ensure compliance with Articles 26b to 26e.]

3.  Competent authorities shall require that risks arising from securitisation transactions, including reputational risks, are evaluated and addressed through appropriate policies and procedures of originators, sponsors, SSPEs and original lenders.

4.  [EU version:  The competent authority] [UK version:  Competent authorities] shall monitor, as applicable, the specific effects that the participation in the securitisation market has on the stability of the financial institution that operates as original lender, originator, sponsor or investor as part of its prudential supervision in the field of securitisation, taking into account, without prejudice to stricter sectoral regulation:

(a)  the size of capital buffers;

(b)  the size of the liquidity buffers; and

(c)  the liquidity risk for investors due to a maturity mismatch between their funding and investments.

[EU version:  In cases where the competent authority identifies a material risk to financial stability of a financial institution or the financial system as a whole, irrespective of its obligations under Article 36, it shall take action to mitigate those risks, report its findings to the designated authority competent for macroprudential instruments under Regulation (EU) No 575/2013 [CRR] and the ESRB.]

[UK version:  Where a competent authority identifies a material risk to the financial stability of a financial institution or to the financial system as a whole, it must take action to mitigate those risks and, unless it is the PRA, report its findings to the Bank of England.]

[EU version:  5.  The competent authority shall monitor any possible circumvention of the obligations set out in Article 6(2) and ensure that sanctions are applied in accordance with Articles 32 and 33.]

[UK version:  5.  Competent authorities shall monitor any suspected circumvention of the obligations set out in Article 6(2) and ensure that sanctions are applied for a  circumvention.]

Article 31

[EU version only: 

Macroprudential oversight of the securitisation market

 

Within the limits of its mandate, the ESRB shall be responsible for the macroprudential oversight of the Union’s securitisation market.

In order to contribute to the prevention or mitigation of systemic risks to financial stability in the Union that arise from developments within the financial system and taking into account macroeconomic developments, so as to avoid periods of widespread financial distress, the ESRB shall continuously monitor developments in the securitisation markets. Where the ESRB considers it necessary, and at least every three years, the ESRB shall, in cooperation with EBA, publish a report on the financial stability implications of the securitisation market in order to highlight financial stability risks.

Without prejudice to paragraph 2 of this Article and to the report referred to in Article 44, the ESRB shall, in close cooperation with the ESAs, publish by 31 December 2022 a report assessing the impact of the introduction of STS on-balance-sheet securitisations on financial stability, and any potential systemic risks, such as risks created by concentration and inter-connectedness among non-public credit protection sellers.

The ESRB report referred to in the first subparagraph shall take into account the specific features of synthetic securitisation, namely its typical bespoke and private character in financial markets, and examine whether the treatment of STS on-balance-sheet securitisation is conducive to overall risk reduction in the financial system and to better financing of the real economy.

When preparing its report, the ESRB shall use a variety of relevant data sources, such as:

(a)          data collected by competent authorities in accordance with Article 7(1);

(b)          the outcome of reviews carried out by competent authorities in accordance with Article 30(2); and

(c)           data held in securitisation repositories in accordance with Article 10.

In accordance with Article 16 of Regulation (EU) No 1092/2010, the ESRB shall provide warnings and, where appropriate, issue recommendations for remedial action in response to the risks referred to in paragraphs 2 and 3 of this Article, including on the appropriateness of modifying the risk-retention levels, or other macroprudential measures.

Within three months of the date of transmission of the recommendation, the addressee of the recommendation shall, in accordance with Article 17 of Regulation (EU) No 1092/2010, communicate to the European Parliament, the Council, the Commission and the ESRB the actions it has taken in response to the recommendation and shall provide adequate justification for any inaction.]

Article 32

[EU version only:  

Administrative sanctions and remedial measures

1.  Without prejudice to the right for Member States to provide for and impose criminal sanctions pursuant to Article 34, Member States shall lay down rules establishing appropriate administrative sanctions, in the case of negligence or intentional infringement, and remedial measures, applicable at least to situations where:

(a)  an originator, sponsor or original lender has failed to meet the requirements provided for in Article 6;

(b)  an originator, sponsor or SSPE has failed to meet the requirements provided for in Article 7;

(c)  an originator, sponsor or original lender has failed to meet the criteria provided for in Article 9;

(d)  an originator, sponsor or SSPE has failed to meet the requirements provided for in Article 18;

[UK version:  (e)  a securitisation is designated as STS and an originator, sponsor or SSPE of that securitisation has failed to meet the requirements provided for in Articles 19 to 22 or Articles 23 to 26;]

[EU version:  (e)  a securitisation is designated as STS and an originator, sponsor or SSPE of that securitisation has failed to meet the requirements provided for in Articles 19 to 22, Articles 23 to 26 or Articles 26a to 26e;]

(f)  an originator or sponsor makes a misleading notification pursuant to Article 27(1);

(g)  an originator or sponsor has failed to meet the requirements provided for in Article 27(4); or

(h)  a third party authorised pursuant to Article 28 has failed to notify material changes to the information provided in accordance with Article 28(1), or any other changes that could reasonably be considered to affect the assessment of its competent authority.

Member States shall also ensure that administrative sanctions and/or remedial measures are effectively implemented.

Those sanctions and measures shall be effective, proportionate and dissuasive.

2.  Member States shall confer on competent authorities the power to apply at least the following sanctions and measures in the event of the infringements referred to in paragraph 1:

(a)  a public statement which indicates the identity of the natural or legal person and the nature of the infringement in accordance with Article 37;

(b)  an order requiring the natural or legal person to cease the conduct and to desist from a repetition of that conduct;

(c)  a temporary ban preventing any member of the originator’s, sponsor’s or SSPE’s management body or any other natural person held responsible for the infringement from exercising management functions in such undertakings;

[UK version:  (d)  in the case of an infringement as referred to in point (e) or (f) of the first subparagraph of paragraph 1 of this Article a temporary ban preventing the originator and sponsor from notifying under Article 27(1) that a securitisation meets the requirements set out in Articles 19 to 22 or Articles 23 to 26;]

[EU version(d)       in the case of an infringement as referred to in point (e) or (f) of the first subparagraph of paragraph 1 of this Article, a temporary ban preventing the originator and sponsor from notifying under Article 27(1) that a securitisation meets the requirements set out in Articles 19 to 22, Articles 23 to 26 or Articles 26a to 26e;]

(e)  in the case of a natural person, maximum administrative pecuniary sanctions of at least EUR 5 000 000 or, in the Member States whose currency is not the euro, the corresponding value in the national currency on 17 January 2018;

(f)  in the case of a legal person, maximum administrative pecuniary sanctions of at least EUR 5 000 000, or in the Member States whose currency is not the euro, the corresponding value in the national currency on 17 January 2018 or of up to 10 % of the total annual net turnover of the legal person according to the last available accounts approved by the management body; where the legal person is a parent undertaking or a subsidiary of the parent undertaking which has to prepare consolidated financial accounts in accordance with Directive 2013/34/EU of the European Parliament and of the Council (35), the relevant total annual net turnover shall be the total net annual turnover or the corresponding type of income in accordance with the relevant accounting legislative acts according to the last available consolidated accounts approved by the management body of the ultimate parent undertaking;

(g)  maximum administrative pecuniary sanctions of at least twice the amount of the benefit derived from the infringement where that benefit can be determined, even if that exceeds the maximum amounts in points (e) and (f);

[UK version:  (h)  in the case of an infringement as referred to in point (h) of the first subparagraph of paragraph 1 of this Article, a temporary withdrawal of the authorisation referred to in Article 28 for the third party authorised to check the compliance of a securitisation with Articles 19 to 22 or Articles 23 to 26.]

[EU version(h)  in the case of an infringement as referred to in point (h) of the first subparagraph of paragraph 1 of this Article, a temporary withdrawal of the authorisation referred to in Article 28 for the third party authorised to assess the compliance of a securitisation with Articles 19 to 22, Articles 23 to 26 or Articles 26a to 26e.]

3.  Where the provisions referred to in the first paragraph apply to legal persons, Member States shall confer on competent authorities the power to apply the administrative sanctions and remedial measures set out in paragraph 2, subject to the conditions provided for in national law, to members of the management body, and to other individuals who under national law are responsible for the infringement.

4.  Member States shall ensure that any decision imposing administrative sanctions or remedial measures set out in paragraph 2 is properly reasoned and is subject to a right of appeal.]

References

Articles 32-34 contemplate local regulators having powers to impose sanctions, including fines of up to 10% of total annual net turnover, for breach of the Securitisation Regulation requirements, on originators, original lenders, sponsors and SSPEs which fail to comply with their various obligations in the Securitisation Regulation.   Sanctions must be published; the identity of the contravening party may be withheld if the authority so determines.

No similar sanctions apply in relation to arguably-similar financings such as covered bonds.  The approach is doubtless intended to concentrate the minds of management, and is likely to encourage a cautious approach.  There is a concern that they may actually create discouragement, even though Article 33(2) helpfully directs competent authorities determining the type and level of a sanction or a remedial measure to take into account criteria, including the gravity of the infringement, the degree of responsibility of any person concerned, whether it caused any loss, whether this was a first offence or not, and so on.

Sanctions are required to be laid down only for “negligence or intentional infringement” - a symbolic industry victory, as this was not found in earlier drafts of the Securitisation Regulation (but even on the old wording an innocent infringement could and presumably would have been lightly punished, or not at all, since Article 32(1) has in all its incarnations required any fines to be “proportionate”, and Article 33(2) requires authorities to consider the gravity of any infringement).  Perhaps of more practical benefit is that, whilst supervisors have the power to apply fines, the maximum fines are less severe than the European Parliament had proposed.  Article 36(3) contemplates a committee to be set up by the European Supervisory Authorities to co-ordinate the approach to be taken by national regulators.

Some evidence that "negligence" has a wider meaning here than English lawyers might conclude can be found by reference to the case of the five banks fined by ESMA in 2018 for issuing credit ratings without being authorised under the CRA Regulation.  The banks appealed, and in March 2019 it was announced they had acted "non-negligently" because they had not realised they were in breach; i.e. their ignorance of the regulation was a defence.

For institutional investors which breach the Article 5 due diligence rerquirements, the sanction is to be found in the new Article 270a of the CRR, which imposes additional risk weights against the relevant holdings.

Article 33

[EU version only:

Exercise of the power to impose administrative sanctions and remedial measures

1.  Competent authorities shall exercise the powers to impose administrative sanctions and remedial measures referred to in Article 32 in accordance with their national legal frameworks, as appropriate:

(a)  directly;

(b)  in collaboration with other authorities;

(c)  under their responsibility by delegation to other authorities;

(d)  by application to the competent judicial authorities.

2.  Competent authorities, when determining the type and level of an administrative sanction or remedial measure imposed under Article 32, shall take into account the extent to which the infringement is intentional or results from negligence and all other relevant circumstances, including, where appropriate:

(a)  the materiality, gravity and the duration of the infringement;

(b)  the degree of responsibility of the natural or legal person responsible for the infringement;

(c)  the financial strength of the responsible natural or legal person;

(d)  the importance of profits gained or losses avoided by the responsible natural or legal person, insofar as they can be determined;

(e)  the losses for third parties caused by the infringement, insofar as they can be determined;

(f)  the level of cooperation of the responsible natural or legal person with the competent authority, without prejudice to the need to ensure disgorgement of profits gained or losses avoided by that person;

(g)  previous infringements by the responsible natural or legal person.]

Article 34

[EU version only:

Criminal sanctions

1.  Member States may decide not to lay down rules for administrative sanctions or remedial measures for infringements which are subject to criminal sanctions under their national law.

2.  Where Member States have chosen, in accordance with paragraph 1 of this Article, to lay down criminal sanctions for the infringement referred to in Article 32(1), they shall ensure that appropriate measures are in place so that competent authorities have all the necessary powers to liaise with judicial, prosecuting, or criminal justice authorities within their jurisdiction to receive specific information related to criminal investigations or proceedings commenced for the infringements referred to in Article 32(1), and to provide the same information to other competent authorities as well as ESMA, the EBA and EIOPA to fulfil their obligation to cooperate for the purposes of this Regulation.]

Article 35

[EU version only:

Notification duties

Member States shall notify the laws, regulations and administrative provisions implementing this Chapter, including any relevant criminal law provisions, to the Commission, ESMA, the EBA and EIOPA by 18 January 2019. Member States shall notify the Commission, ESMA, the EBA and EIOPA without undue delay of any subsequent amendments thereto.]

Article 36

[EU version only:

Cooperation between competent authorities and the ESAs

1.  The competent authorities referred to in Article 29 and ESMA, the EBA and EIOPA shall cooperate closely with each other and exchange information to carry out their duties pursuant to Article 30 to 34.

2.  Competent authorities shall closely coordinate their supervision in order to identify and remedy infringements of this Regulation, develop and promote best practices, facilitate collaboration, foster consistency of interpretation and provide cross-jurisdictional assessments in the event of any disagreements.

3.  A specific securitisation committee shall be established within the framework of the Joint Committee of the European Supervisory Authorities, within which competent authorities shall closely cooperate, in order to carry out their duties pursuant to Articles 30 to 34.

4.  Where a competent authority finds that one or more of the requirements under Articles 6 to 27 have been infringed or has reason to believe so, it shall inform the competent authority of the entity or entities suspected of such infringement of its findings in a sufficiently detailed manner. The competent authorities concerned shall closely coordinate their supervision in order to ensure consistent decisions.

5.  Where the infringement referred to in paragraph 4 of this Article concerns, in particular, an incorrect or misleading notification pursuant to Article 27(1), the competent authority finding that infringement shall notify without delay, the competent authority of the entity designated as the first contact point under Article 27(1) of its findings. The competent authority of the entity designated as the first contact point under Article 27(1) shall in turn inform ESMA, the EBA and EIOPA and shall follow the procedure provided for in paragraph 6 of this Article.

6.  Upon receipt of the information referred to in paragraph 4, the competent authority of the entity suspected of the infringement shall take within 15 working days any necessary action to address the infringement identified and notify the other competent authorities involved, in particular those of the originator, sponsor and SSPE and the competent authorities of the holder of a securitisation position, when known. When a competent authority disagrees with another competent authority regarding the procedure or content of its action or inaction, it shall notify all other competent authorities involved about its disagreement without undue delay. If that disagreement is not resolved within three months of the date on which all competent authorities involved are notified, the matter shall be referred to ESMA in accordance with Article 19 and, where applicable, Article 20 of Regulation (EU) No 1095/2010. The conciliation period referred to in Article 19(2) of Regulation (EU) No 1095/2010 shall be one month.

Where the competent authorities concerned fail to reach an agreement within the conciliation phase referred to in the first subparagraph, ESMA shall take the decision referred to in Article 19(3) of Regulation (EU) No 1095/2010 within one month. During the procedure set out in this Article, a securitisation appearing on the list maintained by ESMA pursuant to Article 27 of this Regulation shall continue to be considered as STS pursuant to Chapter 4 of this Regulation and shall be kept on such list.

Where the competent authorities concerned agree that the infringement is related to non-compliance with Article 18 in good faith, they may decide to grant the originator, sponsor and SSPE a period of up to three months to remedy the identified infringement, starting from the day the originator, sponsor and SSPE were informed of the infringement by the competent authority. During this period, a securitisation appearing on the list maintained by ESMA pursuant to Article 27 shall continue to be considered as STS pursuant to Chapter 4 and shall be kept on such list.

Where one or more of the competent authorities involved is of the opinion that the infringement is not appropriately remedied within the period set out in third subparagraph, first subparagraph shall apply.]

7  Three years from the date of application of this Regulation, ESMA shall conduct a peer review in accordance with Article 30 of Regulation (EU) No 1095/2010 on the implementation of the criteria provided for in Articles 19 to 26 of this Regulation.

8.  ESMA shall, in close cooperation with the EBA and EIOPA, develop draft regulatory technical standards to specify the general cooperation obligation and the information to be exchanged under paragraph 1 and the notification obligations pursuant to paragraphs 4 and 5.

ESMA shall, in close cooperation with the EBA and EIOPA, submit those draft regulatory technical standards to the Commission by 18 January 2019.

The Commission is empowered to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1095/2010.

Article 37

[EU version only:

Publication of administrative sanctions

1.  Member States shall ensure that competent authorities publish on their official websites, without undue delay and as a minimum, any decision imposing an administrative sanction against which there is no appeal and which is imposed for infringement of Article 6, 7, 9 or 27(1) after the addressee of the sanction has been notified of that decision.

2.  The publication referred to in paragraph 1 shall include information on the type and nature of the infringement and the identity of the persons responsible and the sanctions imposed.

3.  Where the publication of the identity, in the case of legal persons, or of the identity and personal data, in the case of natural persons is considered by the competent authority to be disproportionate following a case-by-case assessment, or where the competent authority considers that the publication jeopardises the stability of financial markets or an on-going criminal investigation, or where the publication would cause, insofar as it can be determined, disproportionate damages to the person involved, Member States shall ensure that competent authorities either:

(a)  defer the publication of the decision imposing the administrative sanction until the moment where the reasons for non-publication cease to exist;

(b)  publish the decision imposing the administrative sanction on an anonymous basis, in accordance with national law; or

(c)  not publish at all the decision to impose the administrative sanction in the event that the options set out in points (a) and (b) are considered to be insufficient to ensure:

(d)  that the stability of financial markets would not be put in jeopardy; or

(e)  the proportionality of the publication of such decisions with regard to measures which are deemed to be of a minor nature.

4.  In the case of a decision to publish a sanction on an anonymous basis, the publication of the relevant data may be postponed. Where a competent authority publishes a decision imposing an administrative sanction against which there is an appeal before the relevant judicial authorities, competent authorities shall also immediately add on their official website that information and any subsequent information on the outcome of such appeal. Any judicial decision annulling a decision imposing an administrative sanction shall also be published.

5.  Competent authorities shall ensure that any publication referred to in paragraphs 1 to 4 shall remain on their official website for at least five years after its publication. Personal data contained in the publication shall only be kept on the official website of the competent authority for the period which is necessary in accordance with the applicable data protection rules.

6.  Competent authorities shall inform ESMA of all administrative sanctions imposed, including, where appropriate, any appeal in relation thereto and the outcome thereof.

7.  ESMA shall maintain a central database of administrative sanctions communicated to it. That database shall be only accessible to ESMA, the EBA, EIOPA and the competent authorities and shall be updated on the basis of the information provided by the competent authorities in accordance with paragraph 6.]

Chapter 6

Amendments

Article 38

[EU version only:

Amendment to Directive 2009/65/EC [UCITS Directive]

Article 50a of Directive 2009/65/EC [UCITS Directive] is replaced by the following:

‘Article 50a

Where UCITS management companies or internally managed UCITS are exposed to a securitisation that no longer meets the requirements provided for in the Regulation (EU) 2017/2402 of the European Parliament and of the Council (*1), they shall, in the best interest of the investors in the relevant UCITS, act and take corrective action, if appropriate.]

Article 39

[EU version only:

Amendment to Directive 2009/138/EC [Solvency II]

Directive 2009/138/EC [Solvency II] is amended as follows:

  1. in Article 135, paragraphs 2 and 3 are replaced by the following:

    ‘2. The Commission shall adopt delegated acts in accordance with Article 301a of this Directive supplementing this Directive by laying down the specifications for the circumstances under which a proportionate additional capital charge may be imposed when the requirements provided for in Articles 5 or 6 of Regulation (EU) 2017/2402 of the European Parliament and of the Council (*2) have been breached, without prejudice to Article 101(3) of this Directive.

    3. In order to ensure consistent harmonisation in relation to paragraph 2 of this Article, EIOPA shall, subject to Article 301b, develop draft regulatory technical standards to specify the methodologies for the calculation of a proportionate additional capital charge referred to therein.

    The Commission is empowered to supplement this Directive by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1094/2010.'
  1. Article 308b(11) is deleted.]
Article 40

Amendment to Regulation (EC) No 1060/2009 [Credit Rating Agencies Regulation]

Regulation (EC) No 1060/2009 [Credit Rating Agencies Regulation] is amended as follows:

  1. in recitals 22 and 41, in Article 8c and in point 1 of Part II of Section D of Annex I, ‘structured finance instrument’ is replaced by ‘securitisation instrument’;
  1. in recitals 34 and 40, in Articles 8(4), 8c, 10(3) and 39(4) as well as in the fifth paragraph of point 2 of Section A of Annex I, point 5 of Section B of Annex I, the title and point 2 of Part II of Section D of Annex I, points 8, 24 and 45 of Part I of Annex III and point 8 of Part III of Annex III, ‘structured finance instruments’ is replaced by ‘securitisation instruments’;
  1. in Article 1, the second subparagraph is replaced by the following:

    ‘This Regulation also lays down obligations for issuers and related third parties established in the Union regarding securitisation instruments.’
  1. in Article 3(1), point (l) is replaced by the following:

    ‘(l) “securitisation instrument” means a financial instrument or other assets resulting from a securitisation transaction or scheme referred to in Article 2(1) of Regulation (EU) 2017/2402 (Securitisation Regulation);’
  1. Article 8b is deleted;
  1. in point (b) of Article 4(3), point (b) of the second subparagraph of Article 5(6) and Article 25a, the reference to Article 8b is deleted.
Article 41

[EU version only:

Amendment to Directive 2011/61/EU [AIFM Directive]

Article 17 of Directive 2011/61/EU [AIFM Directive] is replaced by the following:

‘Article 17

Where AIFMs are exposed to a securitisation that no longer meets the requirements provided for in Regulation (EU) 2017/2402 of the European Parliament and of the Council (*3), they shall, in the best interest of the investors in the relevant AIFs, act and take corrective action, if appropriate.']

Article 42

Amendment to Regulation (EU) No 648/2012 [EMIR]

Regulation (EU) No 648/2012 [EMIR] is amended as follows:

  1. in Article 2, the following points are added:

    ‘(30)  “covered bond” means a bond meeting the requirements of Article 129 of Regulation (EU) No 575/2013[CRR].

    (31)  “covered bond entity” means the covered bond issuer or cover pool of a covered bond.’
  1. in Article 4, the following paragraphs are added:

    ‘5.    Paragraph 1 of this Article shall not apply with respect to OTC derivative contracts that are concluded by covered bond entities in connection with a covered bond, or by a securitisation special purpose entity in connection with a securitisation, within the meaning of Regulation (EU) 2017/2402 of the European Parliament and of the Council (*4) provided that:
    1. in the case of securitisation special purpose entities, the securitisation special purpose entity shall solely issue securitisations that meet the requirements of Article 18, and of Articles 19 to 22 or 23 to 26 of Regulation (EU) 2017/2402 (the Securitisation Regulation);
    2. the OTC derivative contract is used only to hedge interest rate or currency mismatches under the covered bond or securitisation; and
    3.   the arrangements under the covered bond or securitisation adequately mitigate counterparty credit risk with respect to the OTC derivative contracts concluded by the covered bond entity or securitisation special purpose entity in connection with the covered bond or securitisation.

6.  In order to ensure consistent application of this Article, and taking into account the need to prevent regulatory arbitrage, the ESAs shall develop draft regulatory technical standards specifying criteria for establishing which arrangements under covered bonds or securitisations adequately mitigate counterparty credit risk, within the meaning of paragraph 5.

The ESAs shall submit those draft regulatory technical standards to the Commission by 18 July 2018.

Power is delegated to the Commission to supplement this Regulation by adopting the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulations (EU) No 1093/2010, (EU) No 1094/2010 or (EU) No 1095/2010.'


  1. in Article 11, paragraph 15 is replaced by the following:

    ‘15. In order to ensure consistent application of this Article, the ESAs shall develop common draft regulatory technical standards specifying:
    1. the risk-management procedures, including the levels and type of collateral and segregation arrangements, required for compliance with paragraph 3;
    2. the procedures for the counterparties and the relevant competent authorities to be followed when applying exemptions under paragraphs 6 to 10;
    3. the applicable criteria referred to in paragraphs 5 to 10 including in particular what is to be considered as a practical or legal impediment to the prompt transfer of own funds and repayment of liabilities between the counterparties.

The level and type of collateral required with respect to OTC derivative contracts that are concluded by covered bond entities in connection with a covered bond, or by a securitisation special purpose entity in connection with a securitisation within the meaning of this Regulation and meeting the conditions of Article 4(5) of this Regulation and the requirements set out in Article 18, and in Articles 19 to 22 or 23 to 26 of Regulation (EU) 2017/2402 (the Securitisation Regulation) shall be determined taking into account any impediments faced in exchanging collateral with respect to existing collateral arrangements under the covered bond or securitisation.

The ESAs shall submit those draft regulatory technical standards to the Commission by 18 July 2018.

Depending on the legal nature of the counterparty, power is delegated to the Commission to adopt the regulatory technical standards referred to in this paragraph in accordance with Articles 10 to 14 of Regulations (EU) No 1093/2010, (EU) No 1094/2010 or (EU) No 1095/2010.’


 

Article 43

Transitional provisions

1.  This Regulation shall apply to securitisations the securities of which are issued on or after 1 January 2019, subject to paragraphs 7 and 8.

2.  In respect of securitisations the securities of which were issued before 1 January 2019, originators, sponsors and SSPEs may use the designation ‘STS’ or ‘simple, transparent and standardised’, or a designation that refers directly or indirectly to those terms, only where the requirements set out in Article 18 and the conditions set out in paragraph 3 of this Article are complied with.

