Introduction

Securitisation Regulation

For securitisation professionals across the UK, the EU and beyond, the passing into law of the Securitisation Regulation, and the related amendments to the Capital Requirements Regulation, was the end of the first leg of a long journey that began with the global financial crisis a decade earlier.  We are now at the beginning of the second leg, as the market comes to grips with a new regulatory landscape which is not without its challenges.  It speaks volumes that on 1st January 2019 the level one laws became applicable without some critical level two RTS being in force, and in particular with the article 7 disclosure RTS in a state of disarray, with severely adverse consequences for many sectors of the market.  

On these pages you will find:

  • the full text of the Securitisation Regulation.  The text is fully linked to all the related EU regulations and directives, related RTS and other useful background materials, and their post-Brexit UK equivalents, and annotated with our commentaries.  We have included the actual names of the EU laws which are referred to, put the definitions in alphabetical order, and have linked the recitals to the articles to which they relate and vice versa.  We hope this will make it easier for you to find your way around the Regulation itself and the related regulatory landscape
  • the related level 2 and level 3 materials
  • commentaries by us on various aspects of the new securitisation regime. 

The new landscape for securitisation is in some respects terra incognita.  We hope these pages will help you navigate this new landscape.  We will be updating them over the coming months as and when there are any significant developments in law, regulation or market practice.

Securitisation Regulation

For securitisation professionals across the UK, the EU and beyond, the passing into law of the Securitisation Regulation, and the related amendments to the Capital Requirements Regulation, was the end of the first leg of a long journey that began with the global financial crisis a decade earlier.  We are now at the beginning of the second leg, as the market comes to grips with a new regulatory landscape which is not without its challenges.  It speaks volumes that on 1st January 2019 the level one laws became applicable without some critical level two RTS being in force, and in particular with the article 7 disclosure RTS in a state of disarray, with severely adverse consequences for many sectors of the market.  

On these pages you will find:

  • the full text of the Securitisation Regulation.  The text is fully linked to all the related EU regulations and directives, related RTS and other useful background materials, and their post-Brexit UK equivalents, and annotated with our commentaries.  We have included the actual names of the EU laws which are referred to, put the definitions in alphabetical order, and have linked the recitals to the articles to which they relate and vice versa.  We hope this will make it easier for you to find your way around the Regulation itself and the related regulatory landscape
  • the related level 2 and level 3 materials
  • commentaries by us on various aspects of the new securitisation regime. 

The new landscape for securitisation is in some respects terra incognita.  We hope these pages will help you navigate this new landscape.  We will be updating them over the coming months as and when there are any significant developments in law, regulation or market practice.

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 mentarmission,

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.
  1. 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;


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:

    1. all liquidity and credit risks of the ABCP programme;
    2. any material dilution risks of the exposures being securitised;
    3. 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:

    1. all liquidity and credit risks of the ABCP transaction;
    2. any material dilution risks of the exposures being securitised in the ABCP transaction;
    3. 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

    1. an insurance undertaking as defined in point (1) of Article 13 of Directive 2009/138/EC [Solvency II] ;
    2. a reinsurance undertaking as defined in point (4) of Article 13 of Directive 2009/138/EC [Solvency II] ;
    3. 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)] ;
    4. 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;
    5. 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];
    6. 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;
    7. 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;

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;


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:

    1. 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
    2. 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;


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:

    1. payments in the transaction or scheme are dependent upon the performance of the exposure or of the pool of exposures;
    2. the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme;
    3. 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 CRE, project finance, ship and aircraft, and the like.  Because the definition of "securitisation" focuses so much on the tranching of risk, this is necessary to avoid catching things that nobody would regard as securitisation 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. 

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 and so, to nobody's surprise, 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 mater 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 is to acquire or finance an asset;

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

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

  • the primary determinant of credit risk is 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.


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.

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. ‘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:

    1. establishes and manages an asset-backed commercial paper programme or other securitisation that purchases exposures from third-party entities, or
    2. 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];

A welcome development - which occurred towards the end of the trilogues - was the widening of the definition of “sponsor”.

The original draft Securitisation Regulation 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). 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.

Now however, this appears to be unnecessary. 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”.

We understand that some in the market are seeking official guidance that this is as wide as it seems to be, but the wording is unambiguous, and the history of the definition as the draft went through the legislative process does not suggest that this was accidental, and even if it were, it clearly says what it says.  Admittedly, it would have been better if the phrase "whether located in the Union or not" had been put after the reference to an investment firm, and the UK post-Brexit onshoring version of this definition, contained in section 4 of the Securitisation (Amendment) (EU Exit) Regulations 2019, does do this.

As a result, non-EU CLO managers - and EU managers which do not have the super authorisations - can much more easily come within the “sponsor” definition (so long as they come within this MIFID definition) and be able to hold the risk retention, without needing to bring themselves within the definition of “originator”.

That is not the end of the story for UK-based CLO managers, because if they are within this definition and so providing investment services or performing investment activities on a professional basis, they would need to obtain authorisation from the UK's FCA under section 19 of the Financial Services and Markets Act 2000, which in itself could be a challenge for some US firms.

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".


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:

  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:
    1. payments in the transaction or scheme are dependent upon the performance of the exposure or of the pool of exposures;
    2. the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme;
    3. 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 CRE, project finance, ship and aircraft, and the like.  Because the definition of "securitisation" focuses so much on the tranching of risk, this is necessary to avoid catching things that nobody would regard as securitisation 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. 

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 and so, to nobody's surprise, 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 mater 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 is to acquire or finance an asset;

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

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

  • the primary determinant of credit risk is 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.  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?  Some level 3 guidance would make sense.

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 deinition 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-balnce sheet item".


  1. ‘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;

  1. ‘originator’ means an entity which:
    1. 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
    2. purchases a third party’s exposures on its own account and then securitises them;

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

  1. ‘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:
    1. establishes and manages an asset-backed commercial paper programme or other securitisation that purchases exposures from third-party entities, or
    2. 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];

References

A welcome development - which occurred towards the end of the trilogues - was the widening of the definition of “sponsor”.

The original draft Securitisation Regulation 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). 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.

Now however, this appears to be unnecessary. 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”.

We understand that some in the market are seeking official guidance that this is as wide as it seems to be, but the wording is unambiguous, and the history of the definition as the draft went through the legislative process does not suggest that this was accidental, and even if it were, it clearly says what it says.  Admittedly, it would have been better if the phrase "whether located in the Union or not" had been put after the reference to an investment firm, and the UK post-Brexit onshoring version of this definition, contained in section 4 of the Securitisation (Amendment) (EU Exit) Regulations 2019, does do this.

As a result, non-EU CLO managers - and EU managers which do not have the super authorisations - can much more easily come within the “sponsor” definition (so long as they come within this MIFID definition) and be able to hold the risk retention, without needing to bring themselves within the definition of “originator”.

That is not the end of the story for UK-based CLO managers, because if they are within this definition and so providing investment services or performing investment activities on a professional basis, they would need to obtain authorisation from the UK's FCA under section 19 of the Financial Services and Markets Act 2000, which in itself could be a challenge for some US firms.

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".


  1. ‘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;

  1. ‘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;

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

  1. ‘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;

  1. ‘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;

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

  1. ‘institutional investor’ means an investor which is one of the following
    1. an insurance undertaking as defined in point (1) of Article 13 of Directive 2009/138/EC [Solvency II] ;
    2. a reinsurance undertaking as defined in point (4) of Article 13 of Directive 2009/138/EC [Solvency II] ;
    3. 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)] ;
    4. 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;
    5. 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];
    6. 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;
    7. 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;

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

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

  1. ‘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;

  1. ‘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. ‘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;

  1. ‘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.

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

  1. ‘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;

  1. ‘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:
    1. all liquidity and credit risks of the ABCP programme;
    2. any material dilution risks of the exposures being securitised;
    3. 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;

  1. ‘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:
    1. all liquidity and credit risks of the ABCP transaction;
    2. any material dilution risks of the exposures being securitised in the ABCP transaction;
    3. 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;

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

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’.

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 point 11 of Article 4(1) of Directive 2014/65/EU [MiFID II] , unless all of the following conditions are fulfilled:
    1. the seller of the securitisation position has performed a suitability test in accordance with Article 25(2) of Directive 2014/65/EU [MiFID II] ;
    2. 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;
    3. the seller of the securitisation position immediately communicates in a report to the retail client the outcome of the suitability test.
  1. 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.
  1. The retail client shall provide the seller with accurate information on the retail client’s financial instrument portfolio, including any investments in securitisation positions.

    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:

  1. the third country is listed as a high-risk and non-cooperative jurisdiction by the FATF;
  2. the third country has not signed an agreement with a Member State 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.

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:
    1. where the originator or original lender established in the Union 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
    2. 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;
    3. if established in the Union, 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;
    4. 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;
    5. 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;

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.   In the event of a no-deal Brexit, it would also catch UK originators which had previously 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.


  1. 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).
  1. 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:
    1. the risk characteristics of the individual securitisation position and of the underlying exposures;
    2. 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;
    3. 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.

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.


  1. An institutional investor, other than the originator, sponsor or original lender, holding a securitisation position, shall at least:
    1. 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;
    2. 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;
    3. in the case of fully supported ABCP programme, regularly perform stress tests on the solvency and liquidity of the sponsor;
    4. 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;
    5. be able to demonstrate to its competent authorities, 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
    6. 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.
  1. 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. 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 under Articles 32 and 33 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 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, if a sponsor wants to sell a non-EU securitisation to EU investors, then indirectly, as a result of Article 5(1)(d), it will need to comply with the Article 6 risk retention requirements.  The EC's explanatory memorandum accompanying the original draft of the Securitisation Regulation suggests this, 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.

Then 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, it 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.

As regards transparency, it is unclear.  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).  This 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 better view is that "where applicable" and "required" must mean something, and the meaning should be that the investor has to verify it only where Article 7 is applicable to the originator, sponsor or SSPE and so requires them to make disclosures i.e. only where they are incorporated in the EU.  However, the concern is that "where applicable" might mean "whichever of them it applies to" (because Article 7(2) requires the three of them to designate one of them to do it) or perhaps, might refer to the applicable information that Article 7 requires to be disclosed.  Some EU investors have been nervous enough not to invest in non-EU deals because of this, and their nervousness is understandable because it would seem to create a loophole allowing deals with EU assets, denominated in EUR, to be structured (by having non-EU originators, sponsor and SSPEs) in a way that sidestepped Article 7 altogether. 

This is currently (as of February 2020) a vexed topic and it 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 new RTS on risk retention will 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.

References

Article 6(1) includes the well-trailed rider:

“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”

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”.  Article 3(6) of the EBA's 31st July 2018 final 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;
(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)".

  1. 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 pursuant to Articles 32 and 33.
  1. 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:
    1. the retention of not less than 5% of the nominal value of each of the tranches sold or transferred to investors;
    2. 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;
    3. 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;
    4. 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
    5. the retention of a first loss exposure of not less than 5% of every securitised exposure in the securitisation.
  1. 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.

    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 and to the Union parent credit institution, financial holding company or mixed financial holding company established in the Union.
  1. Paragraph 1 shall not apply where the securitised exposures are exposures on or exposures fully, unconditionally and irrevocably guaranteed by:
    1. central governments or central banks;
    2. 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] of Member States;
    3. 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];
    4. 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
    5. the multilateral development banks listed in Article 117 of Regulation (EU) No 575/2013 [CRR].
  1. 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.
  1. 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 technical standards to specify in greater detail the risk-retention requirement, in particular with regard to:
    1. the modalities for retaining risk pursuant to paragraph 3, including the fulfilment through a synthetic or contingent form of retention;
    2. the measurement of the level of retention referred to in paragraph 1;
    3. the prohibition of hedging or selling the retained interest;
    4. the conditions for retention on a consolidated basis in accordance with paragraph 4;
    5. the conditions for exempting transactions based on a clear, transparent and accessible index referred to in paragraph 6;

The EBA shall submit those draft regulatory technical standards to the Commission by 18 July 2018.

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

The final draft RTS on risk retention produced by the EBA under Article 6(7) are fairly uncontroversial. They contain 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 are:

  • the EBA’s summary of the feedback it received which accompanied the RTS confirms that it does not intend the direct retention obligation in article 5 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 has 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 can 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 is permitted so long as the credit risk is not transferred, and the wording is careful to recognise that this may involve a title transfer arrangement such as a repo, and that what counts is that “the exposure to” the credit risk is retained.
  • it helpfully confirms 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 is no explicit agreement among them on the point.

There is for the moment only one, minor, concession to synthetics. Where an institution sells off a junior position in a pool of loans to SMEs via a synthetic structure and retains the senior position, the institution may apply to the retained position the lower capital requirements available for STS securitisations where strict criteria (set out in the new Article 270 of the CRR as amended) are met, including that the position is guaranteed by a central government, central bank, or a public sector “promotional entity”, or – if fully collateralised by cash on deposit with the originator – by an institution.

So, in the short term, originators which tranche risk via any synthetic structure – and the orthodox view seems to be that this includes simple credit guarantee arrangements, because these usually provide for a deductible and a cap, which technically makes the guaranteed credit risk “tranched” – will be penalised because they will have to hold capital against the retained piece on the basis of the higher non-STS rules, and the investors will similarly be penalised, which will in turn punish the originator via the return the investors will need to offset this.

