On 18 February 2015 the European Commission launched its Green paper: Building a Capital Markets Union, together with a separate consultation paper relating to securitisations and another paper in respect of prospectuses.
WHAT IS THE CAPITAL MARKETS UNION?
The Capital Markets Union (CMU) is one of the flagship projects of the Commission. It is also a key adjunct to the Commission's EUR315 billion investment plan announced in November 2014 under which the European Fund for Strategic Investments was established to focus on long-term investment projects and financing small and medium-sized enterprises (SMEs).
The CMU aims to further the objective of free movement of capital within the EU, creating a single market for capital for all 28 Member States. The Green Paper highlights the range and availability of funding to SMEs and start-ups in the United States (US), compared with the current funding options for European SMEs and proposes that the CMU should allow SMEs to raise finance as easily as large companies.
The Green Paper identifies several short-term priorities including:
- breaking down the barriers to accessing the capital markets and lowering costs of funding within the EU,
- widening the investor base for SMEs,
- developing proposals to encourage "high quality" securitisations,
- supporting take-up of long-term investment funds; and
- supporting industry-led work to develop the European private placement markets.
As part of the Green Paper the Commission has published a consultation paper on high quality securitisations and a further paper proposing a review of the Prospectus Directive with a view to reducing the burdens on and obstacles for SMEs when publishing a prospectus.
IMPROVING ACCESS FOR SMEs
Two of these identified priorities go to ease of access for SMEs to financing from the capital markets. Typically, that involves a listing and/or public offering of securities which, in turn, means drawing up a prospectus and getting it approved by the national competent authority. That is perceived as expensive, complex and time-consuming, especially for SMEs.
The solutions referred to in the Green Paper are: (i) amend the Prospectus Directive to make it less burdensome for SMEs to issue listed and/publicly offered securities, and (ii) encourage the development of a private placement market which does not require a prospectus.
Amendments to the Prospectus Directive: In relation to the first solution, as mentioned above, the Green Paper has been accompanied by a consultation document: Review of the Prospectus Directive and a consultation webpage: Consultation on the Review of the Prospectus Directive. The scope of the consultation in these documents is extremely broad and goes to three fundamental questions that are at the heart of the Prospectus Directive regime:
- When is a prospectus needed?
- What information should a prospectus contain?
- How are prospectuses approved?
These sort of questions were addressed in the US under the JOBS Act which created a new category of “emerging growth companies” and relaxed many SEC requirements for these companies in connection with their initial public offerings (IPOs) and transition to full SEC-reporting status.
Private Placement Market: In relation to the second solution the Green Paper is supportive of initiatives already being undertaken by finance-industry bodies to encourage the growth of the private placement market. Private placements, by definition, do not require a prospectus and indeed are largely un-regulated, being targeted at sophisticated investors who are deemed not to require the protection of the European prospectus regime.
The Green Paper nevertheless asks what further steps could be taken at the EU level to encourage this market. The reference in the Green Paper to industry initiatives is primarily to the publication by the International Capital Market Association of the Pan-European Corporate Private Placement Market Guide and the publication by the Loan Market Association of standard model framework documentation in January 2015. Together, these publications mark significant milestones in the development of pan-European markets for direct lending and more standardised documentation.
HIGH QUALITY SECURITISATIONS
The consultation paper on "An EU framework for simple, transparent and standardised securitisation" is the latest publication to consider the creation of a high-quality securitisation (HQS) market, following those issued in recent months by the ECB and Bank of England, the EBA, the Basel Committee of Banking Supervision and IOSCO and the IMF. The Commission considers that an EU HQS framework would diversify funding sources and unlock capital thereby allow banks to lend to consumers and businesses more easily.
Purpose of the consultation: The Commission clearly states that there is no intention to row back on the current patch-work of EU legislation governing securitisations. The Commission is though seeking feedback on the functioning of the current European securitisation market with a view to developing proposal that will:
- restart markets on a more sustainable basis, so that simple and transparent standard securitisations can act as an effective funding channel to the economy,
- allow for risk transfers to a broad set of institutional investors as well as banks,
- allow securitisation to function as an effective funding mechanism for some non-banks as well as banks; and
- protect investors and manage systemic risk.