3.  Securitisations the securities of which were issued before 1 January 2019, other than securitisation positions relating to an ABCP transaction or an ABCP programme, shall be considered ‘STS’ provided that:

(a)  they met, at the time of issuance of those securities, the requirements set out in Article 20(1) to (5), (7) to (9) and (11) to (13) and Article 21(1) and (3); and

(b)  they meet, as of the time of notification pursuant to Article 27(1), the requirements set out in Article 20(6) and (10), Article 21(2) and (4) to (10) and Article 22(1) to (5).

4.  For the purposes of point (b) of paragraph 3, the following shall apply:

(a)  in Article 22(2), ‘prior to issuance’ shall be deemed to read ‘prior to notification under Article 27(1)’;

(b)  in Article 22(3), ‘before the pricing of the securitisation’ shall be deemed to read ‘prior to notification under Article 27(1)’;

(c)  in Article 22(5):

(i)  in the second sentence, ‘before pricing’ shall be deemed to read ‘prior to notification under Article 27(1)’;

(ii)  ‘before pricing at least in draft or initial form’ shall be deemed to read ‘prior to notification under Article 27(1)’;

(iii)  the requirement set out in the fourth sentence shall not apply;

(iv)  references to compliance with Article 7 shall be construed as if Article 7 applied to those securitisations notwithstanding Article 43(1).

[UK version only:  4A.  Subject to the second subparagraph, in paragraphs 3 and 4 a reference to a numbered Article is a reference to the Article so numbered of this Regulation as it had effect immediately before exit day, or as it has effect on or after exit day in relation to an EEA State.

In paragraphs 3(b) and 4, in relation to a STS notification made on or after exit day by a person who is established in the United Kingdom, a reference to Article 27(1) is a reference to that Article as it has effect on or after exit day in the United Kingdom.

"STS notification” means notification that a securitisation meets the requirements of Section 1 or Section 2 of Chapter 4. 

5.  In respect of securitisations the securities of which were issued on or after 1 January 2011 but before 1 January 2019 and in respect of securitisations the securities of which were issued before 1 January 2011 where new underlying exposures have been added or substituted after 31 December 2014, the due-diligence requirements as provided for in Regulation (EU) No 575/2013 [CRR], Delegated Regulation Commission Delegated Regulations (EU) 2015/35 (7) [Solvency II Delegated Act] and Delegated Regulation (EU) No 231/2013 [supplementing the AIFM Directive] respectively shall continue to apply in the version applicable on 31 December 2018.

[UK version only:

For the purposes of this paragraph, Articles 407 and 410 of Regulation (EU) No 575/2013(a) (which set out, in part, requirements for due diligence) have effect with the following modifications - 

(a)  in Article 407 (additional risk weight) and Article 410 (uniform condition of application) a reference to Article 405 (retained interest of the issuer) is a reference to that Article as modified by regulation 30(3) of the Securitisation (Amendment) (EU Exit) Regulations 2019;

(b)  in Article 407, in the first subparagraph ignore the reference to Article 409; and

(c)  in Article 410 - 

(i)  ignore paragraph 1;

(ii)  in paragraph 2 -

(aa)  in the first subparagraph read the opening words as if for “EBA shall develop draft regulatory” there were substituted “The FCA and the PRA may each make”, and ignore point (d);

(bb)  ignore the second and third subparagraphs; and

(iii)  in paragraph 3, - 

(aa)  in the first subparagraph read the opening words as if for “EBA shall develop draft regulatory” there were substituted “The FCA and the PRA may each make”;

(bb)  ignore the second and third subparagraphs.]

6.  In respect of securitisations the securities of which were issued before 1 January 2019 [EU version:  credit institutions or investment firms as defined in points (1) and (2) of Article 4(1) of Regulation (EU) No 575/2013 [CRR], insurance undertakings as defined in point (1) of Article 13 of Directive 2009/138/EC [Solvency II] , reinsurance undertakings as defined in point (4) of Article 13 of Directive 2009/138/EC [Solvency II] and alternative investment fund managers (AIFMs) as defined in point (b) of Article 4(1) of Directive 2011/61/EU [AIFM Directive]] [UK version:  a CRR firm (as defined by Article 4(1)(2A) of Regulation (EU) No 575/2013), an insurance undertaking (as defined in section 417(1) of the 2000 Act), a reinsurance undertaking (as defined in that section) and an AIFM (as defined by regulation 4(1) of the Alternative Investment Fund Managers Regulation 2013)] shall continue to apply Article 405 of Regulation (EU) No 575/2013 [CRR] and Chapters I, II and III and Article 22 of Delegated Regulation (EU) No 625/2014 [RTS relating to risk retention made under CRR], Articles 254 and 255 of Delegated Regulation  Commission Delegated Regulations (EU) 2015/35 (7[Solvency II Delegated Act] and Article 51 of Delegated Regulation (EU) No 231/2013 [supplementing the AIFM Directive] respectively as in the version applicable on 31 December 2018.

[UK version only:

For the purposes of this paragraph, Article 405 of Regulation (EU) No 575/2013(a) has effect with the following modifications - 

(a)  read paragraph 2 as if - 

(i)  for the first subparagraph there were substituted - 

Where - 

(a)  a mixed financial holding company,

(b)  a UK parent institution which is a credit institution,

(c)  a financial holding company established in the United Kingdom, or

(d)  a subsidiary of such a company or institution, 

as an originator or sponsor, securitises exposures from one or more credit institutions, investment firms or other financial institutions which are included in the scope of supervision on a consolidated basis, the requirement set out in paragraph 1 may be satisfied on the basis of the consolidated situation of the mixed financial holding company, UK parent institution or financial holding company concerned.”;

(ii)  in the second subparagraph for the words from “, in a timely manner” to the end there were substituted “the information needed to satisfy the requirements set out in Article 409, in a timely manner, to the originator or sponsor and, if the originator or sponsor is a subsidiary, to the mixed financial holding company, UK parent institution or financial holding company which is the parent undertaking of the subsidiary”; and

(iii)  after the second subparagraph there were inserted - 

“In this paragraph - 

(a)  ‘credit institution’, ‘financial holding company’, ‘financial institution’, ‘investment firm’, ‘subsidiary’ and ‘UK parent institution’ have the meaning given in Article 4(1) of Regulation (EU) No 575/2013; and

(b)  ‘mixed financial holding company” has the meaning given in regulation 1(2) of the Financial Conglomerates and Other Financial Groups Regulations 2004(b).”; and

(b) in paragraph 3, in point (b) ignore “of Member States”.]


7.  Until the [EU version:  regulatory technical standards to be adopted by the Commission pursuant Article 6(7) of this Regulation apply] [UK version:  FCA and the PRA, acting jointly, have made technical standards pursuant to Article 6(7) of this Regulation], originators, sponsors or the original lender shall, for the purposes of the obligations set out in Article 6 of this Regulation, apply Chapters I, II and III and Article 22 of Delegated Regulation (EU) No 625/2014[RTS relating to risk retention made under CRR] to securitisations the securities of which are issued on or after 1 January 2019.

8.  Until the [EU version:  regulatory technical standards to be adopted by the Commission pursuant to Article 7(3) of this Regulation apply] [UK version:  FCA and the PRA,acting jointly, have made technical standards pursuant to Article 6(7) of this Regulation], originators, sponsors and SSPEs shall, for the purposes of the obligations set out in points (a) and (e) of the first subparagraph of Article 7(1) of this Regulation, make the information referred to in Annexes I to VIII of Delegated Regulation Commission Delegated Regulations (EU) 2015/35 (7) [Solvency II Delegated Act] available in accordance with Article 7(2) of this Regulation.

9.  For the purpose of this Article, in the case of securitisations which do not involve the issuance of securities, any references to ‘securitisations the securities of which were issued’ shall be deemed to mean ‘securitisations the initial securitisation positions of which are created’, provided that this Regulation applies to any securitisations that create new securitisation positions on or after 1 January 2019.

Article 43a

[EU  version only:] 

Transitional provisions for STS on-balance-sheet securitisations

1.   In respect of synthetic securitisations for which the credit protection agreement has become effective before 9 April 2021, originators and SSPEs may use the designation “STS” or “simple, transparent and standardised”, or a designation that refers directly or indirectly to those terms, only where the requirements set out in Article 18 and the conditions set out in paragraph 3 of this Article are complied with at the time of the notification referred to in Article 27(1).

2.   Until the date of application of the regulatory technical standards referred to in Article 27(6), originators shall, for the purposes of the obligation set out in Article 27(1), make the necessary information available to ESMA in writing.

3.   Securitisations the initial securitisation positions of which were created before 9 April 2021 shall be considered to be STS provided that:

(a) they met, at the time of the creation of the initial securitisation positions, the requirements set out in Articles 26b(1) to (5), (7) to (9) and (11) and (12), Articles 26c(1) and (3), Article 26e(1), the first subparagraph of Article 26e(2), the third and fourth subparagraph of Article 26e(3), and Articles 26e(6) to (9); and

(b) they meet, as of the time of notification pursuant to Article 27(1), the requirements set out in Articles 26b(6) and (10), Articles 26c(2) and (4) to (10), Articles 26d(1) to (5) and the second to seventh subparagraph of Article 26e(2), the first, second and fifth subparagraph of Article 26e(3) and Articles 26e(4) and (5).

4.   For the purposes of point (b) of paragraph 3 of this Article, the following shall apply:

(a) in Article 26d(2), “prior to the closing of the transaction” shall be deemed to read “prior to notification under Article 27(1)”;

(b) in Article 26d(3), “before the pricing of the securitisation” shall be deemed to read “prior to notification under Article 27(1)”;

(c) in Article 26d(5):

(i) in the second sentence, “before pricing” shall be deemed to read “prior to notification under Article 27(1)”;

(ii) in the third sentence, “before pricing at least in draft or initial form” shall be deemed to read “prior to notification under Article 27(1)”;

(iii) the requirement set out in the fourth sentence shall not apply;

(iv) references to compliance with Article 7 shall be construed as if Article 7 applied to those securitisations notwithstanding Article 43(1).]

Article 44

[EU version only:

Reports

By 1 January 2021 and every three years thereafter, the Joint Committee of the European Supervisory Authorities shall publish a report on:

(a)  the implementation of the STS requirements as provided for in Articles 18 to 27;

(b)  an assessment of the actions that competent authorities have undertaken, on material risks and new vulnerabilities that may have materialised and on the actions of market participants to further standardise securitisation documentation;

(c)  the functioning of the due-diligence requirements provided for in Article 5 and the transparency requirements provided for in Article 7 and the level of transparency of the securitisation market in the Union, including on whether the transparency requirements provided for in Article 7 allow the competent authorities to have a sufficient overview of the market to fulfil their respective mandates;

(d)  the requirements provided for in Article 6, including compliance therewith by market participants and the modalities for retaining risk pursuant to Article 6(3);

(e)       the geographical location of SSPEs.

Based on the information provided to it every three years under point (e), the Commission shall provide an assessment of the reasons behind the location choice, including, subject to the availability and accessibility of information, to what extent the existence of a favourable tax and regulatory regime plays a critical role.]

Article 45

[now deleted in both UK and EU versions]

 

Introduction

The EU STS regime for synthetics is a world first:  there is no provision at the Basel/IOSCO level for preferential capital treatment for an STC-qualifying synthetic product.  The 24th July 2020 proposal from the European Commission to enact an STS regime for balance sheet synthetic securitisations by amending the Securitisation Regulation and the CRR (but not, initially at least, Solvency II)  was explicitly in response to the “urgency” of the need to take measures to help the economy recover from the COVID-19 pandemic.  It was broadly welcomed by those who saw it as a way of attracting new risk-takers into the market which would be prepared to take on risk (and be able to do the related due diligence) if the overall package was sufficiently standard, simple and transparent, but not otherwise; the current synthetic market is for the most part, central banks, supranational entities such as the EIB, pension and hedge funds, with monolines having long gone.  

The proposals were adopted in early April 2021 and are effective as from 9th April 2021.  They have been cautiously welcomed, even though they are not the totality of what the market has been asking for, but there are issues  regarding complexity and cost, and one of these issues - the change to Article 248 of the CRR concerning excess spread - applies across the board, not just to STS.  

The EC proposals

When the Securitisation Regulation was enacted, there had been only one, minor, concession to synthetics. Where an institution sold off a junior position in a pool of loans to SMEs via a synthetic structure, it could only apply to the retained position the lower capital requirements available for STS securitisations if the strict criteria set out in Article 270 of the CRR as amended were met, which included that the position was guaranteed by a central government, central bank, or a public sector “promotional entity”, or – but only if fully collateralised by cash on deposit with the originator – by an institution.  Otherwise, originators would have to allocate capital to the retained senior piece on the basis of the higher non-STS rules which, because of the regulatory non-neutrality baked into the regulatory capital requirement for securitisation (i.e. the sum total of capital allocated to all the various tranches of a securitisation will be more than the capital which would be required for a holding of the underlying assets) were, to say the least, discouraging.

Article 45 of the Securitisation Regulation required the EBA to report on the possibility of an STS regime for balance sheet synthetics by 2nd July 2019.  Its "Draft report on STS Framework for Synthetic Securitisation" emerged on 24th September 2019, the delay being due to unresolved differences of opinion among EU regulators about whether or not synthetics should be given any favourable capital treatment or not.  The EBA  considered to what extent buying STS protection should give the protection buyer preferential regulatory capital treatment as regards the portion of risk on the portfolio that it continues to hold (which, post-GFC, is usually the least risky portion, with the first loss risk being transferred to a protection seller).   The EBA envisaged qualifying protection coming from either 0% risk-weighted institutions under the CRR, such as the EIB or, if not, then from entities to which the protection buyer's recourse is fully collateralised in cash or risk-free securities.  It was equivocal about whether STS synthetic securitisations should provide favourable capital treatment for the originator credit institution or not.  Its final proposals for developing a STS framework for synthetic securitisation emerged on 5th May 2020, recommended setting up an STS framework but sat on the fence regarding the capital treatment, merely noting the pros and cons of the introduction of more risk-sensitive regulatory treatment of the STS synthetic product.  The EBA’s summary said:

"On the one hand, developments in the last few years have indicated the potential for the continuing growth of the synthetic sector and have confirmed the technical feasibility of the creation of a prudentially sound STS synthetic securitisation product that is comparable to the STS traditional securitisation product.  In addition, the available performance data do not provide any evidence that the performance of the synthetic securitisation instrument is worse than that of the traditional securitisation instrument.  The introduction of potentially limited and clearly defined differentiated regulatory treatment would match the historical performance of the synthetic securitisation, ensure better alignment with the STS traditional securitisation framework and help overcome the constraints of the current limited STS risk-weight treatment of some SME synthetic securitisations.  

On the other hand, there are limitations of the performance data on which the analysis is based, there is limited experience with the STS traditional framework so far, and the risk of potentially overusing synthetic securitisation, which would potentially lead to a large-scale replacement of regulatory capital by risk mitigation strategies, leading to overleveraging of banks, should be duly taken into account. In addition, the preferential regulatory treatment is not included in the international Basel standards.”

On 12th June 2020, the “High Level Forum on the Capital Markets Union” issued a 129-page “final report” on CMU, the recommendations of which included applying the same regulatory treatment to synthetics as to cash securitisations.  

The new regime for synthetic securitisation

Against this background, the "quick fix" amendments to the Securitisation Regulation have added a new series of articles (Article 26a et seq.) in “Section 2A” to introduce a new regime for synthetics which apply most of the same STS requirements as apply to cash securitisations, plus some others specific to synthetics e.g. requirements mitigating the counterparty credit risk on the protection seller, and the CRR amendments extend the treatment which Article 270 of the CRR had previously allowed to only a limited sub-set of synthetic securitisations.  Some aspects of the proposed regime entail additional cost and complexity over and above what the existing market is used to - for example, protection sellers (which the legislation insists on calling "investors") are required to have recourse to higher-quality collateral to secure repayment of their "investment" than is usual, and that of course comes at a cost.  Some detail has yet to be fleshed out in RTS – those will appear in H1 of 2021 - and there is scope for some level 3 clarification.  There seems to be a lot of devil in the detail and it remains to be seen how this will play out.  

The proposal was enacted after the Brexit transitional period ends, and does not form part of onshored UK law.  The UK had been opposed to the idea of an STS regime for synthetic securitisation, and it was only brought about as a result of Brexit.  It seems unlikely that the UK’s FCA will want to introduce a similar regime under the UKSR.  

Article 45a

[EU version only]:  

Development of a sustainable securitisation framework

1.   By 1 November 2021, EBA, in close cooperation with ESMA and EIOPA, shall publish a report on developing a specific sustainable securitisation framework for the purpose of integrating sustainability-related transparency requirements into this Regulation. That report shall duly assess in particular:

(a) the implementation of proportionate disclosure and due diligence requirements relating to potential positive and adverse impacts of the assets financed by the underlying exposures on sustainability factors;

(b) the content, methodologies and presentation of information in respect of sustainability factors in relation to positive and adverse impacts on environmental, social and governance-related matters;

(c) how to establish a specific sustainable securitisation framework that mirrors or draws upon financial products covered under Articles 8 and 9 of Regulation (EU) 2019/2088 [Sustainable Finance Disclosure Regulation] and takes into account, where appropriate, Regulation (EU) 2020/852 [Taxonomy Regulation] of the European Parliament and of the Council;

(d) possible effects of a sustainable securitisation framework on financial stability, the scaling up of the Union securitisation market and of bank lending capacity.

2.   In drafting the report referred to in paragraph 1 of this Article, EBA shall where relevant, mirror or draw upon the transparency requirements set out in Articles 3, 4, 7, 8 and 9 of Regulation (EU) 2019/2088 [Sustainable Finance Disclosure Regulation] and seek input from the European Environment Agency and the Joint Research Centre of the European Commission.

3.   In conjunction with the review report under Article 46, the Commission shall, based on the EBA report referred to in paragraph 1 of this Article, submit a report to the European Parliament and to the Council on the creation of a specific sustainable securitisation framework. The Commission’s report shall, where appropriate, be accompanied by a legislative proposal.]

Article 46

Review

[EU version:  By 1 January 2022, the Commission shall present a report to the European Parliament and the Council on the functioning of this Regulation, accompanied, if appropriate, by a legislative proposal.]

[UK version: 1. The Treasury must, no later than 1st January 2022, review the functioning of this Regulation and lay a report before Parliament.  

The Treasury must review the functioning of this Regulation if, at any time before that date, the Treasury consider that progress has been made in third countries other than the EEA States with respect to the implementation of international standards on simple, transparent and comparable securitisation.

Where the Treasury review the functioning of this Regulation in response to such progress, the Treasury must lay a report before Parliament.]

[UK version:  this paragraph is numbered "2"]  That report shall [EU version only:  consider in particular the findings of the reports referred to in Article 44, and] shall assess:

(a)  the effects of this Regulation, including the introduction of the STS securitisation designation, on the functioning of the market for securitisations in the Union, the contribution of securitisation to the real economy, in particular on access to credit for SMEs and investments, and interconnectedness between financial institutions and the stability of the financial sector;

(b)  the differences in use of the modalities referred to in Article 6(3), based on the data reported pursuant to point (e)(iii) of the first subparagraph of Article 7(1). If the findings show an increase in prudential risks caused by the use of the modalities referred to in points (a), (b), (c) and (e) of Article 6(3), then suitable redress shall be considered;

(c)  whether there has been a disproportionate rise of the number of transactions referred to in the third subparagraph of Article 7(2), since the application of this Regulation and whether market participants structured transactions in a way to circumvent the obligation under Article 7 to make available information through securitisation repositories;

(d)  whether there is a need to extend disclosure requirements under Article 7 to cover transactions referred to in the third subparagraph of Article 7(2) and investor positions;

(e)  whether in the area of STS securitisations an equivalence regime could be introduced for third-country originators, sponsors and SSPEs, taking into consideration international developments in the area of securitisation, in particular initiatives on simple, transparent and comparable securitisations;

[UK version:  (f)  the implementation of the requirements provided for in Article 22(4) and whether they need to be extended to securitisation where the underlying exposures are not residential loans or auto loans or leases, with the view to mainstreaming environmental, social and governance disclosure;]

[EU version(f)  the implementation of the requirements set out in Articles 22(4) and 26d(4) and whether they may be extended to securitisation where the underlying exposures are not residential loans or auto loans or leases, with a view to mainstreaming environmental, social and governance disclosure;]

(g)  the appropriateness of the third-party verification regime as provided for in Articles 27 and 28, and whether the authorisation regime for third parties provided for in Article 28 fosters sufficient competition among third parties and whether changes in the supervisory framework need to be introduced in order to ensure financial stability; and

(h)  whether there is a need to complement the framework on securitisation set out in this Regulation by establishing a system of limited licensed banks, performing the functions of SSPEs and having the exclusive right to purchase exposures from originators and sell claims backed by the purchased exposures to investors.

[EU version only(i)        the possibility for further standardisation and disclosure requirements in view of evolving market practices, namely through the use of templates, for both traditional and synthetic securitisations, including for bespoke private securitisations where no prospectus has to be drawn up in compliance with Regulation (EU) 2017/1129 of the European Parliament and of the Council [Prospectus Regulation.]

Article 47

[EU version only

Exercise of the delegation

1.  The power to adopt delegated acts is conferred on the Commission subject to the conditions provided for in this Article.

2.  The power to adopt delegated acts referred to in Article 16(2) shall be conferred on the Commission for an indeterminate period of time from 17 January 2018.

3.  The delegation of power referred to Article 16(2) may be revoked at any time by the European Parliament or by the Council. A decision to revoke shall put an end to the delegation of the power specified in that decision. It shall take effect the day following the publication of the decision in the Official Journal of the European Union or at a later date specified therein. It shall not affect the validity of any delegated acts already in force.

4.  Before adopting a delegated act, the Commission shall consult experts designated by each Member State in accordance with the principles laid down in the Interinstitutional Agreement of 13 April 2016 on Better Law-Making.

5.  As soon as it adopts a delegated act, the Commission shall notify it simultaneously to the European Parliament and to the Council.

6.  A delegated act adopted pursuant to Article 16(2) shall enter into force only if no objection has been expressed either by the European Parliament or the Council within a period of two months of notification of that act to the European Parliament and the Council or if, before the expiry of that period, the European Parliament and the Council have both informed the Commission that they will not object. That period shall be extended by two months at the initiative of the European Parliament or of the Council.]

Article 48

Entry into force

This Regulation shall enter into force on the twentieth day following that of its publication in the Official Journal of the European Union.

It shall apply from 1 January 2019.

[EU version only:  This Regulation shall be binding in its entirety and directly applicable in all Member States.]

Done at Strasbourg, 12 December 2017. 

For the European Parliament
The President
A. TAJANI 

For the Council
The President
M. MAASIKAS


The text of the Securitisation Regulation is reproduced with the permission of the European Union and is © European Union, https://eur-lex.europa.eu, 1998-2019.

Footnotes
  1. OJ C 219, 17.6.2016, p. 2.
  2. OJ C 82, 3.3.2016, p. 1.
  3. Position of the European Parliament of 26 October 2017 and decision of the Council of 20 November 2017.
  4. Regulation (EU) No 1092/2010 of the European Parliament and of the Council of 24 November 2010 on European Union macro-prudential oversight of the financial system and establishing a European Systemic Risk Board (OJ L 331, 15.12.2010, p. 1).
  5. Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (OJ L 173, 12.6.2014, p. 349).
  6. Regulation (EU) No 1095/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Securities and Markets Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/77/EC (OJ L 331, 15.12.2010, p. 84).
  7. Commission Delegated Regulation (EU) 2015/35 of 10 October 2014 supplementing Directive 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) (OJ L 12, 17.1.2015, p. 1).
  8. Commission Delegated Regulation (EU) 2015/61 of 10 October 2014 to supplement Regulation (EU) No 575/2013 of the European Parliament and the Council with regard to liquidity coverage requirement for Credit Institutions (OJ L 11, 17.1.2015, p. 1).
  9. Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/78/EC (OJ L 331, 15.12.2010, p. 12).
  10. Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on credit agreements for consumers and repealing Council Directive 87/102/EEC (OJ L 133, 22.5.2008, p. 66).
  11. Directive 2014/17/EU of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010 (OJ L 60, 28.2.2014, p. 34).
  12. Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions (OJ L 287, 29.10.2013, p. 63).
  13. Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (OJ L 302, 17.11.2009, p. 32).
  14. Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) (OJ L 335, 17.12.2009, p. 1).
  15. Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010 (OJ L 174, 1.7.2011, p. 1).
  16. Regulation (EC) No 1060/2009 of the European Parliament and of the Council of 16 September 2009 on credit rating agencies (OJ L 302, 17.11.2009, p. 1).
  17. Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories (OJ L 201, 27.7.2012, p. 1).
  18. OJ L 123, 12.5.2016, p. 1.
  19. Commission Delegated Regulation (EU) No 625/2014 of 13 March 2014 supplementing Regulation (EU) No 575/2013 of the European Parliament and of the Council by way of regulatory technical standards specifying the requirements for investor, sponsor, original lenders and originator institutions relating to exposures to transferred credit risk (OJ L 174, 13.6.2014, p. 16).
  20. Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (OJ L 176, 27.6.2013, p. 1).
  21. Commission Delegated Regulation (EU) No 231/2013 of 19 December 2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision (OJ L 83, 22.3.2013, p. 1).
  22. Commission Delegated Regulation (EU) 2015/3 of 30 September 2014 supplementing Regulation (EC) No 1060/2009 of the European Parliament and of the Council with regard to regulatory technical standards on disclosure requirements for structured finance instruments (OJ L 2, 6.1.2015, p. 57).
  23. Directive (EU) 2016/2341 of the European Parliament and of the Council of 14 December 2016 on the activities and supervision of institutions for occupational retirement provision (IORPs) (OJ L 354, 23.12.2016, p. 37).
  24. Directive 2002/87/EC of the European Parliament and of the Council of 16 December 2002 on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate and amending Council Directives 73/239/EEC, 79/267/EEC, 92/49/EEC, 92/96/EEC, 93/6/EEC and 93/22/EEC, and Directives 98/78/EC and 2000/12/EC of the European Parliament and of the Council (OJ L 35, 11.2.2003, p. 1).
  25. Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (OJ L 176, 27.6.2013, p. 338).
  26. Regulation (EU) 2015/1017 of the European Parliament and of the Council of 25 June 2015 on the European Fund for Strategic Investments, the European Investment Advisory Hub and the European Investment Project Portal and amending Regulations (EU) No 1291/2013 and (EU) No 1316/2013 — the European Fund for Strategic Investments (OJ L 169, 1.7.2015, p. 1).
  27. Regulation (EU) No 1094/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Insurance and Occupational Pensions Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/79/EC (OJ L 331, 15.12.2010, p. 48).
  28. Directive 2003/71/EC of the European Parliament and of the Council of 4 November 2003 on the prospectus to be published when securities are offered to the public or admitted to trading and amending Directive 2001/34/EC (OJ L 345, 31.12.2003, p. 64).
  29. Regulation (EU) No 596/2014 of the European Parliament and of the Council of 16 April 2014 on market abuse (market abuse regulation) and repealing Directive 2003/6/EC of the European Parliament and of the Council and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72/EC (OJ L 173, 12.6.2014, p. 1).
  30. Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012 (OJ L 337, 23.12.2015, p. 1).
  31. Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council (OJ L 173, 12.6.2014, p. 190).
  32. Regulation (EU) No 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010 (OJ L 225, 30.7.2014, p. 1).
  33. Directive 2003/41/EC of the European Parliament and of the Council of 3 June 2003 on the activities and supervision of institutions for occupational retirement provision (OJ L 235, 23.9.2003, p. 10).
  34. Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 (OJ L 173, 12.6.2014, p. 84).
  35. Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013 on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, amending Directive 2006/43/EC of the European Parliament and of the Council and repealing Council Directives 78/660/EEC and 83/349/EEC (OJ L 182, 29.6.2013, p. 19).