However, developments, and possibly a regime for STS synthetic securitisations, can be expected during the course of 2020 and, given that the securitisation framework for regulatory capital allocation is non-neutral (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), perhaps the most likely (and quite possibly unintended) outcome will be that banks wanting to sell off assets via a synthetic sale and seeking STS status – perhaps because they cannot get a necessary borrower consent – will decide to wait until the synthetic framework becomes law.

The EBA discussion paper "Draft report on STS Framework for Synthetic Securitisation" was published, later than its due date, on 24th September 2019.  One reaction to it might be to ask: why?  In the bad old days before 2009, the investor herd was buying sometimes horribly complex securitisation paper on the basis of a rating and no significant due diligence without understanding what they were doing, other than to know that their competitors were doing it and they couldn't simply leave their investors' funds on deposit.  So the STS label for true sale securitisations at least has an obvious rationale - to protect them from their animal spirits.  But synthetic securitisation is a different jungle, inhabited by different beasts: the protection sellers are no longer monoline insurers but, for the most part, central banks, supranational entities such as the EIB, pension and hedge funds (the chart gives the EIB's breakdown of the market).  Do these entities need an underwriting proposition to carry an "STS label?  Or are they able to look after themselves?  Post-GFC synthetics are, according to the EBA, entirely private bilateral deals where protection sellers can bargain for whatever they want (an argument that failed to convince the EU to leave private deals outside the Securitisation Regulation disclosure rules of course). 

The EBA seems to be motivated by the fact that true sale issues are now regulated, and so to ensure a "level playing field", so should synthetic deals; and perhaps a desire to make it easier for new entrants to join the market as protection sellers, who would at present be daunted by the need to do all the due diligence.  This seems debatable: it notes that the market is reviving, with an increasing degree of standardisation, but does not seem to wonder why it has managed to do that without any "help" from regulators; and suggests that an STS label would be "of crucial importance for the destigmatisation" of the market - evidently however, not a stigma that is deterring existing participants.  Is this not an argument that this is increasing moral hazard, if it encourages inadequately-skilled new entrants to join the credit risk market?  Be that as it may, the market response has not been so negative, even though at the time of writing (29th January) the EBA has not yet published its response to the consultation.  This seems to be on the basis that an STS regime may encourage more investors to enter the market and take some credit risk away from the banking sector (e.g. by buying credit linked notes) – and the more investors there are, the better for the banks of course – as well as because an STS regime would hopefully go hand in hand with a more favourable capital treatment for banks as regards the risk which they retain; although (see below) this remains to be seen, and the EBA was equivocal about this aspect. 

The Report envisages a two stage process: first, to consider a set of STS criteria for synthetics: largely the same as or based on those for true sales (the "overarching rationale"), plus some additional ones for synthetics; and then to consider 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 (in which respect the EBA notes that whereas pre-GFC deals typically sold off the least risky portion and retained the rest, now it tends to be the other way around, with the first loss risk being transferred to a protection seller).  And if this is eventually a significant attraction for a protection buyer (these deals are almost always done by a regulated entity such as a bank subject to the CRR) then that STS label might be worth pursuing.  This would be an EU special case, as there is no provision at the Basel/IOSCO level for preferential capital treatment for an STC-qualifying synthetic product).

It envisages 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 (and an enforceability legal opinion regarding the credit protection is a specific requirement).  This only contemplates "balance sheet synthetic securitisations" and not "arbitrage" ones (see further the EBA's December 2015 "Report" on the difference: "balance sheet" ones are intended to get assets off a bank's balance sheet, especially for regulatory capital purposes): this is spelt out in the Securitisation Regulation

So will STS for synthetics gain traction?  There were reports in the trade press suggesting that EU regulators were not ad idem on giving preferential capital treatment to banks which did synthetic securitisations, which is why the EBA has not made any particular recommendation about this in its discussion paper.  But without a more favourable capital treatment, why would a regulated entity bother going after the STS label?  The risk weighting for banks holding the senior tranche of a securitised portfolio is now 15% for non-STS and 10% for STS: that would be attractive for bank issuers, but, that aside, the STS label would do nothing for existing investors in synthetics, who know what they are doing anyway.

Market reaction to the EBA consultation

A point made by AFME in its response to the EBA which is worth noting is that the history of synthetic securitisation shows credit losses of much less than would be implied by the regulatory capital requirements (“virtually zero losses to the senior tranches of synthetic securitisations”) – and that as the CRR exists at present, the capital requirements that apply to the risk retained by an originating bank under any synthetic securitisation are the same – whether it is a simple deal transferring more than significant risk to a third party or a risky “arbitrage” synthetic securitisation

Signs signs of resistance were reported in the trade press to two of the EBA’s proposed criteria for synthetic STS:

  • Criterion 35 in the EBA synthetic STS discussion paper states: “The protection buyer should not commit to any amount of excess spread available for the investors”.  This, one of the requirements specific to synthetics and with no comparable true sale STS criterion, refers to the common structure whereby an SPV issues senior and junior CLNs to investors (usually the originator bank holds the senior and outside investors take the junior, first loss, tranche), the SPV then writes a credit default swap with the bank, which pays the SPV annual premiums, and unless and until there is a default in the underlying loan portfolio, the coupon paid on the CLNs should be less than the sum of the premiums receivable and the income earned on the collateral which the SPV invests in using the proceeds of the issue of the CLNs.  That difference is the excess spread, and if the SPV accumulates it, it acts as a cushion against loss, making the CLNs less risky.  So what is the problem with that?  The EBA regards it as “a complex structural feature…The complexity arises with respect to the quantum of committed excess spread, and its calculation and allocation mechanism” and so, for the sake of simplicity, it should not be present in an “STS” structure.
  • Criterion 36 requires the collateral to take the form of 0% risk-weight securities or cash, to be held by a third party institution, not the originator.  This means that the originator cannot use the collateral and, while this is not the primary benefit of a synthetic, because the primary benefit is transferring risk, not acquiring funding, it can be a secondary benefit for an originator.  This criterion is designed, presumably, for the benefit of the investors, who are being asked to take the credit risk only on the underlying portfolio, not also on the originating bank, and so it is, like criterion 35, aimed at making the analysis simple for the investors.  Some structures permit the originator to hold and use the collateral unless they suffer a rating downgrade below an acceptable level.  The EBA proposal would not, as currently drafted, permit this.

The next step - which Article 45(2) of the Securitisation Regulation required by 2nd January 2020 and so is overdue - is for the EBA to submit a report to the European Parliament on including balance sheet synthetic securitisations in the STS regime, together with any draft legislation.  For more background on synthetic securitisation, see FinBrief, and the Glossaries.

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 authorities referred to in Article 29 and, upon request, to potential investors:
    1. 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;
    2. all underlying documentation that is essential for the understanding of the transaction, including but not limited to, where applicable, the following documents:
      1. the final offering document or the prospectus together with the closing transaction documents, excluding legal opinions;
      2. for traditional securitisation the asset sale agreement, assignment, novation or transfer agreement and any relevant declaration of trust;
      3. the derivatives and guarantee agreements, as well as any relevant documents on collateralisation arrangements where the exposures being securitised remain exposures of the originator;
      4. the servicing, back-up servicing, administration and cash management agreements;
      5. 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;
      6. 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;
    3. 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), a transaction summary or overview of the main features of the securitisation, including, where applicable:
      1. details regarding the structure of the deal, including the structure diagrams containing an overview of the transaction, the cash flows and the ownership structure;
      2. details regarding the exposure characteristics, cash flows, loss waterfall, credit enhancement and liquidity support features;
      3. details regarding the voting rights of the holders of a securitisation position and their relationship to other secured creditors;
      4. 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;
    4. in the case of STS securitisations, the STS notification referred to in Article 27;
    5. quarterly investor reports, or, in the case of ABCP, monthly investor reports, containing the following:
      1. all materially relevant data on the credit quality and performance of underlying exposures;
      2. 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;
      3. 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.
    6. 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;
    7. where point (f) does not apply, any significant event such as:
      1. 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;
      2. a change in the structural features that can materially impact the performance of the securitisation;
      3. a change in the risk characteristics of the securitisation or of the underlying exposures that can materially impact the performance of the securitisation;
      4. in the case of STS securitisations, where the securitisation ceases to meet the STS requirements or where competent authorities have taken remedial or administrative actions;
      5. 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 competent authorities.

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 national and Union law 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.

Competent authorities 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.


  1. 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 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)] .

    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:
    1. includes a well-functioning data quality control system;
    2. 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;
    3. is subject to appropriate systems, controls and procedures that identify all relevant sources of operational risk;
    4.   includes systems that ensure the protection and integrity of the information received and the prompt recording of the information; and
    5. 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.


  1. ESMA, in close cooperation with the EBA and EIOPA, shall develop draft regulatory 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

    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.

ESMA final draft RTS specifying the information to be made available by the originator, sponsor and SSPE


  1. In order to ensure uniform conditions of application for the information to be specified in accordance with paragraph 3, ESMA, in close cooperation with the EBA and EIOPA, shall develop draft implementing technical standards specifying the format thereof by means of standardised templates.

    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.

ESMA final draft ITS (format and standardised templates for disclosing information and details of a securitisation)

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).

Who and what is caught by Article 7?

The Article 7 transparency requirements apply to all securitisations (and article 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.

Much of the detail in Article 7 is not changed much, or at all, compared to the original EC draft, and the problematic European Parliament proposals for investor name disclosure and details of credit scoring were entirely rejected.  Full underlying deal documentation (apart from the legal opinions), or a summary of it, 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)).

The disclosure RTS and ITS

The detail regarding transparency is found in the related RTS/ITS.  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 - draft RTS specifying the information and  details to be disclosed (January 2019) and draft ITS with regard to the format and standardised templates (January 2019).  Because of the bumpy ride these had, they did not become law, and as of 1st January 2019 the market has had to operate with the benefit of the 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".  Using the usual form of words for non-no action letters, ESMA declared its expectation that the local competent authorities would exercise their supervisory and enforcement powers "in a proportionate and risk-based manner" - so, "comply or explain", to be applied on a case-by-case basis.

The controversy about 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, but did not then re-consult!  What seems to have happened is that ESMA took, or perhaps re-interpreted, legal advice over the scope of its powers under the Article 7(3) mandate and then significantly redrafted them.  

The RTS/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 is right that the scope of Article 7 extends to private deals, but what it could have done, but did not, was to pay more attention to the wording in Article 7(3) that the information to be disclosed should take into account its usefulness to the investors; which arguably permitted ESMA to distinguish between the requirements for public and private deals.  But that argument has been lost, and so Article 7 requires a significant amount of disclosure, regardless of what the investor may want. 

So, in summary, private deals are not exempt from the disclosure requirements in Article 7(1); the only differentiator in Article 7 itself is that disclosure must be via a repository for public deals, but not for private deals. 

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. 

For private deals, 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.

Compliance with the RTS and templates

In October 2019, the EC published RTS (with associated Annexes) and ITS (with associated Annexes) on disclosure, based on drafts initially submitted by ESMA on 22nd August 2018 and revised on 31st January 2019.  Both are in the final stages of being enacted and this is expected to happen at some point in February 2020.  Until they are, the market will continue to operate under the non-no action letter issued by the ESAs on 30th November 2018.  It had been hoped by some that there would be an extended period before the RTS actually "apply", but the final version of the text just has the standard “30 days after publication in the OJEU” wording, so originators’ and sponsors’ best hope may be that at least there could be a further non-no action letter effectively extending the official leniency provided by the letter of 30th November 2018, because their implementation will create operational issues for reporting entities because they have to make substantial additional information available and so need to make substantial adjustments to reporting systems.  This is a particular issue for less sophisticated issuers, such as corporates which rely upon private securitisations to finance trade receivables, which do not normally access the public ABS market.  As AFME explained to EMSA when it requested an extension to the non-noaction period:

“management of data – especially at the highly granular level prescribed - is notoriously difficult.  Significant changes to operations, internal processes and information technology are required. For banks subject to disclosure obligations, this presents significant challenges.  Adapting legacy systems to ensure the collection and faithful reporting of the correct data is highly detailed, meticulous work.  Ensuring it is done correctly for hundreds or thousands of assets (especially where they are sometimes decades-old legacy assets) requires a large investment of time and resources – and this is a task banks have been working towards for over a year now...  For non-bank originators, the challenge is even greater, as they will frequently be corporates whose systems have historically not been designed to produce loan-level data or investor report information at anything like the level of granularity required by the Disclosure RTS” 

AFME concludes that “complete compliance across all market sectors and asset classes within a few months is not achievable as a practical matter”.  ESMA itself said in its 22nd August 2018 final report, “Technical standards on disclosure requirements under the Securitisation Regulation”, that a transition period of 15-18 months would be necessary for reporting entities to achieve full compliance, and one would expect ESMA to be sympathetic so long as entities are getting on with it as quickly as they reasonably can. 

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

Problematic issues regarding the templates, where it is hoped the ESMA Q&A might be expanded include various mandatory template fields, the lack of a template for trade receivables, and 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) and for CLOs (regarding the corporate template).  AFME issued a detailed communication to ESMA in April 2019 about these, and about various points of detail.  

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 templates are required for disclosures in relation both to public and private issues; the major difference being that for public issues the disclosed data becomes publicly available via the securitisation repository to which it has been submitted.

