The Joint Committee of the European Supervisory Authorities (the European Securities and Markets Authority (ESMA), the European Banking Authority (EBA) and the European Insurance and Occupational Pensions Authority (EIOPA) - together, the "ESAs") have issued a Report on Securitisation, which addresses the key issues in the securitisation market of due diligence and disclosure. The Report also serves as the ESAs' response to the European Commission's Green Paper on Building a Capital Markets Union (CMU), which included consultations on developing an EU framework for Simple, Transparent and Standardised (STS) securitisation, and on a Review of the Prospectus Directive (see the Feature Piece in Edition 15 of this SCM Briefing for detailed background). Focusing specifically on whether the existing disclosure and due diligence requirements (introduced via the Credit Rating Agencies Regulation III (CRA III), Capital Requirements Directive IV and Regulation (CRD IV / CRR), the Prospectus Directive, the Alternative Investment Fund Managers Directive (AIMFD) and Solvency II, amongst others) have been set up in a consistent manner, and whether there are inconsistencies that should be dealt with, the ESAs make nine recommendations which should improve the transparency of structured finance instruments and contribute to the recovery of European securitisation markets:
- Harmonising due diligence requirements: since existing due diligence requirements differ as they depend on the investor-type (i.e. bank, insurer, investment fund etc), they should be well-aligned and where possible, consistent (with common due diligence requirements across investor types to be introduced where possible).
- Due diligence requirements should drive disclosure requirements: investor due diligence needs must be fully met by the disclosure requirements (this is only partially achieved through some of the CRA III requirements, for example). The ESAs recommend several new items for disclosure, including borrower credit scores, the status and level of credit enhancement for all tranches, detailed information about triggers, and Basel capital ratios. In addition, all legal entities specified in the transaction documentation should have an assigned Legal Entity Identifier (LEI).
- Standardised investor reports should reflect structured finance dynamics and be stored in a centralised public space: as you will be aware, the Regulatory Technical Standards (RTS) accompanying CRA III establish a new platform, the "SFIs website", for the collection of individual rating data to which issuers of structured finance instruments must submit information (from January 2017). The ESAs recommend that the various information (including loan-level data, investor reports, default data etc) be presented in a dynamic document that can be adapted to allow it to be produced in a format that can allow investors to meet their due diligence requirements. In addition, prospectuses, investor reports and all other transaction documents should be stored on the SFIs website (with back-up storage on the originator/sponsor (or other parties') own website).
- Data providers should be allowed to fulfil disclosure requirements: the ESAs recommend that flexibility is allowed in terms of which party makes certain disclosures, such that the "data owner" should be the most efficient entity to provide it (whether that be the originator, sponsor or issuer).
- Loan-by-loan data should be provided to investors: the disclosure requirements in the CRA III RTS should set the common basis for the disclosure of loan-level data in structured finance transactions (with the ESAs not recommending any relaxation of those requirements, but suggesting that loan-level data should be provided to investors), and that the loan-level reporting templates are modified to incorporate additional fields that would capture prepayments and borrower creditworthiness data.
- All investor-types should be empowered to effectively conduct their own stress tests:the ESAs recommend independent validation (by third parties) of cash flow models, the introduction of basic stress test requirements (of default rates), and a new requirement for a liability cash flow model to be made available to investors.
- Further work is required to explain/review definitions and key terms in relevant EU legislation: work should be undertaken to review the use of different definitions and key terms throughout EU legislation, and develop a comprehensive, EU-wide glossary. In addition, a harmonised approach should be adopted regarding extending the disclosure requirements to private and bilateral SFIs (see our update on CRAs in Edition 15 of this SCM briefing for further background).
- Enhance investor protection through SFI disclosure requirements which enable investors to comply with their due diligence requirements: since investors will come to invest in SFIs through different channels (e.g. SFIs admitted to trading on an EU market or offered to the public, or a non-EU market, or over-the-counter), there should be an adequate level of transparency and disclosure regardless of the channel, and the disclosure requirements should be mandatory for all SFIs admitted to trading on a regulated market or offered to the public.
- Comprehensive framework for supervision and enforcement: the ESAs suggest that capital requirements, the rules governing the eligibility of assets as High Quality Liquid Assets under CRR, as Type 1 / Type 2 under Solvency II, central bank collateral eligibility rules and admission to trading rules should all be linked to compliance with the disclosure requirements, to ensure their effectiveness.
The Report is not a consultative document, but (since it is intended to serve as the ESAs' response to the CMU Green Paper), some or all of the ESA's recommendations may be taken forward by the European Commission in developing the CMU (the Commission's CMU Action Plan is expected to be issued during Summer 2015). Otherwise, the Report provides an excellent, detailed overview of the various disclosure and due diligence requirements affecting structured finance transactions and an analysis of the extent to which transaction parties are required to provide the information investors need to perform effective due diligence on these instruments.
Joint Committee Report on Securitisation
European Commission Green Paper on Building A Capital Markets Union