*1  Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012  

 *2     Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012 (OJ L 347, 28.12.2017, p. 35).’"

*3   Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012

*4   Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012 (OJ L 347, 28.12.2017, p. 35).’"

For any securitisation of an acquired portfolio, Article 9(3) requires the originator - which, in such a case, will be a limb (b) originator - to "verify that:

  • the related limb (a) originator (i.e. the entity which was, directly or indirectly, involved in the original agreement which created the obligations or potential obligations to be securitised) applies "the same sound and well-defined criteria for credit-granting" to both the exposures being securitised and those which are not;
  • the limb (a) originator applies "the same clearly established processes for approving and, where relevant, amending, renewing and refinancing credits"
  • the relevant originators, sponsors and original lenders have "effective systems in place to apply those criteria and processes in order to ensure that credit-granting is based on a thorough assessment of the obligor’s creditworthiness taking appropriate account of factors relevant to verifying the prospect of the obligor meeting his obligations under the credit agreement".

art 9(3)

and, if STS is envisaged, the limb (b) originator must also comply with Article 20(11).  Post-securitisation, the Article 7 transparency and reporting obligations apply.

Article 9(3)

In Article 9(3) the obligation is to "verify" that the "entity which was, directly or indirectly, involved in the original agreement which created the obligations or potential obligations to be securitised [in other words, the limb (a) originator of the exposures] fulfils the requirements referred to in paragraph 1".  The standards required to achieve an appropriate "verification" for Article 9(3) purposes are left unstated.  What if seller warranties are unavailable e.g. if the seller is not the original lender, or if the original lender has been wound up?  A limb (b) originator has no current official guidance on this point; perhaps some guidance will eventually be provided (it seems the envisaged joint committee of the ESAs may issue some eventually). 

For NPL portfolios particularly, there are two exemptions that can help:

  • Article 9(4)(a) disapplies Article 9(3) if the original loan agreements pre-dated the application of the Mortgage Credits Directive (which will vary from country to country but which had to be by 21st March 2016)
  • Article 9(4)(b) permits limb (b) originators to comply instead with Article 21(2) of the RTS relating to risk retention made under CRR (and so "obtain all the necessary information to assess whether the criteria applied in the credit-granting for those exposures are as sound and well-defined as the criteria applied to non-securitised exposures").
Agency and model risk

Agency risk

The EBA never defines “agency risk”. For many people, it typically refers to the risk arising from a party having a discretion. These phrases, all taken from the EBA 2015 Report on STS, indicate what the EBA has in mind:

“the agency risks due to the multiplicity of parties involved in the transaction…”
“…active portfolio management adds a layer of complexity and increases the agency risk arising in the securitisation by making the securitisation’s performance dependent on both the performance of the underlying exposures and the performance of the management of the transaction…”
“The approach to regulatory capital applicable to securitisations… has taken the form of, inter alia, risk weight floors and risk weight adjustments for maturity, aimed at addressing modelling/agency risks introduced by the securitisation process…”This is rather broad brush. CLOs certainly involve agency risk – which we might define as the risk arising by the allowance of a discretion to a party which is not necessarily acting the in best interests of the investor – but many securitisations of fixed pools of assets are precisely hard-wired precisely to eliminate any discretions”.

Model risk

Model risk means the risk that a pool of assets will not perform when under stress in the way that was modelled. The EBA in its 2015 Report on STS focusses particularly on the risk arising from high degrees of leverage and the consequent volatility of any lower ranking tranche:

“… many securitisations which contained high levels of leverage failed (CDOs of ABS, CDOs squared, CPDOs, etc.). Leverage implies that very small changes in the credit performance of the underlying assets have a substantial impact on the credit performance of the securitisation. As such, these securitisations relied on a purported degree of accuracy in the measurement of the credit risk (including issues of correlation) that proved highly illusory. Put differently, highly leveraged securitisations are very vulnerable to model risk and the credit rating agencies, as well as the market, placed unwarranted faith in the capacity of models based on limited data sets to gauge credit outcomes”.

This underpins many of the STS requirements, such as the concerns about transparency – to provide the underlying information to investors – and homogeneity – to make it relatively straightforward to do the modelling, plus a requirement for no derivatives apart from for prudent hedging, and so on.

A history of homogeneity

The 28th May 2019 homogeneity RTS are the final chapter (for the moment at least) in a long history, which consists of:

The STS market will have get comfortable with the homogeneity RTS as finally enacted, and they are a great improvement on the first draft, but in cases where there is doubt, it may be helpful and instructive to see how the formulation has gradually developed over the period since October 2014.   Taking these in turn:

EBA Discussion Paper October 2014

“Criterion 4: The securitisation should be backed by exposures that are homogeneous in terms of asset type, currency and legal system under which they are subject… [no mention here of “jurisdiction”]

Rationale

Simple securitisations should include underlying exposures that are standard obligations, in terms of rights to payments and/or income from assets”.

Basel Consultative Document December 2014

“In simple, transparent and comparable securitisations, the assets underlying the securitisation should be credit claims or receivables that are homogeneous with respect to their asset type, jurisdiction, legal system and currency.  [“Jurisdiction” is mentioned here.]

As more exotic asset classes require more complex and deeper analysis, credit claims or receivables should have defined terms relating to rental, principal, interest, or principal and interest payments…

…“homogeneity with respect to geographical origin” may need to be defined, depending on the application of the criterion”.

EBA Report July 2015

The one-sentence “rationale” from the discussion paper was replaced by a more elaborate rationale and explanatory note:

“Simple securitisations should be such that investors would not need to analyse and assess materially different credit risk factors and risk profiles when carrying out risk analysis and due diligence checks. As the type of risk analysis required for different asset types can vary substantially it is deemed appropriate that securitisation pools include homogenous assets. Homogeneity in terms of asset type should be assessed on the basis of common parameters, including risk factors and risk profiles.  Simple securitisations should include underlying exposures that are standard obligations, in terms of rights to payments and/or income from assets and that result in a periodic and well-defined stream of payments to investors. Credit card facilities should be deemed to result in a periodic and well-defined stream of payments to investors for the purposes of this criterion. The exposures that are to be securitised should not belong to an asset class that is outside the ordinary business of the originator, i.e. an asset class in which the originator may have less expertise and/or interest at stake. The quality of the securitised exposures should not be dependent on any significant changes in underwriting standards and only exposures underwritten to broadly consistent standards should be in the pool. In any case, all relevant changes in underwriting standards over time should not be material and should be fully disclosed to investors. Simple securitisations should only rely on underlying assets arising from legally enforceable obligations: as such, they should not include assets arising from obligations vis-à-vis special purpose entities, against which enforceability is more complex…

The following auto loan examples can be used to interpret (for auto loans) and extrapolate (for other asset classes) what is meant by homogeneity. Examples of a homogeneous auto loan pool would include, as of the securitisation closing date:

  • loans originated in the same currency;
  • loans subject to the same legal framework for origination, transfer, and enforcement;
  • loans that are retail instalment sale contracts secured by a mix of new and used cars, trucks and utility vehicles; and
  • loans that have level monthly payments that fully amortise the amount financed over its original term, except that the payment in the first or last month during the life of the loan may be minimally different from the level payment. Examples of a non-homogeneous auto loan pool would include:
    • collateral mix of auto loans with fleet assets or rental car assets:
    • collateral mix of auto loans with corporate/floorplan/dealer assets;
    • collateral mix of auto loans with auto leases.”

Basel July 2016 document “Revisions to the securitization framework”

Following the wording quoted above, this was inserted:

“Additional guidance for capital purposes

“Homogeneity”

For capital purposes, this criterion should be assessed taking into account the following principles:

The nature of assets should be such that investors would not need to analyse and assess materially different legal and/or credit risk factors and risk profiles when carrying out risk analysis and due diligence checks.

  • Homogeneity should be assessed on the basis of common risk drivers, including similar risk factors and risk profiles…

Securitisation Regulation wording – the Commission draft

“The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type”.

Securitisation Regulation wording – the Council version

“The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, such as pools of residential loans, pools of corporate loans, leases and credit facilities to undertakings of the same category to finance capital expenditures or business operations, pools of auto loans and leases to borrowers or lessees and pools of credit facilities to individuals for personal, family or household consumption purposes. A pool of underlying exposures shall only comprise one asset type.”

Securitisation Regulation wording – the European Parliament’s draft

“The securitisation shall be backed by a pool of underlying exposures that are homogeneous. The underlying exposures in a pool shall be deemed to be homogeneous where they belong to the same asset type and where their contractual, credit risk, prepayment and other characteristics that determine the cash flows on those assets are sufficiently similar.  Pools of residential loans, pools of corporate loans, business property loans, leases and credit facilities of the same category, pools of auto loans and auto leases, and pools of credit facilities to individuals for personal, family or household consumption purposes shall be deemed as single asset types.”

The March 2017 non-paper

“The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type.  

[Notice that the list of asset types examples (pools of residential loans, pools of corporate loans etc.) has been deleted because the EBA guidelines would provide clarity on asset types categorisation and it is preferable to avoid examples in legal provisions in order not to suggest the list of examples is exhaustive.]

[9a.      With a view to establishing consistent, efficient and effective supervisory practices within the single market and to ensuring the common, uniform and consistent application of Union law, the European Banking Authority (EBA), in close cooperation with the European Securities and Market Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA), may issue guidelines to further specify the characteristics on the basis of which the underlying exposures referred to in paragraph 4 are deemed to be homogeneous in terms of asset type, including the characteristics relating to the cash flows of different asset types taking into account their contractual, credit risk and prepayment characteristics.]”

Securitisation Regulation wording – the “compromise wording”

“The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the characteristics relating to the cash flows of different asset types including their contractual, credit risk and prepayment characteristics….

Note:

Aligned list to be included in recital 18: “Pools of residential loans, pools of corporate loans, leases and credit facilities to undertakings of the same category, pools of auto loans and auto leases, and pools of credit facilities to individuals for personal, family or household consumption purposes”.

Securitisation Regulation wording – the final text – Article 20(8) and Recital (27)

“8.        The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the specific characteristics relating to the cash flows of the asset type including their contractual, credit-risk and prepayment characteristics. A pool of underlying exposures shall comprise only one asset type…

(27) To ensure that investors perform robust due diligence and to facilitate the assessment of underlying risks, it is important that securitisation transactions are backed by pools of exposures that are homogenous in asset type, such as pools of residential loans, or pools of corporate loans, business property loans, leases and credit facilities to undertakings of the same category, or pools of auto loans and leases, or pools of credit facilities to individuals for personal, family or household consumption purposes."
Article 20(5) – minimum perfection triggers

The Article 20(5) minimum perfection triggers will concentrate minds on STS deals, especially legacy deals which parties wish to elevate to STS status, where Article 43(3) requires parties who would like to have them badged "STS" to make do with the wording they inherit.  The phrase seems reasonably wide in scope. 

art 20_5

Section 4 of the EBA Guidelines suggests that the documentation should identify "credit quality thresholds that are objectively observable and related to the financial health of the seller".  This replaces the reference in the draft guidelines to "credit quality thresholds generally used and recognised by market participants" to include a wider range than simply credit ratings, so long as they are objectively observable.

"Insolvency of the seller" should be straightforward, both for new and for legacy deals.

"Unremedied breaches of contractual obligations" is less straightforward.  Does it imply that even trivial breaches must lead to a perfection trigger being pulled?  Probably not: the word "unremedied" suggests that you could have a remedy period or routine before the trigger was pulled, and our understanding is that the ECB is not expecting this to change market practice.  So, whilst the wording requires these triggers to exist, it does not require them to be hair triggers, and does not preclude protections for the parties against the trigger being pulled in circumstances which would not warrant it commercially, so long as the trigger is not rendered altogether illusory.  Unhelpfully, paragraph 20 of the "Background and rationale" section of the EBA Guidelines refers to Article 20(5) as specifying "a minimum set of events subsequent to closing that should trigger the perfection of the transfer of the underlying exposures", and "should" is less forgiving than a word such as "could", and the Guidelines themselves are silent after this.

Article 43(3)(a) requires the Article 20(5) requirements to have been met at the time of issuance of the securities, and not merely at the time the STS notification is given.  Where Article 43(3)(a) applies, there is no scope for amending the terms of a legacy issue to bring it within the STS regime.

Article 20(6) – underlying exposures unencumbered and enforceable

 The required seller warranty is that “to the best of its knowledge” the condition of the assets cannot be foreseen adversely to affect the enforceability of the sale. Article 20(6) does not simply refer to bans on assignment in the underlying debt documentation, but, those aside, it is not obvious how the “condition” of a loan asset could affect the enforceability of its sale.  The EBA Guidelines add nothing to this.  An obvious concern is how the representations and warranties could be provided when there is no direct relationship between the seller and the original lender, and especially for NPLs acquired from insolvency officials or a resolution authority but, in any case, the warranty is "best of knowledge" and not absolute.  "Best of knowledge" is an uncertain standard - whose knowledge is to be attributed to the seller? - but it should usually be clear enough what the seller knows, and the ambit of the represetnation is narrow.

A unified regime for investors

In place of the old piecemeal approach, the Securitisation Regulation provides a single unified regime applying to all "institutional investors":new regime schematic

Credit institutions

The CRR Amendments Regulation replaced CRR Articles 404 to 410, covering risk retention, due diligence, criteria for credit granting and transparency and entirely replaces Chapter 5 (Articles 242 to 270, entitled "Securitisation").

Commission Delegated Regulation 2018/1620 of 13th July 2018 amended the Liquidity Coverage Ratio Commission Delegated Act to align the criteria for "Level 2B securitisations" (in the context of calculating the value of a credit institution's liquidity buffer) to reflect and accommodate STS securitisations.

Insurers

A Commission Delegated Regulation on 1st June 2018 amended the Solvency II Delegated Act to align it with the Securitisation Regulation, particularly:

  • to conform the definitions used in the Solvency II Delegated Act regarding securitisation to those in the Securitisation Regulation
  • to repeal the old rules regarding risk retention and due diligence, since these have been restated (and made directly applicable) in the STS Regulation
  • to apply the new, more favourable, calibration for non-senior tranches of STS securitisations (and make some technical improvements to the methodology of calculation).

IORPs

There were no due diligence rules for institutions for occupational retirement provision until the Securitisation Regulation.

UCITS

There were no due diligence rules for UCITS until the Securitisation Regulation.

Alternative investment fund managers

The AIFMR rules (especially Articles 51-53) on risk retention, due diligence, criteria for credit granting and transparency are superseded by the Securitisation Regulation.

Structured finance instruments

Article 40(5) of the Securitisation Regulation also repeals Article 8b of the Credit Rating Agency Regulation, which required issuers, originators and sponsors to publish specified information on structured finance instruments.

Brexit - impacts and changes for securitisations in the UK and Europe

Securitisation remains one of the most effective and efficient forms of financing to support business growth and development.  In spite of years of regulatory interference, delay and badly developed regulation the market continues to operate, admittedly at significantly reduced levels. The UK now has the opportunity to re-establish a securitisation regulatory regime that is effective and more appropriate to the risk and structures involved.  This is however likely to be some way off as participants initially continue to operate within the current regulatory framework.

With effect from 1 January 2021, businesses looking to use securitisation to fund activities have been faced with a challenging interplay of EU and UK regulation as the UK establishes its framework outside the European Union. Activity within the European securitisation market transcends national European boundaries, and participants need to evaluate the consequences, for existing issuances and new issuances, of the UK leaving the EU and becoming a “third country” from a European securitisation perspective. 

Historic European issuance EUR bn
The European market has not rebounded after 2008, with no obvious uplift from STS.  

Source: AFME Securitisation Data Report Q3 2020, Q4 data grossed up by reference to average 2010-19 European Q4 issuance

This paper aims to assist potential issuers and other participants work through the complex interaction of EU and UK legislation.

The new UK legislative regime adopts the position of the EU Securitisation Regulation as at 31 December 2020 and develops that position for the purposes of the UK securitisation market.  We look at what has changed, and at what sponsors, originators, issuers and investors will need to know in order to comply with the requirements applying in the UK whilst continuing to comply with the rules now applying in the EU.   

A dual securitisation regime

With effect from 1 January 2021, regulation of the European securitisation market has been bifurcated into two sets of rules:

  • the EU Securitisation Regulation ((EU) 2017/2402) (the “EUSR”), to be amended sometime in the next couple of months by the “quick fix” amendments introduced in 2020; and
  • the UK Securitisation Regulation (the “UKSR”), made up of the text of the EUSR as it stood on 31 December 2020, as amended in accordance with section 8 of the European Union (Withdrawal) Act 20181 (”EU Withdrawal Act”) (itself as amended by the European Union (Withdrawal Agreement) Act 2020) and by the Securitisation (Amendment) (EU Exit) Regulations 2019 (which themselves have been amended three times since they were originally issued).

The need to apply two sets of regulations to a market that had operated as a single market up until 1 January 2021 will present some complexity as participants from each of the UK and EU continue to operate on a cross border basis reflecting the operations of the market rather than the operation of newly erected jurisdictional boundaries.  The fact that neither the EU regulatory rules nor the new UK regulatory framework are in a complete state leads to further requirements to remain watchful of the developing regulatory positions.

2020 placed issuance by country of collateral
During 2020 the major segments were RMBS, ABS and CLOs, often pan-European and managed from London

Source: AFME Securitisation Data Report Q3 2020, Q4 data grossed up by reference to average 2010-19 European Q4 issuance

The EU Withdrawal Act onshored all level 2 rules which were legally binding at the end of the Brexit transition period.  The expectation is that any regulatory technical standards or implementing technical standards that were not in force on 31st December 2020 will be adopted - in some form or another - by the Financial Conduct Authority (“FCA”) in due course.  The most important regulatory technical standards that were not in effect on 31st December 2020 were the final draft regulatory technical standards specifying the requirements for originators, sponsors and original lenders relating to risk retention pursuant to Article 6(7) of Regulation (EU) 2017/2402, the final text of which was adopted by the EBA on 31st July 2018 and submitted to the European Commission, but which has still not yet been officially published.

Level three guidance – particularly, the EBA Guidelines on STS requirements2 and the ESMA Q&A on the EUSR– is not onshored by the EU Withdrawal Act, but the Bank of England and the Prudential Regulation Authority (“PRA”) in their 2019 joint policy statement, “Interpretation of EU Guidelines and Recommendations” said that they expected UK-regulated firms to continue to make every effort to comply with them “to the extent that they remain relevant when the UK leaves the EU”.

The inadequacies of the existing regulatory framework have been well documented and the new interplay between two separate regulatory regimes will make for even greater implementation and operational challenges for participants to follow.  For these reasons we recommend readers to bookmark our dual law Securitisation Regulation text, which shows the similarities and differences between the two regimes, and which will be amended as necessary from time to time – for example, to accommodate the EU “quick fix” amendments once they have gone through the jurist/linguist process.  These materials also contain links to relevant level 2 and 3 texts and indeed much more background and related materials which will be helpful in understanding why the market has adopted certain regulatory positions.

UK risk retention holders in EU securitisations

Article 6(1) of the EUSR requires the risk retention holder to be the originator, sponsor or original lender.  “Originator” and “original lender”, as defined in Article 2 of the EUSR, are simply required to be “entities”, whether or not established in the EU (a point emphasised by Article 5(1)(b) of the EUSR), and if a UK-based risk retention holder falls into one of these two categories, the requirements of Article 6(1) EUSR should continue to be met.  However, if a UK-based risk retention holder has been holding as “sponsor”, it needs to examine if it continues to fall within the definition of “sponsor” for the purposes of the EUSR to make sure it can continue to fulfil this role on EU securitisations.

As readers will probably know, this definition is not unambiguous as regards investment firms.  Credit institutions “whether located in the Union or not”, are clearly within the definition of “sponsor”, but the fact that, in the definition of “sponsor”, this phrase appears after "credit institution" but before "investment firm", has created doubt and no little discussion as to whether or not non-EU investment firms are included.  Although the definition in Article 4(1)(1) of MIFID does not have any geographical limitation, in the context of MIFID itself, “investment firm” is usually taken to refer to EU-organised firms3.  However, in the context of the EUSR, Article 5(1)(d) clearly envisages the possibility of the sponsor being established in a third country.The first draft of the EUSR had defined “investment firm” so as to require a fully-authorised MIFID firm (as was the case under the previous Capital Requirements Regulation (“CRR”) rules) and this would certainly have caused problems for many UK CLO managers, which do not usually have the MIFID super-authorisations.  The point then went away – until Brexit revived it - after the definition was switched during one of the trilogues to what we now have in the EUSR, although there was no official commentary explaining why this was done, nor what the legislators intended by it.  Some official interpretation or guidance on this point would be very welcome, but none has yet been provided.  The corresponding definition in the UKSR has no equivalent ambiguity because of the amendment to it made by the Securitisation (Amendment) (EU Exit) Regulations 20194.

This means that for UK investment firms wishing to hold or continue holding the risk retention in European CLOs and which are able to come within the definition of “originator”, the approach which provides most certainty is to do so as an originator rather than as sponsor, unless and until there is any official EU guidance on the point.

Risk retention on a consolidated basis may be affected

Article 6(4) of the EUSR recognises and permits the practice of having one entity within a financial group being permitted to hold the risk retention for securitisations which another group company has originated or sponsored.  This can be convenient for obvious reasons, because the flexibility avoids any need to examine the extent of the definition of “originator”.  That flexibility no longer applies where the group has a UK parent, because Article 6(4) of the EUSR only permits this where the parent or holding company is EU-organised.  Article 6(4) of the UKSR is broadly consistent with this, requiring a UK holding company or parent.

Reduced access to STS issuances for EU investors, but not for UK investors

The UK securitisation regime does not require EU investors to cease to hold securitisations which have a UK originator, sponsor or SSPE, but issuances which had been classified as “STS” prior to 1 January 2021, and had an originator, sponsor or SSPE established in the UK, ceased to qualify as EU-STS with effect from 1 January 2021 because EU-STS status requires all of them to be established in the EU. The European Securities and Markets Authority (“ESMA”) wasted no time in amending its list of STS deals on Tuesday 5 January 2021, to exclude 81 UK-related issues accordingly.  Loss of the STS label for these securities meant that any EU regulated institutions which were still holding them would correspondingly lose the preferential treatment available for STS labelled securities under the CRR and the Liquidity Coverage Ratio (where STS labelled securities are classed as level 2B). It is likely that EU investors would have transferred those assets to UK investment entities or become forced sellers of those assets. 

The UK FCA’s list of issues which qualify as UK-STS was established on 1 January 2021.  In addition to these, so as to maintain an accessible pool of STS labelled  product for UK institutional investors, the FCA grandfathered all EU securitisations which were notified to ESMA before the end of the transition period as meeting the EU STS criteria, and announced it would accept any EU-STS issues which were notified to ESMA in the first two years after Brexit (seemingly this means legal Brexit – 31 January 2020, rather than the transition period end date of 31 December 2020).  The result is that so long as these remain on ESMA’s list, they will also qualify as UK STS for the life of the transaction.