The use of ND1-4 in disclosures about public deals

In January 2020, ESMA issued a Consultation Paper, “Guidelines on securitisation repository data completeness and consistency thresholds” containing draft guidelines for securitisation repositories, telling them how to go about deciding whether to accept or reject a submission made to them for a public securitisation. 

By way of background:

  • Article 17 of the Securitisation Regulation (“Availability of data held in a securitisation repository”) requires a securitisation repository to collect and maintain details of securitisations, and requires ESMA to develop RTS on the “operational standards” required to allow the timely, structured and comprehensive collection of that data. A draft was produced in November 2018, and a final draft RTS was issued on 29th November 2019;
  • Article 4(2)(d) of the November 2019 draft RTS requires repositories to verify that the ND options are only used where permitted and “do not prevent the data submission from being sufficiently representative of the underlying exposures in the securitisation”.

ESMA’s consultation is about the “sufficiently representative” requirement, and although the guidelines are directly addressed to securitisation repositories, they are indirectly addressed to sponsors and originators, because they have to comply with their obligations under Article 7 and, if their data submission is rejected by a depository on the basis of failure to meet the requirements set out in these guidelines, they will have failed to comply with Article 7.  They relate to ND1-4, and not ND5 (“not applicable”) i.e. to cases where the data was not collected because at the time there was no need for it, or else it has been collected but it is not easy to get hold of it.

In the guidelines, ESMA proposes “tolerance thresholds” for two cases: where the assets are fairly old and some of the data does not exist (“legacy assets”) or where the data is stored in other databases and cannot be retrieved in the short run without significant disproportionate expense by reporting entities (“legacy IT systems”).   So to give one example, for a public securitisation of auto loans and leases, there are a total of 78 fields, and in 41 of them ND is an option.  ESMA proposes that a maximum of 15 NDs will be allowed on account of the “legacy assets” excuse and another 15 on account of “legacy IT systems”.  The intention is to reduce these maxima over time.  The consultation runs until 16th March 2020.

As of 24th February, AFME is considering its response.Its initial view is that the guidelines are potentially problematic in a few area, including (amongst others):

  • Non-EU entities trying to comply with the Article 7 disclosure requirements in order to accommodate EU investors, who might otherwise not feel that they can safely buy an issue;
  • For synthetic securitisations, where some of the required data (e.g. the Annex 4 requirements for data on cashflows from underlying corporate exposures) is not collected because it is irrelevant for a synthetic (unlike for a true sale) deal;
  • For deals, such as CMBS, where the pool is small (e.g. if you only have 5 loans, even a 10% tolerance doesn’t help – unless it is set at 20%, you have no useable tolerance).

The use of ND1-4 in disclosures about private deals

It is worth considering the relevance of these guidelines to private deals.  It is clear that they do not apply directly, because private deals do not require disclosure to a securitisation data repository.  However, the fundamental disclosure obligations in Article 7 do apply equally to both.  Article 7(1) contains minimum disclosure standards, and under Article 7(3) ESMA has developed the (still draft but seemingly now finalised) disclosure RTS.  Recital (16) notes that disclosure should in any event be of “all materially relevant data on the credit quality and performance of underlying exposures

There is an argument that the guidelines are setting out what ESMA would regard as its minimum requirements for proper disclosure under Article 7 and that a material failure to meet them in respect of a private securitisation, because of the extensive use of ND1-4, would be regarded by ESMA as being a breach of Article 7.  From a practical viewpoint, disclosure under Article 7 would be made to the relevant national competent authority and not directly to ESMA, and ESMA would have difficulty in policing private disclosures of course because it does not have immediate access to the data and may in any event be less concerned about private deals than public ones (on the basis, as alluded to in Recital (13), that these are bespoke deals where the degree of disclosure is a matter for direct agreement between the investors and the originator/sponsor).  It seems ESMA has said privately that it would be more flexible in relation to private deals, which is consistent with what is said above. 

Note that Recitals (12) and (13) of the disclosure RTS state:

“(12) For reasons of transparency, where information cannot be made available or is not applicable, the originator, sponsor, or SSPE should signal and explain, in a standardised manner, the specific reason and circumstances why the data is not reported. A set of ‘No data’ options should therefore be developed for that purpose, reflecting existing practices for disclosures of securitisation information.

(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 note further that Article 9 of the disclosure RTS states:

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.”

This is arguably a sufficient code in itself for private deals, although originators and sponsors of private deals might be brave if they were to refer solely to these principles in cases where they were not complying with at least the spirit of the guidelines, and the more cautious approach will be to have regard to them in both cases. 

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.

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?

 

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:
    1. any securitisation the securities of which were issued before 1 January 2019; and
    2. 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.
  1. A competent authority 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 referred to in the first subparagraph of this paragraph shall consult with the resolution authority 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 resolution authority, and any other authority relevant for that entity, of the need for consultation.

    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.
  1. For the purposes of this Article, the following shall be deemed to be legitimate purposes:
    1. the facilitation of the winding-up of a credit institution, an investment firm or a financial institution;
    2. 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
    3. where the underlying exposures are non-performing, the preservation of the interests of investors.
  1. 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.
  1. 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, ESMA, in close cooperation with the EBA, may develop draft regulatory technical standards to supplement the list of legitimate purposes set out in paragraph 3.

    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.
  1. Where the underlying exposures of securitisations are residential loans made after the entry into force of 2014/17/EU [the Mortgage Credits Directive], 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.
  1. 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.
  1. Paragraph 3 does not apply if:
    1. the original agreement, which created the obligations or potential obligations of the debtor or potential debtor, was entered into before the entry into force of 2014/17/EU [the Mortgage Credits Directive]; and
    2. 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 a limb (b) originator has to comply with Article 9(3) and, if STS is envisaged, Article 20(11). Post-securitisation, the Article 7 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 [query why it does not simply refer to the "original lender", the definition of which in article 2(20) is almost identical] fulfils the requirements referred to in paragraph 1".  The paragraph 1 requirements are that the originator, sponsor and original lender applies non-discriminatory underwriting criteria and clearly established underwriting processes and has effective systems to ensure that underwriting is based on a thorough assessment of the obligor's creditworthiness taking into account relevant factors.

The standards required to achieve an appropriate "verification" for Article 9(3) purposes are left unstated. 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 is left in the dark unless and until any guidance is provided (it seems the envisaged joint committee of the ESAs may issue some eventually) should do what it reasonably could in the circumstances. 

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 ESMA for the purposes of Article 5 under the conditions and the procedure set out in this Article.
  1. To be eligible to be registered under this Article, a securitisation repository shall be a legal person established in the Union, 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.
  1. The registration of a securitisation repository shall be effective for the entire territory of the Union.
  1. A registered securitisation repository shall comply at all times with the conditions for registration. A securitisation repository shall, without undue delay, notify ESMA of any material changes to the conditions for registration.
  1. A securitisation repository shall submit to ESMA either of the following:
    1. an application for registration;
    2. 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)
  1. ESMA shall assess whether the application is complete within 20 working days of receipt of the application.

    Where the application is not complete, ESMA shall set a deadline by which the securitisation repository is to provide additional information.

    After having assessed an application as complete, ESMA shall notify the securitisation repository accordingly.
  1. In order to ensure consistent application of this Article, ESMA shall develop draft regulatory technical standards specifying the details of all of the following:
    1. 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);
    2. the application for registration referred to in point (a) of paragraph 5;
    3. a simplified application for an extension of registration referred to in point (b) of paragraph 5.

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.

  1. In order to ensure uniform conditions of application of paragraphs 1 and 2, ESMA shall develop draft implementing technical standards specifying the format of both of the following:
    1. the application for registration referred to in point (a) of paragraph 5;
    2. the application for an extension of registration referred to in point (b) of paragraph 5.

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

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.
  1. 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. ESMA 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.
  1. A decision issued by ESMA pursuant to paragraph 1 shall take effect on the fifth working day following that of its adoption.
Article 13

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.
  1. ESMA shall, without undue delay, notify the competent authority as referred to in Article 11(1) of its decision.
  1. ESMA shall communicate, without undue delay, any decision taken in accordance with paragraph 1 to the Commission.
  1. 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.
Article 14

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.
  1. 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.
Article 15

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:
    1. expressly renounces the registration or has provided no services for the preceding six months;
    2. obtained the registration by making false statements or by other irregular means; or
    3. no longer meets the conditions under which it was registered.
  1. 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.
  1. 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.
  1. The competent authority referred to in paragraph 3 of this Article shall be the authority designated under Article 29 of this Regulation.
Article 16

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.
  1. 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:
    1. ESMA;
    2. the EBA;
    3. EIOPA;
    4. the ESRB;
    5. 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;
    6. the relevant authorities whose respective supervisory responsibilities and mandates cover transactions, markets, participants and assets which fall within the scope of this Regulation;the resolution authorities designated under Article 3 of Directive 2014/59/EU of the European Parliament and the
    7. Council (31);
    8. the Single Resolution Board established by Regulation (EU) No 806/2014 of the European Parliament and of the Council (32);
    9. the authorities referred to in Article 29;
    10. investors and potential investors.
  1. 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 technical standards specifying:
    1. 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);
    2.   the operational standards required, to allow the timely, structured and comprehensive:
      1. collection of data by securitisation repositories; and
      2. aggregation and comparison of data across securitisation repositories;
    3. 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;
    4. 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.
  2. 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.
  1. In order to ensure uniform conditions of application for paragraph 2, ESMA, in close cooperation with the EBA and EIOPA shall develop draft implementing 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.

    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.

Chapter 4

Simple, Transparent and Standardised Securitisations

Article 18

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

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:

  1. the securitisation meets all the requirements of Section 1 or Section 2 of this Chapter, and ESMA has been notified pursuant to Article 27(1); and
  2. the securitisation is included in the list referred to in Article 27(5).

The originator, sponsor and SSPE involved in a securitisation considered STS shall be established in the Union.

References

In the EU27

Post-Brexit, the UK will become a non-EU "third country" and, pending the adoption of any "third country regime" (see below), that will prevent STS issues with any UK party being eligible for STS status, because under EU STS, all three of the issuer, originator and sponsor must be established in the EU (Article 18).  The European Parliament had proposed, in response to the Brexit referendum result, an equivalence regime; a solution which would have given the market the full depth it would lack without the participation of UK institutions, and which would have acted as a powerful control over any competitive loosening of UK regulation post-Brexit under threat of an equivalence declaration being withdrawn by the EU27.  However, this was dropped as it was regarded by some EU countries (reports suggested France and Germany) as being too political for resolution except as part of the Brexit agreement.

Instead, we are left with Article 46, which contemplates that within the first 3 years after the Securitisation Regulation has effect, the European Commission will produce a report examining whether an equivalence regime could be introduced for STS securitisations. The outcome is unfortunate, and concerns have been raised that restricting STS status to EU originated securitisations may invite other markets to impose similar geographical restrictions, fragmenting the market regionally, whereas an aim of CMU is to create deeper and more liquid markets, but politically, it is probably unsurprising, and the market will have to hope that once the political heat dissipates, there can be sensible movement. Until there is, sponsors will have to work around this as best they can: perhaps, if possible, making use of an EU-incorporated affiliate and sub-contracting as much as possible straight back to London.

In the UK

The Securitisation Regulation is already part of UK law and will be adopted post-Brexit - subject to the amendments mentioned below - along with all other "direct EU legislation" by section 3 of the EU Withdrawal Act 2018, together with any RTS and ITS which have already become EU law. Any that remain in draft are likely to be adopted by the FCA, along with most or all of the ESMA Q&A and the EBA guidance.

Section 8 of the EU Withdrawal Act 2018 permits amendments to be made 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 do this in relation to the Securitisation Regulation itself, and (as regards securitisation) to related European laws such as the CRR.  In many cases the changes are purely necessary transitional - changing "the Union" to "the united Kingdom" for example, but there are a few more interesting ones:

  • as noted in "Who can be a sponsor?", the Regulations make some sensible improvements to the definition of "sponsor".
  • issues which have been notified to ESMA before Brexit, or which are notified to ESM,A in the first two years after Brexit as being (EU) STS are grandfathered and will be treated as (UK) STS for UK STS purposes
  • [any others? Check once the redline is done]

It has been questioned whether all of these fall strictly within the scope of section 8 of the EU Withdrawal Act, but it is not obvious whether anybody is likely to object, as they are benign and desirable. 

Article 19

Section 1

Requirements for simple, transparent and standardised non-ABCP securitisation

Simple, transparent and standardised securitisation

  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.
  1. 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

There is for the moment only one, minor, concession to synthetics. Where an institution sells off a junior position in a pool of loans to SMEs via a synthetic structure and retains the senior position, the institution may apply to the retained position the lower capital requirements available for STS securitisations where strict criteria (set out in the new Article 270 of the CRR as amended) are met, including that the position is guaranteed by a central government, central bank, or a public sector “promotional entity”, or – if fully collateralised by cash on deposit with the originator – by an institution.

So, in the short term, originators which tranche risk via any synthetic structure – and the orthodox view seems to be that this includes simple credit guarantee arrangements, because these usually provide for a deductible and a cap, which technically makes the guaranteed credit risk “tranched” – will be penalised because they will have to hold capital against the retained piece on the basis of the higher non-STS rules, and the investors will similarly be penalised, which will in turn punish the originator via the return the investors will need to offset this.

