The European Banking Authority (EBA) has published an Opinion how to improve the functioning of the European securitisation market, which is based on a detailed Report which assesses compliance by competent authorities with legislative provisions on securitisation risk retention, due diligence and disclosure requirements (focusing on jurisdictions which have an active securitisation market, i.e., the UK, the Netherlands, Spain and Italy). Preparation of the Report was prompted by Article 410(1) of the Capital Requirements Regulation (CRR), which requires the EBA to report to the European Commission on an annual basis about the measures taken by competent authorities to ensure compliance with Articles 405-409 of the CRR (the 5% securitisation risk retention requirement, and the related investor due diligence and disclosure requirements), but also as a result of a Commission Call for Evidence (sent to the EBA in January 2014) requesting the EBA's advice on the appropriateness and effectiveness of the CRR and Capital Requirements Directive IV (CRD IV) risk retention provisions for investors, sponsors and originators, in light of international market developments. The EBA's advice to the Commission may be summarised in the following ten recommendations:
- Introducing a complementary "direct" approach to risk retention to supplement the "indirect" approach which places the onus on the investor to ensure compliance with the risk retention provisions. The "direct" approach would oblige originators / sponsors / original lenders to publicly disclose their (level of) retention on a detailed, standardised form, that would reduce compliance costs and improve legal certainty for investors (and would also assist with meeting some of the recently-proposed criteria for "high quality securitisation" (HQS) which propose that the originator or sponsor should retain a material net economic exposure and demonstrate a financial incentive in the performance of the assets following their securitisation).
- The existing five forms of retention (a 5% vertical slice, first-loss piece, no less than 5% of nominal value of randomly-selected exposures ("representative sample"), L-shaped retention (combined first loss and vertical retention) and the "seller's share" (designed for master trusts)) should not be supplemented at this time with further options, and that the effectiveness of the existing retention forms should be assessed.
- No alternative mechanisms beyond risk retention should be introduced as substitutes for the risk retention requirements.
- Consolidation (e.g. treating a subsidiary's capital as belonging to that of a group, or, in this case, the group retaining on behalf of an individual entity) is essential, and the existing scope of consolidation (set out in Article 405(2) CRR) should not be expanded.
- Since there are sufficient ways of complying with the retention rule, no further exemptions and/or exceptions should be introduced at this time. However, the EBA recommends assessing the possibility of introducing a provision whereby the retaining entity can change during the life of a transaction, to ensure that the retaining party is always the most appropriate one.
- The definition of "originator" should be narrowed down to reduce potential misuse of the retention requirements and close a loophole that has allowed parties to retain which have not always aligned the interests of the most appropriate party to retain the interest with that of the investor(s). The EBA offers to carry out further work on narrowing down the scope of the originator definition, and it will be important to keep an eye on this, as it may impact (amongst other transaction structures) collateralised loan obligations (CLOs).
- The disclosure requirements (Article 409 CRR and Articles 22 and 23 of the relevant Regulatory Technical Standard) are appropriate and fit for purpose (and have been / will continue to be supplemented by other measures such as Article 8b of the EU Regulation on Credit Rating Agencies (note that the final Regulatory Technical Standards on Disclosure Requirements for Structured Finance Instruments - implementing Article 8b - have now been published in the Official Journal of the EU and take effect from 1 January 2017) so the EBA does not recommend any changes to these requirements.
- The due diligence requirements (Article 406 CRR) are sufficient and appropriate to enable investors to conduct appropriate due diligence, and the EBA makes no recommendations for any changes to these requirements.
- The current sanctions (the application of incrementally-increasing risk-weights for infringements under Articles 245(6) and 337(3) CRR)) and the related administrative penalties (under Article 67 of CRD IV) serve as an adequate deterrent to violating the risk retention, due diligence and disclosure requirements. The EBA notes that there has been a very low number of non-compliant cases requiring the imposition of sanctions.
- Supporting the International Organisation of Securities Commissions' (IOSCO) Peer Review of securitisation markets, the EBA encourages more alignment and consistency between the EU and (specifically) the US risk retention regimes, noting that a "real wedge" may be driven in global securitisation markets if this issue is not addressed.
The EBA's Opinion and Report have been sent to the European Commission, which will review the recommendations and respond to the EBA accordingly. Given that some aspects of the legislative framework for risk retention (in particular the RTS and ITS accompanying CRD IV / CRR) have only been recently finalised, the EBA notes that it is fairly early days in the full application of the risk retention framework to properly assess its effectiveness. As a result, significant changes are unlikely to be made to CRD IV / CRR and its Level 2 and 3 measures, within the immediate future.