EU due diligence and information disclosure requirements: no significant changes

EU institutional investors are permitted to acquire securities even where the relevant  securitisation special purpose entity (“SSPE”), sponsor, originator or original lender is located in the UK.  These EU investors are required to conduct due diligence in accordance with Article 5 of the EUSR prior to holding a securitisation position, and if that issuance has a UK originator or original lender, the legal obligation on the EU investors to verify credit granting criteria and risk retention switches from the provisions of Article 5(1)(a) and (c) of the EUSR to the provisions of Article 5(1)(b) and (d) of the EUSR, but these are not qualitatively very different. 

EU investors however need to consider Article 5(1)(e) of the EUSR, and the vexed question of what information EU investors are required to receive from the originator, sponsor or SSPE (as the case may be) under Article 7 of the EUSR.  This topic is problematic for EU investors wanting to buy into securitisations which are not structured to align with Article 7 of the EUSR; for example, securitisations originating from markets like the US which do not require granular loan level information like that prescribed by Article 7 (a point discussed in more detail in our commentary, “Do EU investors need loan level data to invest in non-EU issues?”).  For UK issuances this distinction should not make a difference because of the similarity of the practices of disclosure under both regimes.

Positions we are seeing being taken in early 2021 deals include requirements for parties such as sponsors or originators to provide information on a reasonable efforts basis to assist EU-based investors (in UK securitisations) or UK-based investors (in EU securitisations) in complying with the requirements of Article 5 of the EUSR or UKSR, as applicable.  We are also seeing requirements for parties, in the event that the regimes diverge, to enter into negotiations to agree amendments or waivers to transaction documents and, if no agreement can be reached, triggering a redemption of the securities held by the affected investor. 

UK due diligence and information disclosure requirements

For UK investors, the position is largely the same as is outlined above for EU investors.  The UKSR has divided Article 5(1)(e) into sub-articles (e) and (f) – usefully correcting a drafting deficiency in the EU text – but as noted above, the practices regarding disclosure under the EUSR and the UKSR are currently the same in any event, as are the substantive provisions of Article 7 of the UKSR and the related EU regulatory technical standards, which came into force on 23 September 2020 and have been adopted as part of retained EU law by the UK under the EU Withdrawal Act.  As such, a UK investor should be able to satisfy itself that it has the information it needs to perform its due diligence under Article 5 of the UKSR even for an issuance structured principally with the EUSR in mind.

UK sponsors and originators might have hoped that the Securitisation (Amendment) (EU Exit) Regulations 2019 would have disapplied the Article 7 disclosure requirements in respect of private securitisations, but for the time being the UK has not done this.  On 31 January 2019, the FCA and PRA issued a final Direction under the UK's Securitisation Regulations 2018 specifying the manner in which disclosure should be made to them in respect of a private securitisation established in the UK, annexed to which were short form templates to be used for the purpose.  The 2018 Regulations were routine implementation regulations and not Brexit-related and, whilst administratively convenient, they did not disapply nor vary Article 7 of the EUSR: noteholders and, on request, potential investors, and indeed the regulators themselves, are entitled to the full Article 7 disclosure (subject to Article 7(1), which has a paragraph that permits just a summary of the deal documentation to be provided rather than copies of all the bible documentation).

UK CLO asset managers for European CLO’s?

From January 2021, UK-based collateral managers with no EU27 offices will need to examine whether they can legally provide management services to an EU27-incorporated CLO entity (European CLO issues are typically done through an Irish DAC particularly as the Dutch CLO market has largely disappeared). Prior to January 2021, any UK collateral manager would have been a MIFID-authorised “investment firm”, but that authorisation has of course now lapsed and, since there has not been any MIFID equivalence determination from the EU, UK CLO managers will need to consider whether applicable local law permits them to provide the management services to the SSPE. 

In the case of an issuance where the SSPE is an Irish DAC, a UK collateral manager should be able to provide the collateral management services, even though the UK is now a “third country” for EU MIFID purposes, because MIFIR Article 54(1) permits third country investment firms to provide collateral management services into the EU in accordance with relevant local law “until three years after the adoption by the Commission of a decision in relation to the relevant third country in accordance with Article 47”, and the Irish European Union (Markets in Financial Instruments) Regulations 2017, which implemented MIFID II into Irish law permit certain non-EU investment firms to provide collateral management services into the EU to Irish persons.  There are some detailed requirements to be met (the manager may not have a branch in Ireland and must be subject to authorisation and supervision in the UK), and there must be – as there are – appropriate co-operation arrangements in place between the Central Bank of Ireland and the FCA for the exchange of information.  Subject to this, a UK collateral manager may provide management services to any per se professional clients or eligible counterparties (as defined in MIFID II) .

In some cases however, there is a trap for unwary UK collateral managers.  As a general rule, non-STS securitisations may have their sponsor located anywhere in the world.  However, there is an anomaly in the wording of the EUSR which the EU has acknowledged to be unintentional, which is relevant.  This is that, if a non-EU sponsor establishes the securitisation but then delegates day to day active portfolio management to a manager, then, because limb (b) of the definition of “sponsor” requires the manager to be authorised under the UCITS Directive, the AIFM Directive or MIFID, the manager must - as drafted - be in the EU.  The UK post-Brexit onshoring version of this definition, contained in section 4 of the Securitisation (Amendment) (EU Exit) Regulations 2019, has already corrected the corresponding wording in the definition, and allows delegation to be to any entity "which is authorised to manage assets belonging to another person in accordance with the law of the country in which the entity is established".

Is there any significance for deal documentation governed by English law?

The absence of any UK/EU agreement on continuation of the 2012 Brussels (Recast) Regulation on jurisdiction and the recognition and enforcement of judgments means that, unless and until the EU agrees to the UK becoming a party to the 2007 Lugano Convention, the position regarding the recognition and enforcement of UK judgments in the EU27 is governed by the 2005 Hague Convention (the “Hague Convention”).  The generally held view is that the Hague Convention probably only applies if the jurisdiction clause is fully exclusive (i.e. as regards not only the debtor parties but also the trustee, which may not always be the case in legacy documentation).  Having said this, in practice there may be limited circumstances in which litigation on the deal documentation in non-English jurisdictions is likely to arise, save as regards the validity of any transfer of assets by an originator to an issuer (in which event it is likely that the parties would have chosen the laws of the place where the asset is situated) and so, whilst Brexit does have some consequences for the status of English law judgments in the EU27, these should not normally be significant nor necessarily preclude the continuing use of asymmetric clauses.

An uncontroversial point of detail is that the UK and EU now have separate bail-in regimes and so under Article 55 of the EU BRRD and its UK-onshored equivalent, a contractual recognition of bail-in clause is likely to be required in mixed UK/EU securitisations.  The wording of such a clause is quite standard and, as it merely restores the pre-Brexit status quo ante, its inclusion will be uncontroversial.

Is there any prospect of an equivalence regime for STS issues?

As it stands today, the UK is a non-EU "third country" and, pending the adoption of any "third country regime" under the EUSR – which it is difficult to see happening any time soon -  issuances by any UK party are ineligible for STS status, because under EU STS, all three of the issuer, originator and sponsor must be established in the EU.  Back in 2016, the European Parliament had proposed, in response to the Brexit referendum result, an equivalence regime - a solution which one might have thought would be appealing both to EU investors (because it would have given the post-withdrawal STS market the same depth it had pre-withdrawal) and to EU regulators (because any subsequent competitive loosening of UK regulation would be constrained by the prospect of the equivalence declaration being withdrawn).  However, this was dropped as it was regarded by some EU countries (reports at the time suggested France and Germany) as being too political for resolution except as part of a future UK-EU agreement.  Instead, we are left with Article 46 of the EUSR, which contemplates that within the first 3 years after the EUSR has effect, the European Commission will produce a report examining whether an equivalence regime could be introduced for STS securitisations.

Meanwhile, as regards STS, because Article 19 of the EUSR restricts EU STS status to EU originated securitisations, whilst the equivalent UKSR provision does largely the same for UK STS securitisations (the difference being that the SSPE need not be a UK entity - so that, for example, the familiar Irish law DAC can continue to be used) the consequence is a fragmented market, which is not good for issuers or investors. Once the political dust has settled, perhaps a more pragmatic approach can be adopted.

Conclusion

It is ironic that the impetus to revive the European securitisation market after the Global Financial Crisis – and much of the impetus for Capital Markets Union – came from the City of London.  The development of two regulatory frameworks will certainly make it more complex for participants to manage issuances in the near term on a Europe wide basis.  It is hoped however that the current process can act as a starting point for rationalisation of an ill developed regulatory framework which provides an essential tool for funding businesses that will need to drive growth in a post COVID environment.  Businesses looking to issue and investors looking to invest are likely to find their way to the most rational, liquid and well managed market and regulators in both the UK and EU can learn from improvements that drive efficient capital markets across Europe for the benefit of issuers, investors and consumers alike.

For further information please contact our Securitisation group:


Footnotes

1. Section 8 of the EU Withdrawal Act 2018 permits H.M. Treasury to make amendments to adopted EU law "to prevent, remedy or mitigate (a) any failure of retained EU law to operate effectively, or (b) any other deficiency in retained EU law, arising from the withdrawal of the United Kingdom from the EU", and the Securitisation (Amendment) (EU Exit) Regulations 2019 have done this.  In many cases the changes are straightforward updates to reflect this now being UK law - changing "the Union" to "the United Kingdom" for example - but there are some more interesting ones, such as improving the definition of "sponsor", clarifying the due diligence requirements for UK regulated investors in non-UK securitisations, and permitting non-UK SSPEs.  It may be questioned whether all of these fall strictly within the scope of section 8, but it is unlikely that anybody would challenge such helpful changes.

2. Guidelines on the STS criteria for ABCP securitisation, and Guidelines on the STS criteria for non-ABCP securitisation, each published on 12 December 2018.

3. This is because there is a separate definition (Article 4(1)(57)) of "third-country firm" which means (italics added) "a firm that would be… an investment firm if its head office or registered office were located within the Union", which suggests that in the context of MIFID, such a firm is not an "investment firm".

4. The UK text refers to the definition which appears in paragraph 1A of Article 2 of Regulation 600/2014/EU, this is because it is referring to the onshored version of MIFIR, as amended by section 26 of the Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018; the definition is, broadly speaking, a person whose regular occupation or business is the provision of one or more investment services to third parties or the performance of one or more investment activities on a professional basis.

Capital and liquidity requirements

Summary

After the GFC, securitisation was perceived as being too complex, with too much agency and model risk, and, to some, unnecessary.  These attitudes still persist: several MEPs displayed quite high levels of suspicion and hostility to very idea of securitisation during the passage of the Securitisation Regulation, despite the evidence that default rates for European ABS remained low (in contrast to US sub-prime) and to this day there have apparently been no losses on the senior tranches of any pre-GFC European securitisation.  Having said that, the European Commission accepts that securitisation could be an important part of its grand Capital Markets Union plan - so long as it was regulated. 

A consequence of this unfavourable perception is that the regulatory capital regime retains a deliberate bias against securitisation (expressed somewhat obliquely by the presence of a factor "p" - sometimes known as the "supervisory parameter") - in the relevant formulae.  The same set of financial assets could be held on an institution's balance sheet or could be securitised and removed from it, with the securitisation securities being held on a number of different balance sheets.  This in-built regulatory bias ensures that the sum total of required capital in the latter case is above the amount required in the former case.  Regulatory bias persists both in relation to capital adequacy treatment and liquidity treatment (under the LCR - see below), especially in comparison to the treatment of covered bonds, and the industry continues to point out that the capital required is disproportionate to the amount of risk which the actual evidence shows to exist.  

CAPITAL ADEQUACY

The amendments set out in the CRR Amendment Regulation broadly implemented the changes made by the BCBS in July 2016 to the original Basel III requirements to accommodate STC securitisations. These include the wholesale deletion and replacement of Chapter 5 (Articles 242 et seq.) of the CRR. Apart from this, the changes made to the CRR are largely consequential other than as regards the hierarchy of approaches (see below), and in particular no changes are made to the provisions concerning significant risk transfer, the ban on implicit support, or the requirements on external credit assessments.

Hierarchies

The main deviation from Basel concerns Article 254 and the hierarchy of approaches. The Basel hierarchy of IRBA -> ERBA -> SA has been inverted so that in principle, and subject to the caveats in article 254, SA ranks before ERBA.

This is the outcome of a debate about the effect of sovereign rating caps which has been going on between the north and south of Europe since at least 2014, and represents a victory for banks in the south over the EBA, which had considered the possibility of discarding SEC-ERBA altogether (in order to avoid precisely this consequence and to underpin the principle that the three methods should produce progressively higher levels of capital charge as one descended the hierarchy*) but then rejected it in the 2014 EBA Report. This led to a public statement on 28th June 2017 by the United Kingdom and Germany expressing concerns about the consequences for financial stability and the wider economy, and calling on the EBA and the EC to monitor closely the impact of the reversed hierarchy of methods on financial stability and other potential unintended consequences.

The CRR Amendment Regulation provides however for some moderation of this inversion:

  • Firstly, the availability of SEC-IRBA is widened by permitting greater use of proxy data “where sufficient accurate or reliable data on the underlying pool is not available” (Article 255(9)(b) – the detail will be found in RTS to be developed by the EBA within the first year after the CRR Amendment Regulation comes into force). This is already the case in the USA
  • Secondly, SEC-SA ranks behind (not ahead of) SEC-ERBA:
    • for STS securitisations where SEC-SA would result in a risk weight higher than 25% (Article 254(2)(a));
    • for non-STS securitisations where SEC-SA would result in a risk weight higher than 25% or where SEC-ERBA would result in a risk weight higher than 75% (Article 254(2)(b));
    • for securitisations backed by pools of auto loans, auto leases or equipment leases (Article 254(2)(c));
    • if regulators have elected to prohibit its use, which they may on the ground that the application of SEC-SA “is not commensurate to the risks posed to the institution or to financial stability” (which a preamble explains is particularly concerned with the "risks that the securitisation poses to the solvability of the institution concerned or to financial stability”) (Article 254(4));
    • where institutions have notified their national regulator that they intend to apply SEC-ERBA to all their rated securitisation positions (Article 254(3): a development which only emerged during the trilogues).

The EBA is required to monitor the impact of all this, report annually to the EC on its findings and issue guidelines where relevant.

Regulators may prohibit institutions, on a case by case basis, from applying SEC-SA if the resulting risk weighted exposure amount is not commensurate to the risks, particularly as regards (non-STS) securitisations with complex and risky features. Whatever method is used, new risk weights will generally be much higher than under the current rules.

Why are securitisation holdings penalised compared to covered bonds?

As many industry bodies have noted with dismay, overall levels of capital required for STS securitisation holdings remain higher than arguably-comparable investments such as covered bonds, because the regulators regard the tranching of risk in a securitisation as giving rise to structural risks, such as agency risk (the unaligned interests of the parties which arise where the originator and sponsor have little or no skin in the game) and model risk, which go beyond simple credit risks.  In the words of the CRR Amendment Regulation (recital (5)), securitisations “give rise to some degree of uncertainty in the calculation of capital requirements for securitisations even after all appropriate risk drivers have been taken into account”, and the EBA sees significant differences between the two:

  • the dual recourse under covered bonds – to the assets and to the issuer – and correspondingly the absence of any risk transfer
  • the fact that the issuer is (for CRR-compliant covered bonds at least) a supervised credit institution
  • the absence of tranching in covered bonds
  • the much lower or absence of model and agency risk
  • differences in default and loss performance during the financial crisis

For senior positions, the new regulations provide (Article 267) that the risk weighting should be no higher than the exposure-weighted average risk weighting that would apply to the underlying assets if they had not been securitised.  This so-called “look-through approach” arguably illustrates the inherent regulatory prejudice against securitisations, since the approach takes no account of the credit enhancement provided by the tranching and the existence of any lower-ranking tranches; logically, the weight should not be “no higher than” the underlying exposures, but “much less”.  On any measure, it is a significant loading, and the risk weight floors and, under the formula-based approaches, a minimum supervisory parameter “p” of 0.3, ensure that overall securitisation capital surcharges are higher than the total capital requirements on the underlying exposures.  Accordingly, the sum of the capital charges applying to all the tranches of a given portfolio of underlying assets which have been securitised is “ non-neutral”; it remains higher than the sum of the charges that would apply if they had not been and remained on the originating lender's balance sheet.  In the EBA Report it was illustrated to be 2.4 times for a pool of 50% risk weighted assets and 1.7 times where the pool was risk-weighted 35%.  In February 2016 the European Round Table on Financial Services reported that some banks had calculated that, under the new rules for capital allocation, SEC-ERBA would produce an own funds requirement of almost 4 times for an STS securitisation, and 5 times for a non-STS, compared to what would be required if the assets were not securitised; and an analysis by the EBA in its 2014 paper shows similar non-neutrality under SEC-ERBA, and over 2 times even under SEC-IRBA.  Similar criticisms appear in the June 2020 “final report” on CMU by the "High Level Forum on the Capital Markets Union  – a group of market participants, trade bodies and academics, which recommends reducing the capital charges applied to investments in securitisations, especially for senior tranches, originator and sponsor banks under the CRR and for insurers under Solvency 2, applying the same regulatory treatment to synthetics as to cash securitisations, and upgrading the eligibility of senior STS and non-STS tranches as “high quality liquid assets” for LCR purposes (at present, STS investments can be eligible as level 2B HQLA under the LCR - see further below).

* The EBA Report referred to "the impact of sovereign rating caps and equivalent methodologies [prevented] senior tranches of securitisations issued in periphery countries from achieving maximum ratings and imposing on these securitisations higher levels of credit enhancement. Both factors lead to higher capital charges under SEC-ERBA."

LIQUIDITY

The LCR is the ratio of a banks’ “high quality liquid assets” to its total net liquidity outflows over a 30 day period.  In short, it requires a bank to maintain adequate liquidity – in the form of cash, government bonds, covered bonds, and other HQLAs such as investment grade corporate bonds - in case there is a run on it.  Holdings of securitisation paper can count as HQLAs, but only up to a point, and that point is set at a level which is consistent with the arguably undue regulatory bias that applies as regards capital treatment.  Even the most senior tranche of the highest quality securitisation has a minimum haircut of 25%.  For covered bonds, it is only 7%.  As from 30th April 2020, only STS holdings count.  Needless to say, since securities yield more than cash, banks would be expected to try to maximise their holdings of these for obvious reasons, but limits apply.

Statistics show that post-GFC there were liquid markets into which securitisation notes could be sold by willing sellers but, despite lobbying, securitisation holdings - even those which STS - remain classified as Level 2B or lower, and so treated less favourably than covered bonds (which fall into Level 2A) and subject to bigger haircuts – even though a key aim of CMU is to revive this market.  Furthermore, there is no grandfathering: at present, Article 13 of the LCR defines what securitisation assets can quality as Level 2B, but the revised Article 13 will be amended and only extend to STS securitisations, so existing Level 2B assets will be declassified.  Recital

The EC explanatory memorandum said “As regards the alignment with the definition of STS securitisations, the impact is expected to be quite marginal as the total amount of securitisations held as liquid assets is limited due to the cap on Level 2B assets in the liquidity buffer and to diversification requirements”, which is not what the industry lobbying had said. 

Another limiting factor of the LCR for banks is that the wieghted average maturity of LCR-eligible ABS paper may not exceed 5 years.

INSURERS

The CRR and the LCR apply to EU-regulated banks.  Insurers are regulated under "Solvency II" (to be precise, "Commission Delegated Regulation (EU) 2015/35 of 10th October 2014 supplementing Directive 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the business of Insurance and Reinsurance", as amended by Commission "Delegated Regulation (EU) 2018/1221 of 1st June 2018 amending Delegated Regulation (EU) 2015/35 as regards the calculation of regulatory capital requirements for securitisations and simple, transparent and standardised securitisations held by insurance and reinsurance undertakings"). 

Insurers are potentially an important part of the investor base for securitisations, and if they were encouraged to invest in securities issued by SSPEs it would allow them to acquire some exposure to the underlying assets - but in a liquid form , which would enable them to spread the risk of their investments, and, by allowing them to do this, would allow the risk on the underlying financial assets to be more widely spread; all of which would surely be desirable.  However, as it is, Solvency II actually creates disincentives for insurers:  although senior STS positions are treated in the same way as covered bonds, non-senior STS positions, and non-STS holdings, are made unattractive, and perversely insurers are encouraged to invest in the underlying assets (in an un-securitised and illiquid format) rather than liquid securitised form: the capital requirement for an insurer investing in the senior tranche of a securitisation is, according to AFME, often higher than it is for the holding of a whole loan despite the senior tranche benefitting from the credit enhancement which arises from the fact of the junior tranche(s) being subordinated behind the senior tranche.

The financial industry’s position on Solvency II is set out well in this paper issued jointly by AFME, ICMA, and various pan-European, Dutch and German trade bodies in June 2018.

MONEY MARKET FUNDS

STS issues are eligible for investment by money market funds subject to the Money Market Funds Regulation: see Commission Delegated Regulation (EU) 2018/990 of 10th April 2018 which amended the Money Market Funds Regulation (and, in particular, Article 11(1) of it) to accommodate, among other things, STS issues.  

CMBS – a cinderella asset class?

CMBS remains excluded from STS despite industry appeals for its rehabilitation on the basis that, although the post-crisis issues showed clear shortcomings in relation to direct real estate finance, European CMBS did not suffer from them. Typically, loans were bifurcated, with only the senior slice being securitised, and the argument is that logically it should be preferable for risk-averse REF investors to be able to buy the highest-rated bonds issued by a CMBS issuer rather than having to seek exposure via direct lending.

However, the Commission was not persuaded. Following the line taken by Basel/IOSCO, it considered CMBS inappropriate for STS status because it entailed too much refinancing risk, and this sentiment is reflected in Recital 29, reflecting similar provisions in the BCBS criteria for STC securitisation.

As such, Article 20(13) applies.  This expressly excludes structures where repayment of the bonds or notes depends predominately on the sale of the underlying assets (as does Recital 29). It does not refer to their refinancing, and in theory a deal could perhaps be structured so that the SPV and its directors would go down a refinancing route ahead of bond maturity, but this would be directly contrary to what Recital (29) says in black and white, and so would be more than a little bold, and Paragraphs 43-46 of the EBA Guidelines, which elaborate on this, say that "it is expected" that CMBS would not meet these requirements.

And for bank investors, CMBS are highly unlikely to qualify as STS for capital treatment purposes because they lack the necessary granularity: in the CRR Amendment Regulation, the new CRR Article 243(2) requirement that no single exposure exceeds 2% (the test being done at the loan level rather than, as commercial logic might suggest, looking at diversification at the rental payment level and the creditworthiness of the underlying tenants).  For example, a CMBS of a shopping centre might involve a handful of anchor tenants and dozens of individual tennts; a more extreme example would be a CMBS where the underlying loan is to a landlord providing private or social housing to several thousands of seprate tenants.

Do EU investors need loan level data to invest in non-EU issues?

A major uncertainty about the Securitisation Regulation since its inception has been about what transparency it (indirectly) requires non-EU issuers to provide to potential EU investors so that they can do their due diligence under Article 5(1)(e).  By way of a reminder:

  • Article 5 applies to EU institutional investors in securitisations, and Article 5(1)(e) requires the originator, sponsor or SSPE to have "where applicable, made available the information required by Article 7 in accordance with the frequency and modalities provided for in that Article". 
  • Article 7’s “modalities” include using specific templates issued under the  disclosure ITS and the associated Annexes
  • However, Article 7 cannot apply to non-EU issuers without being extra-territorial (which on first principles it should not be, and other parts of the drafting support this too).  
  • But, even though Article 7 does not apply directly to an issue, does the issue have to comply with it indirectly in order to allow non-EU issuers to invest? 

The key is what “where applicable” means inArticle 5(1)(e), and the problem is that there are two ways to interpret it, neither of which is satisfactory:

  • if it means “in a case where Article 7 applies to the issue directly” then some would argue that you could get round the disclosure requirements easily by having a non-EU issue denominated in EUR with EU assets, which would drive a coach and horses through the regulation.   However, Recital (9) says “it is essential that institutional investors be subject to proportionate due-diligence requirements…” and Article 5(3) and (4) contain general requirements on EU investors to do proper due diligence before investing, and these are not disapplied even if, for non-EU issues, they are not provided with granular loan-level data, so this is not the "coach and horses" that some might argue it was;
  • if it means “as the case may be”, you have an extra-territorial effect that probably stops EU investors buying non-EU issues, thus preventing them diversifying their investments and fragmenting the market.  This would not be supportive of Capital Markets Union.

The first of these interpretations would be preferable, but no law firm had been prepared to provide a clean opinion on the matter, and whilst some EU investors had been prepared to invest regardless, others had been boycotting non-EU issues which did not provide the granular loan level data. 

The big sticking point is whether or not you need to have loan-level data disclosure, as Article 7 requires.  In the USA (and apparently Australia and Japan too) this kind of granular loan level disclosure is not the norm.  In the USA, there is no loan level data disclosure required for issues under Rule 144A, just aggregated data; public (prospectus) issues require asset-level data for RMBS, CMBS, and auto loans/leases, but not for credit cards.

The EC had received several communications, from the likes of AFME (FM Update 26th April 2019), the US-based Structured Finance Association (15th July 2019) and the FMLC (5th November, 2019), requesting it to provide clarity, and the 2020 Work Programme of the joint committee of the ESAs identified "the jurisdictional scope of application" as one of the issues requiring their attention, and on 25 March 2021 the ESAs' Joint Opinion was issued.  Unfortunately for the market, it came to the conclusion that, given the reference to complying with the “frequency and modalities” of disclosure referred to in Article 7, a third country securitisation would have to use ESMA templates or, at a minimum, templates with the same content, and that those be disclosed with the same frequency as that of ESMA’s.  The ESAs therefore concluded that:

"it seems very unlikely, or at least very challenging, that EU-located institutional investors would currently be able to discharge the requirement set out in Article 5(1)(e) of the SECR in relation to third country securitisations, as a result of which they will not be able to invest in them". 

