Differences in scope
"US risk retention rules and their impact on non-US securitisations" reported on the final US risk retention rules, which were adopted in October 2014 and will apply from December 24 2016 to asset-backed securities (ABS) issued on or after December 24 2016 with respect to all asset classes other than residential mortgage-backed securities (RMBS) (to which the rules have applied since December 24 2015).
This update summarises the key differences between US and EU risk retention requirements for securitisations.
The US and EU risk retention rules do not completely align; therefore, securitisations distributed into both the US and EU markets must be careful to comply with both sets of rules. Key differences between the US and EU risk retention rules include the following:
- The US rules regulate sponsors, whereas the EU rules (at least currently) apply to certain types of investor.
- The definition of 'sponsor' in the US rules is not the same as the definition of 'sponsor' in the EU rules, but instead is closer in meaning to the EU definition of 'originator'. Therefore, care is needed when using terminology and assessing the roles of the various transaction parties under the EU and US rules.
- The scope of the rules is different due to the different terms used to describe transactions that are subject to risk retention: the US risk retention rules apply to 'securitisation transactions' and the EU risk retention rules apply to 'securitisations'. The terms are defined quite differently.
- The EU risk retention rules permit retention in the form of retaining a random sample of the securitised exposures or a first loss of every securitised exposure, while the US rules provide no equivalent forms of retention.
- Unlike the US risk retention rules, the EU risk retention rules do not contain exemptions specific to qualifying asset classes.
- The US risk retention rules measure the horizontal/first loss retention requirements using a fair value calculation (which requires complicated pre and post-closing disclosure), whereas the EU rules measure the retention requirements based on nominal value.
- The US risk retention rules provide for a sunset mechanism that terminates the restrictions on hedging and transfer of the retention requirements in certain instances, while the equivalent EU restrictions apply at all times.
To the extent that transactions already complying with the EU risk retention rules may need to be modified to address the US risk retention rules, the European Union has adopted regulatory technical standards which permit the form of retention to be modified in 'exceptional circumstances', which in the accompanying commentary are stated to include compliance with "new risk retention rules of a third country."
The EU risk retention rules apply to any 'securitisation', which is defined as:
"a transaction or scheme, whereby the credit risk associated with an exposure or pool of exposures is tranched, having both of the following characteristics:
(a) payments in the transaction or scheme are dependent upon the performance of the exposure or pool of exposures; and
(b) the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme."
The US risk retention rules apply to any 'securitisation transaction', which is defined as "a transaction involving the offer and sale of asset-backed securities by an issuing entity", where an 'ABS' is defined, in part, as:
"a fixed-income or other security collateralized by any type of self-liquidating financial asset (including a loan, a lease, a mortgage, or a secured or unsecured receivable) that allows the holder of the security to receive payments that depend primarily on cash flow from the asset, including—
a collateralized mortgage obligation;
a collateralized debt obligation;
a collateralized bond obligation;
a collateralized debt obligation of asset-backed securities;
a collateralized debt obligation of collateralized debt obligations; and
(vi)a security that the Commission, by rule, determines to be an asset-backed security."
Consequently, although tranches and subordination are essential elements of determining whether a transaction falls within the EU risk retention rules, they are not specific factors in determining whether a transaction falls within the US risk retention rules.
As discussed in "US risk retention rules and their impact on non-US securitisations", determining whether a transaction involves the issuance of a 'security' is a critical factor in determining whether the US risk retention rules apply to a securitisation.
For further information on this topic please contact Dennis Dillon at Hogan Lovells International LLP by telephone (+44 20 7296 2000) or email ([email protected]). The Hogan Lovells International website can be accessed at www.hoganlovells.com.