The Securitisation Regulation is split into two main parts - the first provides a harmonised set of EU securitisation rules applicable to all transactions (whether STS or not), bringing together all the various aspects of the differing legislation that apply to securitisation (covering the key definitions, due diligence, risk-retention and transparency rules) and the second part sets out the specific STS Criteria for both long-term and short-term (asset-backed commercial paper or ABCP) transactions, of which there are over 50 separate Criteria. Then follows the supervision framework for the STS Criteria and a final section sets out the (fairly minor) amendments required to be made to other pieces of EU legislation, all which are described below.
Part 1 - harmonising existing legislation
- Definitions: definitions of all the key concepts relating to securitisation are set out in the legislation (some for the first time), including the provision of a 'clear definition' of "securitisation" (which is actually the same as that currently set out in Article 4(1) CRR, referencing the tranching of credit risk associated with a pool of exposures, with payments dependent upon the performance of that pool, and subordination of the tranches determining the distribution of losses) and definitions of "Securitisation Special Purpose Entity" (SSPE), "originator", "sponsor", "tranche", "ABCP", "servicer", "investor" and so on are also provided (Article 2). Interestingly, (some of) the corresponding references in CRA III to the term "structured finance instrument" would be replaced by references to "securitisation instrument", which helpfully introduces a degree of consistency previously lacking as a result of the differing terminology used in existing legislation.
- Due diligence: existing due diligence rules across all sectors of investor (banks, insurance companies and investment firms) will be repealed and replaced by the harmonised, streamlined provisions set out in Article 3. These provisions will be extended in future to include investors in securitisations that are regulated under the Directive on Undertakings for Collective Investment in Transferable Securities (UCITS), and the Directive on Institutions for Occupational Retirement Provision (IORPs). By way of recap, the due diligence provisions require investors to verify (non-bank) originators' origination practices and that the risk-retention provisions are being met, assess the risk characteristics and structural features of the securitisation, establish written procedures for compliance with the due diligence requirements, perform stress tests on the underlying cash flows and collateral, ensure adequate internal reporting, and be able to demonstrate to regulators that they have a thorough understanding of their securitisation positions. Additional provisions require investors in STS securitisations to have carried out specific due diligence on the deal's compliance with the STS Criteria (and not just that the (5%) material net economic interest is being held by the party retaining risk). Templates for the "originator, sponsor or SSPE" to jointly declare the deal's compliance with the Criteria (then notify ESMA which will publish an official notice on its website), and for investors to complete their due diligence, will be developed. The central role of issuer "self-attestation" (as to compliance with the STS Criteria) under the proposals is significant: there would be no independent, third-party verification of a deal's compliance with the Criteria, which the majority of market participants have to date appeared to support, given the potential for wide (and possibly divergent) interpretations of the Criteria by the 28 Member States' national regulators. Originators and sponsors are jointly liable for any loss or damage resulting from incorrect or misleading notifications, and deals which cease to meet the Criteria (or where remedial measures have been imposed by the competent authority) should be notified to ESMA.
- Risk-retention: the existing "indirect approach" to risk-retention will be replaced with a new "direct approach" requiring the originator, sponsor or original lender to retain the 5% net economic interest and confirm they have done so under Article 4 (by way of notification to ESMA via a standard template - see Article 14). This is in addition to the obligation placed on EU investors to verify (prior to becoming exposed to a securitisation) that the retention obligation is being met. The five main forms of risk-retention remain largely unchanged (save for a clarification of the "originator interest" form of retention to the effect it can be used for any revolving securitisation and not just securitisations of revolving exposures, as currently) and have not been expanded. The Commission notes in the explanatory text of the Securitisation Regulation that the existing indirect approach will remain available, but only to non-EU-established originators, sponsors and original lenders, however, the proposed legislation does not appear to explicitly provide for this. With further RTS to specify additional detail on the risk-retention requirement (which must be submitted by the EBA within six months of the Regulation taking effect), this may be where these provisions are set out. Following some - but by no means all - of the EBA's key recommendations on risk-retention set out in its December 2014 Report and Opinion to the Commission, as outlined in Edition 14 of this SCM Briefing, the Commission notes that it is closing the "loophole" which allowed a looser interpretation of the (existing) risk-retention provisions (such that an entity NOT the originator, sponsor or original lender could retain risk, which effectively allowed third-party entities in collateralised debt obligation (CLO) transactions to hold the retention piece rather than the CLO manager having to hold it as "sponsor"). Article 4 makes clear that an entity (i.e. an SSPE) established for the sole purpose of securitising exposures cannot be considered an originator, with the Commission giving the example that the entity retaining the economic interest must have the capacity to meet a payment obligation from resources not related to the exposures being securitised.