This is disappointing, and the ESAs did admit that "the current verification duty laid out in Article 5(1)(e) of the SECR may be overly inflexible for third country securitisations" and recommended that it "should be reassessed to determine whether more flexibility could be added to the framework without undermining its ultimate objective".  This is of course what the UKSR has already done by its new Article 5(1)(f).  This is however a “level 1” issue i.e. it relates to the text of the Securitisation Regulation itself, not some “level 2” RTS or ITS, and it will inevitably take time to amend it.  This is unlikely to be achieved until after the EC's Article 46 review, which is required by the end of 2021.  Brussels is thought to be disappointed at the muted effect on the securitisation market that has been seen in the first year of the Securitisation Regulation and is apparently keen to improve matters. 

As to how this is done, two possibilities had already been aired before the ESAs' Opinion:

  • one, mooted during 2020 in some quarters, was to promote the idea of "substantive compliance", i.e. that disclosure would be made, even if not on the prescribed official ESMA templates, but the SFA letter (see above) had said that this would still be a problem for its USA-based members;
  • in June 2020, the High Level Forum on Capital Markets Union's final report invited the EC to "allow an EU-regulated investor in third-country securitisations to determine [i.e. for itself] whether it has received sufficient information to meet the requirements of Article 5... to carry out its due diligence obligation proportionate to the risk profile of such securitisation" and suggested "clarification" that Article 5(1)(e) does not apply to securitisations with non-EU originators, sponsors or SSPEs, and that, instead, the EU investor must receive "sufficient information to meet the requirements for due diligence proportionate to the risk profile of the securitisation exposure".

The ESAs' Joint Opinion of 25 March 2021 has suggested a third approach:

  • the EUSR should be amended to include an "equivalence" regime for transparency requirements in relation to third country securitisations i.e. its disclosure obligations should require:
    • "substantially the same information" as that required by Article 7
    • with "sufficient frequency” even if the exact frequency of disclosure is not exactly the same as under Article 7
    • with a “modality” of disclosure in the form of disclosure templates of "similar quality and granularity" as those set out in the Disclosure RTS and the Disclosure ITS
  • an EU institutional investor could then comply with Article 5(1)(e) by verifying disclosure compliance either with Article 7 or the equivalent disclosure regime.

This is in some respects similar to "substantive compliance" and will not satisfy the market because it would require the same granularity of disclosure and so run into the same problem in cases where that is not the market norm in the place where the issue takes place.  The market must hope that the EC, in its Article 45 review, pays more attention to the views of the High Level Forum.

For UK investors, as from 1st January 2021 the problem has diminished to an extent because the legislation which implements the Securitisation Regulation into UK law - The Securitisation (Amendment) (EU Exit) Regulations 2019 - has already improved the drafting in Article 5(1)(e), so that (e) applies in relation to originators, sponsors and SPPEs established in the UK, and a new sub-clause (f) applies to those established elsewhere, requiring "substantially" the same information, which contains some latitude and does not require use of the Article 7 templates.  We await guidance on what "substantially" means, and bear in mind that the EU/UK article 7 disclosure requirements are unmatched by anything in the USA or Japan or elsehwere in the world, and so there is a serious risk that Article 5(1)(f) would at most restrict UK investors to UK assets and EU assets).  The position for UK investors in non-UK issues (such as USA issues) is preferable to that of EU investors wanting to buy those same USA issues, but it would be far better if the UK were to move away from the Article 5(1)(e)and (f) requirements.  AFME's preference would be to replace them with a more general principle that required proportionate due diligence to be done. 

A related issue concerns non-EU subsidiaries of EU regulated institutions.  Those subsidiaries are indirectly subject to article 5 by the parent's obligation to ensure the consolidated application of Article 5 via Article 14 of the CRR by requiring them to "implement arrangements, processes and mechanisms to ensure compliance” with Article 5.  The extent of this obligation is unclear, but if it means subsidiaries have to comply line-by-line, then the problems are obvious, and put them at a competitive disadvantage compared to local investors.  The ESAs recommend the CRR is amended to provide some flexibility, either:

  • by allowing the EU parent to "ring-fence" the subsidiary via some "structural separation" - there is no detail provided for this and query whether the idea has any legs; or
  • allowing some "proportionate investment limits on the subsidiary’s investments in third country securitisations by reference to the consolidated situation of the EU parent" - which sounds much more feasible.
Due diligence, risk retention and transparency – extra-territorial?

The due diligence provisions in Article 5 clearly apply to EU investors, and similarly the Article 6 risk retention and Article 7 transparency and credit granting criteria provisions clearly apply to originators, sponsors and original lenders doing business in the EU.  But what about cross-border cases?

The better view is that Articles 6 and 7 do not apply to entities which are established outside the EU. This would be consistent with the fundamental presumption that legislation should not be extra-territorial unless that is its clear intention; and in any event, as regards risk retention, if a non-EU sponsor wants to sell a non-EU securitisation to EU investors, then indirectly, as a result of Article 5(1)(d), it would need to comply with the Article 6 risk retention requirements.  The EC's explanatory memorandum accompanying the original draft of the Securitisation Regulation suggested this was the position, and in the final draft RTS on risk retention (at page 27) the EBA helpfully observed, in respect of comments it received in response to its discussion draft RTS on risk retention, that, although the scope of application and jurisdictional scope of the ‘direct’ retention obligation was outside the scope of the draft RTS, it agreed that a ‘direct’ obligation should apply only to originators, sponsors and original lenders established in the EU; and finally, the ESAs' Joint Opinion of 25 March 2021 expressed the same view i.e. that articles 6, 7 and 9 do not apply directly to non-EU parties on the sell side (if there is a mix of EU and non-EU sell-side parties, the ESAs' view is that those located in the EU have a direct obligation to comply with the rules).

As regards transparency, there is the vexed question whether EU investors can invest in non-EU issues that do not comply with Article 7.  As regards risk retention, the position is clear: Article 5(1)(c) requires investors to verify that Article 6 is complied with if the issue is an EU one, and then Article 5(1)(d) is equally clear that where it is a non-EU issue, the originator, sponsor or original lender must retain 5%, determined in accordance with the Article 6 methodology.  So, the wording acknowledges explicitly that the issue could be EU or non-EU, and deals with both in turn.  The same is true of the requirement to verify that the originator's or original lender's credit-granting criteria were acceptable: Article 5(1)(a) applies where they are EU entities, and Article 5(1)(b) applies where they are not.  In comparison, as regards transparency, instead of having a third pair of requirements, one for EU issues and one for non-EU issues, Article 5(1) just has a single requirement, Article 5(1)(e) which requires an EU investor to verify that the originator, sponsor or SSPE "has, where applicable, made available the information required by Article 7 in accordance with the frequency and modalities provided for in that Article", and those modalities require detailed loan-level data in accordance with the prescribed templates, and not just aggregate data.  The ESAs' Joint Opinion of 25 March 2021 was that, given the reference to complying with the “frequency and modalities” of disclosure referred to in Article 7, a third country securitisation would have to use ESMA templates or, at a minimum, templates with the same content, and that those be disclosed with the same frequency as that of ESMA’s.  The ESAs therefore concluded that "it seems very unlikely, or at least very challenging, that EU-located institutional investors would currently be able to discharge the requirement set out in Article 5(1)(e) of the SECR in relation to third country securitisations, as a result of which they will not be able to invest in them".  This is disappointing, and the ESAs did admit that "the current verification duty laid out in Article 5(1)(e) of the SECR may be overly inflexible for third country securitisations" and recommended that it "should be reassessed to determine whether more flexibility could be added to the framework without undermining its ultimate objective".  This is of course what the UKSR has already done by its new Article 5(1)(f).  

This issue is discussed in detail on another page: "Do EU investors need loan level data to invest in non-EU issues"? 

Consolidated non-EU subsidiaries of EU entities

As of 1st January 2019, there was a temporary hiccup concerning the position of consolidated subsidiaries of EU regulated entities, because of the interplay of the Securitisation Regulation and the CRR (as revised by the 2018 CRR Amendment Regulation).  The actual detail is long and complex but, in short, the old CCR's Article 14 required EU regulated entities to ensure that their non-EU subsidiaries complied with the whole of the old part 5 of the CRR, which imposed due diligence obligations on investors and obligations on originators and sponsors regarding sound credit granting criteria and transparency, but as regards both the indirect retention obligation and investor due diligence, this was moderated by Article 14(2) of the CRR.  Because the old part 5 was replaced by the Securitisation Regulation, Article 14 was amended by the 2018 CRR Amendment Regulation to change the reference to Part 5 to refer to Chapter 2 of the Securitisation Regulation (articles 5 to 9, covering due diligence, risk retention, transparency, the ban on resecuritisation and criteria for credit granting).  At first glance this looked consistent, and it took a while before it was noticed that this went too far, e.g. a non-EU subsidiary acting as an originator, sponsor or original lender outside the EU would be required to comply with EU risk retention rules as well as its own home country ones.

The detailed explanation of all this need not concern us now because Article 1(9) of CRR II has changed the wording of CRR Article 14 so that rather than the whole of Chapter 2 applying to consolidated non-EU subsidiaries, only the Article 5 due diligence requirements will:

"1.  Parent undertakings and their subsidiaries that are subject to this Regulation shall be required to meet the obligations laid down in Article 5 of Regulation (EU) 2017/2402 [i.e. the Securitisation Regulation] on a consolidated or sub-consolidated basis, to ensure that their arrangements, processes and mechanisms required by those provisions are consistent and well- integrated and that any data and information relevant to the purpose of supervision can be produced. In particular, they shall ensure that subsidiaries that are not subject to this Regulation implement arrangements, processes and mechanisms to ensure compliance with those provisions.
2.  Institutions shall apply an additional risk weight in accordance with Article 270a of this Regulation when applying Article 92 of this Regulation on a consolidated or sub-consolidated basis if the requirements laid down in Article 5 of Regulation (EU) 2017/2402 are breached at the level of an entity established in a third country included in the consolidation in accordance with Article 18 of this Regulation if the breach is material in relation to the overall risk profile of the group.”

The RTS on risk retention moderate its application in the same way that CDR 625/2014 previously did as regards the old indirect risk retention requirement.  So not only does Article 14(2) apply (so that a breach of the due diligence requirements at the subsidiary level will not result in a penalty capital charge unless the breach is material in relation to the overall risk profile of the group - this is the old position) but also, Article 2(4) of the new RTS will now apply to prevent it being a breach of Article 14(2) in the first place if a breach of the due diligence requirements occurs at the subsidiary level.

Environmental disclosures

The original Securitisation Regulation had a difficult legislative passage, with some Green/Left factions of the European Parliament seemingly suspicious if not hostile to the very idea of this financial technique, whilst being keen to promote their political preferences for "environmental" issues.  These were largely kept at bay, save for two concessions which were offered as a quid pro quo for their giving up some of their more contentious positions, such as relating to risk retention:

  • Article 22(4), which requires "available information related to the environmental performance" of the houses financed by an STS RMBS or the cars financed by an STS of auto loans and leases to be disclosed to investors quarterly (it only applies to term STS, not ABCP).  The provision has no relationship of course with the "standardisation" pillar of STS or STC, nor the rational interests of prudent investment, but was a necessary expedient.  The EBA Guidelines paragraph 84 require this only if the information on the energy performance certificates for the assets financed by the underlying exposures is available to the originator, sponsor or the SSPE and captured in its internal database or IT systems, and of course it is unlikely that it will be;
  • Article 46(f), which expressly requires the European Commission review under Article 46 (due within the first three years) to review the working of Article 22(4), on the face of it to consider whether the disclosure should be extended to other asset classes.  

Some of the same MEPs represented the Parliament in its examination of the EC's 2020 draft "quick fix" amendments in response to coronavirus, and their efforts have led to more ESG-related positions being conceded for the purpose of getting the EC's package of measures to help with synthetic and NPL securitisations over the line:

  • Article 22(4)  (Requirements relating to transparency) is to be amended to permit (but not require) originators to publish available information related to the "principal adverse impacts on sustainability factors" of the assets financed by the underlying exposures
  • within 3 months after entry into force of the quick fix amendment, the ESAs must develop draft RTS on the content, methodologies and presentation of these principal adverse impacts
  • a new Article 45a - "Development of a sustainable securitisation framework" - will require the EBA to produce a report on developing a specific sustainable securitisation framework for the purpose of integrating sustainability-related transparency requirements into the Securitisation Regulation.  This is required by 1st November 2021.

The UK market will be relieved that, although Article 22(4) in its present form does form part of the onshored UKSR, these new proposals do not.

 

 

Investor due diligence (Article 5)

Sound and consistent credit-granting criteria (Article 5(1)(a) and (b))

Consistency of underwriting is an important theme not only in the Securitisation Regulation, but also in the Basel/IOSCO proposals on STC.  In this respect, a useful contribution was made by the European Parliament during the passage of the Securitisation Regulation, by narrowing the scope of the underwriting verification to the credits which give rise to the underlying exposures being securitised - which is consistent with requirement A4 in Basel/IOSCO.  The EC had originally proposed that it should extend to the basis on which the originator or original lender granted "all" its credits, whether they were being securitised or not (consistent with Article 52 of the old  AIFM rules).

This verification requirement does not apply if the originator or original lender is a credit institution or investment firm as defined in Article 4(1)(1) and (2) of the CRR.  Many CLO managers will not be because many are not fully authorised, and so if they are acting as originator of an issue, this would catch the issue if the exposures were not originated by a credit institution or one of the other exempt categories: for example, securitisations of auto loans and leases, and credit or store cards; and post-Brexit, it also catches UK originators which would previously have been authorised institutions, because they would now fall within Article 5(1)(b).  A nice question is whether a securitisation of exposures originated by a UK credit institution before Brexit but securitised after Brexit would fall within (a) - in which case its credit-granting criteria etc. would require not verification by EU27 investors - or (b) - in which case they would.

Verification that risk has been retained (Article 5(1)(c) and (d))

An institutional investor must verify before becoming exposed to a securitisation that the originator, sponsor or original lender meets the risk retention criteria in Article 6 (non-EU originators or original lenders are not themselves directly obliged to do this, but EU investors cannot buy the paper if they do not; because Dodd-Frank has slightly different rules on risk retention, this means EU investors may not be able to buy some US issues).

It is not specified what "verification" a potential investor is supposed to do, and no RTS or guidelines can flesh out any of the detail.

Verification of compliance with the transparency criteria (Article 5(1)(e))

This raises the vexed question of what an EU investor in a non-EU securitisation has to do.  This is analysed here.

Institutional investors' heightened due diligence assessment  for STS (Article 5(3)(c))

As well as the assessments required by Article 5(3) and (4) for any investment, before investing in an STS securitisation, EU institutional investors have to comply with the heightened due diligence requirements in article 5(3)(c) to check that it meets the STS criteria.  When doing this, they can "rely to an appropriate extent" on the STS notification, but must not rely on it "solely or mechanistically".  As of June 2019 it seems that some investors have a preference for non-STS deals in order to avoid having to get into this.

Procedures, regular testing, internal reporting and understanding (article 5(4))

On a point of detail, the wording of Article 5(4)(e) presumably should have, but (seemingly in error) does not, carve out fully-supported ABCP (unlike in Article 5(4)(b)) and so it seems that ABCP investors must be able to demonstrate that they have a comprehensive and thorough understanding of the credit quality of the underlying exposures; which makes no sense at all in the context.

The due diligence obligations contain no provision for RTS nor even guidelines to supplement them.  It is to be hoped that the joint committee of the ESAs may be able to issue some clarity (this is particularly an issue as regards the extraterritoriality question).  RTS (Commission Delegated Regulation 625/2014)) were issued to supplement the old Article 406 of the CRR. The Commission seems to have been determined to impose a principles-based obligation so that investors would need to exercise caution in their due diligence. It is clear that regulated investors will need to establish and follow detailed policies and procedures so that they can demonstrate to their regulator that best practice has been followed, and presumably it will then be for their regulator to adopt a common-sense approach in not penalising investors which have done what they reasonably can.

On the positive side, the new requirements do away with some of the existing excessive qualitative due diligence required of insurers by Article 256(3) of Solvency II and of AIFMs by Article 53 of the CRD for AIFMs, and they recognise that in the case of fully-supported ABCP programmes, what counts principally is the quality of the support, not the underlying exposures.

AIFMs

The ESAs' Joint Opinion of 25 March 2021 noted potential inconsistencies between the provisions of the EUSR and the requirements of Directive 2011/61/EU [the AIFM Directive], especially the lack of clarity regarding how the due diligence obligations on AIFMs in respect of securitisations in Article 17 ("Investment in securitisation positions") meshes with the EUSR, and which national regulator should ensure compliance with the relevant due diligence obligations.  The ESAs recommended various clarifications and changes including:

  • amending the EUSR and the AIFMD to ensure that third country AIFMs comply with the due diligence obligations with respect to funds marketed in the EU, and to clarify whether third country AIFMs should be regarded as “institutional investors”;
  • amending the EUSR to clarify the powers of EU national regulators to enforce the due diligence requirements in respect of third country AIFMs, and to clarify whether smaller AIFMs (those below the threshold in article 3(2)) are within the definition of an “institutional investor” or not (the ESAs think they should be);
  • clarification regarding the ability of a fund manager to delegate the due diligence activity to another manager; and
  • amending the EUSR definition of “sponsor” to clarify that AIFM sponsors may only delegate day-to-day active portfolio management involved with a securitisation to a servicer which is an EU authorised investment firm, AIFM or UCITS management company, and not to third country AIFMs or sub-threshold AIFMs).
Level 2 and 3, and other relevant, materials

On this page:

Level two materials

Level three materials

How to find details of public STS deals

UK onshoring 

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Level two materials

Risk retention (Article 6)

EBA's revised draft risk retention RTS (consultation running until 30th September).

Draft risk retention RTS July 2018 [never implemented and now superseded by the above]

Until risk retention RTS are implemented, the old RTS made in 2014 under the CRR continue to apply in the EUSR.  They will also apply under the UKSR unless and until UK technical standards are adopted.  The 8th September 2020 FCA quarterly consultation, CP20/18 said that the PRA would consult about this.

Disclosure (Article 7) 

The disclosure RTS:  RTS specifying the information and the details of a securitisation to be made available by the originator, sponsor and SSPE [in force 23rd September 2020]

The disclosure ITS:  ITS with regard to the format and standardised templates for making available the information and details of a securitisation by the originator, sponsor and SSPE [in force 23rd September 2020]

In addition, the ESMA Q&A on the Securitisation Regulation contain several relating to completion of the reporting templates.

Securitisation repositories - operational standards (Articles 7 and 17)

RTS on operational standardsRTS on securitisation repository operational standards for data collection, aggregation, comparison, access and verification of completeness and consistency [in force 23rd September 2020]

In addition, see the ESMA Guidelines on securitisation repository data completeness and consistency thresholds (use of ‘No-Data’ options in data submissions for public issues) [finalised].

STS requirements

Homogeneity (article 20(8)): RTS on homogeneity (28th May 2019) [in force]

RTS on STS notifications (article 27(6)):  RTS specifying the information to be provided in accordance with the STS notification requirements [in force 23rd September 2020]

ITS on STS notifications (article 27(7):  ITS with regard to templates for the provision of information in accordance with the STS notification requirements [in force 23rd September 2020]

Third party verifier authorisation 

RTS specifying information to be provided to a competent authority in an application for authorisation of a third party assessing STS compliance (5 February 2019) [in force]

Securitisation repositories - application for registration

ITS on registration:  ITS with regard to the format of applications for registration as a securitisation repository or for extension of a registration of a trade repository pursuant to Regulation (EU) 2017/2402 [in force 23rd September 2020]

RTS on registration:  RTS specifying the details of the application for registration of a securitisation repository and the details of the simplified application for an extension of registration of a trade repository [in force 23rd September 2020]

The Delegated Regulation on fees for securitisation repositories 

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Level three materials  

Joint Committee of ESAs Q&A 26 March 2021

ESAs’ Opinion to the EC on the Jurisdictional Scope of Application of the Securitisation Regulation 25 March 2021

EBA Guidelines on STS requirements 12 December 2018 (non-ABCP) [final]

EBA Guidelines on STS requirements 12 December 2018 (ABCP) [final]

ESMA Q&A on the Securitisation Regulation

ESMA Guidelines on securitisation repository data completeness and consistency thresholds 10 July 2020 (use of ‘No-Data’ options in data submissions for public issues).

PRA and FCA joint statement on reporting of private securitisations, 20th December 2018.

Bank of England and PRA Statement of Policy, “Interpretation of EU Guidelines and Recommendations: Bank of England and PRA approach after the UK’s withdrawal from the EU”, April 2019

H.M. Treasury's June 2021 Call for Evidence (regarding its upcoming Article 46 report)

Other materials  

ESMA Q&A on CRA III

Article 7: the ESAs' non-no action letter of 30th November 2018

The June 2020 “Final report” on CMU by the High Level Forum on the Capital Markets Union

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Public STS issues  

List of EU STS issues notified to ESMA

List of UK STS issues notified to the FCA

STS verification agencies' lists of verified deals:

PCS - under the "STS Transactions" tab

STS -Verification – under the “Transactions” tab. 

The Dublin GEM Exchange

The Luxembourg Stock Exchange (this useful guidance note describes how to find a prospectus on Luxemburg)

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UK onshoring

The Securitisation (Amendment) (EU Exit) Regulations 2019 (which, in addition to amending the Securitisation Regulation, also makes securitisation-related consequential amendments to the onshored versions of CRA III, EMIR, the CRR, the Liquidity Commission Delegated Regulation and the securitisation-related CRR Amending Regulation).  This SI has itself been amended by (i) the Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2020 (S.I. 2020/646) (to amend the definition of the "EMIR regulation"); the Financial Services and Economic and Monetary Policy (Consequential Amendments) (EU Exit) Regulations 2020 (S.I. 2020/1301) (to change references to "exit day" to "IP completion day") and the Securities Financing Transactions, Securitisation and Miscellaneous Amendments (EU Exit) Regulations 2020 (S.I. 2020/1385) (to amend the definition of “the EMIR regulation”, to amend the definition of "institutional investor", and update a cross-reference).

The UK FCA's securitisation page

UK binding technical standards: 

Temporary transitional power directions:

  • The PRA issued a 3-page guidance note on 28th December 2020 regarding its 28th December 2020 transitional direction (made under the temporary transitional power conferred on it by the Financial Services and Markets Act 2000 (Amendment) (EU Exit) Regulations 2019).  The direction applies until 31st March 2022 and contains a few permissive transitional compliance provisions. 
  • Similarly, on 29th December 2020, the FCA issued permissive transitional directions, and this link is to the securitisation section of Annex A to those directions.
Non-performing loans

Introduction

2020 saw the European Commission rapidly respond to the consequences of coronavirus by introducing (on 24th July 2020) some "quick fix" proposals to assist with the securitisation of NPLs.  By 16th December these proposals had been through trilogues and reached political agreement, and they completed their legislative journey in April 2021, and our dual-law text incorporates the quick fix amendments to the EU Securitisation Regulation.   

Background

NPL securitisations are different from securitisations of performing assets, where usually, the major risk being transferred to the investors is credit risk.  For NPLs, the main risk is that the workout of the NPLs in question recovers less value than the discounted purchase price at which they were bought, and a major influence on that is the quantum of the discount at which the NPLs have been bought and the success of the workout. Typically, a special servicer is responsible for this and its fees are success-dependent. This produced anomalies, because the CRR and the Securitisation Regulation were both drafted with performing assets in mind, and the anomalies included:

The regulatory capital position produced excessive capital charges (see further below)

The 5% risk retention under Article 6 of the Securitisation Regulation as it was originally enacted, and Article 10(1) of the risk retention RTS, was calculated by reference to nominal values, disregarding the acquisition price of the assets, but in the case of NPLs which have been bought at a substantial discount, this produced an excessive result. If, say, 100 nominal of assets were bought for 12 (88% discount) with the intention of being securitised with a senior piece of 10 and a junior (retained) structure of 2, the required risk retention would nevertheless be 5, which would be 50% of the actual loss risk to the investors, and not 5%.  Further, under the terms of Article 6 as originally enacted, the risk retention could only be held by the originator, sponsor or original lender, and not by the special servicer - but the person with the most skin in the game is the special servicer, which will be on a success fee.

The transparency requirements in Article 7 and the disclosure RTS and related templates require granular, detailed loan-level information. Article 7(1)(a) requires information on the underlying exposures to be produced on a quarterly basis, and Article 2 of the disclosure RTS requires this to be done by completing the Annex IV template (for corporate underlying exposures) and, where the securitisation is more than 50% (in terms of outstanding principal) made up of exposures which are non-performing or credit-impaired, also the Annex X template. This is a laborious amount of detail, assuming it is available, but some of it may not be, because it was never collected, or because the originator is not the original lender and so does not have it, and may not be able to get it, either because it has no contractual or other relationship with the original lender or because the original lender no longer exists. This is partially mitigated to the extent that the “no data” (“ND”) option is available, but as our commentary on Article 7 explains, there are limits to its use.