However, developments, and possibly a regime for STS synthetic securitisations, can be expected during the course of 2020 and, given that the securitisation framework for regulatory capital allocation is non-neutral (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), perhaps the most likely (and quite possibly unintended) outcome will be that banks wanting to sell off assets via a synthetic sale and seeking STS status – perhaps because they cannot get a necessary borrower consent – will decide to wait until the synthetic framework becomes law.

The EBA discussion paper "Draft report on STS Framework for Synthetic Securitisation" was published, later than its due date, on 24th September 2019.  One reaction to it might be to ask: why?  In the bad old days before 2009, the investor herd was buying sometimes horribly complex securitisation paper on the basis of a rating and no significant due diligence without understanding what they were doing, other than to know that their competitors were doing it and they couldn't simply leave their investors' funds on deposit.  So the STS label for true sale securitisations at least has an obvious rationale - to protect them from their animal spirits.  But synthetic securitisation is a different jungle, inhabited by different beasts: the protection sellers are no longer monoline insurers but, for the most part, central banks, supranational entities such as the EIB, pension and hedge funds (the chart gives the EIB's breakdown of the market).  Do these entities need an underwriting proposition to carry an "STS label?  Or are they able to look after themselves?  Post-GFC synthetics are, according to the EBA, entirely private bilateral deals where protection sellers can bargain for whatever they want (an argument that failed to convince the EU to leave private deals outside the Securitisation Regulation disclosure rules of course). 

The EBA seems to be motivated by the fact that true sale issues are now regulated, and so to ensure a "level playing field", so should synthetic deals; and perhaps a desire to make it easier for new entrants to join the market as protection sellers, who would at present be daunted by the need to do all the due diligence.  This seems debatable: it notes that the market is reviving, with an increasing degree of standardisation, but does not seem to wonder why it has managed to do that without any "help" from regulators; and suggests that an STS label would be "of crucial importance for the destigmatisation" of the market - evidently however, not a stigma that is deterring existing participants.  Is this not an argument that this is increasing moral hazard, if it encourages inadequately-skilled new entrants to join the credit risk market?  Be that as it may, the market response has not been so negative, even though at the time of writing (29th January) the EBA has not yet published its response to the consultation.  This seems to be on the basis that an STS regime may encourage more investors to enter the market and take some credit risk away from the banking sector (e.g. by buying credit linked notes) – and the more investors there are, the better for the banks of course – as well as because an STS regime would hopefully go hand in hand with a more favourable capital treatment for banks as regards the risk which they retain; although (see below) this remains to be seen, and the EBA was equivocal about this aspect. 

The Report envisages a two stage process: first, to consider a set of STS criteria for synthetics: largely the same as or based on those for true sales (the "overarching rationale"), plus some additional ones for synthetics; and then to consider 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 (in which respect the EBA notes that whereas pre-GFC deals typically sold off the least risky portion and retained the rest, now it tends to be the other way around, with the first loss risk being transferred to a protection seller).  And if this is eventually a significant attraction for a protection buyer (these deals are almost always done by a regulated entity such as a bank subject to the CRR) then that STS label might be worth pursuing.  This would be an EU special case, as there is no provision at the Basel/IOSCO level for preferential capital treatment for an STC-qualifying synthetic product).

It envisages 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 (and an enforceability legal opinion regarding the credit protection is a specific requirement).  This only contemplates "balance sheet synthetic securitisations" and not "arbitrage" ones (see further the EBA's December 2015 "Report" on the difference: "balance sheet" ones are intended to get assets off a bank's balance sheet, especially for regulatory capital purposes): this is spelt out in the Securitisation Regulation

So will STS for synthetics gain traction?  There were reports in the trade press suggesting that EU regulators were not ad idem on giving preferential capital treatment to banks which did synthetic securitisations, which is why the EBA has not made any particular recommendation about this in its discussion paper.  But without a more favourable capital treatment, why would a regulated entity bother going after the STS label?  The risk weighting for banks holding the senior tranche of a securitised portfolio is now 15% for non-STS and 10% for STS: that would be attractive for bank issuers, but, that aside, the STS label would do nothing for existing investors in synthetics, who know what they are doing anyway.

Market reaction to the EBA consultation

A point made by AFME in its response to the EBA which is worth noting is that the history of synthetic securitisation shows credit losses of much less than would be implied by the regulatory capital requirements (“virtually zero losses to the senior tranches of synthetic securitisations”) – and that as the CRR exists at present, the capital requirements that apply to the risk retained by an originating bank under any synthetic securitisation are the same – whether it is a simple deal transferring more than significant risk to a third party or a risky “arbitrage” synthetic securitisation

Signs signs of resistance were reported in the trade press to two of the EBA’s proposed criteria for synthetic STS:

  • Criterion 35 in the EBA synthetic STS discussion paper states: “The protection buyer should not commit to any amount of excess spread available for the investors”.  This, one of the requirements specific to synthetics and with no comparable true sale STS criterion, refers to the common structure whereby an SPV issues senior and junior CLNs to investors (usually the originator bank holds the senior and outside investors take the junior, first loss, tranche), the SPV then writes a credit default swap with the bank, which pays the SPV annual premiums, and unless and until there is a default in the underlying loan portfolio, the coupon paid on the CLNs should be less than the sum of the premiums receivable and the income earned on the collateral which the SPV invests in using the proceeds of the issue of the CLNs.  That difference is the excess spread, and if the SPV accumulates it, it acts as a cushion against loss, making the CLNs less risky.  So what is the problem with that?  The EBA regards it as “a complex structural feature…The complexity arises with respect to the quantum of committed excess spread, and its calculation and allocation mechanism” and so, for the sake of simplicity, it should not be present in an “STS” structure.
  • Criterion 36 requires the collateral to take the form of 0% risk-weight securities or cash, to be held by a third party institution, not the originator.  This means that the originator cannot use the collateral and, while this is not the primary benefit of a synthetic, because the primary benefit is transferring risk, not acquiring funding, it can be a secondary benefit for an originator.  This criterion is designed, presumably, for the benefit of the investors, who are being asked to take the credit risk only on the underlying portfolio, not also on the originating bank, and so it is, like criterion 35, aimed at making the analysis simple for the investors.  Some structures permit the originator to hold and use the collateral unless they suffer a rating downgrade below an acceptable level.  The EBA proposal would not, as currently drafted, permit this.

The next step - which Article 45(2) of the Securitisation Regulation required by 2nd January 2020 and so is overdue - is for the EBA to submit a report to the European Parliament on including balance sheet synthetic securitisations in the STS regime, together with any draft legislation.  For more background on synthetic securitisation, see FinBrief, and the Glossaries.

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”.


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

  1. 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.
  1. 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

  1. 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:
    1. severe deterioration in the seller credit quality standing;
    2. insolvency of the seller; and
    3. 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.  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.


  1. 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.


  1. 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

  1. 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 [MiFID II] , 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):

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


  1. 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.


  1. 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.

  1. 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:
    1. 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:
      1. 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
      2.   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;
    2. 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
    3. 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

  1. 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

  1. 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 are then transferred to an issuer together with title to the vehicles, the structure could not qualify as STS because the debt is supporting the RV as well as the committed rentals.  Hence the second paragraph, which allows structures where the RV is underwritten by the manufacturer or its finance company.

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" 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 thje 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).


  1. The 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.

    The EBA shall submit those draft regulatory technical standards to the Commission by 18 July 2018.

    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

  1. 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

  1. 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 the 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."

  1.  Where an enforcement or an acceleration notice has been delivered:
    1. 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;
    2. 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;
    3. repayment of the securitisation positions shall not be reversed with regard to their seniority; and
    4. 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

  1. 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

  1. 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:
    1. a deterioration in the credit quality of the underlying exposures to or below a predetermined threshold;
    2. the occurrence of an insolvency-related event with regard to the originator or the servicer;
    3. the value of the underlying exposures held by the SSPE falls below a predetermined threshold (early amortisation event); and
    4. 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

  1. The transaction documentation shall clearly specify:
    1. the contractual obligations, duties and responsibilities of the servicer and the trustee, if any, and other ancillary service providers;
    2. 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
    3. 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

  1. 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

  1. 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

  1. 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

  1. 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

  1. 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

  1. 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).
EBA Guidelines
Background and rationale para. 78-79
Guidelines para. 84
Q&A 32-33

Article 22(4) is a Green-inspired piece of gesture politics 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 is vague - and presumably that cuts both ways, and so can be regarded as complied with so long as something is disclosed - and of course has no relationship whatsoever to the standardisation pillar of STS or STC, nor the rational interests of prudent investment.  There is a European Commission review under Article 46 due within the first three years: Article 46(f) expressly requires it 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.  Perhaps if the political climate is right, it could recommend that it is abandoned altogether; but this may be wishful thinking.  Meanwhile, 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.

  1. 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.

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.
  1. 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’.
  1. 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”.

There is for the moment only one, minor, concession to synthetics. Where an institution sells off a junior position in a pool of loans to SMEs via a synthetic structure and retains the senior position, the institution may apply to the retained position the lower capital requirements available for STS securitisations where strict criteria (set out in the new Article 270 of the CRR as amended) are met, including that the position is guaranteed by a central government, central bank, or a public sector “promotional entity”, or – if fully collateralised by cash on deposit with the originator – by an institution.

So, in the short term, originators which tranche risk via any synthetic structure – and the orthodox view seems to be that this includes simple credit guarantee arrangements, because these usually provide for a deductible and a cap, which technically makes the guaranteed credit risk “tranched” – will be penalised because they will have to hold capital against the retained piece on the basis of the higher non-STS rules, and the investors will similarly be penalised, which will in turn punish the originator via the return the investors will need to offset this.

However, developments, and possibly a regime for STS synthetic securitisations, can be expected during the course of 2020 and, given that the securitisation framework for regulatory capital allocation is non-neutral (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), perhaps the most likely (and quite possibly unintended) outcome will be that banks wanting to sell off assets via a synthetic sale and seeking STS status – perhaps because they cannot get a necessary borrower consent – will decide to wait until the synthetic framework becomes law.

The EBA discussion paper "Draft report on STS Framework for Synthetic Securitisation" was published, later than its due date, on 24th September 2019.  One reaction to it might be to ask: why?  In the bad old days before 2009, the investor herd was buying sometimes horribly complex securitisation paper on the basis of a rating and no significant due diligence without understanding what they were doing, other than to know that their competitors were doing it and they couldn't simply leave their investors' funds on deposit.  So the STS label for true sale securitisations at least has an obvious rationale - to protect them from their animal spirits.  But synthetic securitisation is a different jungle, inhabited by different beasts: the protection sellers are no longer monoline insurers but, for the most part, central banks, supranational entities such as the EIB, pension and hedge funds (the chart gives the EIB's breakdown of the market).  Do these entities need an underwriting proposition to carry an "STS label?  Or are they able to look after themselves?  Post-GFC synthetics are, according to the EBA, entirely private bilateral deals where protection sellers can bargain for whatever they want (an argument that failed to convince the EU to leave private deals outside the Securitisation Regulation disclosure rules of course). 

The EBA seems to be motivated by the fact that true sale issues are now regulated, and so to ensure a "level playing field", so should synthetic deals; and perhaps a desire to make it easier for new entrants to join the market as protection sellers, who would at present be daunted by the need to do all the due diligence.  This seems debatable: it notes that the market is reviving, with an increasing degree of standardisation, but does not seem to wonder why it has managed to do that without any "help" from regulators; and suggests that an STS label would be "of crucial importance for the destigmatisation" of the market - evidently however, not a stigma that is deterring existing participants.  Is this not an argument that this is increasing moral hazard, if it encourages inadequately-skilled new entrants to join the credit risk market?  Be that as it may, the market response has not been so negative, even though at the time of writing (29th January) the EBA has not yet published its response to the consultation.  This seems to be on the basis that an STS regime may encourage more investors to enter the market and take some credit risk away from the banking sector (e.g. by buying credit linked notes) – and the more investors there are, the better for the banks of course – as well as because an STS regime would hopefully go hand in hand with a more favourable capital treatment for banks as regards the risk which they retain; although (see below) this remains to be seen, and the EBA was equivocal about this aspect. 

The Report envisages a two stage process: first, to consider a set of STS criteria for synthetics: largely the same as or based on those for true sales (the "overarching rationale"), plus some additional ones for synthetics; and then to consider 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 (in which respect the EBA notes that whereas pre-GFC deals typically sold off the least risky portion and retained the rest, now it tends to be the other way around, with the first loss risk being transferred to a protection seller).  And if this is eventually a significant attraction for a protection buyer (these deals are almost always done by a regulated entity such as a bank subject to the CRR) then that STS label might be worth pursuing.  This would be an EU special case, as there is no provision at the Basel/IOSCO level for preferential capital treatment for an STC-qualifying synthetic product).

It envisages 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 (and an enforceability legal opinion regarding the credit protection is a specific requirement).  This only contemplates "balance sheet synthetic securitisations" and not "arbitrage" ones (see further the EBA's December 2015 "Report" on the difference: "balance sheet" ones are intended to get assets off a bank's balance sheet, especially for regulatory capital purposes): this is spelt out in the Securitisation Regulation

So will STS for synthetics gain traction?  There were reports in the trade press suggesting that EU regulators were not ad idem on giving preferential capital treatment to banks which did synthetic securitisations, which is why the EBA has not made any particular recommendation about this in its discussion paper.  But without a more favourable capital treatment, why would a regulated entity bother going after the STS label?  The risk weighting for banks holding the senior tranche of a securitised portfolio is now 15% for non-STS and 10% for STS: that would be attractive for bank issuers, but, that aside, the STS label would do nothing for existing investors in synthetics, who know what they are doing anyway.