- Transparency and disclosure: the proposed Securitisation Regulation specifies the minimum information to be made available to investors and competent authorities, and requires the use of common templates for reporting of information to investors (which must include loan-level information, transaction documents, a detailed description of the priority of payments, hedging documents, and, for STS deals, a copy of the notification to ESMA which is required under Article 14). The originator, sponsor and SSPE are to designate amongst themselves one entity to fulfil these requirements. The Regulation provides for the set-up of a free, centralised website for storage of STS notifications, deal documentation and reporting forms (Article 5). The reporting requirements will utilise and build on the existing standardised disclosure templates and will possibly add others for the first time (e.g. for ABCP). This approach is intended to allow reporting to e.g. the existing European Data Warehouse. Again, RTS will be drafted to specify in further detail the information to be provided, which will also define the "private and bilateral" transactions that are (currently) excluded from the reporting obligations (for further background on this issue, please see Edition 12 of this SCM Briefing). How the transparency requirements will fit with the (near-equivalent) transparency provisions of Article 8b of CRA III (which are not repealed by the Securitisation Regulation) is currently unclear, but additional RTS yet to be drafted may deal with this, which will hopefully also provide for what should happen during the intervening period between the Securitisation Regulation taking effect and the application of the new RTS.
Part 2 - the STS Criteria - Articles 8, 9 and 10 (long-term deals)
- The underlying exposures must be acquired by an SSPE means of a "sale" or assignment that is enforceable against the seller or other third party including in the event of the seller's insolvency, and there must be no severe clawback provisions. Synthetic deals cannot comply, but the Commission will continue to assess whether those and other transactions could be covered (such as non-true-sale deals.)
- The seller must provide representations and warranties that the underlying exposures are not encumbered or in a condition that could adversely affect enforceability of the sale or assignment.
- The exposures must meet predetermined and clearly defined eligibility criteria for the transfer of exposures from the seller to the SSPE (and thereafter, no active portfolio management or sales of transferred exposures.)
- The transaction must be backed by pools of homogenous exposures which are contractually guaranteed and enforceable obligations with full recourse to debtors, with defined payment streams, and not be backed by transferable securities as defined by MiFID. (This provision does not apply to ABCP - see below for further information on the differing requirements for ABCP transactions.)
- The underlying exposures must not include assets that are themselves securitisations (so that "resecuritisations" are effectively excluded.)
- The exposures must be originated in the ordinary course of the originator's or original lender's business, with requirements imposed upon those entities to meet particular underwriting standards, including creditworthiness assessments as required under, e.g. the Directive on Mortgage Credit. (This provision does not apply to ABCP - see below.)
- At the time of transfer to the SSPE, the exposures are not in default, and do not include exposures to a credit-impaired debtor/guarantor that has declared insolvency, agreed a debt dismissal or reschedule etc, or is on an official registry of persons with adverse credit history, or has a credit score indicating significant risk that payments will not be made.
- At the time of transfer, the debtors must have made at least one payment (except where the deal is backed by loans to individuals for personal, family or household consumption purposes, trade receivables or other receivables payable in a single instalment.)
- The repayment (of the securitisation, rather than the exposures) does not depend substantially on the sale of assets securing the underlying exposures (this does not prevent assets being rolled-over or refinanced.)
- The originator, sponsor or original lender must satisfy the risk-retention requirement under Article 4.