The criteria for credit-granting in Article 9(3) require an originator which is securitising assets which it has bought to verify that the original lender applied the same “sound and well-defined criteria for credit-granting” to those assets as it did to non-securitised exposures – the mischief being adverse selection, i.e. where originators select poorer quality assets for securitisation than those they conitnue to hold on their balance sheet.  In November 2018, the EBA was asked about the amount of due diligence that needed to be done to verify the original credit-granting criteria in a case such as with NPLs, where the assets were originated some time ago, perhaps by a lender which has gone bust and no longer exists, or which has no incentive to help and no contractual obligation to help.  The EBA’s answer said that the securitising originator should use “adequate resources” and “make reasonable efforts” to obtain “as much information as is available and appropriate for such verification in accordance with sound market standards of due diligence for the class of assets and the nature and type of securitisation”, which helpfully indicates that the EBA views the Article 9(3) requirement with flexibility and is prepared to defer to good market practice.  This is consistent with what we had heard was a general inclination in Brussels to be as helpful as they can (within the confines of level 2 and level 3) because they were aware that securitisation in Europe had not taken off they way they had hoped it would after the Securitisation Regulation came into force. Whilst this was moderately helpful, it was only level 3 guidance and the Article 9(3) verification requirements represent the actual legal position.  As our commentary on “Acquired portfolios” says, Article 9(4) contains two provisions that can help with NPL portfolios:

  • Article 9(4)(a), which disapplies Article 9(3) if the original loan agreements pre-dated the application of the Mortgage Credits Directive (which will vary from country to country but which had to be by 21st March 2016)
  • Article 9(4)(b) permits limb (b) originators to comply instead with Article 21(2) of the RTS relating to risk retention made under CRR (and so "obtain all the necessary information to assess whether the criteria applied in the credit-granting for those exposures are as sound and well-defined as the criteria applied to non-securitised exposures").

Proposals for reform

On 23rd October 2019, the EBA published a 36-page  “Opinion” on the regulatory treatment of securitisations of NPLs.  As it said, securitisation of NPLs was being hampered by the requirements of the CRR, which imposed capital requirements on investor credit institutions under the CRR which overstate the actual risk embedded in the portfolio, and by certain aspects of the risk retention and due diligence requirements under the Securitisation Regulation. The Opinion recommended amendments to the CRR and the Securitisation Regulation, and the coronavirus consequences led the EC to take the bull by the horns, and its 24th July 2020 proposals to amend the Securitisation Regulation and to amend the CRR by adopting the EBA's report came as a welcome surprise.  

The "quick fix" amendments

The amendments to the Securitisation Regulation for the most part addressed the market's requirements, although:

  • the new Article 5(1) due diligence requirement - to verify that "sound standards in the selection and pricing of the exposures are applied" - is not said to be in place of (or "by way of derogarion from" as the legislation tends to put it) the requirement in (a) and (b) (i.e. to verify that the originator or original lender used sound and well-defined credit-granting criteria criteria and clearly established processes, etc. - which make sense for performing loans but not for NPEs).  The intention was surely that this was a replacement - and the point is made as regards the similar amendment to Article 9, but as drafted it does not, awkwardly,  disapply (a) or (b);
  • in article 6, the servicer is permitted to hold the risk retention, but - even though this is irrelevant to the mere holding of the retention - it may only do so if it can demonstrate its expertise in servicing exposures etc.;
  • the new risk retention wording relating to non-refundable purchase price discounts and fees is awkward in places and will require careful reading;
  • no changes have yet been made to the disclosure RTS regarding non-availability of information, and it is to be hoped this will follow
  • the alternative due diligence wording for NPLs in article 9 - to verify that "at the time the originator purchased them from the relevant third party, sound standards shall apply in the selection and pricing of the exposures” - is unhelpfully vague, although capable of being interpreted helpfully by some level 3 guidance.

The CRR regulatory capital adjustments to the NPL prudential calibration were based on the public consultation launched by the Basel Committee on 23rd June 2020, rather than the proposals in the October 2019 EBA opinion.  Originally, the EBA therefore proposed (following Basel) to apply a flat 100% risk weight to the senior tranche and a floor of 100% to the risk weights of any other tranches, even though this could actually increase the risk weights compared to the existing regime (which can produce a risk weight of only 65% for a senior tranche), and even though it must be illogical that the senior tranche would have the same risk weight as the underlying assets despite benefitting from the subordination of the junior tranche(s).  Fortunately, during the trilogues, the risk weight floor was reduced from the proposed 100% to 50%, and the changes to the CRR came into force on 31st March 2012.  

We wait to see whether the amendments will, overall, be enough.  

In the UK

The quick fix changes have effect as from 9th April 2021, and so do not form part of onshored UK law.   The UK PRA’s 4th June 2021 CP10/21 “Implementation of Basel standards: Non-performing loan securitisations” proposes a “more appropriately calibrated NPE securitisation framework” for the required capital allocation against NPLs for UK banks under the UK CRR.  The main one seems to be (following the Basel Committee’s June 2020 consultation) a 100% risk weighting for the senior tranche, which is the same as in the EU CRR following the 31st March 2021 quick fix amendment.  The EU quick fix was seemingly more lenient regarding the EU CRR in its new Article 269a(5) and (6) (the detail is quite technical), but the PRA said that it “does not propose to adopt the EU approach, as it considers there is insufficient evidence to determine that it would be in line with the PRA’s safety and soundness objective”.  Despite its more cautious approach, the PRA thinks that:

“for the securitisation internal ratings based approach ((SEC-IRBA), excluding the foundation approach), and securitisation standardised approach (SEC-SA), there may be a material reduction in capital costs”. 

This is less ambitious than the EU quick fix, and in particular it does not propose any amendment to the UK Securitisation Regulation to deal with the risk retention requirement for NPLs, which in the EU is now based (Article 6(3a)) on the net value of the NPLs rather than their nominal (pre-impairment) value.  Perhaps the issue is less pressing for UK banks, which have lower exposures to NPLs than (particularly) southern European banks.

 

Reliance on asset sales

As the EBA Report explained, to mitigate refinancing risk and the extent to which the securitisation embeds maturity transformation, the exposures to be securitised should be largely self-liquidating. Reliance on refinancing and/or asset liquidation increases the liquidity and market risks to which the securitisation is exposed and makes the credit risk of the securitisation more difficult to model and assess from an investor’s perspective, and so creates model risk.

The EBA envisaged, following the Basel Committee almost to the letter, that partial reliance on refinancing or resale of the assets securing the exposure would be permissible so long as that re-financing was sufficiently distributed within the pool and the residual values on which the transaction relies were sufficiently low, such that reliance on refinancing would not be substantial, and the position in the Securitisation Regulation seems to be essentially the same or perhaps even a little more liberal:

  • Article 20(8) states that:

“underlying exposures may also generate proceeds from the sale of any financed or leased assets”

(and Article 24(15) has the same regarding ABCP)

  • Article 20(13) states that:

“repayment of the holders of the securitisation positions shall not have been structured to depend predominately on the sale of assets securing the underlying exposures. This shall not prevent such assets from being subsequently rolled-over or refinanced. The repayment of the holders of a securitisation position whose underlying exposures are secured by assets the value of which is guaranteed or fully mitigated by a repurchase obligation by the seller of the assets securing the underlying exposures or by another third party shall not be considered to depend on the sale of assets securing those underlying exposures”

(and Article 24(11) has the same statement). 

To take the example of car loans, where it is not uncommon for a new car to be taken by the buyer on a relatively short lease – 3 years perhaps – under which the PV of the rentals is much less than the cost of the car, leaving residual value risk with the lessor, if those assets were transferred to an issuer together with title to the vehicles, the structure could not qualify as STS under the first paragraph in Article 20(13), because the debt is supporting the RV as well as the committed rentals.  Hence the second paragraph, which allows structures - common in Germany - where the RV is underwritten by the manufacturer or its finance company.  The EBA Guidelines have more to say on this (see below).

So, Article 20 is intended to prevent holders taking any significant residual value risk or market risk on asset values, and the focus is on how the deal is structured (Article 20(13)) rather than what actually happens in practice (Article 20(8)).

Paragraphs 43-46 of the EBA Guidelines elaborate on this, particularly that to assess "predominant dependence", three aspects should be taken into account:

(i) the principal balance of the underlying exposures that depend on the sale of assets securing those underlying exposures to repay the balance;

(ii) the distribution of maturities of those exposures across the life of the transaction (a broad distribution will reduce the risk of correlated defaults due to idiosyncratic shocks); and

(iii) how granular the asset pool is.

The Guidelines say that no types of assets will automatically fail this test, but "it is expected" that CMBS, and securitisations where the assets are commodities (e.g. oil, grain, gold), or bonds with maturity dates falling after the maturity date of the securitisation, would not meet these requirements, because then (a) the repayment would be predominantly reliant on the sale of the assets, (b) other possible ways to repay the securitisation positions would be substantially limited, and (c) the granularity of the portfolio would be low.

The second subparagraph of Article 20(13) expressly permits cases where repayment does depend on a sale of the assets but the value "is guaranteed or fully mitigated by a repurchase obligation by the seller".  This is an EU addition, not to be found in Basel, and inserted to permit STS securitisations of German auto loans and leases, where this structure is common.    The Guidelines say that that the guarantor or repurchase entity must not be "an empty-shell or defaulted entity, so that it has sufficient loss absorbency to exercise the guarantee of the repurchase of the assets"; presumably to be tested at the time of the STS notification rather than any later date.  A full put-back or guarantee clearly falls within this but the position of partial or limited guarantees remains uncertain, beyond the general principles to be found in Recital (29) that note how "strong reliance... on the sale of assets securing the underlying assets creates vulnerabilities", singling out CMBS here, and Paragraphs 43-46 of the Guidelines.

For regulated EU banks which securitise lease receivables with a view to them being eligible collateral for the ECB, residual value cannot be included in the securitisation.  Article 73 of the 19th December 2014 ECB Guidelines (ECB/2014/60) on the implementation of the Eurosystem monetary policy framework requires all assets backing eligible ABS to be homogenous by reference to one of 8 categories, one of which is "leasing receivables", which is defined in Article 2 as "the scheduled and contractually mandated payments by the lessee to the lessor under the terms of a lease agreement", and the definition concludes starkly: "Residual values are not leasing receivables". 

Reliance on third party verification agents

A third party can obtain authorisation under Article 28 if it meets the criteria, and is happy with the degree of supervision (which is a "light touch").  Three have been successful - the UK-based PCS, and Germany's True Sale International and STS Verification International, and have been involved in many of the STS issues done since 1st January 2019, but the sponsor, issuer or originator cannot devolve its responsibility for ensuring that the STS label is properly applied, because the ECB was always concerned about moral hazard, and the Commission was concerned not to recreate a pre-crisis kind of over-reliance on external credit rating agencies, with insufficient levels of investor due diligence.  Article 46(g) itemises it as a topic for the EC to cover in its review, due by 1st January 2022.  

Resecuritisations

Resecuritisations are forbidden (Article 20(9) and 24(8)) from meeting STS standards, and even non-STS resecuritisations are only permitted where:

  • they are done for “legitimate purposes”, typically in context of a winding up or resolution or
  • the deal was done before effective date of the Securitisation Regulation;

and there are further provisions regarding permissible non-STS ABCP programmes.

The wording used in all three places in the Securitisation Regulation is odd - a securitisation's exposures "shall not include securitisation positions".  Does this forbid EU investors buying resecuritisations, or does it just forbid EU sponsors and issuers from issuing resecuritisation paper?  EU investors will presumably be cautious.

The prohibition is by reference to "securitisation" - which as defined requires there to be contractually-established tranching of debt. Query whether parties may be tempted to structure around this.

Paragraph 31 of the EBA Guidelines refers darkly to pre-2009 days when resecuritisations were structured in a highly leveraged way, with a small change in the credit performance of the underlying assets having a severe impact on the credit quality of the bonds.  The EBA considered that this made the modelling of the credit risk very difficult.  It would certainly have required more time and analysis than the average buy-side professional would have had, making reliance on the rating all the more tempting.

Risk retention

Risk retention was one of the most controversial aspects during the passage of the Securitisation Regulation, and the eventual agreement to leave it alone was a victory for the market after severe changes had been proposed by Green and Left Wing MEPs who were clearly suspicious of, and often hostile to, the very idea of securitisation.

As a compromise to the strongly-held views of those MEPs who wanted to make it more stringent, Article 31 gives the ESRB a mandate to monitor developments in the securitisation market with respect to the build-up of any excessive risk and, where necessary, in collaboration with the EBA, to issue warnings and recommendations for action, including on the appropriateness of modifying the risk retention levels.

Risk retention – a brief history

The European Parliament had proposed increasing minimum risk retention levels to 10%, except for a first loss tranche, where the minimum would remain at 5%, and retention of a first loss exposure for every securitised exposure, where the minimum would be 7.5%. Further, it had proposed that the EBA and ESRB would have the power to revise retention rates up to 20% on the basis of market circumstances, and that risk retention rates should be reviewed every two years. Rapporteur Tang had been impressed by an academic paper, “Skin-in-the-Game in ABS Transactions: A Critical Review of Policy Options” which highlighted the very different levels of skin in the game represented by horizontal and vertical 5% retention strips.

The Commission put out a non-paper in April 2017 which emphasized the consensus for retaining the current risk retention framework, which is based on the Basel-IOSCO standard and supported by reviews done by CEBS and the EBA, and three public consultations, including the ECB-BOE May 2014 joint paper, “The case for a better functioning securitisation market in the European Union” and the European Banking Authority December 2014 “report on securitisation risk retention, due diligence and disclosure”.  It quoted the European Central Bank’s conclusion in its September 2016 paper, “Issues on risk retention”, that not only was an increase of the 5% minimum retention rate unwarranted, but also a retention rate increase would place European issuers at a disadvantage, and concluded that there was no evidence justifying any change to the risk retention framework, while the proposals to revisit the rates every two years in the future would create excessive uncertainty. Its written response to Rapporteur Tang was worded accordingly.

The outcome was therefore that the position remains unchanged from what we had in the old CRR and Solvency II, and the only remaining vestige of the European Parliament’s failed attempts to change it is a prohibition (Article 6(2) on deliberately adverse selection practices; and even this is much more benign than the original European Parliament’s proposal of an objective test comparing the performance of sold and retained assets.

The risk retention RTS

As of 1st July 2021, the EBA began a fresh consultation, running until 30th September 2021, on the RTS for Article 6.  It had been odd that the final draft RTS on risk retention from July 2018 had never been finalised (and so were not onshored into the UK regime), and the new ones apparently “carry over a substantial amount of provisions” from those.  The new main points are:

  • how the risk retention options apply to NPE securitisations;
  • how to meet the retention requirement through a synthetic or contingent form of retention;
  • requirements for the expertise of servicers acting as a retainers in NPE securitisations
  • the impact of fees payable to the retainer on risk retention
  • risk retention in re-securitisations or in securitisations of own issued debt instruments
  • clarification on the treatment of synthetic excess spread. 

Until we have some implemented risk retention RTS in the EU and in the UK, the old RTS made in 2014 under the CRR continue to apply.  The 8th September 2020 FCA 200 page quarterly consultation, CP20/18, said that the PRA would consult soon about how to adopt risk retention technical standards for the UKSR, but no surprises are likely.

The July 2018 draft RTS contained clarification on points of detail regarding the time when an exposure is taken to have arisen, the measurement of the retention using each of the five permitted methods, and disclosure of the retention.  Notable aspects were:

  • the EBA’s summary of the feedback it received which accompanied the RTS confirms that it did not intend the direct retention obligation in article 6 to apply to parties established outside the EU, in line with normal jurisprudential principles and the view of the EC;
  • clarificatory principles regarding whether an originator had been established for the "sole purpose" of securitising exposures
  • detail regarding synthetic or contingent forms of retention
  • detail on adverse selection of assets
  • a provision regarding circumstances in which a retention originally held by an entity could be transferred to another entity (being where insolvency proceedings in respect of the original retainer have been started, or the original retainer is “unable to continue” holding it either because of a transfer of a holding in the retainer or for “legal reasons beyond its control”). This was an article in the original draft RTS but became a mere recital in the final version, a downgrading of emphasis that may be because it is not referred to at all in the Securitisation Regulation.
  • detail relevant to hedging the retained interest or financing it on a secured basis – it had proposed that it would be permitted so long as the credit risk were not transferred, and the wording had been careful to recognise that this may involve a title transfer arrangement such as a repo, and that what counted was that “the exposure to” the credit risk is retained.
  • it helpfully confirmed that the initial disclosure of the identity of the risk retainer should be considered as evidence of the decision of the eligible retainers with regard to which of them will retain it, in case there was no explicit agreement among them on the point.

Risk retention and non-performing loans securitisations

The risk retention rules are currently unconducive to the securitisation of non-performing loans, because the 5% is calculated on the nominal (par) value of the underlying assets, even though they may have been bought at a considerable discount.  The July 2021 draft RTS address this.  This is discussed in more detail in this commentary.

Fees to be "taken into account"?

The "quick fix" amendments to the EUSR made two unheralded changes to Article 6.  The Article 6(1) amendment which was adopted was essentially the European Council's wording, but a further sub-paragraph was included:

"In measuring the material net economic interest the retainer shall take into account any fees that may in practice be used to reduce the effective material net economic interest";

and then Article 6(7) was amended to require the EBA to produce further RTS to specify in greater detail "the impact of fees paid to the retainer on the effective material net economic interest within the meaning of paragraph 1".  These were required within 6 months of the amendment taking effect, and presumably the revised draft RTS address this.  At a guess the amendment came from that faction in the European Parliament which is generally suspicious of securitisation and sees fees as a way of undermining the principles of "skin in the game", and presumably the intention is that the retention will have to amount to 5% after deducting fees.

What entity should hold the retention?

Article 6(1) is clear that the originator, sponsor or original lender should hold it and they should agree amongst themselves which one will.  Article 6(4) - where its conditions are met - allows the retention to be done by another group company on a consolidated basis.  Article 3 of the draft EU risk retention RTS requires that where the exposures have been created by multiple originators, the retention should be held by each originator or original lender on a pro rata basis, although Article 3(4) (tracking what the old CRR RTS said) permits the retention to be held by a single originator or original lender if it has "established" the securitisation and originated more than 50 % of the total securitised exposures (and there is a provision covering multiple sponsors). 

Somewhat contrary to this, the 1st April 2021 joint opinion of the ESAs “On the Jurisdictional Scope of Application of the Securitisation Regulation” came to the unhelpful view that where some of the relevant entities (originators or whatever) were outside the EU, the risk retention should, under Article 6, be held by a party that was within the EU.  The ESAs' logic is to have it held by an entity within the EU jurisdiction and so subject to the (direct) obligation contained in Article 6, although actually requiring the holding to be by an EU entity goes further than merely requiring an EU entity to be responsible making sure that Article 6 is complied with, and this restrictive interpretation seems contrary to what the level 1 text actually says: Article 5(1)(d) is quite clear that the risk retention may be held by a non-EU party, and it would be bizarre is this only were only to apply where all the relevant parties were non-EU. 

This is just the ESAs' opinion and is not legally binding, and it runs contrary to the basic idea that a risk retention is to ensure alignment of interests and skin in the game; and commercially, it could well make sense for, say, a US parent to hold the retention than its EU27 subsidiary.  Will the EC endorse the ESAs' view in its overall Article 46 review?  The topic highlights the debate between having "Fortress Europe" on the one hand, and making a success of CMU on the other, and developments are likely - such as a statement from the EC - on this during 2021.  Meanwhile, the ESAs have really not helped the market.

Sanctions for breach

Articles 32-34 contemplate local regulators having powers to impose sanctions, including fines of up to 10% of total annual net turnover, for breach of the Securitisation Regulation requirements, on originators, original lenders, sponsors and SSPEs which fail to comply with their various obligations in the Securitisation Regulation.   Sanctions must be published; the identity of the contravening party may be withheld if the authority so determines.

No similar sanctions apply in relation to arguably-similar financings such as covered bonds.  The approach is doubtless intended to concentrate the minds of management, and is likely to encourage a cautious approach.  There is a concern that they may actually create discouragement, even though Article 33(2) helpfully directs competent authorities determining the type and level of a sanction or a remedial measure to take into account criteria, including the gravity of the infringement, the degree of responsibility of any person concerned, whether it caused any loss, whether this was a first offence or not, and so on.

Sanctions are required to be laid down only for “negligence or intentional infringement” - a symbolic industry victory, as this was not found in earlier drafts of the Securitisation Regulation (but even on the old wording an innocent infringement could and presumably would have been lightly punished, or not at all, since Article 32(1) has in all its incarnations required any fines to be “proportionate”, and Article 33(2) requires authorities to consider the gravity of any infringement).  Perhaps of more practical benefit is that, whilst supervisors have the power to apply fines, the maximum fines are less severe than the European Parliament had proposed.  Article 36(3) contemplates a committee to be set up by the European Supervisory Authorities to co-ordinate the approach to be taken by national regulators.

Some evidence that "negligence" has a wider meaning here than English lawyers might conclude can be found by reference to the case of the five banks fined by ESMA in 2018 for issuing credit ratings without being authorised under the CRA Regulation.  The banks appealed, and in March 2019 it was announced they had acted "non-negligently" because they had not realised they were in breach; i.e. their ignorance of the regulation was a defence.

For institutional investors which breach the Article 5 due diligence rerquirements, the sanction is to be found in the new Article 270a of the CRR, which imposes additional risk weights against the relevant holdings.

Severe clawback

Articles 20 and 24 do not allow deals to qualify as STS if the asset sale is subject to "severe clawback".  Article 20(2) and (3) for term STS, and Article 24(2) and (3) for ABCP STS, explain that this includes a simple liquidator's power to invalidate a sale within a certain period regardless of the circumstances, but they make it clear that laws on fraudulent transfers (actio Pauliana), unfair prejudice and unfair preference are permitted.  The intent seems clearly not to overturn market expectations or undermine prevailing practices.  The EBA Guidelines envisage one or more legal opinions being obtained in respect of the insolvency aspects relating to a transfer, which is normal practice in any event.

It may be noted that the European Commission’s November 2016 proposal for a European Insolvency Directive explicitly ducked the possibility of harmonising clawback provisions, because although this would be useful for achieving cross-border certainty, “the current diversity in Member States' legal systems over insolvency proceedings seems too large to bridge”.

Sole purpose – a loophole plugged

Article 6(1):

“For the purposes of this Article [i.e. Article 6 – risk retention], an entity shall not be considered to be an originator where the entity has been established or operates for the sole* purpose of securitising exposures”

was included in the Securitisation Regulation to plug the perceived loophole the EBA identified in its December 2014 report, which could allow for originate-to-distribute structures under which the “real” originator would be able to sidestep the 5% retention requirement.**

Article 6 does not altogether reflect the EC’s original explanatory memorandum: there is no requirement that “the entity retaining the economic interest has to have the capacity to meet a payment obligation from resources not related to the exposures being securitised”.  However, Article 2(7) of the revised draft RTS on risk retention picks this up, adding some clarificatory principles regarding whether an originator has been established for the “sole purpose” of securitising exposures, requiring “appropriate consideration” to be given to whether:

"(a) the entity has a business strategy and the capacity to meet payment obligations consistent with a broader business enterprise and involving material support from capital, assets, fees or other income available to the entity, relying neither on the exposures being securitised by that entity, nor on any interests retained or proposed to be retained in accordance with this Regulation, as well as any corresponding income from such exposures and interests as its sole or predominant source of revenue;
(b) the responsible decision makers have the required experience to enable the entity to pursue the established business strategy, as well as an adequate corporate governance arrangement."

The EBA accepted that the sole purpose test should be principles-based, and on that basis was disinclined to - and so did not - provide any detail regarding "sole purpose" over and above what is said in Article 3(6).

* This wording was the subject of prior debate; an earlier draft had proposed "primary" rather than "sole".

** The EBA December 2014 report noted:

"As a result of the wide scope of the ‘originator’ definition in the CRR, it is possible to establish an ‘originator SSPE’ with third-party equity investors solely for creating an ‘originator’ that meets the legal definition of the regulation and which will become the retainer in a securitisation. For example, an ‘originator SSPE’ is established solely for buying a third party’s exposures and securitises the exposures within one day. Another example is when an ‘originator SSPE’ has asymmetric exposure to a securitisation and benefits from any ‘upside’ but not ‘downside’ of the retained interest (see Annex I for the possible transaction structure)".
Specialised lending exposures

Introduction

So-called specialised lending exposures include many exposures arising in respect of commercial real estate, project finance, ship and aircraft, and the like, which might be caught if the definition of "securitisation" covered any situation where the credit risk was tranched, payments were dependent upon the performance of the exposure or of the pool of exposures, and the subordination of the tranches determines the distribution of losses - which had been the definition of "securitisation" in article 4(61) of the CRR.  

So, to avoid catching financings which nobody would regard as being "securitisations", and which involve exposures which are only assumed by specialist lenders which need no protection when considering whether or not to commit themselves, the Securitisation Regulation adopted the definition of "securitisation" in article 4(61) of the CRR but then added a third limb - sub-paragraph (c) - which excludes any transaction or scheme which creates exposures which possess all the characteristics listed in Article 147(8) of the CRR, i.e. specialised lending exposures.  We comment further below on the history of this defintion.   

What are specialised lending exposures?