Market reaction to the EBA consultation

A point made by AFME in its response to the EBA which is worth noting is that the history of synthetic securitisation shows credit losses of much less than would be implied by the regulatory capital requirements (“virtually zero losses to the senior tranches of synthetic securitisations”) – and that as the CRR exists at present, the capital requirements that apply to the risk retained by an originating bank under any synthetic securitisation are the same – whether it is a simple deal transferring more than significant risk to a third party or a risky “arbitrage” synthetic securitisation

Signs signs of resistance were reported in the trade press to two of the EBA’s proposed criteria for synthetic STS:

  • Criterion 35 in the EBA synthetic STS discussion paper states: “The protection buyer should not commit to any amount of excess spread available for the investors”.  This, one of the requirements specific to synthetics and with no comparable true sale STS criterion, refers to the common structure whereby an SPV issues senior and junior CLNs to investors (usually the originator bank holds the senior and outside investors take the junior, first loss, tranche), the SPV then writes a credit default swap with the bank, which pays the SPV annual premiums, and unless and until there is a default in the underlying loan portfolio, the coupon paid on the CLNs should be less than the sum of the premiums receivable and the income earned on the collateral which the SPV invests in using the proceeds of the issue of the CLNs.  That difference is the excess spread, and if the SPV accumulates it, it acts as a cushion against loss, making the CLNs less risky.  So what is the problem with that?  The EBA regards it as “a complex structural feature…The complexity arises with respect to the quantum of committed excess spread, and its calculation and allocation mechanism” and so, for the sake of simplicity, it should not be present in an “STS” structure.
  • Criterion 36 requires the collateral to take the form of 0% risk-weight securities or cash, to be held by a third party institution, not the originator.  This means that the originator cannot use the collateral and, while this is not the primary benefit of a synthetic, because the primary benefit is transferring risk, not acquiring funding, it can be a secondary benefit for an originator.  This criterion is designed, presumably, for the benefit of the investors, who are being asked to take the credit risk only on the underlying portfolio, not also on the originating bank, and so it is, like criterion 35, aimed at making the analysis simple for the investors.  Some structures permit the originator to hold and use the collateral unless they suffer a rating downgrade below an acceptable level.  The EBA proposal would not, as currently drafted, permit this.

The next step - which Article 45(2) of the Securitisation Regulation required by 2nd January 2020 and so is overdue - is for the EBA to submit a report to the European Parliament on including balance sheet synthetic securitisations in the STS regime, together with any draft legislation.  For more background on synthetic securitisation, see FinBrief, and the Glossaries.


  1. For the purpose of paragraph 1, any of the following shall constitute severe clawback provisions:
    1. 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;
    2. 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.
  1. 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.
  1. 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.
  1. 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:
    1. severe deterioration in the seller credit quality standing;
    2. insolvency of the seller; and
    3. unremedied breaches of contractual obligations by the seller, including the seller’s default.
  1. 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.
  1. 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.
  1. 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.


  1. 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:
    1. 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:
      1. 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
      2. 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;
    2. 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
    3. 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.
  1. 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.
  1. 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 are then transferred to an issuer together with title to the vehicles, the structure could not qualify as STS because the debt is supporting the RV as well as the committed rentals.  Hence the second paragraph, which allows structures where the RV is underwritten by the manufacturer or its finance company.

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" 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 thje 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". 


  1. 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.
  1. 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.
  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. 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.
  1. 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 (44) of Article 4(1) of Directive 2014/65/EU [MiFID II] other than corporate bonds, that are not listed on a trading venue.

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):

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


  1. 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 the 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."

  1. Following the seller’s default or an acceleration event:
    1. 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;
    2. 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
    3. no provisions shall require automatic liquidation of the underlying exposures at market value.
  1. 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.

  1. 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:
    1. a deterioration in the credit quality of the underlying exposures to or below a predetermined threshold; and
    2. the occurrence of an insolvency-related event with regard to the seller or the servicer.
  1. The transaction documentation shall clearly specify:
    1. the contractual obligations, duties and responsibilities of the sponsor, the servicer and the trustee, if any, and other ancillary service providers;
    2. the processes and responsibilities necessary to ensure that a default or insolvency of the servicer does not result in a termination of servicing;
    3. provisions that ensure the replacement of derivative counterparties and the account bank upon their default, insolvency and other specified events, where applicable; and
    4. how the sponsor meets the requirements of Article 25(3).
  1. The EBA, in close cooperation with ESMA and EIOPA, shall develop draft regulatory technical standards further specifying which underlying exposures referred to in paragraph 15 are deemed to be homogeneous.

The EBA shall submit those draft regulatory technical standards to the Commission by 18 July 2018.

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 credit institution supervised under Directive 2013/36/EU [CRD IV].
  1. 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.
  1. Before being able to sponsor an STS ABCP programme, the credit institution shall demonstrate to its competent authority 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 the competent authority 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.
  1. 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.
  1. 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.
  1. 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:
    1. the aggregate information required by point (a) of the first subparagraph of Article 7(1); and
    2. the information required by points (b) to (e) of the first subparagraph of Article 7(1), at least in draft or initial form.
  1. 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.
  1. The remaining weighted average life of the underlying exposures of an ABCP programme shall not be more than two years.
  1. The ABCP programme shall be fully supported by a sponsor in accordance with Article 25(2).
  1. The ABCP programme shall not contain any resecuritisation and the credit enhancement shall not establish a second layer of tranching at the programme level.
  1. 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.
  1. 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.
  1.   The documentation relating to the ABCP programme shall clearly specify:
    1. the responsibilities of the trustee and other entities with fiduciary duties, if any, to investors;
    2. 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;
    3. the processes and responsibilities necessary to ensure that a default or insolvency of the servicer does not result in a termination of servicing;
    4. 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;
    5. 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
    6. 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.
  1. 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 27

Section 3

STS notification

STS notification requirements

  1. 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 of Articles 19 to 22 or Articles 23 to 26 (‘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.

    The STS notification shall include an explanation by the originator and sponsor of how each of the STS criteria set out in Articles 20 to 22 or Articles 24 to 26 has 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.

  1. 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.

    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, its place of establishment and the name of the competent authority that authorised it.
  1. 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 Union, the notification pursuant to paragraph 1 of this Article shall be accompanied by the following:
    1. 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
    2. a declaration by the originator or original lender as to whether credit granting referred to in point (a) is subject to supervision.
  1. The originator and sponsor shall immediately notify ESMA and inform their competent authority when a securitisation no longer meets the requirements of either Articles 19 to 22 or Articles 23 to 26.

  1. ESMA shall maintain on its official website a list of all securitisations which the originators and sponsors have notified to it as meeting the requirements of Articles 19 to 22 or Articles 23 to 26. 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.
  1. ESMA, in close cooperation with the EBA and EIOPA, shall develop draft regulatory 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.

    ESMA shall submit those draft regulatory technical standards to the Commission by 18 July 2018.

    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.
  1. In order to ensure uniform conditions for the implementation of this Regulation, ESMA, in close cooperation with the EBA and EIOPA, shall develop draft implementing technical standards to establish the templates to be used for the provision of the information referred to in paragraph 6.

    ESMA shall submit those draft implementing technical standards to the Commission by 18 July 2018.

    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. A third party 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 or Articles 23 to 26. The competent authority shall grant the authorisation if the following conditions are met:
    1. 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;
    2. 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 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;
    3. 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;
    4. 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;
    5. the management body of the third party includes at least one third, but no fewer than two, independent directors;
    6. 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
    7. the third party can demonstrate that it has proper operational safeguards and internal processes that enable it to assess STS compliance.

The competent authority shall withdraw the authorisation when it considers the third party to be materially non-compliant with the first subparagraph.

  1. A third party authorised in accordance with paragraph 1 shall notify its competent authority 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 its competent authority.
  1. The competent authority 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.
  1. ESMA shall develop draft regulatory technical standards specifying the information to be provided to the competent authorities in the application for the authorisation of a third party in accordance with paragraph 1.

    ESMA shall submit those draft regulatory technical standards to the Commission by 18 July 2018.

    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", not least because regulators have other things to do), and presumably its imprimatur will carry some weight, but the sponsor, issuer or originator cannot devolve its responsibility for ensuring that the STS label is properly applied. The ECB was always concerned about moral hazard, and the Commission was never likely to bow to the industry's most optimistic proposals because it 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 review by the EC in its review, suggesting the legislators also have doubts. We wait to see how many applications are made for authorisation.  As of June 2019 there are two on the ESMA website, and they have been busy, as sponsors seek to rely on their expertise as regards the STS requirements, and their early knowledge gained from frequent contact with regulators

Chapter 5

Supervision

Article 29

Designation of competent authorities

  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:
    1. for insurance and reinsurance undertakings, the competent authority designated in accordance with point (10) of Article 13 of Directive 2009/138/EC [Solvency II] ;
    2. for alternative investment fund managers, the competent authority responsible designated in accordance with Article 44 of 2011/61/EU [AIFM Directive];
    3. for UCITS and UCITS management companies, the competent authority designated in accordance with Article 97 of Directive 2009/65/EC [UCITS Directive];
    4. 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);
    5. 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.
  1. 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.
  1. 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.
  1. For originators, original lenders and SSPEs established in the Union and not covered by the Union legislative acts referred to in paragraph 3, Member States shall designate one or more competent authorities to supervise compliance with the obligations set out in Articles 6, 7, 8 and 9. 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.
  1. Member States 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. Member States shall inform the Commission and ESMA of the designation of competent authorities pursuant to this paragraph by 18 January 2019.
  1. 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.
  1. 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.
  1. 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

  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.
  1. The competent authority 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:
    1. 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;
    2. 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
    3. 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).
  1. 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.
  1. The competent authority 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:
    1. The size of capital buffers;
    2. The size of the liquidity buffers; and
    3. The liquidity risk for investors due to a maturity mismatch between their funding and investments.

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.


  1. 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.
Article 31

Macroprudential oversight of the securitisation market

  1. Within the limits of its mandate, the ESRB shall be responsible for the macroprudential oversight of the Union’s securitisation market.
  1. 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, or at least every 3 years, in order to highlight financial stability risks, the ESRB shall, in collaboration with the EBA, publish a report on the financial stability implications of the securitisation market. If material risks are observed, the ESRB shall provide warnings and, where appropriate, issue recommendations for remedial action in response to those risks pursuant to Article 16 of Regulation (EU) No 1092/2010, including on the appropriateness of modifying the risk-retention levels, or the taking of other macroprudential measures, to the Commission, the ESAs and to the Member States. The Commission, the ESAs and the Member States shall, in accordance with Article 17 of Regulation (EU) No 1092/2010, communicate to the ESRB, the European Parliament and the Council the actions undertaken in response to the recommendation and shall provide adequate justification for any inaction within three months of the date of transmission of the recommendation to the addressees.
Article 32

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:
    1. an originator, sponsor or original lender has failed to meet the requirements provided for in Article 6;
    2. an originator, sponsor or SSPE has failed to meet the requirements provided for in Article 7;
    3. an originator, sponsor or original lender has failed to meet the criteria provided for in Article 9;
    4. an originator, sponsor or SSPE has failed to meet the requirements provided for in Article 18;
    5. 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;
    6. an originator or sponsor makes a misleading notification pursuant to Article 27(1);
    7. an originator or sponsor has failed to meet the requirements provided for in Article 27(4); or
    8. 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.


  1. 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:
    1. a public statement which indicates the identity of the natural or legal person and the nature of the infringement in accordance with Article 37;
    2. an order requiring the natural or legal person to cease the conduct and to desist from a repetition of that conduct;
    3. 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;
    4. 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;
    5. 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;
    6. 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;
    7. 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);
    8. 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.
  1. 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.
  1. 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

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:
    1. directly;
    2. in collaboration with other authorities;
    3. under their responsibility by delegation to other authorities;
    4. by application to the competent judicial authorities.
  1. 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:
    1. the materiality, gravity and the duration of the infringement;
    2. the degree of responsibility of the natural or legal person responsible for the infringement;
    3. the financial strength of the responsible natural or legal person;
    4. the importance of profits gained or losses avoided by the responsible natural or legal person, insofar as they can be determined;
    5. the losses for third parties caused by the infringement, insofar as they can be determined;
    6. 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;
    7. previous infringements by the responsible natural or legal person.
Article 34

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.
  1. 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

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

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.
  1. 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.
  1. 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.
  1. 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.
  1. 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.
  1. 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.

  1. 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.
  1. 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

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.
  1. 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.
  1. 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:
    1. defer the publication of the decision imposing the administrative sanction until the moment where the reasons for non-publication cease to exist;
    2. publish the decision imposing the administrative sanction on an anonymous basis, in accordance with national law; or
    3. 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:
      1. that the stability of financial markets would not be put in jeopardy; or
      2. the proportionality of the publication of such decisions with regard to measures which are deemed to be of a minor nature.
  1. 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.
  1. 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.
  1. Competent authorities shall inform ESMA of all administrative sanctions imposed, including, where appropriate, any appeal in relation thereto and the outcome thereof.
  1. 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

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

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

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.

  1. 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.

