The European Union (EU) sees the development of a simple, transparent and standardised (STS) securitisation market as constituting a key building block of the Capital Markets Union. Against the backdrop of this objective, the European Commission has published a new regulation establishing common rules and a framework for simple, transparent and standardised securitisation. Catherine Overton and Cathy Stringer comment on the proposed framework and summarise the key changes.
Simple, transparent and standardised
On 30 September 2015, the European Commission published its proposed regulations for a “high quality securitisation” framework. The regulations introduce criteria for STS securitisation, thereby identifying “sound instruments based on clear eligibility criteria”, which will qualify for lower capital charges. The STS standard is not intended to mean that the securitisation is devoid of risk, but rather that the product respects a number of criteria which should enable a prudent investor to analyse the risk involved.
The regulations will also harmonise definitions and the rules on risk retention, disclosure and due diligence, which are currently set out in different EU regulations, are not consistent and don’t yet apply to all sectors.
Originators, sponsors, original lenders and every type of EU institutional investor in securitisation transactions, including credit institutions, CRR investment firms, insurance and reinsurance undertakings, IORPs, AIFMs and UCITS management companies, will be affected.
The three key features of the proposed securitisation framework
As expected, there are proposed changes to remedy perceived weaknesses in the existing risk retention regime:
- there will be a direct risk retention requirement and reporting obligation on the originator, sponsor or original lender (as opposed to the onus being solely on, or sanction resting solely with, the investor); and
- the retention piece cannot be held by an originator entity which has been established or operates for the sole purpose of securitising exposures.
Due Diligence and Disclosure
All institutional investors must carry out specified due diligence before investing, while originators, sponsors and securitisation special purpose entities (SSPEs) must make specified information available to investors and competent authorities at specific times.
A transaction may be designated by originators, sponsors and SSPEs as a STS securitisation if it meets all specified criteria. Notification is required if a transaction no longer meets the STS criteria. There will be two sets of STS requirements: one set of criteria for term securitisations and one set for ABCP. Synthetic securitisations do not qualify (i.e. only true sales will qualify).
How and when will the securitisation framework have an impact?
Originators, sponsors, original lenders and SSPEs that fail to comply with their obligations under the regulation relating to risk retention, disclosure and STS notification will be subject to sanctions. The potential sanctions may include criminal sanctions or administrative sanctions such as bans and fines of up to EUR 500,000 or (for legal persons) up to 10% of the total annual turnover, which, in certain cases, could be an even higher percentage.
Crucially, transactions which do not meet the STS criteria will not benefit from the lower capital charges.
The framework will apply to securitisations closing after entry into force of the regulation. Due diligence requirements for institutional investors will also apply to securitisations issued on or after 1 January 2011 or to which new exposures have been added or substituted after 31 December 2014. Outstanding securitisations may be designated STS securitisations only if they meet the STS criteria.
Once adopted, the regulation will enter into force 20 days after publication in the EU’s Official Journal. However, it must first be approved by the European Parliament and Council of the EU which can take many months.
How to prepare for the STS framework
Even though the new regulation is not expected to come into force until the second half of 2016 at the earliest, the proposed framework will need to be borne in mind when structuring current transactions. Structurers will want to ensure, when dealing with a relevant asset class such as RMBS, that their deals meet all of the criteria to qualify as a STS transaction. In particular, continued focus will need to be placed on structuring of the risk retention and identity of the holder of the risk retention piece.
There are certain asset classes which de facto will not meet the STS securitisation criteria, such as CMBS and managed CLOs. Although it seems unlikely that the regulations will change to accommodate such transactions, no doubt there will be further representations from the industry on this.
An important point to note is that a number of the provisions require further detail which will be set out in associated regulatory technical standards (RTS) to be published in due course. The RTS in force in respect of the current securitisation regime, such as the risk retention RTS and the disclosure RTS for structured finance instruments (under article 8b of CRA3) will be replaced. However, it is not known whether the new RTS will be replicate these or whether there will be significant changes.
A broadly welcome measure
The securitisation market in Europe has been flooded by new regulations since the credit crisis. By drawing together the different regulatory strands under specific themes such as risk retention and disclosure, the new regulation has broadly been welcomed by market participants, providing as it does a more coherent and clear repository of, and sourcebook for, securitisation regulation.
In terms of specific technical changes that have appeared for the first time, the most significant is probably the risk retention requirement, being for the first time a direct legal obligation of the originator/sponsor/original lender, as opposed to the sanction for non-compliance resting solely with the investor. Regulators had expressed concern that the existing framework for risk retention was open to abuse and so they have sought to address this by extending the burden to those originating and structuring the deals.
In terms of direct economic impact, implementing the new concept of so-called “high quality securitisation” – a concept which itself has proved somewhat controversial as it implies the notion of ‘good’ and ‘bad’ ABS – provides a means of alleviating the extremely onerous regulatory capital charges imposed by Basel III on asset backed securities (ABS). The European market has already seen new demand from credit institutions and other institutional investors for new issuance of beneficiary asset classes, such as RMBS, largely stemming from the revised capital charges.
However, practitioners and issuers of CMBS and certain other asset classes are still waiting for relief as these asset classes have been (some would argue, arbitrarily) excluded from the “high quality securitisation” label. As the new regulation is still in draft form awaiting approval by the European Parliament and the Council, there is in theory still scope for further changes, although those hoping for further favourable revisions may yet be disappointed.