Article 147(8) specifies the following characteristics:

  1. "the exposure is to an entity which was created specifically to finance or operate physical assets or is an economically comparable exposure;
  2. the contractual arrangements give the lender a substantial degree of control over the assets and the income that they generate;

  3. the primary source of repayment of the obligation is the income generated by the assets being financed, rather than the independent capacity of a broader commercial enterprise"

Limb (c) of the definition thus emphasises the related recital (6) (which itself repeats the final sentence of recital (50) of the CRR):

"An exposure that creates a direct payment obligation for a transaction or scheme used to finance or operate physical assets should not be considered an exposure to a securitisation, even if the transaction or scheme has payment obligations of different seniority".

It is generally understood that limb (c) is capable of encompassing:

  • project finance

  • object finance (e.g. ship, aircraft, rail)

  • commodities finance

  • commercial real estate

  • some types of ABL.

It may be that Recital (6) applies over and above limb (c), although the more prudent approach is probably to assume that the Recital would not exclude a securitisation that did not fall within limb (c).

So, for example, take the common case of a JPUT set up to raise finance to fund the acquisition and holding of some commercial property by way of a mixture of equity and mezzanine and senior debt.  It holds no other assets of note and there is no broader commercial purpose, just the holding of this one asset, and the lenders take the usual comprehensive security package over the asset and the rent derived from it.  This should, absent any unusual characeristics, satisfy the three requirements of article 147(8) and so fall outside the definition, and so outside the scope of the Securitisation Regulation. 

It is possible of course to come up with debt structures which are difficult to classify with the same degree of confidence, no matter how much analysis is done.  In the last analysis, if a client is faced with such a case, and in the absence (possibly) of its being able to discuss the matter with its regulator, it may need to proceed on the basis of good faith on the basis that, if subsequently its regulator disagreed with its classification, it could expect leniency on the basis that this arose from a simple honest mistake.  In case it is necessary to consider a case which is less than clear-cut, what follows examines the history of this category.

Background

The term “specialised lending” is defined in Article 147(8) of the CRR (quoted above). Conceptually, it encompasses lending where the systemic component of the credit risk is largely linked to the source of income which is generated by the holding of assets rather than an exposure to an active business; see also the EBA's 20th December 2013 commentary on the final draft RTS regarding identification of an exposure for CRD IV purposes; and, as regards UK-regulated banks, Rule 4.5.3 of the FCA's BIPRU Rulebook. Its application in any particular case may be a matter of debate and degree, depending on the circumstances and the relative importance of the income generated - largely passively - by the assets being financed compared to the "independent capacity of a broader commercial enterprise". It is possible to come up with examples which are clearly one or the other, but there are inevitably some where the analysis is more nuanced.

The distinction was made in Article 86 of the Banking Consolidation Directive, which required regulated institutions to sub-divide corporate credits into those which possessed the three characteristics which are now identified in Article 147(8) from those which did not. This left it unclear whether financings which possessed the twin characteristics that payment was dependent on the performance of underlying exposures and ongoing losses were distributed via the tranching of different categories of debt fell within securitisation or within specialised lending. Accordingly, when the distinction was continued in the CRR, recital (50) explained that an exposure that creates a direct payment obligation for a transaction or scheme used to finance or operate physical assets should not be considered an exposure to a securitisation, even if the transaction or scheme has payment obligations of different seniority.  The Securitisation Regulation continued this with Recital (6) but at a trilogue meeting on 17th June 2017 it was agreed to add limb (c) - presumably for added emphasis - to provide that specialised lending exposures were by definition outside the meaning of "securitisation".

By way of further background, the rationale for the distinction goes back to the Basel Committee's approach to assessing corporate exposures i.e. those where the source of repayment of the loan is based primarily on the operations of the borrower, and any security taken over assets is a secondary risk mitigant: see the BCBS’s Working Paper on the Internal Ratings-Based Approach to Specialised Lending Exposures of 2001. The BCBS's task force distinguished these from what it described as "specialised lending exposures", i.e. loans which are structured in such a way that repayment depends principally on the cash flow generated by the asset rather than the credit quality of the borrower. It explained that this type of loan had certain characteristics, either in legal form or economic substance:

  • the economic purpose of the loan was to acquire or finance an asset;

  • the cash flow generated by the collateral was the loan’s sole or almost exclusive source of repayment;

  • the subject loan represented a significant liability in the borrower’s capital structure; and

  • the primary determinant of credit risk was the variability of the cash flow generated by the collateral rather than the independent capacity of a broader commercial enterprise.

The BCBS task force identified categories of loan with these characteristics  (each described in more detail in the 2001 paper):

  • project finance

  • object finance (e.g. ship, aircraft, rail)

  • commodities finance

  • income-producing real estate, and high-volatility commercial real estate.

This distinction was made for two primary reasons: firstly, because such loans possess unique loss distribution and risk characteristics, and in particular, display greater risk volatility (in times of distress, banks are likely to be faced with both high default rates and high loss rates); and secondly, because most banks using the IRB have different risk rating criteria for such loans. In addition, the 2001 paper addressed other forms of ABL i.e. loans where a company:

"uses its current assets (e.g., accounts receivable and inventory) as collateral for a loan. The loan is structured so that the amount of credit is limited in relation to the value of the collateral. The product is differentiated from other types of lending secured by accounts receivable and inventory by the lender’s use of controls over the borrower’s cash receipts and disbursements and the quality of collateral. This form of lending can be extended to both solvent and bankrupt borrowers. Debtor in possession (DIP) financing is a type of asset-based lending activity where banks extend credit to bankrupt borrowers based upon their accounts receivable and inventory which is taken as collateral";

and expressed its "preliminary view" that this kind of loan may also fall under the IRB framework for specialised lending.

Standard reference rates (Article 21(3))

Any referenced interest payments for either the assets or liabilities of an STS securitisation must be based on “generally used market interest rates or generally used sectoral rates reflective of the cost of funds".

This latter wording was intended to allay concerns that mortgage loans based on banks' standard variable rates might otherwise be excluded, but it arguably missed the mark because of the phrase "generally used".  The Basel/IOSCO November 2015 paper addressed this but there are important differences.  Basel/IOSCO explains that examples of “commonly encountered market interest rates” would include "sectoral rates reflective of a lender’s cost of funds, such as internal interest rates that directly reflect the market costs of a bank’s funding or that of a subset of institutions”.  The Securitisation Regulation however only permits "generally used" sectoral rates.  The Basel/IOSCO wording made it clear that mortgage loans based on banks' standard variable rates were included.  However, the standard variable rate for one lender is only used for its products, not by others in the market, and so there is an unhelpful doubt that one lender’s rate is therefore not a “generally used” rate, and that “generally used” might mean only, say, minimum lending rate or base rate of a central bank.  This looks like a drafting error, and paragraph 57 of the EBA Guidelines does its best to rescue matters by explicitly permitting not only usual market benchmarks such as LIBOR and EURIBOR, and official central bank and monetary authority rates, but also:

"(c) sectoral rates reflective of a lender’s cost of funds, including standard variable rates and internal interest rates that directly reflect the market costs of funding of a bank or a subset of institutions, to the extent that sufficient data are provided to investors to allow them to assess the relation of the sectoral rates to other market rates."
STS - 18 months gone

An analysis of the STS data available from ESMA shows few surprises.  Perhaps the main point is that after 18 months there has been 312 of them – on average 17 a month, although these include some legacy deals being raised to STS status, so the number of new deals is less than this.  The EC might have hoped for more when it launched CMU…  There is a fairly even split between public and private, and as between term and ABCP: All the ABCP is private (147), and most (89%) of the private is ABCP.  HSBC’s “The European securitisation market in 2020” tells us that as at the end of 2019, STS represented 50.6% of the “distributed European market” (presumably this means the proportion that was placed with investors rather than being retained on balance sheet and/or used as collateral for loans from the ECB) and 59.3% of the number for H1 of 2020.

The main assets by number of deals are residential mortgage, auto loans/leases and trade receivables:Asset typesand the main countries are the UK, Germany, Netherlands and Italy:CountriesExamining the data for the main countries shows that the UK has seen, in particular, RMBS, auto and credit cards, whilst in Germany and Netherlands the market is more dominated by a single product: in Germany, auto – reflecting the strength of the country’s motor vehicle industry – is to the fore, and for the Netherlands, RMBS makes up 85% by number:

UK public asset types Germany public asset types Netherlands public asset types

For H1 2020, HSBC’s “The European securitisation market in 2020”’s analysis of distributed ABS reflects the STS analysis above, with RMBS and auto the main collateral types (left chart) and UK, Netherlands, Spain and Germany the main jurisdictions (right chart):

H1 2020 distributed ABS by collateral type

  H1 2020 distributed ABS by jurisdiction

How has securitisation fared since coronavirus?  HSBC’s research shows the size of the impact on the year-opening optimism:Issuance

Q1 2020’s public issuance of EUR 16.2bn (vs EUR 10bn in Q1 2019) was followed in Q2 EUR 4.4bn (11 issues), making the lowest H1 figure since 2009.  It also shows (see chart) how significant the ECB was in March, buying ABS to provide liquidity to Eurozone banks (as it did after 2009 – in 2009, only 6% of issuance was placed in the market):

ECB purchases

Some medium term impact of government requirements to allow borrowers repayment holidays is being seen, although HSBC notes that “most ABS and RMBS transactions contain structural features that cover short- and medium-term liquidity stress” and that “many transactions allow principal receipts to pay interest”.  HSBC sees the quantum of the longer-term impact of the pandemic, as government’s withdraw pandemic support measures, as being unclear at present, but with more downside than upside risk. 

Meanwhile, the latest data from AFME  (its report for Q3 2020) shows how all this continues to pale compared to pre-GFC levels, and with no significant increase since 1st January 2019 when the Securitisation Regulation came into effect.  And elsewhere, European Datawarehouse’s latest report on CMBS shows how the pandemic has squashed the expectations of a few months ago: only 3 issues this year (all in Q1 pre-Covid), all single borrower deals, one for EUR 600m from the Netherlands backed by a mixed portfolio of loans, another secured on Paris offices (this will be the EUR 200m River Green Finance 2020 DAC (see FM Update 31st January) and the third a GBP 257m mixed portfolio of loans.

Synthetics

Introduction

The EU STS regime for synthetics is a world first:  there is no provision at the Basel/IOSCO level for preferential capital treatment for an STC-qualifying synthetic product.  The 24th July 2020 proposal from the European Commission to enact an STS regime for balance sheet synthetic securitisations by amending the Securitisation Regulation and the CRR (but not, initially at least, Solvency II)  was explicitly in response to the “urgency” of the need to take measures to help the economy recover from the COVID-19 pandemic.  It was broadly welcomed by those who saw it as a way of attracting new risk-takers into the market which would be prepared to take on risk (and be able to do the related due diligence) if the overall package was sufficiently standard, simple and transparent, but not otherwise; the current synthetic market is for the most part, central banks, supranational entities such as the EIB, pension and hedge funds, with monolines having long gone.  

The proposals were adopted in early April 2021 and are effective as from 9th April 2021.  They have been cautiously welcomed, even though they are not the totality of what the market has been asking for, but there are issues  regarding complexity and cost, and one of these issues - the change to Article 248 of the CRR concerning excess spread - applies across the board, not just to STS.  

The EC proposals

When the Securitisation Regulation was enacted, there had been only one, minor, concession to synthetics. Where an institution sold off a junior position in a pool of loans to SMEs via a synthetic structure, it could only apply to the retained position the lower capital requirements available for STS securitisations if the strict criteria set out in Article 270 of the CRR as amended were met, which included that the position was guaranteed by a central government, central bank, or a public sector “promotional entity”, or – but only if fully collateralised by cash on deposit with the originator – by an institution.  Otherwise, originators would have to allocate capital to the retained senior piece on the basis of the higher non-STS rules which, because of the regulatory non-neutrality baked into the regulatory capital requirement for securitisation (i.e. the sum total of capital allocated to all the various tranches of a securitisation will be more than the capital which would be required for a holding of the underlying assets) were, to say the least, discouraging.

Article 45 of the Securitisation Regulation required the EBA to report on the possibility of an STS regime for balance sheet synthetics by 2nd July 2019.  Its "Draft report on STS Framework for Synthetic Securitisation" emerged on 24th September 2019, the delay being due to unresolved differences of opinion among EU regulators about whether or not synthetics should be given any favourable capital treatment or not.  The EBA  considered to what extent buying STS protection should give the protection buyer preferential regulatory capital treatment as regards the portion of risk on the portfolio that it continues to hold (which, post-GFC, is usually the least risky portion, with the first loss risk being transferred to a protection seller).   The EBA envisaged qualifying protection coming from either 0% risk-weighted institutions under the CRR, such as the EIB or, if not, then from entities to which the protection buyer's recourse is fully collateralised in cash or risk-free securities.  It was equivocal about whether STS synthetic securitisations should provide favourable capital treatment for the originator credit institution or not.  Its final proposals for developing a STS framework for synthetic securitisation emerged on 5th May 2020, recommended setting up an STS framework but sat on the fence regarding the capital treatment, merely noting the pros and cons of the introduction of more risk-sensitive regulatory treatment of the STS synthetic product.  The EBA’s summary said:

"On the one hand, developments in the last few years have indicated the potential for the continuing growth of the synthetic sector and have confirmed the technical feasibility of the creation of a prudentially sound STS synthetic securitisation product that is comparable to the STS traditional securitisation product.  In addition, the available performance data do not provide any evidence that the performance of the synthetic securitisation instrument is worse than that of the traditional securitisation instrument.  The introduction of potentially limited and clearly defined differentiated regulatory treatment would match the historical performance of the synthetic securitisation, ensure better alignment with the STS traditional securitisation framework and help overcome the constraints of the current limited STS risk-weight treatment of some SME synthetic securitisations.  

On the other hand, there are limitations of the performance data on which the analysis is based, there is limited experience with the STS traditional framework so far, and the risk of potentially overusing synthetic securitisation, which would potentially lead to a large-scale replacement of regulatory capital by risk mitigation strategies, leading to overleveraging of banks, should be duly taken into account. In addition, the preferential regulatory treatment is not included in the international Basel standards.”

On 12th June 2020, the “High Level Forum on the Capital Markets Union” issued a 129-page “final report” on CMU, the recommendations of which included applying the same regulatory treatment to synthetics as to cash securitisations.  

The new regime for synthetic securitisation

Against this background, the "quick fix" amendments to the Securitisation Regulation have added a new series of articles (Article 26a et seq.) in “Section 2A” to introduce a new regime for synthetics which apply most of the same STS requirements as apply to cash securitisations, plus some others specific to synthetics e.g. requirements mitigating the counterparty credit risk on the protection seller, and the CRR amendments extend the treatment which Article 270 of the CRR had previously allowed to only a limited sub-set of synthetic securitisations.  Some aspects of the proposed regime entail additional cost and complexity over and above what the existing market is used to - for example, protection sellers (which the legislation insists on calling "investors") are required to have recourse to higher-quality collateral to secure repayment of their "investment" than is usual, and that of course comes at a cost.  Some detail has yet to be fleshed out in RTS – those will appear in H1 of 2021 - and there is scope for some level 3 clarification.  There seems to be a lot of devil in the detail and it remains to be seen how this will play out.  

The proposal was enacted after the Brexit transitional period ends, and does not form part of onshored UK law.  The UK had been opposed to the idea of an STS regime for synthetic securitisation, and it was only brought about as a result of Brexit.  It seems unlikely that the UK’s FCA will want to introduce a similar regime under the UKSR.  

The definition of "securitisation"

The definition of "securitisation" takes the old CRR definition and adds sub-paragraph (c) to clarify that specialised lending exposures are not securitisations (for much more on this, see our commentary on Specialised Lending Exposures).  So the definition is not significantly changed. 

However, the definition is now more significant because of the scope of the Securitisation Regulation, and there are traps for the unwary.  The emphasis on contractual tranching of credit risk is capable of applying to structuring arrangements that the parties concerned may not think of as being securitisation.  The precise wording of the definition, and the related definition of "tranching", can be pored over if the parties are aware of the risk that their deal could accidentally be caught, but not if they are not.  When are payments "dependent on the performance" of exposures?  If there is full recourse to the original seller then the performance of the exposures may be incidental.  But what if recourse is partial; or if the credit of the seller is dubious?  And why is a division of risk between equity and debt, or via structural subordination, permitted, but a "contractually established" subordination possibly not?  Level 3 guidance would be helpful, and meanwhile commentaries and references back to the meaning of "specialised lending exposures" may provide some degree of clarity.

In passing, we might add that, given the many references to "exposure" in the Regulation, and bearing mind Recital (6) ("it is appropriate to provide definitions of all the key concepts of securitisation") it is surprising that "exposure" is not defined.  The CRR does have a definition of it in article 5, although for the limited purpose of calculating capital requirements for credit risk (articles 107 et seq.) as "an asset or off-balance sheet item".

The shadow of the SIVs

A generation of bankers and lawyers has grown up since the demise of structured investment vehicles, but their influence on the Securitisation Regulation remains significant. According to the EBA Report, as of November 2007 their CP had a weighted average life of 5.5 months compared to a weighted average life of several years for the securities being financed. In the Securitisation Regulation:

  • the absolute ban on resecuritisations being capable of STS status (Articles 20(9) and 24(8),
  • the limitations on the weighted average and residual maturities of pools backing ABCP (Article 24(15)),
  • the exclusion of commercial and residential mortgage loans from an ABCP pool (Article 24(15)),
  • the insistence on the programme being fully supported (Article 25(2))

all address perceived serious shortcomings in their structures, in particular as regards refinancing and maturity transformation risk and the inaccuracy of and difficulty in doing the related modelling.

Timeline and key papers

15th September 2008             

Lehman Brothers Holdings Inc. files for protection under Chapter 11 of the US Bankruptcy Code. Lehman Brothers International (Europe) and Lehman Brothers Limited goes into administration under the UK Insolvency Act 1986

2009

First risk retention rules imposed: Capital Requirements Directive II (for credit institutions); Solvency II (for insurers)

2011                                     

Risk retention rules for alternative investment fund managers imposed by the AIFMD.

May 2014                              

Bank of England and European Central Bank joint paper “The case for a better functioning securitisation market in the European Union

26th November 2014              

European Commission “Investment Plan for Europe

11th December 2014              

Basel Committee on Banking Supervision “Revisions to the securitisation framework” (superseded in 2016 – see below)

22nd December 2014             

European Banking Authority “report on securitisation risk retention, due diligence and disclosure

July 2015                               

Basel Committee on Banking Supervision consultation document, “Criteria for identifying simple, transparent and comparable securitisations

July 2015                               

European Banking Authority advice to the European Commission on a framework for qualifying securitisation and accompanying Report on Qualifying Securitisation.

30th September 2015             

European Commission original proposal for the Securitisation Regulation and for the CRR Amendment Regulation

November 2015                     

Basel Committee on Banking Supervision consultation document, “Capital treatment for 'simple, transparent and comparable' securitisations” (superseded in 2016 – see below)

30th November 2015              

The Presidency of the European Council published its “Third Compromise Proposal

December 2015                     

EBA report on synthetic securitisations (EBA/Op/2015/26)

11th March 2016                    

The ECB opinion on the proposed Securitisation Regulation and CRR Amendment Regulation (CON/2016/11)

July 2016                               

Basel Committee on Banking Supervision, “Revisions to the securitisation framework, amended to include the alternative capital treatment for “simple, transparent and comparable” securitisations” (superseding the December 2014 paper and November 2015 consultation document)

8th December 2016                

European Parliament finalising its revised proposals

January 2017                        

Trilogues start

February 2017                       

Skin-in-the-Game in ABS Transactions: A Critical Review of Policy Options” by Krahnen and Wilde

6th April 2017                         

The EC's written response to Rapporteur Tang's position on skin in the game.

7th April 2017                         

EC non-papers on risk retention, securitisation repositories and private transactions, and the powers of the ESAs (these are private and we are unable to link to them)

30th May 2017                       

Political agreement reached in trilogue

12th December 2017             

Regulation published in the Official Journal of the European Union

12th December 2018

EBA Guidelines on STS requirements 

1st January 2019                   

Securitisation Regulation becomes applicable

28th May 2019

Homogeneity RTS (Commission Delegated Regulation (EU) 2019/1851) 

23rd October 2019

EBA "Opinion” on the regulatory treatment of securitisations of NPLs

10th July 2020

ESMA Guidelines on securitisation repository data completeness and consistency thresholds 

24th July 2020

Proposals from the European Commission to amend the Securitisation Regulation and to amend the CRR to introduce a regime for synthetic securitisations and the securitisation of NPLs.

25th March 2019

The Securitisation (Amendment) (EU Exit) Regulations 2019   

23rd September 2020

The disclosure RTS, the disclosure ITS, the RTS on securitisation repository operational standards, the RTS on STS notification requirements (article 27(6)), the ITS (templates) on STS notification requirements (article 27(7), the ITS on registration as a securitisation repository and the RTS on registration of a securitisation repository.

Transparency (article 7)

Who and what is caught by Article 7?

The Article 7 transparency requirements apply to all securitisations (and article 22 has some enhanced requirements for STS - see below).  The disclosure obligation is on one of the originator, sponsor and issuer, which should decide among themselves is to do it - presumably the sponsor in most cases, and in the case of STS Article 22(5) designates both the originator and the sponsor to do it.

Full underlying deal documentation (apart from the legal opinions), as well as regular reporting of information on the underlying exposures and their performance is required to be disclosed to a repository (in the case of public issues), and the repository has to provide "direct and immediate access free of charge" to a range of regulators and supervisors, plus "investors and potential investors" (under Article 17(1)).  There are however two cases where disclosure of a transaction summary of the deal documentation may be disclosed:

  • for public issues, the un-numbered penultimate paragraph of Article 7(1), which refers to Article 7(1)(b);
  • Article 7(1)(c), which applies to a securitisation issue where a prospectus is not legally required under applicable EU or UK prospectus regulations 

For public issues, it should be born in mind that the Article 7(1)(b) exemption is narrow.  Article 7(1) is not well-drafted and there had been a view that the penultimate paragraph ("with regard to the information referred to in point (b) of the first subparagraph, the originator, sponsor and SSPE may provide a summary of the documentation concerned") offered a generally-available alternative to full publication.  However, in the Joint Committee Q&A published on 26th March 2021, the ESAs gave a very narrow interpretation of the penultimate paragraph: it only permitted a summary to be provided in cases where full disclosure of the documentation would contravene the pre-penultimate paragraph, which states that, when doing so, a disclosing originator, sponsor or SSPE must not breach any law governing the protection of confidentiality of information and the processing of personal data.  If full disclosure would involve such a breach, then there is the choice of providing the summary or anonymising or aggregating the confidential information.  As regards Article 7(1)(c), the point is less significant, because in a private deal the investors would usually want the underlying documentation and so this would be disclosed in any event.

The disclosure RTS and ITS

The detail regarding transparency is found in the related disclosure RTS and associated Annexes and the disclosure ITS and associated Annexes.  ESMA was given two mandates under the Securitisation Regulation to produce templates:

Article 7(4) authorises it to produce templates which relate to the disclosure obligations under article 7(1)(a) and (e) (covering line-by-line disclosure of information on each of the underlying exposures on a loan-by-loan basis, not aggregate data); and
Article 17(3) authorises it to produce templates which relate to disclosure to a securitisation repository (which is only required for public securitisations).  This mandate extends to all disclosure required under Article 7(1), not just Article 7(1)(a) and (e), and so in particular this extends to Article 7(1)(f) and (g) (relating to inside information and significant events).  

ESMA combined these into a single pair of RTS and ITS.  Because of the bumpy ride these had, the first drafts which were released did not become law, and initially the market had to operate under a non-no action letter issued by the ESAs on 30th November 2018.  The letter recognises that reporting entities face "severe operational challenges" in complying, especially if in the past they had not had to provide using the CRA3 templates (e.g. CLO managers, because CLOs were out of scope for CRA3) and might need to make "substantial and costly adjustments to their reporting systems to comply with the CRA3 templates on a temporary basis, until the ESMA disclosure templates enter into application".  

The application of Article 7 to private deals

A large part of EU securitisation issuance consists of private deals, i.e. deals where no prospectus is drawn up under the Prospectus Regulation.  ABCP (which the European Commission noted made up about 40% of EU issuance) is predominately private.  Private and bilateral transactions were exempted from complying with the detailed disclosure requirements under the old Article 8b, and when ESMA initially consulted on the disclosure RTS that was the position it took: the first draft RTS/ITS, issued in December 2017, had an adjusted standard for private deals which explicitly did not require completion of the data templates (see Recital (3)).  Consequently, originators and sponsors of private issues did not take part in the consultation.  ESMA then surprised everyone by putting private deals in scope, seemingly on the basis of the legal advice it received.  

The disclosure RTS and the disclosure ITS cover two related disclosure requirements:

Articles 7(3) and 7(4), which extend to all securitisations, public and private
Article 17(2)(a) which applies to data held in a securitisation repository, and so only extends to public issues.

Accordingly, the ITS made under Article 7(4) - which deal with the format and templates for making available information - distinguish between public and private: the templates on underlying exposures and investor reports apply to both, but the templates on inside information and significant events are for public only; and the RTS made under Article 7(3) - which deal with the information itself - similarly distinguish between public and private.

In the August 2018 so-called "final" (but since superseded) RTS/ITS, ESMA affirmed its view that Article 7(1)(a) and 7(1)(e), and Recital (13), made no distinction between private and public securitisations as regards reporting requirements and templates (other than a repository being required for public issues).  It stated that it:

"recognises that the application of these draft technical standards may have an impact on private securitisations compared with current practice... However, ESMA considers that using the technical standards as a vehicle for defining different categories of information to be provided for public versus private securitisations, on the basis of "the holder of the securitisation position", would not be within the scope of ESMA's mandate".