  1. 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:
    1. 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
    2. 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).
  1. For the purposes of point (b) of paragraph 3, the following shall apply:
    1. in Article 22(2), ‘prior to issuance’ shall be deemed to read ‘prior to notification under Article 27(1)’;
    2. in Article 22(3), ‘before the pricing of the securitisation’ shall be deemed to read ‘prior to notification under Article 27(1)’;
    3. in Article 22(5):
      1. in the second sentence, ‘before pricing’ shall be deemed to read ‘prior to notification under Article 27(1)’;
      2. ‘before pricing at least in draft or initial form’ shall be deemed to read ‘prior to notification under Article 27(1)’;
      3. the requirement set out in the fourth sentence shall not apply;
      4. references to compliance with Article 7 shall be construed as if Article 7 applied to those securitisations notwithstanding Article 43(1).
  1. 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.

  1. In respect of securitisations the securities of which were issued before 1 January 2019 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] 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.

  1. Until the regulatory technical standards to be adopted by the Commission pursuant Article 6(7) of this Regulation apply, 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.

  1. Until the regulatory technical standards to be adopted by the Commission pursuant to Article 7(3) of this Regulation apply, 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.

  1. 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 44

Reports

By 1 January 2021 and every three years thereafter, the Joint Committee of the European Supervisory Authorities shall publish a report on:

  1. the implementation of the STS requirements as provided for in Articles 18 to 27;
  2. 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;
  3. 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;
  4. the requirements provided for in Article 6, including compliance therewith by market participants and the modalities for retaining risk pursuant to Article 6(3).
Article 45

Synthetic securitisations

  1. By 2 July 2019, the EBA, in close cooperation with ESMA and EIOPA, shall publish a report on the feasibility of a specific framework for simple, transparent and standardised synthetic securitisation, limited to balance-sheet synthetic securitisation.
  1. By 2 January 2020, the Commission shall, on the basis of the EBA report referred to in paragraph 1, submit a report to the European Parliament and the Council on the creation of a specific framework for simple, transparent and standardised synthetic securitisation, limited to balance-sheet synthetic securitisation, together with a legislative proposal, if appropriate.

There is for the moment only one, minor, concession to synthetics. Where an institution sells off a junior position in a pool of loans to SMEs via a synthetic structure and retains the senior position, the institution may apply to the retained position the lower capital requirements available for STS securitisations where strict criteria (set out in the new Article 270 of the CRR as amended) are met, including that the position is guaranteed by a central government, central bank, or a public sector “promotional entity”, or – if fully collateralised by cash on deposit with the originator – by an institution.

So, in the short term, originators which tranche risk via any synthetic structure – and the orthodox view seems to be that this includes simple credit guarantee arrangements, because these usually provide for a deductible and a cap, which technically makes the guaranteed credit risk “tranched” – will be penalised because they will have to hold capital against the retained piece on the basis of the higher non-STS rules, and the investors will similarly be penalised, which will in turn punish the originator via the return the investors will need to offset this.

However, developments, and possibly a regime for STS synthetic securitisations, can be expected during the course of 2020 and, given that the securitisation framework for regulatory capital allocation is non-neutral (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), perhaps the most likely (and quite possibly unintended) outcome will be that banks wanting to sell off assets via a synthetic sale and seeking STS status – perhaps because they cannot get a necessary borrower consent – will decide to wait until the synthetic framework becomes law.

The EBA discussion paper "Draft report on STS Framework for Synthetic Securitisation" was published, later than its due date, on 24th September 2019.  One reaction to it might be to ask: why?  In the bad old days before 2009, the investor herd was buying sometimes horribly complex securitisation paper on the basis of a rating and no significant due diligence without understanding what they were doing, other than to know that their competitors were doing it and they couldn't simply leave their investors' funds on deposit.  So the STS label for true sale securitisations at least has an obvious rationale - to protect them from their animal spirits.  But synthetic securitisation is a different jungle, inhabited by different beasts: the protection sellers are no longer monoline insurers but, for the most part, central banks, supranational entities such as the EIB, pension and hedge funds (the chart gives the EIB's breakdown of the market).  Do these entities need an underwriting proposition to carry an "STS label?  Or are they able to look after themselves?  Post-GFC synthetics are, according to the EBA, entirely private bilateral deals where protection sellers can bargain for whatever they want (an argument that failed to convince the EU to leave private deals outside the Securitisation Regulation disclosure rules of course). 

The EBA seems to be motivated by the fact that true sale issues are now regulated, and so to ensure a "level playing field", so should synthetic deals; and perhaps a desire to make it easier for new entrants to join the market as protection sellers, who would at present be daunted by the need to do all the due diligence.  This seems debatable: it notes that the market is reviving, with an increasing degree of standardisation, but does not seem to wonder why it has managed to do that without any "help" from regulators; and suggests that an STS label would be "of crucial importance for the destigmatisation" of the market - evidently however, not a stigma that is deterring existing participants.  Is this not an argument that this is increasing moral hazard, if it encourages inadequately-skilled new entrants to join the credit risk market?  Be that as it may, the market response has not been so negative, even though at the time of writing (29th January) the EBA has not yet published its response to the consultation.  This seems to be on the basis that an STS regime may encourage more investors to enter the market and take some credit risk away from the banking sector (e.g. by buying credit linked notes) – and the more investors there are, the better for the banks of course – as well as because an STS regime would hopefully go hand in hand with a more favourable capital treatment for banks as regards the risk which they retain; although (see below) this remains to be seen, and the EBA was equivocal about this aspect. 

The Report envisages a two stage process: first, to consider a set of STS criteria for synthetics: largely the same as or based on those for true sales (the "overarching rationale"), plus some additional ones for synthetics; and then to consider 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 (in which respect the EBA notes that whereas pre-GFC deals typically sold off the least risky portion and retained the rest, now it tends to be the other way around, with the first loss risk being transferred to a protection seller).  And if this is eventually a significant attraction for a protection buyer (these deals are almost always done by a regulated entity such as a bank subject to the CRR) then that STS label might be worth pursuing.  This would be an EU special case, as there is no provision at the Basel/IOSCO level for preferential capital treatment for an STC-qualifying synthetic product).

It envisages 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 (and an enforceability legal opinion regarding the credit protection is a specific requirement).  This only contemplates "balance sheet synthetic securitisations" and not "arbitrage" ones (see further the EBA's December 2015 "Report" on the difference: "balance sheet" ones are intended to get assets off a bank's balance sheet, especially for regulatory capital purposes): this is spelt out in the Securitisation Regulation

So will STS for synthetics gain traction?  There were reports in the trade press suggesting that EU regulators were not ad idem on giving preferential capital treatment to banks which did synthetic securitisations, which is why the EBA has not made any particular recommendation about this in its discussion paper.  But without a more favourable capital treatment, why would a regulated entity bother going after the STS label?  The risk weighting for banks holding the senior tranche of a securitised portfolio is now 15% for non-STS and 10% for STS: that would be attractive for bank issuers, but, that aside, the STS label would do nothing for existing investors in synthetics, who know what they are doing anyway.

Market reaction to the EBA consultation

A point made by AFME in its response to the EBA which is worth noting is that the history of synthetic securitisation shows credit losses of much less than would be implied by the regulatory capital requirements (“virtually zero losses to the senior tranches of synthetic securitisations”) – and that as the CRR exists at present, the capital requirements that apply to the risk retained by an originating bank under any synthetic securitisation are the same – whether it is a simple deal transferring more than significant risk to a third party or a risky “arbitrage” synthetic securitisation

Signs signs of resistance were reported in the trade press to two of the EBA’s proposed criteria for synthetic STS:

  • Criterion 35 in the EBA synthetic STS discussion paper states: “The protection buyer should not commit to any amount of excess spread available for the investors”.  This, one of the requirements specific to synthetics and with no comparable true sale STS criterion, refers to the common structure whereby an SPV issues senior and junior CLNs to investors (usually the originator bank holds the senior and outside investors take the junior, first loss, tranche), the SPV then writes a credit default swap with the bank, which pays the SPV annual premiums, and unless and until there is a default in the underlying loan portfolio, the coupon paid on the CLNs should be less than the sum of the premiums receivable and the income earned on the collateral which the SPV invests in using the proceeds of the issue of the CLNs.  That difference is the excess spread, and if the SPV accumulates it, it acts as a cushion against loss, making the CLNs less risky.  So what is the problem with that?  The EBA regards it as “a complex structural feature…The complexity arises with respect to the quantum of committed excess spread, and its calculation and allocation mechanism” and so, for the sake of simplicity, it should not be present in an “STS” structure.
  • Criterion 36 requires the collateral to take the form of 0% risk-weight securities or cash, to be held by a third party institution, not the originator.  This means that the originator cannot use the collateral and, while this is not the primary benefit of a synthetic, because the primary benefit is transferring risk, not acquiring funding, it can be a secondary benefit for an originator.  This criterion is designed, presumably, for the benefit of the investors, who are being asked to take the credit risk only on the underlying portfolio, not also on the originating bank, and so it is, like criterion 35, aimed at making the analysis simple for the investors.  Some structures permit the originator to hold and use the collateral unless they suffer a rating downgrade below an acceptable level.  The EBA proposal would not, as currently drafted, permit this.

The next step - which Article 45(2) of the Securitisation Regulation required by 2nd January 2020 and so is overdue - is for the EBA to submit a report to the European Parliament on including balance sheet synthetic securitisations in the STS regime, together with any draft legislation.  For more background on synthetic securitisation, see FinBrief, and the Glossaries.

Article 46

Review

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.

That report shall consider in particular the findings of the reports referred to in Article 44, and shall assess:

  1. 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;
  2. 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;
  3. 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;
  4. 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;
  5. 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;
  6. 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;
  7. 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
  8. 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.
Article 47

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.
  1. 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.
  1. 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.
  1. 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.
  1. As soon as it adopts a delegated act, the Commission shall notify it simultaneously to the European Parliament and to the Council.
  1. 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.

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 a limb (b) originator has to comply with Article 9(3) and, if STS is envisaged, Article 20(11). Post-securitisation, the Article 7 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 [query why it does not simply refer to the "original lender", the definition of which in article 2(20) is almost identical] fulfils the requirements referred to in paragraph 1".  The paragraph 1 requirements are that the originator, sponsor and original lender applies non-discriminatory underwriting criteria and clearly established underwriting processes and has effective systems to ensure that underwriting is based on a thorough assessment of the obligor's creditworthiness taking into account relevant factors.

The standards required to achieve an appropriate "verification" for Article 9(3) purposes are left unstated. 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 is left in the dark unless and until any guidance is provided (it seems the envisaged joint committee of the ESAs may issue some eventually) should do what it reasonably could in the circumstances. 

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.  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":

Credit institutions

The CRR Amendments Regulation replaces 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 will apply as from 30th April 2020, to amend 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 (applicable as from 1st January 2019) 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

In the EU27

Post-Brexit, the UK will become a non-EU "third country" and, pending the adoption of any "third country regime" (see below), that will prevent STS issues with any UK party being eligible for STS status, because under EU STS, all three of the issuer, originator and sponsor must be established in the EU (Article 18).  The European Parliament had proposed, in response to the Brexit referendum result, an equivalence regime; a solution which would have given the market the full depth it would lack without the participation of UK institutions, and which would have acted as a powerful control over any competitive loosening of UK regulation post-Brexit under threat of an equivalence declaration being withdrawn by the EU27.  However, this was dropped as it was regarded by some EU countries (reports suggested France and Germany) as being too political for resolution except as part of the Brexit agreement.

Instead, we are left with Article 46, which contemplates that within the first 3 years after the Securitisation Regulation has effect, the European Commission will produce a report examining whether an equivalence regime could be introduced for STS securitisations. The outcome is unfortunate, and concerns have been raised that restricting STS status to EU originated securitisations may invite other markets to impose similar geographical restrictions, fragmenting the market regionally, whereas an aim of CMU is to create deeper and more liquid markets, but politically, it is probably unsurprising, and the market will have to hope that once the political heat dissipates, there can be sensible movement. Until there is, sponsors will have to work around this as best they can: perhaps, if possible, making use of an EU-incorporated affiliate and sub-contracting as much as possible straight back to London.

In the UK

The Securitisation Regulation is already part of UK law and will be adopted post-Brexit - subject to the amendments mentioned below - along with all other "direct EU legislation" by section 3 of the EU Withdrawal Act 2018, together with any RTS and ITS which have already become EU law. Any that remain in draft are likely to be adopted by the FCA, along with most or all of the ESMA Q&A and the EBA guidance.

Section 8 of the EU Withdrawal Act 2018 permits amendments to be made 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 do this in relation to the Securitisation Regulation itself, and (as regards securitisation) to related European laws such as the CRR.  In many cases the changes are purely necessary transitional - changing "the Union" to "the united Kingdom" for example, but there are a few more interesting ones:

  • as noted in "Who can be a sponsor?", the Regulations make some sensible improvements to the definition of "sponsor".
  • issues which have been notified to ESMA before Brexit, or which are notified to ESM,A in the first two years after Brexit as being (EU) STS are grandfathered and will be treated as (UK) STS for UK STS purposes
  • [any others? Check once the redline is done]

It has been questioned whether all of these fall strictly within the scope of section 8 of the EU Withdrawal Act, but it is not obvious whether anybody is likely to object, as they are benign and desirable. 

