European Commission's proposed EMIR reform raises questions for Securitisation SPVs
Following the completion of a planned review of the European Market Infrastructure Regulation (EMIR), the European Commission has proposed a new Regulation amending EMIR that would make several changes to the legislation in terms of reporting, clearing and risk mitigation for over-the-counter (OTC) derivatives. While many of these proposed reforms would appear to ease certain burdens and introduce welcome simplifications, there is a key proposal that would, if implemented in its current form, impact on special purpose entities used in securitisation transactions ("SSPEs").
The proposal would re-categorise SSPEs (as defined in the Capital Requirements Regulation1 as "financial counterparties" ("FCs") under EMIR. At present, they are classed as "non-financial counterparties" ("NFCs"). This re-categorisation would mean that:
- SSPEs would be subject to the margining rules as well as being brought within the scope of other enhanced risk-mitigation obligations, such as monthly reports to the competent authority of OTC transactions unconfirmed for over 5 business days and those involving large disputes (currently applicable to FCs) and daily marking to market, tighter timeframes for exchange of confirmations and other frequent portfolio reconciliations (currently applicable to FCs and NFC+).
- SSPEs would become more likely to be subject to the clearing obligation unless either:
- the transaction is bespoke and does not fall within the class of OTC derivatives designated as subject to the clearing obligation;
- the transaction is entered into with an entity not subject to the EMIR clearing obligation;
- the transaction is a one-off OTC derivative transaction (as the clearing obligation only bites on future transactions once the threshold has been breached); or
- they can take advantage of a new clearing threshold for FCs that would allow them to be classed as a "small FC".
- The determination of whether an FC is small will use the same clearing thresholds currently applicable to NFCs2 however a small FC would be more likely to breach one of the clearing thresholds than is presently the case for NFCs, since the scope of the transactions included in the calculation will be broader for a small FC than for NFCs. A small FC would be required to include all its own OTC derivatives as well as those of all its group entities (not just those of the non-financial entities within the group as is currently the case with NFCs). Moreover, currently SSPEs may take some comfort from the hedging exemption in their analysis of their obligation to comply with the clearing obligation. Broadly, this allows NFCs to exclude any OTC transactions that are commercial hedging or treasury activity. However, the new reform proposals have no such hedging exemption included for small FCs, so all OTC derivatives would need to be included in assessing whether a small FC has breached any of the clearing thresholds.
- Where the SSPE uses a typical orphan structure, it is arguable that such SSPE should not be treated as part of a wider group for clearing and margining threshold purposes, although the exact criteria will need to be clarified in the final rules. However, it may be more difficult for certain types of vehicle to avoid breaching these thresholds, such as programme vehicles or where swap notional sizes are large.
The application of the margining obligation to FCs would subject all SSPEs (whether classed as FCs or small FCs) to daily mark-to-mark valuations and margin exchange under EMIR. This would be highly impractical for a typical SSPE, since they are often structured specifically to generate little or no profit, and would not be expected to have any liquid collateral with which to meet any margin obligations. Moreover an imposition of the margin requirement would lead to additional operational concerns for SSPEs (such as daily valuation and reconciliation requirements) which would need to be delegated as typically SSPEs are not resourced for such arrangements. Given that covered bond issuers benefit from an exemption from collateral posting requirements under EMIR, there is perhaps an argument for treatment of securitisations and covered bonds on a more level playing field, despite some acknowledged key differences between these types of issuing vehicle.
It is worth remembering that this is just a proposal and (some aspects) may not survive the EU negotiation process. The legislation is not expected to be finalised until sometime in 2018, and certain aspects will be phased-in, so they are still some way off in terms of application. Following the example of the successful industry lobbying that saw covered bond issuers being exempted from the collateral posting obligation we can expect trade associations such as the International Swaps and Derivative Association (ISDA) and the Association for Financial Markets in Europe (AFME) to lobby against the re-categorisation of SSPEs as FCs (having been involved in the original lobbying effort that saw SSPEs avoid being classed as FCs under the original EMIR). In any event, the securitisation industry has become accustomed to arguing for regulatory treatment which is proportionate to actual systemic importance while avoiding unintended consequences.
The proposals relating to SSPEs do not specifically provide for any "grandfathering", or transitional period(s) to allow securitisations existing at the time of entry into force of the amended EMIR time to ensure their compliance with the potential new categorisation of an SSPE as an FC and meet the resulting obligations. We can expect trade associations to lobby against retroactive effect and in favour of time for phase-in since, without any transitional changes, the proposed reforms would mean that the re-categorisation of SSPEs as FCs would take effect as soon as the amendment takes force (i.e. on the twentieth day after publication in the Official Journal of the European Union) whilst the clearing obligation would take effect six months after the entry into force of the amendments and some other aspects of the legislation would take effect up to 18 months after entry into force. This would mean that any newly re-categorised small FC would need to comply with the margin exchange requirement as soon as the amendments are in force (currently the EMIR risk mitigation obligations do not include explicit power to specify an effective date or phase in for application of the risk mitigation obligation).
In the meantime, we recommend that transaction parties consider as carefully as possible whether transaction documents can be 'future-proofed' for a possible change in status of SSPEs to become FCs or small FCs under the amended EMIR. This may include ensuring that any necessary noteholder consents and notification provisions are built into the documents to avoid potential disputes. In any case, there will likely need to be an assessment of whether an SSPE can practically comply with the obligations, or whether alternative steps needs to be taken to comply (such as those set out above). As a last resort, an SSPE may have to consider whether it should seek to avoid hedging in future altogether.