ESMA has issued Guidelines on securitisation repository data completeness and consistency thresholds which limit the use of the ‘No-Data’ options in public issues (disclosure via a securitisation repository is only required by Article 7 in the case of a public securitisation).  These do not apply to private issues.  ESMA does not regulate private deals (and its carefully-worded comments in its 10th July Final Report suggest it is happy not to get involved): private deals are a matter for national regulators, which therefore have the scope to be more flexible, subject to the overriding requirement that article 7 of the Securitisation Regulation (as supplemented by the disclosure RTS and the disclosure ITS) is complied with.  Time will tell to what extent national regulators may be inclined to flex the requirements for private issues.  Article 7(3) states that the information to be disclosed should take into account its usefulness to investors.  This arguably permits a distinction to be made between public and private deals, and whilst ESMA did not itself do this when issuing its draft RTS and ITS, national competent authorities may choose to when determining whether or not Article 7 has been complied with. 

How should disclosure be made in respect of private deals?

Private deal disclosure of information on underlying exposures (Article 7(1)(a)) and quarterly investor reports (Article 7(1)(e)) has to be done in accordance with the related RTS/ITS, and so using the specified templates: see further below.  No method for disclosing the information to holders and potential holders is specified, and Q5.1.2.2 of the ESMA Q&A confirms that, as under Article 22 of the old RTS 625/2014 made under the CRR, disclosure can be made (subject to any instructions or guidance provided by national competent authorities) using any arrangements that meet the conditions of the Securitisation Regulation.

How should disclosure be made in respect of private UK deals post Brexit?

On 20th December 2018, the FCA and PRA issued a final Direction under the UK's Securitisation Regulations 2018 specifying the manner disclosure must be made to them in respect of a private securitisation established in the UK.  Annexed to it are short form templates to be used for the purpose.  The 2018 Regulations were routine implementation regulations and not Brexit-related, and do not disapply nor vary Article 7: noteholders and, on request, potential investors, and indeed the regulators themselves, are entitled to the full Article 7 disclosure (save to the extent, if any, that just a summary of the deal documentation to be provided rather than copies of all the bible documentation).  Whilst it would make much sense to have a light-touch (or no touch) regime for private deals, the UK has not - yet at least - deviated from the prevailing EU approach.

Compliance with the RTS and templates

The disclosure RTS and the disclosure ITS were published in October 2019 and should be fully applicable by mid-2020.  Less sophisticated issuers, such as corporates which rely upon private securitisations to finance trade receivables, which do not normally access the public ABS market, had asked for a longer transitional period, because the management of data – especially at the highly granular level prescribed - is difficult, and significant changes to operations, internal processes and information technology may be required; and some banks subject to disclosure obligations may have significant challenges in adapting legacy systems to ensure the collection and faithful reporting of the correct data, and to ensure that it is done correctly for hundreds or thousands of assets (especially where they are sometimes decades-old legacy assets).  Corporate originators may have bigger challenges, as their systems may well not have been designed to produce loan-level data or investor report information at anything like the level of granularity required by the Disclosure RTS.

The templates

Links to the individual templates are below.  These are to the versions produced by ESMA in spreadsheet format.  ESMA says that, to assist analsysis, they include references to the ECB’s asset-backed securities loan-level data template fields, where available, but cautions that the official versions are those on the EC’s website:

Annex 2: Underlying exposures - residential real estate

Annex 3: Underlying exposures - commercial real estate

Annex 4: Underlying exposures - corporate

Annex 5: Underlying exposures - automobile

Annex 6: Underlying exposures - consumer

Annex 7: Underlying exposures - credit cards

Annex 8: Underlying exposures - leasing

Annex 9: Underlying exposures - esoteric

Annex 10: Underlying exposures - add-on non-performing exposures

Annex 11: Underlying exposures - ABCP

Annex 12: Investor report - Non-ABCP securitisation

Annex 13: Investor report - ABCP securitisation

Annex 14: Inside information or significant event information - Non-ABCP securitisation

Annex 15: Inside information or significant event information - ABCP securitisation

Completion of templates - some problematic issues

There are some potentially problematic issues regarding the templates, including:

  • various mandatory template fields
  • the lack of a template for trade receivables
  • points of detail for NPL loan securitisations (the disclosure RTS require not only the specific NPL Annex 10 template but also the routine template required by Article 2(1) for the relevant category of loan, and that could be difficult or impossible) 
  • for CLOs (regarding the corporate template) - now alleviated by an increase in the ability to use "ND" - see further below.    

Two minor anomalies:

  • as regards disclosure of inside information etc.  As noted above, ESMA's mandate under Article 7(3) only extends to producing templates relating to 7(1)(a) and (e), whereas its mandate under Article 17(2) extends the the whole of Article 7.  Consequently, the template it has produced for the disclosure of inside information and significant events under Article 7(1)(f) and (g) only applies to public deals, not private ones.  Article 6 of the RTS misses this point.  It simply says that "inside information that the reporting entity for a non-ABCP securitisation shall make available pursuant to Article 7(1)(f) of Regulation (EU) 2017/2402 is set out in Annex 14", which on the face of it applies to both public and private;
  • for private STS issues where the underlying exposures are residential or auto loans or leases, the "environmental" disclosure (discussed here) required (as a result of pressure from the Green faction in the European Parliament) by Article 22(4) has to be published, "as part of the information disclosed pursuant to Article 7(1)(a)" - a contradiction in terms where Article 7 does not require public disclosure.

Completion of templates - use of ND options 

When completing a reporting template (as required by Article 7 and the disclosure RTS) the relevant template permits some use to be made of a “no data” – or “ND” - answer.  There are five types of “ND” answer, defined in Article 9(3) of the disclosure RTS:

ND1

the required information has not been collected because it was not required by the lending or underwriting criteria at the time of origination of the underlying exposure 

ND2

the required information has been collected at the time of origination of the underlying exposure but is not loaded into the reporting system of the reporting entity at the data cut-off date

ND3

the required information has been collected at the time of origination of the underlying exposure but is loaded into a separate system from the reporting system of the reporting entity at the data cut-off date

ND4-YYYY-MM-DD

the required information has been collected but it will only be possible to make it available at a date taking place after the data cut-off date. ‘YYYY-MM-DD’ shall respectively refer to the numerical year, month, and day corresponding to the future date at which the required information will be made available

ND5

the required information is not applicable to the item being reported

The use of ND options in relation to public securitisations 

Disclosures relating to public deals (where the disclosure is via a securitisation repository) is governed by the RTS on operational standards for securitisation repositories and the related ESMA Guidelines on securitisation repository data completeness and consistency thresholds.  The Guidelines direct securitisation repositories ab out how to determine whether to accept or reject a submission made to them for a public securitisation.  They also contain two types of "threshold" tolerances to permit, within limits, the non-disclosure of information which would otherwise be required, by allowing the use of one of the ‘No Data’ options (where the specific template field allows such options to be entered).  The two types of threshold are:

  • a percentage threshold, which allows ND1-4 to be used in relation to a percentage of the the total number of active underlying exposures (known as "legacy assets"), to address situations where data is not available for a few underlying exposures, perhaps because they were originated far earlier than the remaining underlying exposures;
  • a numerical threshold, which sets a limit on the number of fields in a given underlying exposure data submission that contain one or more ND1-ND4 values.  The rationale for this is that certain categories of information may not be available: perhaps because it being stored in an old database that cannot be accessed in the short run without significant disproportionate expense (these being referred to as “legacy IT systems”). 

Fields demanding disclosure of data where "ND" is a permitted response may be completed with one of the "ND" options, within these limits, although there are other overriding limitations which apply.  In particular as regards public securitisations, Article 4(2)(d) of the RTS on operational standards requires repositories to verify that the ND options are only used where they “do not prevent the data submission from being sufficiently representative of the underlying exposures in the securitisation”.  In addition, there are the requirements noted below (regarding the use of the ND options in the context of private securitisations) set out in Recital (13) and Article 9 of the disclosure RTS, and in Recital (16) of the Securitisation Regulation itself.

ESMA's guidelines contain various limitations on the use of "ND".  In response to the publication of its consultation draft guidelines, ESMA received various industry feedback, which to a degree led to refinements being made in the final guidelines contained in ESMA's Final Report, although the changes fall short of what industry had asked for, and it remains to be seen how problematic the guidelines, and their limits on the use of a "No Data" option, will prove to be.  Some of those industry requests, and ESMA's responses to them, are worth examining here because they illustrate areas where problems for some market participants may arise in the future: 

  • Should there be no specific limit on the use of ND1 (data not collected as not required by the lending or underwriting)?  The argument in favour of there being no limit is that certain data for which the relevant template has a field might not have been collected because it irrelevant (e.g. the earned income of the borrower is irrelevant to the underwriting of a buy to let mortgage loan).  ESMA refused to accommodate this, although its rationale – “understanding the reasons why data is missing is a useful input for securitisation investors when performing due diligence and monitoring of securitisations” – might be said to miss the point, because limiting the use of ND1 does not merely require an explanation for the absence of data: it requires the reporting of that data.
  • Should non-EU disclosing parties be allowed more use of ND1-4?   A particular concern here was that non-EU parties might have local law confidentiality or bank secrecy laws to comply with (e.g. Swiss banks).  Again, ESMA refused: it said that the underlying exposure templates comply with ESMA’s mandate under the Securitisation Regulation, and were based on past experience of disclosures required under the old Article 8b and the ECB templates; which, again, might be said to miss the point, because private and bilateral transactions were exempted from complying with the detailed disclosure requirements under the old Article 8b.
  • Should the maxima differentiate between different types of deal that use the same template?  ESMA would not do this – so, in particular, the thresholds for Annex 4 (Corporate risk assets) apply whatever the deal is – a CLO, or something else – but it did at least say it would keep the matter under review.
  • CLOs: As noted above, there are “tolerance thresholds” applicable in the case of "legacy assets” and “legacy IT systems”.   ESMA had proposed that “ND” would be a permitted answer in the case of “legacy assets” and on account of “legacy IT systems”, but only up to a maximum number.  The LMA and AFME had requested more flexibility as regards the Annex 4 Corporate underlying exposure template given that there is no CLO-specific template, and ESMA has responded by increasing the tolerance thresholds here (with a view to tightening them later).
  • What about CMBS which, as is often the case, only have a small number of underlying exposures?  The tolerances built into the guidelines are of no help if they produce a number less than one, and so, for example, if there are fewer than 10 underlying loans, a percentage threshold of 10% is no help).  ESMA was not persuaded by the logic of this argument, and took the view that in any event the number of fields that would need to be reported is not onerous.

The use of ND options in relation to private securitisations 

As regards disclosures relating to private deals (where a securitisation repository is not involved) ESMA's guidelines do not apply, which allows more flexibility because the limits set out in the guidelines do not apply either.  Disclosing parties are however still subject to other requirements relating to disclosure, including Recital (16) of the Securitisation Regulation itself (which states the investor report t be produced under Article 7(1)(e)) should in any event contain “all materially relevant data on the credit quality and performance of underlying exposures")  and more specifically the disclosure RTS, where particular note should be made of recital (13):

"(13) The set of ‘No data’ (‘ND’) options should only be used where information is not available for justifiable reasons, including where a specific reporting item is not applicable due to the heterogeneity of the underlying exposures for a given securitisation. The use of ND options should however in no way constitute a circumvention of reporting requirements. The use of ND options should therefore be objectively verifiable on an ongoing basis, in particular by providing explanations to competent authorities at any time, upon request, of the circumstances that have resulted in the use of the ND values”;

and of Article 9:

Information completeness and consistency

(1)  The information made available pursuant to this Regulation shall be complete and consistent…

(3) Where permitted in the corresponding Annex, the reporting entity may report one of the following ‘No Data Option’ (‘ND’) values corresponding to the reason justifying the unavailability of the information to be made available:

(a) value ‘ND1’, where the required information has not been collected because it was not required by the lending or underwriting criteria at the time of origination of the underlying exposure;

(b) value ‘ND2’, where the required information has been collected at the time of origination of the underlying exposure but is not loaded into the reporting system of the reporting entity at the data cut-off date;

(c) value ‘ND3’, where the required information has been collected at the time of origination of the underlying exposure but is loaded into a separate system from the reporting system of the reporting entity at the data cut-off date;

(d) value ‘ND4-YYYY-MM-DD’, where the required information has been collected but it will only be possible to make it available at a date taking place after the data cut-off date. ‘YYYY-MM-DD’ shall respectively refer to the numerical year, month, and day corresponding to the future date at which the required information will be made available;

(e) value ‘ND5’, where the required information is not applicable to the item being reported.

For the purposes of this paragraph, the report of any ND values shall not be used to circumvent the requirements in this Regulation.

Upon request by competent authorities, the reporting entity shall provide details of the circumstances that justify the use of those ND values.”

GEM-listed CLOs: disclosure of material breaches, structure, risk characteristics, amendments and material inside information 

Disclosure of material breaches and so on has been the cause of some puzzlement for CLOs, which have to determine how they must report any disclosable information under Articles 7(1)(f) and (g).  This is because Articles 7(1)(f) and (g) differentiate between cases where the Market Abuse Regulation applies - in which case disclosure has to be made under Article 7(1)(f) - and where it does not, in which case Article (7(1)(g)) applies.  Article 2 of the MAR essentially limits its scope to issues of financial instruments admitted to trading on a regulated market, an MTF or an OTF, and so in particular, the MAR would apply to notes listed on the GEM (i.e. the Euronext Dublin Global Exchange Market - a trading name of the Irish Stock Exchange) because the GEM is a regulated market and MTF which the ISE is authorised to operate by the Central Bank of Ireland under MIFID, and this is so even though GEM listings are not subject to a prospectus drawn up in compliance with the Prospectus Regulation, and so are not "public issues" even though these may well have a wide distribution (GEM listings are available for issuers seeking admission of securities which, "because of their nature, are normally bought and traded by a limited number of investors who are particularly knowledgeable in investment matters", and GEM issues are structured so as to avoid the Prospectus Regulation requirements e.g., as an offer solely to qualified investors, or to fewer than 150 offerees per Member State, or in a denomination of at least EUR 100,000).  So in conclusion, many CLOs are private deals, but because they are listed on the GEM, Article 7(1)(f) catches them and so requires reporting of any inside information and significant events. 

The question then arises: how should that disclosure be made?  Annex 14 ("Inside information or significant event information - non-asset backed commercial paper securitisation") is referenced by article 6(1) of the RTS as the template to be used to report "inside information" that must be reported pursuant to Article 7(1)(f) of the Securitisation Regulation, and by article 7(1) of the RTS as the template to be used to report "information on significant events" that must be reported to Article 7(1)(g), but since Annex 14 is produced under ESMA's Article 17 mandate, not its Article 7 mandate, it does not apply to private deals, and consequently, GEM-listed CLOs have to disclose under Article 7(1)(f) and (g) but have flexibility about the format, because Annex 14 does not apply, even though it seems capable of being used if the disclosing entity wants to.

Additional disclosure requirements for STS 

Over and above Article 7, the STS rules have further transparency requirements, in Article 22 for term STS and Article 24(14) for ABCP STS:

  • 5 years of performance data on comparable exposures (or 3 years for short term receivables backing ABCP) must be disclosed before pricing;
  • for term STS but not ABCP, a sample of these must be independently verified and a liability cash flow model must be provided.

The comparable exposures data requirement applies to private deals as well as public ones, which is an unhelpful for ABCP (which is mostly private) and not conducive to sponsors raising ABCP to STS status; and for new asset classes it raises the question what would be comparable.

Disclosure post-Brexit in relation to UK securitisations

To assist firms in preparing to comply with their post-Brexit regulatory obligations, the FCA was given "temporary transitional powers" by HM Treasury to suspend or modify the effect of onshoring changes for a temporary period (known as the "standstill period"), and the FCA has in many cases done this with effect until 31 March 2022 under the FCA Transitional Directions December 2020 made under Part 7 of the Financial Services and Markets Act 2000 (Amendment) (EU Exit) Regulations 2019.  These direct that where, as a result of the operation of a Brexit exit instrument, the post-Brexit obligation is different from the pre-Brexit obligation, during the standstill period the obligation is modified so that it is not breached by a person which instead complies with the pre-Brexit version of the obligation.  Paragraph 32 of Annex A to the December 2020 Directions states that the standstill direction applies to various amendments made to the EUSR by the Securitisation (Amendment) (EU Exit) Regulations 2019, and to the transparency RTS and ITS by the Technical Standards (Specifying the Information and the Details of a Securitisation to be Made Available by the Originator, Sponsor and SSPE (EU Exit) Instrument 2020.  As regards templates, this Instrument made some detailed amendments to the formats as set out in the disclosure ITS.  Paragraph 32 explains that:

“Without relief, originators, sponsors and SSPEs of UK securitisations would have to use UK disclosure templates to satisfy the transparency requirements of article 7 of the Securitisation Regulation, when they would have limited time before IP completion day to modify their systems to take into account the changes made by the Technical Standards (Specifying the Information and the Details of a Securitisation to be Made Available by the Originator, Sponsor and SSPE (EU Exit) Instrument 2020.  Therefore, the FCA is applying the standstill direction so that originators, sponsors and SSPEs of UK securitisations can continue to use the disclosure templates as they had effect prior to IP completion day.”

So, if a notification has to be made under Article 7, during the standstill period, it can continue to be done using the EU disclosure ITS templates rather than the newly-specified UK templates (available here). 

Additional difficulties for ABCP programmes to comply with reporting requirements

Additional difficulties for ABCP programmes include:

(1) the need to provide loan-level data to the sponsoring bank of the ABCP programme and if requested, to the relevant competent authorities, even though information to investors of ABCP can be on an aggregated basis. Getting detailed and structured loan-level data from SMEs in which ABCP issuers often invest is more challenging than from banks which have the systems to deal with it as part of their business; and

(2) the need to provide monthly reports at ABCP programme level, while the underlying securitisation exposures which ABCP transactions invest in only provide reports on a quarterly basis. It is unclear whether the monthly reports for ABCP programme can rely on (and effectively repeat) the information in the previous quarterly reports for the months that there is no securitisation level reporting, or would the ABCP issuer require the underlying securitisation to report on a monthly basis instead?

What was replaced by Article 7?

Article 7 replaced the old rules regarding transparency in the old CRR Article 409 and Articles 22-23 of the related RTS (625/2014) and, as regards "structured finance instruments", in more detailed form in Article 8b of CRA III and the related RTS (2015/3).

What is homogeneity and how do we know it when we see it?

The homogeneity requirements (in Article 20(8) for term STS and Article 24(15) for ABCP STS) are easier to state than to define with certainty.  The 31st July 2018 revised draft RTS were a great improvement on the original draft RTS and gave participants guidance beyond the "you know it when you see it" position from which many of them will have started.  The enacted 28th May 2019 homogeneity RTS (Commission Delegated Regulation (EU) 2019/1851) have further changes to the recitals (which have been largely rewritten and reduced in number), and Article 1 has been reworked with a view to greater clarity.  To some extent the RTS have reverted to "you know it if you see it", in a way that may provide some reassurance that it is not intending to change market practice. These have been supplemented by the 12th December 2018 EBA guidelines.  All this shows the difficulty in trying to pin down this slippery concept, and in steering a course between making the test neither too easy to satisfy nor too difficult.

History

The development of the homogeneity concept can been seen by reading various papers put out starting in 2014, and then the various iterations of the Securitisation Regulation itself:

and some guidance on interpretation can perhaps be found by considering how the homogeneity concept developed over this period.   A full review of all these is available here.

Level one text

The starting point for term STS is Article 20(8):

"8.  The securitisation shall be backed by a pool of underlying exposures that are homogeneous in terms of asset type, taking into account the specific characteristics relating to the cash flows of the asset type including their contractual, credit-risk and prepayment characteristics. A pool of underlying exposures shall comprise only one asset type. The underlying exposures shall contain obligations that are contractually binding and enforceable, with full recourse to debtors and, where applicable, guarantors.
The underlying exposures shall have defined periodic payment streams, the instalments of which may differ in their amounts, relating to rental, principal, or interest payments, or to any other right to receive income from assets supporting such payments. The underlying exposures may also generate proceeds from the sale of any financed or leased assets.
The underlying exposures shall not include transferable securities, as defined in point (44) of Article 4(1) of Directive 2014/65/EU, other than corporate bonds that are not listed on a trading venue."

Article 24(15) for ABCP contains principles which are similar to the first paragraph of Article 20(8) but there is additional detail reflecting the particular rules for ABCP, and in what follows we concentrate on term STS.

Recital (27) explains that the rationale for the homogeneity requirement is to "ensure that investors perform robust due diligence and to facilitate the assessment of underlying risks".  For this reason, securitisation transactions should be "backed by pools of exposures that are homogenous in asset type", and it gives four categories by way of example:

  • residential loans
  • corporate loans, business property loans, leases and credit facilities to undertakings of the same category
  • auto loans and leases
  • credit facilities to individuals for personal, family or household consumption purposes.

It forbids pools which include transferable securities, apart from unlisted bonds issued by non-financial corporations to credit institutions in markets where such bonds are common practice in place of loan agreements, e.g. pfandbriefe.

So a pool may only contain one "asset type", and illustrations of "types" are provided in Recital (27).

But just having the same asset type in the pool is not enough by itself to make the pool homogeneous. The pool assets (of the same asset type) must, taking the wording of Article 20(8), be homogeneous "taking into account the characteristics relating to the cash flows… including their contractual, credit risk and prepayment characteristics".   The cash flow characteristics will include interest payments, the likely incidence of prepayments and whether an asset amortises fully, partly or not at all.

Level two text - the homogeneity RTS

Article 20(8) does not explicitly refer to the rationale from EBA 2015 and Basel 2016 - that investors should not need to analyse and assess materially different credit risk factors and risk profiles when carrying out risk analysis and due diligence checks.  The RTS however do in Recital (3), which explains that since underwriting standards are designed to measure and assess credit risk, exposures sharing similar underwriting standards can be taken to have similar risk profiles and therefore be regarded as homogeneous, whereas dissimilar underwriting standards may result in exposures with "materially different risk profiles", even if the standards are all high quality.

The original draft RTS had clearly struggled trying to define homogeneity, and in its feedback on the public consultation exercise the EBA admitted as much. Whilst there was "strong support" for determining homogeneity by reference to the similarity of the underwriting and servicing standards and the adherence to a single asset category, it noted that:

"A substantial number of respondents have raised concerns with the homogeneity factor requirement… and with respect to the perceived lack of clear guidance on how the homogeneity factor requirement should apply in practice, and how their relevance should be determined for a specific securitisation. Overall, it was noted that the current proposal would have severe negative consequences on the market, would produce excessively concentrated pools, would not allow to recognise the existing well-established securitisations as homogeneous, and would penalise smaller entities that would face difficulties with generating critical portfolio mass".

The EBA's response was to try to be clearer, renaming the former ‘risk factor’ as ‘homogeneity factor’ to avoid misconceptions that the homogeneity is about assessment of the credit risk of the individual exposures in the pool, and reducing the number of the homogeneity factors.  In the 28th May 2019 homogeneity RTS it went further, emphasising the central roles of:

  • similar underwriting standards
  • similar servicing procedures, systems and governance

Recital (2) explains that market practice has already identified well established asset types to determine the homogeneity of a given pool of underlying exposures, and stressing that there was no desire to limit either financial innovation nor existing market practice, so that asset pools that do not correspond to a well-established type should also be allowed "on the basis of the internal methodologies and parameters consistently applied by the originator or sponsor", and Recital (4) identified how sensitive cash flow projections and assumptions about payment and default characteristics were to servicing procedures.

So long as the underwriting and servicing standards are similar, consumer credit assets and trade receivables are sufficiently homogeneous without the need for any further examination - to do otherwise would lead to excessive concentrations.  For other asset types, it was necessary to go further and apply "one or more relevant factors on a case-by-case basis" (Recital (5)).

Article 1 of the RTS accordingly goes on to state that the STS homogeneity requirement will be met if four conditions are met:

  • the assets fall into a single defined "asset type" - broadly speaking, residential mortgage loans, commercial mortgage loans, consumer credit, corporate credit, auto loans and leases, credit cards, trade receivables, or - tracking Recital (2), a group of exposures considered by the originator or the sponsor "to constitute a distinct asset type on the basis of internal methodologies and parameters"
  • similar underwriting standards
  • similar servicing procedures
  • except for consumer credit assets and trade receivables, at least one "homogeneity factor" applies the assets in the pool.

The homogeneity factors vary according to the assets in question and can be summarised by reference to the following table (based on Article 2 of the RTS):

homog table

A related point arises under the RTS/ITS on STS Notification produced by ESMA under Article 27 of the Securitisation Regulation.  Field STSS27 requires the notification to provide:

"a detailed explanation as to the homogeneity of the pool of underlying exposures backing the securitisation.  For that purpose the originator and sponsor shall refer to the EBA RTS on homogeneity (Commission Delegated Regulation (EU) […], and shall explain in detail how each of the conditions specified in the Article 1 of the RTS are met."

There is no need to justify the choice of homogeneity factor.  Examples of how field STSS27 is being completed in practice can be found on the ESMA list of STS notifications.

The emphasis on underwriting standards leads to the conclusion that buy-to-let and owner-occupier credits could not form a homogeneous pool, because the origination criteria would have been different.  However, a loan which was originated as an owner-occupier loan but which subsequently became a BTL loan should be able to form part of the same pool as other owner-occupier loans because they have all been (and assuming that they were in fact) originated according to the underwriting standards.  There had bee