Capital and liquidity requirements

Summary

After the GFC, securitisation was perceived as being "mad, bad and dangerous to know": far too complex, far too much agency and model risk, unnecessary and altogether too clever by half.  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.  This disagreement between the industry and its regulator is seemingly unlikely to be resolved in the short term.

CAPITAL ADEQUACY

The amendments set out in the CRR Amendment Regulation broadly implement 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 is 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.

* 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. 

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 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).

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 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, if a sponsor wants to sell a non-EU securitisation to EU investors, then indirectly, as a result of Article 5(1)(d), it will need to comply with the Article 6 risk retention requirements.  The EC's explanatory memorandum accompanying the original draft of the Securitisation Regulation suggests this, 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.

Then 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, it 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.

As regards transparency, it is unclear.  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).  This 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 better view is that "where applicable" and "required" must mean something, and the meaning should be that the investor has to verify it only where Article 7 is applicable to the originator, sponsor or SSPE and so requires them to make disclosures i.e. only where they are incorporated in the EU.  However, the concern is that "where applicable" might mean "whichever of them it applies to" (because Article 7(2) requires the three of them to designate one of them to do it) or perhaps, might refer to the applicable information that Article 7 requires to be disclosed.  Some EU investors have been nervous enough not to invest in non-EU deals because of this, and their nervousness is understandable because it would seem to create a loophole allowing deals with EU assets, denominated in EUR, to be structured (by having non-EU originators, sponsor and SSPEs) in a way that sidestepped Article 7 altogether. 

This is currently (as of February 2020) a vexed topic and it 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 new RTS on risk retention will 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 – a political trade-off (Article 22(4))

Article 22(4) is a Green-inspired piece of gesture politics 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 is vague - and presumably that cuts both ways, and so can be regarded as complied with so long as something is disclosed - and of course has no relationship whatsoever to the standardisation pillar of STS or STC, nor the rational interests of prudent investment.  There is a European Commission review under Article 46 due within the first three years: Article 46(f) expressly requires it 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.  Perhaps if the political climate is right, it could recommend that it is abandoned altogether; but this may be wishful thinking.  Meanwhile, 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.

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.   In the event of a no-deal Brexit, it would also catch UK originators which had previously 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.

Level Two and Three Materials

Level two materials

Risk retention 

Draft risk retention RTS July 2018 

Transparency (disclosure) 

Draft RTS specifying the information and the details of a securitisation to be made available by the originator, sponsor and SSPE (16th October 2019)

Draft ITS with regard to the format and standardised templates for making available information and details of a securitisation by the originator, sponsor and SSPE (January 2019)

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

 

Homogeneity 

Enacted RTS on homogeneity (28th May 2019)

STS notification

The EC's final draft of the RTS developed by ESMA under article 27(6) to specify the information to be provided in accordance with the STS notification requirements (the annexes are in this separate document) are awaiting enactment.  These short RTS have several differences from the text in the 16th July 12018 ESMA final report but the substance is little different.  As our redline shows, there is now a specific reference (the new recital (2)) to the need to disclose the basis on which homogeneity is claimed, but that was always in field STSS27 in any event. 

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)

Securitisation repositories

Draft RTS with regard to regulatory technical standards specifying securitisation repository operational standards for data collection, aggregation, comparison, access and verification of completeness and consistency (29th November 2019 draft)

Draft RTS on securitisation repository operational standards for data collection, aggregation, comparison, access and verification of completeness and consistency

Draft RTS on information to be provided in the application for registration of a securitisation repository

Draft ITS on the format of information to be provided in the application for the registration of a securitisation repository

Level three materials  

EBA Guidelines 12 December 2018

ESMA Q&A

Other materials  

Article 7: the ESAs' non-no action letter of 30th November 2018

Notified STS issues  

List of STS issues notified to ESMA

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 are then transferred to an issuer together with title to the vehicles, the structure could not qualify as STS because the debt is supporting the RV as well as the committed rentals.  Hence the second paragraph, which allows structures where the RV is underwritten by the manufacturer or its finance company.

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" 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 thje 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 authorised third parties

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", not least because regulators have other things to do), and presumably its imprimatur will carry some weight, but the sponsor, issuer or originator cannot devolve its responsibility for ensuring that the STS label is properly applied. The ECB was always concerned about moral hazard, and the Commission was never likely to bow to the industry's most optimistic proposals because it 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 review by the EC in its review, suggesting the legislators also have doubts. We wait to see how many applications are made for authorisation.  As of June 2019 there are two on the ESMA website, and they have been busy, as sponsors seek to rely on their expertise as regards the STS requirements, and their early knowledge gained from frequent contact with regulators

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

The final draft RTS on risk retention produced by the EBA under Article 6(7) are fairly uncontroversial. They contain 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 are:

  • the EBA’s summary of the feedback it received which accompanied the RTS confirms that it does not intend the direct retention obligation in article 5 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 has 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 can 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 is permitted so long as the credit risk is not transferred, and the wording is careful to recognise that this may involve a title transfer arrangement such as a repo, and that what counts is that “the exposure to” the credit risk is retained.
  • it helpfully confirms 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 is no explicit agreement among them on the point.
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) includes the well-trailed rider:

“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”

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”.  Article 3(6) of the EBA's 31st July 2018 final 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;
(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 CRE, project finance, ship and aircraft, and the like.  Because the definition of "securitisation" focuses so much on the tranching of risk, this is necessary to avoid catching things that nobody would regard as securitisation 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. 

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 and so, to nobody's surprise, 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 mater 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 is to acquire or finance an asset;

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

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

  • the primary determinant of credit risk is 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 the 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."
Synthetics

There is for the moment only one, minor, concession to synthetics. Where an institution sells off a junior position in a pool of loans to SMEs via a synthetic structure and retains the senior position, the institution may apply to the retained position the lower capital requirements available for STS securitisations where strict criteria (set out in the new Article 270 of the CRR as amended) are met, including that the position is guaranteed by a central government, central bank, or a public sector “promotional entity”, or – if fully collateralised by cash on deposit with the originator – by an institution.

So, in the short term, originators which tranche risk via any synthetic structure – and the orthodox view seems to be that this includes simple credit guarantee arrangements, because these usually provide for a deductible and a cap, which technically makes the guaranteed credit risk “tranched” – will be penalised because they will have to hold capital against the retained piece on the basis of the higher non-STS rules, and the investors will similarly be penalised, which will in turn punish the originator via the return the investors will need to offset this.

However, developments, and possibly a regime for STS synthetic securitisations, can be expected during the course of 2020 and, given that the securitisation framework for regulatory capital allocation is non-neutral (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), perhaps the most likely (and quite possibly unintended) outcome will be that banks wanting to sell off assets via a synthetic sale and seeking STS status – perhaps because they cannot get a necessary borrower consent – will decide to wait until the synthetic framework becomes law.

The EBA discussion paper "Draft report on STS Framework for Synthetic Securitisation" was published, later than its due date, on 24th September 2019.  One reaction to it might be to ask: why?  In the bad old days before 2009, the investor herd was buying sometimes horribly complex securitisation paper on the basis of a rating and no significant due diligence without understanding what they were doing, other than to know that their competitors were doing it and they couldn't simply leave their investors' funds on deposit.  So the STS label for true sale securitisations at least has an obvious rationale - to protect them from their animal spirits.  But synthetic securitisation is a different jungle, inhabited by different beasts: the protection sellers are no longer monoline insurers but, for the most part, central banks, supranational entities such as the EIB, pension and hedge funds (the chart gives the EIB's breakdown of the market).  Do these entities need an underwriting proposition to carry an "STS label?  Or are they able to look after themselves?  Post-GFC synthetics are, according to the EBA, entirely private bilateral deals where protection sellers can bargain for whatever they want (an argument that failed to convince the EU to leave private deals outside the Securitisation Regulation disclosure rules of course). 

The EBA seems to be motivated by the fact that true sale issues are now regulated, and so to ensure a "level playing field", so should synthetic deals; and perhaps a desire to make it easier for new entrants to join the market as protection sellers, who would at present be daunted by the need to do all the due diligence.  This seems debatable: it notes that the market is reviving, with an increasing degree of standardisation, but does not seem to wonder why it has managed to do that without any "help" from regulators; and suggests that an STS label would be "of crucial importance for the destigmatisation" of the market - evidently however, not a stigma that is deterring existing participants.  Is this not an argument that this is increasing moral hazard, if it encourages inadequately-skilled new entrants to join the credit risk market?  Be that as it may, the market response has not been so negative, even though at the time of writing (29th January) the EBA has not yet published its response to the consultation.  This seems to be on the basis that an STS regime may encourage more investors to enter the market and take some credit risk away from the banking sector (e.g. by buying credit linked notes) – and the more investors there are, the better for the banks of course – as well as because an STS regime would hopefully go hand in hand with a more favourable capital treatment for banks as regards the risk which they retain; although (see below) this remains to be seen, and the EBA was equivocal about this aspect. 

The Report envisages a two stage process: first, to consider a set of STS criteria for synthetics: largely the same as or based on those for true sales (the "overarching rationale"), plus some additional ones for synthetics; and then to consider 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 (in which respect the EBA notes that whereas pre-GFC deals typically sold off the least risky portion and retained the rest, now it tends to be the other way around, with the first loss risk being transferred to a protection seller).  And if this is eventually a significant attraction for a protection buyer (these deals are almost always done by a regulated entity such as a bank subject to the CRR) then that STS label might be worth pursuing.  This would be an EU special case, as there is no provision at the Basel/IOSCO level for preferential capital treatment for an STC-qualifying synthetic product).

It envisages 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 (and an enforceability legal opinion regarding the credit protection is a specific requirement).  This only contemplates "balance sheet synthetic securitisations" and not "arbitrage" ones (see further the EBA's December 2015 "Report" on the difference: "balance sheet" ones are intended to get assets off a bank's balance sheet, especially for regulatory capital purposes): this is spelt out in the Securitisation Regulation

So will STS for synthetics gain traction?  There were reports in the trade press suggesting that EU regulators were not ad idem on giving preferential capital treatment to banks which did synthetic securitisations, which is why the EBA has not made any particular recommendation about this in its discussion paper.  But without a more favourable capital treatment, why would a regulated entity bother going after the STS label?  The risk weighting for banks holding the senior tranche of a securitised portfolio is now 15% for non-STS and 10% for STS: that would be attractive for bank issuers, but, that aside, the STS label would do nothing for existing investors in synthetics, who know what they are doing anyway.

Market reaction to the EBA consultation

A point made by AFME in its response to the EBA which is worth noting is that the history of synthetic securitisation shows credit losses of much less than would be implied by the regulatory capital requirements (“virtually zero losses to the senior tranches of synthetic securitisations”) – and that as the CRR exists at present, the capital requirements that apply to the risk retained by an originating bank under any synthetic securitisation are the same – whether it is a simple deal transferring more than significant risk to a third party or a risky “arbitrage” synthetic securitisation

Signs signs of resistance were reported in the trade press to two of the EBA’s proposed criteria for synthetic STS:

  • Criterion 35 in the EBA synthetic STS discussion paper states: “The protection buyer should not commit to any amount of excess spread available for the investors”.  This, one of the requirements specific to synthetics and with no comparable true sale STS criterion, refers to the common structure whereby an SPV issues senior and junior CLNs to investors (usually the originator bank holds the senior and outside investors take the junior, first loss, tranche), the SPV then writes a credit default swap with the bank, which pays the SPV annual premiums, and unless and until there is a default in the underlying loan portfolio, the coupon paid on the CLNs should be less than the sum of the premiums receivable and the income earned on the collateral which the SPV invests in using the proceeds of the issue of the CLNs.  That difference is the excess spread, and if the SPV accumulates it, it acts as a cushion against loss, making the CLNs less risky.  So what is the problem with that?  The EBA regards it as “a complex structural feature…The complexity arises with respect to the quantum of committed excess spread, and its calculation and allocation mechanism” and so, for the sake of simplicity, it should not be present in an “STS” structure.
  • Criterion 36 requires the collateral to take the form of 0% risk-weight securities or cash, to be held by a third party institution, not the originator.  This means that the originator cannot use the collateral and, while this is not the primary benefit of a synthetic, because the primary benefit is transferring risk, not acquiring funding, it can be a secondary benefit for an originator.  This criterion is designed, presumably, for the benefit of the investors, who are being asked to take the credit risk only on the underlying portfolio, not also on the originating bank, and so it is, like criterion 35, aimed at making the analysis simple for the investors.  Some structures permit the originator to hold and use the collateral unless they suffer a rating downgrade below an acceptable level.  The EBA proposal would not, as currently drafted, permit this.

The next step - which Article 45(2) of the Securitisation Regulation required by 2nd January 2020 and so is overdue - is for the EBA to submit a report to the European Parliament on including balance sheet synthetic securitisations in the STS regime, together with any draft legislation.  For more background on synthetic securitisation, see FinBrief, and the Glossaries.

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 go 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

1st January 2019                   

Securitisation Regulation becomes applicable

Transparency (article 7)

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).

Who and what is caught by Article 7?

The Article 7 transparency requirements apply to all securitisations (and article 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.

Much of the detail in Article 7 is not changed much, or at all, compared to the original EC draft, and the problematic European Parliament proposals for investor name disclosure and details of credit scoring were entirely rejected.  Full underlying deal documentation (apart from the legal opinions), or a summary of it, 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)).