- Interest rate and currency risks must be appropriately mitigated and documented, with only derivatives used to hedge currency risk and interest rate risk allowed to be included alongside the underlying exposures.
- Any referenced interest payments must be based on generally used market interest rates and must not reference complex formulae or derivatives. (This provision does not apply to ABCP - see below.)
- In transactions with no revolving period (or where the revolving period has terminated) and where an enforcement notice has been delivered, principal receipts from the exposures are passed to the investors via sequential amortisation and no substantial amount of cash is trapped in the SSPE on the payment date. Payment of investors in "reverse" priority is not foreseen and performance-related triggers should be present in deals with non-sequential priority of payments.There must be no provisions requiring automatic liquidation of the underlying exposures at market value. (These provisions do not apply to ABCP - see below.)
- Transactions that do feature revolving periods should include provisions for appropriate early amortisation events and/or triggers for termination of the revolving period, which include at a minimum all of: deterioration in the credit quality of the underlying exposures to below a pre-determined threshold; the occurrence of an insolvency-related event with regard to the originator or servicer; the value of the underlying exposures held by the SSPE falls below a pre-determined threshold; and a failure to acquire sufficient new underlying exposures. (These provisions do not apply to ABCP - see below.)
- The transaction documentation must clearly specify the contractual obligations, duties and responsibilities of the servicer and (where applicable) the trustee and other ancillary service providers, and provide for replacement of counterparties (to avoid, e.g., termination of servicing). (Again, this provision does not apply to ABCP - see below.)
- The transaction documentation must clearly provide definitions, remedies and actions relating to delinquency and default of debtors, debt restructuring or forgiveness, forbearance, payment holidays, losses, charge-offs, recoveries and other asset performance remedies. The documentation must specify payment priorities, triggers, changes in priority following trigger breaches, and the obligation to report such breaches. Any change in payment priority must be reported when it occurs.
- The transaction documentation must include clear provisions that facilitate the timely resolution of conflicts between different classes of investors, voting rights must be clearly defined and allocated to investors, and the trustee's and others' fiduciary duties and responsibilities must be clearly defined. (This provision does not apply to ABCP - see below.)
- The investors must be provided with access to data on static and dynamic default history and loss performance for substantially similar assets to those being securitised, covering a period of at least seven years for non-retail exposures and five years for retail exposures.
- A sample of the underlying exposures should be subject to external, third-party verification prior to issuance (to a confidence level of 95%.)
- The originator or sponsor must provide a liability cash-flow model to investors, both prior to pricing and on an ongoing basis.
- The originator, sponsor and SSPE must comply with the transparency provisions of Article 5 and make all the information required by Article 5(1) (credit quality and performance information, loan-level information and the key transaction documents) available to investors before pricing at least in draft or initial form, with final documentation to be provided to investors at the latest 15 days after closing of the transaction.
Part 2 - the STS Criteria - Articles 12 and 13 (ABCP)
- For ABCP, a note references the various provisions of Articles 8, 9 and 10 (above) that do not apply, or apply differently (as noted above where relevant). The risk-retention, due diligence and transparency rules all apply in largely the same way, the ABCP programme must not be a resecuritisation and the credit enhancement must not effect tranching at the programme level. Additional provisions for ABCP are set out separately at both the transaction level and programme level (and for ABCP issued at the programme level to be eligible, the programme must be eligible, as must every transaction in the programme). For ABCP issued at the transaction level, the Criteria include: the underlying exposures must again be homogenous, but they must have a remaining maturity of no more than two years (and none with a residual maturity of longer than three years); and they must not be loans secured by residential or commercial mortgages or fully-guaranteed residential loans. For programmes, the Criteria include: the sponsor must be a credit institution (i.e. a bank) supervised under CRD IV; the issued securities must not include call options, extension clauses or any other provisions that would have an effect on final maturity; and the final documentation must be made available to investors 15 days after close of the transaction (at the latest). Since the ABCP provisions appear to have been drafted in at a late stage, these may be subject to lengthy negotiations amongst the European authorities and additional amendments may be made prior to their finalisation.