Following Dechert’s Legal Update published on 14 September 2015, we have had sight of an updated draft of the proposed EU legislation on securitisations. The updated draft shows signs that regulators have taken on board some of the comments that Dechert, along with certain other leading law firms, raised earlier this month, however we believe that there is still room for improvement.
After the leak of a preliminary draft of the EU legislation, markets expressed concern that the proposed legislation would among other things significantly curtail the “Originator” option and have a damaging effect on securitisations, including CLOs. Despite assurances by regulators that the changes were only intended to limit the “abuses” and not to change the status quo, a number of transactions and warehouses were put on hold. The first draft of the securitisation regulation provided that “For the purpose of the application of [the risk retention provisions], an entity shall not be considered to be an originator if it has been established or operates primarily for the purpose of securitising exposures” (emphasis added). This created substantial uncertainty in the market since many Originators do securitise assets as a significant portion of their business. Dechert collaborated with other leading law firms to suggest an alternative casting of this provision to create a more certain test for whether an originator vehicle had sufficient substance to act as a retainer. The Firms suggested a test based on the entity having a business strategy and a capacity to meet a payment obligation consistent with a broader business enterprise or the entity having a broader business enterprise and not exist for the sole purpose of securitizing exposures.
The updated draft regulation addresses at least some of our concerns, and therefore is a step in the right direction. Specifically, it amends the requirement for originator retainers: “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”. This move away from a primary purpose test is critical to eliminating uncertainty. In the introduction to the updated draft regulation, the European Commission have also commented “it is specified that for the purposes of [the risk retention provisions] an entity established as a dedicated shelf for the sole purpose of securitising exposures and without a broad business purpose cannot be considered as an originator. For instance, 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”. This introduction provides some useful guidance for investors in determining whether an entity is a valid originator, although the commentary on the draft regulation is not legally binding. We would note that many of the structures we have described in Dechert OnPoints (The Rise of the C-MOA and Capitalized Manager Vehicles, Majority Owned Affiliates and other FAQs) would have the type of broad business purpose contemplated by the updated draft regulation.
The updated draft regulation also seeks to address concerns we raised about the lack of grandfathering provisions in the draft regulation. The updated draft regulation states that for securitizations entered into before the entry into force of the regulation, the existing risk retention regime will generally apply. However, in relation to due diligence requirements, the position remains that, since these are essentially taking over from existing law, the due diligence and disclosure obligations will apply to all securitizations issued on or after 1 January 2011 and to securitizations issued before that date, where new underlying exposures have been added or substituted after 31 December 2014. The updated draft also clarifies that the current regulatory technical standards will continue to apply until new regulatory technical standards are adopted, which is helpful. Otherwise, the market could not be certain that much of the clarity provided by the existing regulatory technical standards would continue to apply.
The updated draft regulation does not, unfortunately, take on board our suggestions to revise the definition of “Sponsor” in the Capital Requirements Regulation so investment firms with CRD 3 permissions and U.S. Registered Investment Advisors are not currently able to act as “sponsors”. As a result, sponsors are limited to EU established, MiFID authorized, investment firms, which creates an unfortunate disconnect with the U.S. risk retention rules and does not comport with the reality that many CLO transactions by U.S. registered investment advisors will continue to seek EU compliance and will be limited by such an approach to relying solely on an originator option. Similarly, concerns raised about extra-territorial application have not been directly addressed. We will work with other leading law firms to follow up on both points.