The disclosure RTS and ITS

The detail regarding transparency is found in the related RTS/ITS.  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 - draft RTS specifying the information and  details to be disclosed (January 2019) and draft ITS with regard to the format and standardised templates (January 2019).  Because of the bumpy ride these had, they did not become law, and as of 1st January 2019 the market has had to operate with the benefit of the 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".  Using the usual form of words for non-no action letters, ESMA declared its expectation that the local competent authorities would exercise their supervisory and enforcement powers "in a proportionate and risk-based manner" - so, "comply or explain", to be applied on a case-by-case basis.

The controversy about 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, but did not then re-consult!  What seems to have happened is that ESMA took, or perhaps re-interpreted, legal advice over the scope of its powers under the Article 7(3) mandate and then significantly redrafted them.  

The RTS/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 is right that the scope of Article 7 extends to private deals, but what it could have done, but did not, was to pay more attention to the wording in Article 7(3) that the information to be disclosed should take into account its usefulness to the investors; which arguably permitted ESMA to distinguish between the requirements for public and private deals.  But that argument has been lost, and so Article 7 requires a significant amount of disclosure, regardless of what the investor may want. 

So, in summary, private deals are not exempt from the disclosure requirements in Article 7(1); the only differentiator in Article 7 itself is that disclosure must be via a repository for public deals, but not for private deals. 

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. 

For private deals, 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.

Compliance with the RTS and templates

In October 2019, the EC published RTS (with associated Annexes) and ITS (with associated Annexes) on disclosure, based on drafts initially submitted by ESMA on 22nd August 2018 and revised on 31st January 2019.  Both are in the final stages of being enacted and this is expected to happen at some point in February 2020.  Until they are, the market will continue to operate under the non-no action letter issued by the ESAs on 30th November 2018.  It had been hoped by some that there would be an extended period before the RTS actually "apply", but the final version of the text just has the standard “30 days after publication in the OJEU” wording, so originators’ and sponsors’ best hope may be that at least there could be a further non-no action letter effectively extending the official leniency provided by the letter of 30th November 2018, because their implementation will create operational issues for reporting entities because they have to make substantial additional information available and so need to make substantial adjustments to reporting systems.  This is a particular issue for less sophisticated issuers, such as corporates which rely upon private securitisations to finance trade receivables, which do not normally access the public ABS market.  As AFME explained to EMSA when it requested an extension to the non-noaction period:

“management of data – especially at the highly granular level prescribed - is notoriously difficult.  Significant changes to operations, internal processes and information technology are required. For banks subject to disclosure obligations, this presents significant challenges.  Adapting legacy systems to ensure the collection and faithful reporting of the correct data is highly detailed, meticulous work.  Ensuring it is done correctly for hundreds or thousands of assets (especially where they are sometimes decades-old legacy assets) requires a large investment of time and resources – and this is a task banks have been working towards for over a year now...  For non-bank originators, the challenge is even greater, as they will frequently be corporates whose systems have historically not been designed to produce loan-level data or investor report information at anything like the level of granularity required by the Disclosure RTS” 

AFME concludes that “complete compliance across all market sectors and asset classes within a few months is not achievable as a practical matter”.  ESMA itself said in its 22nd August 2018 final report, “Technical standards on disclosure requirements under the Securitisation Regulation”, that a transition period of 15-18 months would be necessary for reporting entities to achieve full compliance, and one would expect ESMA to be sympathetic so long as entities are getting on with it as quickly as they reasonably can. 

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

Problematic issues regarding the templates, where it is hoped the ESMA Q&A might be expanded include various mandatory template fields, the lack of a template for trade receivables, and 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) and for CLOs (regarding the corporate template).  AFME issued a detailed communication to ESMA in April 2019 about these, and about various points of detail.  

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 templates are required for disclosures in relation both to public and private issues; the major difference being that for public issues the disclosed data becomes publicly available via the securitisation repository to which it has been submitted.

The use of ND1-4 in disclosures about public deals

In January 2020, ESMA issued a Consultation Paper, “Guidelines on securitisation repository data completeness and consistency thresholds” containing draft guidelines for securitisation repositories, telling them how to go about deciding whether to accept or reject a submission made to them for a public securitisation. 

By way of background:

  • Article 17 of the Securitisation Regulation (“Availability of data held in a securitisation repository”) requires a securitisation repository to collect and maintain details of securitisations, and requires ESMA to develop RTS on the “operational standards” required to allow the timely, structured and comprehensive collection of that data. A draft was produced in November 2018, and a final draft RTS was issued on 29th November 2019;
  • Article 4(2)(d) of the November 2019 draft RTS requires repositories to verify that the ND options are only used where permitted and “do not prevent the data submission from being sufficiently representative of the underlying exposures in the securitisation”.

ESMA’s consultation is about the “sufficiently representative” requirement, and although the guidelines are directly addressed to securitisation repositories, they are indirectly addressed to sponsors and originators, because they have to comply with their obligations under Article 7 and, if their data submission is rejected by a depository on the basis of failure to meet the requirements set out in these guidelines, they will have failed to comply with Article 7.  They relate to ND1-4, and not ND5 (“not applicable”) i.e. to cases where the data was not collected because at the time there was no need for it, or else it has been collected but it is not easy to get hold of it.

In the guidelines, ESMA proposes “tolerance thresholds” for two cases: where the assets are fairly old and some of the data does not exist (“legacy assets”) or where the data is stored in other databases and cannot be retrieved in the short run without significant disproportionate expense by reporting entities (“legacy IT systems”).   So to give one example, for a public securitisation of auto loans and leases, there are a total of 78 fields, and in 41 of them ND is an option.  ESMA proposes that a maximum of 15 NDs will be allowed on account of the “legacy assets” excuse and another 15 on account of “legacy IT systems”.  The intention is to reduce these maxima over time.  The consultation runs until 16th March 2020.

As of 24th February, AFME is considering its response.Its initial view is that the guidelines are potentially problematic in a few area, including (amongst others):

  • Non-EU entities trying to comply with the Article 7 disclosure requirements in order to accommodate EU investors, who might otherwise not feel that they can safely buy an issue;
  • For synthetic securitisations, where some of the required data (e.g. the Annex 4 requirements for data on cashflows from underlying corporate exposures) is not collected because it is irrelevant for a synthetic (unlike for a true sale) deal;
  • For deals, such as CMBS, where the pool is small (e.g. if you only have 5 loans, even a 10% tolerance doesn’t help – unless it is set at 20%, you have no useable tolerance).

The use of ND1-4 in disclosures about private deals

It is worth considering the relevance of these guidelines to private deals.  It is clear that they do not apply directly, because private deals do not require disclosure to a securitisation data repository.  However, the fundamental disclosure obligations in Article 7 do apply equally to both.  Article 7(1) contains minimum disclosure standards, and under Article 7(3) ESMA has developed the (still draft but seemingly now finalised) disclosure RTS.  Recital (16) notes that disclosure should in any event be of “all materially relevant data on the credit quality and performance of underlying exposures

There is an argument that the guidelines are setting out what ESMA would regard as its minimum requirements for proper disclosure under Article 7 and that a material failure to meet them in respect of a private securitisation, because of the extensive use of ND1-4, would be regarded by ESMA as being a breach of Article 7.  From a practical viewpoint, disclosure under Article 7 would be made to the relevant national competent authority and not directly to ESMA, and ESMA would have difficulty in policing private disclosures of course because it does not have immediate access to the data and may in any event be less concerned about private deals than public ones (on the basis, as alluded to in Recital (13), that these are bespoke deals where the degree of disclosure is a matter for direct agreement between the investors and the originator/sponsor).  It seems ESMA has said privately that it would be more flexible in relation to private deals, which is consistent with what is said above. 

Note that Recitals (12) and (13) of the disclosure RTS state:

“(12) For reasons of transparency, where information cannot be made available or is not applicable, the originator, sponsor, or SSPE should signal and explain, in a standardised manner, the specific reason and circumstances why the data is not reported. A set of ‘No data’ options should therefore be developed for that purpose, reflecting existing practices for disclosures of securitisation information.

(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 note further that Article 9 of the disclosure RTS states:

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.”

This is arguably a sufficient code in itself for private deals, although originators and sponsors of private deals might be brave if they were to refer solely to these principles in cases where they were not complying with at least the spirit of the guidelines, and the more cautious approach will be to have regard to them in both cases. 

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.

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 exactly is a securitisation?

The definition of "securitisation" takes the old CRR definition and adds sub-paragraph (c) to clarify that specialised lending exposures are not securitisations.  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?  Some level 3 guidance would make sense.

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 deinition 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-balnce sheet item".

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):

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.

Who can be a sponsor

A welcome development - which occurred towards the end of the trilogues - was the widening of the definition of “sponsor”.

The original draft Securitisation Regulation 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). 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.

Now however, this appears to be unnecessary. 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”.

We understand that some in the market are seeking official guidance that this is as wide as it seems to be, but the wording is unambiguous, and the history of the definition as the draft went through the legislative process does not suggest that this was accidental, and even if it were, it clearly says what it says.  Admittedly, it would have been better if the phrase "whether located in the Union or not" had been put after the reference to an investment firm, and the UK post-Brexit onshoring version of this definition, contained in section 4 of the Securitisation (Amendment) (EU Exit) Regulations 2019, does do this.

As a result, non-EU CLO managers - and EU managers which do not have the super authorisations - can much more easily come within the “sponsor” definition (so long as they come within this MIFID definition) and be able to hold the risk retention, without needing to bring themselves within the definition of “originator”.

That is not the end of the story for UK-based CLO managers, because if they are within this definition and so providing investment services or performing investment activities on a professional basis, they would need to obtain authorisation from the UK's FCA under section 19 of the Financial Services and Markets Act 2000, which in itself could be a challenge for some US firms.

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".

Will ACBP STS succeed?

 

Will the STS requirements for ABCP deter institutions from trying to achieve the status for their ABCP transactions and programmes?  The main hurdles to achieving STS for ABCP are probably:

  1. For individual STS ABCP transactions, the ban on assets in default (Article 24(9), reflecting Article 20(11) for term STS).  Credit card deals will often not meet this.
  2. For an STS ABCP programme, it seems that all transactions funded by an STS programmes must be STS securitisations, with the exception that Article 26(1) permits a maximum of 5% of the aggregate underlying exposures funded by an ABCP programme to be “temporarily” non-compliant with Articles 24(9), (10) or (11). Paragraph 78 of the EBA Guidelines indicates that "temporarily" means no longer than 6 months. But for this purpose a sample of the asset pool must “regularly be subject to external verification of compliance by an appropriate and independent party” (Paragraph 81 of the EBA Guidelines states that such external verification needs to be conducted at least annually), adding inconvenience and additional cost. For term STS a sample of the assets has to undergo external verification before issue, but that is a one-off requirement and easier to bear. . However, an "independent party" which conducts such external verification cannot be a credit rating agency or, rather strangely, a third party verifier of STS status under the Securitisation Regulation (Paragraph 82 of EBA Guidelines). Another difficulty for an STS ABCP programme is that all originators, sponsors and SSPEs involved must be established in the EU.
  3. With the exception of auto loans and leases and equipment leases, which are given special treatment, the limits to maturity of the underlying assets.
  4. The disclosure requirements in Article 24(14), which require comparable performance data to be disclosed - potentially problematic where the asset class is new - even for a private issue (which most ABCP is).
  5. A sense that the requirements are unnecessarily complex and detailed, especially those in Article 25 which must be satisfied by the sponsor of an STS ABCP programme. For example, Article 25(4) requires the sponsor not only to perform its own due diligence and verify compliance with the requirements of Article 5, but also to verify that the asset seller's servicing and collection processes comply with Article 265(2)(h) to (p) of the CRR (as amended)*. Given that the programme must be fully supported, so that ABCP investors already have dual recourse and from a credit point of view not dissimilar to covered bondholders, and the sponsor already has plenty of incentive not to take on risk recklessly, this seems excessive.
  6. Having said that, the majority of ABCP funding in Europe is provided by EU money market funds, since July 2018 the Money Markets Fund Regulation has imposed qualitative and quantitative limits on the type of assets in which they may invest, including a limit of 20% of its assets being in securitisations, with a sub-limit of 15% of its assets being in non-STS securitisations and ABCP. An MMF wanting to exceed the 15% limit will have to find STS ABCP, which may tempt some EU banks to try to achieve STS status for some ABCP programmes in order to meet that demand. Since a vast majority of current ABCP programmes would not satisfy STS requirements, it remains to be seen whether the sponsor banks would find the STS status attractive enough to make them decide on establishing new programmes, or substantially restructure existing programmes to obtain STS status.

* These (a) contain requirements for (i) an ABCP programme's underwriting and liability management standards, (ii) its asset eligibility criteria, and (iii) its collection policies and processes (which must take into account the operational capability and credit quality of the servicer and include features to mitigate performance-related risks), (b) require an analysis of the originator's credit risk and business profile, including (i) its past and expected future financial performance, (ii) its current and expected market position and competitiveness, (iii) its leverage, cash flow, interest cover and debt rating, and (iv) its underwriting standards, servicing capabilities and collection processes, (c) have requirements regarding the programme's collection policies and processes, the way in which the estimate of the asset pool's losses is produced, the reserves it holds, the way in which the programme's credit enhancement level is sized, and the structural features of the programme to mitigate potential credit deterioration (wind-down triggers for example), and (d) require the programme sponsor to evaluate the underlying asset pool's weighted average credit score, concentrations and granularity.

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