Comparison with US market: The Commission presents the development of an HQS market as a building block of the CMU and a contribution to the return of sustainable growth and job creation. Following one of the general themes from the Green Paper, the Commission acknowledges in the securitisation consultation paper that the securitisation markets in the US have recovered more strongly than EU markets since the financial crisis. This is despite the US not being at the forefront of developing an HQS regime. In contrast, investors in Europe have generally preferred covered bond instruments. The Commission flags a number of features of the EU covered bond markets that may support this preference including the existence of well-developed national frameworks, the regulatory capital treatment of covered bond for investors and the originator support provided by guarantees on covered bonds. The first two features are picked up in the securitisation consultation document where the Commission asks whether changes to these aspects of securitisations could improve the EU securitisation market.
Key areas for consultation: The following are key questions raised in the securitisation consultation paper on which the Commission is seeking responses.
Criteria for qualifying securitisations
The Commission suggests that the criteria in the Liquidity Coverage Ratio (LCR) and Solvency II could be grouped around the themes below with the first three being the "foundation criteria" and used as the basis for a refined qualifying securitisation regime.
- Simplicity – such as the requirement that underlying exposures are homogeneous.
- Transparency – such as provision of loan-level data.
- Standardisation – such as the requirement for a true sale.
- Additional risk features – such as the requirement for the debt instrument to be listed on a regulated market or recognised exchange.
The Commission notes that these requirements are limited to banks and insurers acting as investors although we would expect to see all transactions seeking to qualify given the prevalence of bank treasuries as investors and to maximise liquidity.
The Commission recognises that the current rules relating to qualifying securitisations in the Liquidity Coverage Ratio (LCR) and Solvency II do not apply to short term instruments, such as ABCP. Neither was ABCP included in the scope of other recent consultations on HQS, such as the BCBS-IOSCO consultation paper. The Commission is seeking feedback on whether specific eligibility criteria should be developed for ABCP.
Similar to the recent European Banking Authority report and opinion on risk retention, the securitisation consultation paper asks whether the current approach to risk retention where investors have the responsibility for verifying the risk retention requirements (the so-called "indirect" approach) could be adjusted to a "direct" approach for HQS and whether there are any other elements of the current rules on risk retention that should be adjusted for qualifying securitisations.
Under the "direct" approach it is expected that regulated investors would be able to rely directly on the statement made by the originator as to risk retention in the prospectus.
The securitisation consultation paper raises the difficult question of how compliance with the HQS criteria would be monitored and verified. If, as is currently the case, HQS status will feed into the regulatory capital requirements for regulated investors (ie, banks and insurers) we could see those investors wanting to retain involvement in determining the status of investments. However, there could be some benefits in terms of efficiency and certainty in HQS status being established for the originator so that the transaction can be marketed with certainty as qualifying. The paper seeks thoughts on whether this would take the form of a statement from the originator as to compliance or whether a public authority or private organisation would be responsible for confirming compliance.
Harmonisation of EU securitisation structure
The securitisation consultation paper also raises the possibility of the creation of a standardised securitisation structure. For example, this could involve a single legal form of SPV for use across the EU, standardisation of the way receivables are transferred and standardisation of the rights of noteholders.
While these seem like worthy goals we query the impact of such changes in developing the market in comparison to the myriad issues and complexities that would need to be overcome to formulate and implement such changes. Such reforms could also risk overriding settled and developed principles of local Member State law making securitisation a more (rather than less) complex and uncertain exercise.
The paper proposes adjusting capital requirements for higher rated securitisations under Basel Revised Securitisation Framework published in December 2014. Obviously, consideration would also need to be given to haircuts under LCR and to risk weightings, for insurers, under Solvency II. It must certainly be unhelpful that regulatory capital treatment is not more closely aligned as between equivalently rated structured finance instruments (such as securitisations and covered bonds).
The paper indicates that the regulatory treatment of securitisations could be refined for asset managers although in what way is not clear.
The securitisation consultation paper also considers the following areas:
- Disclosure - the paper acknowledges the need to avoid overlaps or inconsistencies between the different disclosure requirements as this could prove a disincentive to originators and investors. The questions on this topic potentially open the door to adjustments to the loan-level data requirements for certain asset classes.
- Credit ratings - what alternatives are there to credit ratings?
- Market infrastructure, service providers and swap counterparties – is further market infrastructure required to promote a functioning secondary market? Should the provision of ancillary services (eg, swap counterparties, liquidity facility providers etc) to securitisations be encouraged?
- SMEs – will changes (such as standardisation) encourage the emergence of SME securitisations?
WHAT ARE THE NEXT STEPS?
Responses to the consultation papers are requested by 13 May 2015. The Commission then plans to organise a conference in the summer of 2015 and then publish an Action Plan later in 2015 setting out its roadmap for putting in place the building blocks for a Capital Markets Union by 2019.