As part of its implementation of the Action Plan on Building a Capital Markets Union, the European Commission issued two draft regulations on securitisations on September 30 2015. If implemented, the regulations will make major changes to European securitisation rules, including the creation of a simple, transparent and standardised (STS) designation for securitisation. Investments in STS securitisations will benefit from preferential regulatory capital treatment. However, originators, sponsors and securitisation special purpose entities (SSPEs) of STS securitisations will be jointly responsible for determining that the securitisation complies with the STS criteria.
The draft regulations also consolidate and revise the rules applicable to all types of securitisation in Europe (not just to STS securitisations).
If implemented largely as proposed, the draft regulations will likely have an impact on securitisation markets far beyond European borders, as issuers and investors in the United States, Canada, Australia and elsewhere grapple with the consequences of a two-track securitisation regime that differs from what is and likely will be in place in their home countries.
On September 30 2015 the European Commission published its much-anticipated action plan. This followed the launch of a green paper entitled "Building a Capital Markets Union", together with a consultation paper on the creation of a high-quality securitisation market and a further paper proposing a review of the EU Prospectus Directive on February 18 2015. Responses to the consultation paper were requested by May 13 2015, following which a conference took place over the summer.
The action plan included two draft regulations on securitisations which, if implemented, will make major changes to European securitisation rules.
The first regulation (the Securitisation Regulation) will harmonise rules on risk retention, due diligence and disclosure across the different categories of European institutional investor (which are currently addressed in separate and varying regulations applicable to different categories of investor), which will apply to all securitisations (subject to grandfathering provisions), and will introduce a new framework for STS securitisations. The regulation will also repeal existing provisions that would otherwise become overlapping in legislation relating to the banking, asset management and insurance sectors.
The second regulation (the Amending Regulation) will implement the revised Basel framework for securitisation in the European Union and implement a more risk-sensitive prudential treatment for STS securitisations similar to that recommended by the European Banking Authority.
The Securitisation Regulation distinguishes between STS securitisations and those securitisations which do not meet the STS criteria (non-STS securitisations). The main benefit of compliance with the STS criteria will be preferential regulatory capital treatment for institutional investors. However, originators, sponsors and SSPEs of securitisations will need to choose to apply the STS label to each securitisation; if they do so, they will be jointly responsible for determining that the securitisation complies with the STS criteria and will be liable for any loss or damage resulting from incorrect or misleading STS notifications.
Rules applicable to all securitisations
Definition of 'originator'
The Securitisation Regulation amends the definition of 'originator' for the purposes of the risk retention provisions by providing that "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". Although it appears that the European Commission has softened this provision during the course of drafting this legislative proposal, this definition of 'originator' may still be of concern to those market participants involved in the issuance of securitisations involving portfolio sales and marketplace lending, as well as collateralised loan obligations - particularly given the statement in the explanatory memorandum to the Securitisation Regulation that "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".
The Securitisation Regulation repeals the separate (and differing) disclosure, due diligence and risk retention provisions in the Capital Requirements Regulation, the EU Alternative Investment Fund Managers (AIFM) Directive and Solvency II, and replaces them with one set of shorter, harmonised rules to apply across all financial sectors to banks, investment firms, insurers, alternative investment managers, undertakings for collective investment in transferable securities and institutions for occupational retirement provision, where relevant.
New regulatory technical standards
While it appears that regulatory technical standards will be prepared in due course in relation to risk retention and disclosure standards, the Securitisation Regulation does not confirm that such standards will also be prepared in relation to the new due diligence requirements. In relation to disclosure standards, it appears that, as currently drafted, the disclosure requirements will apply to all securitisations, including private and bilateral securitisations. It is hoped that this position will be clarified in due course, given the European Securities and Markets Authority's (ESMA) workstream on disclosure obligations on private and bilateral transactions. Industry participants have raised concerns that if disclosure standards are not adapted to take account of key confidential and market-sensitive information which is common to many private transactions, then securitisation may no longer be a sustainable form of funding for the private market. There is also concern that until the new regulatory technical standards (RTS) are developed, the current RTS will apply to new transactions; this could lead to difficulties ensuring that transactions comply with the differing requirements under the two sets of RTS.
There are separate but broadly similar STS criteria for term securitisations and asset-backed commercial paper (ABCP), which take account of their structural differences; these differ from the criteria published by the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions, which do not take account of ABCP at this time. Currently, only 'true sale' securitisations can be STS securitisations. Various issues in the current draft of the STS criteria in the Securitisation Regulation would prove concerning for securitisations, such as the requirement to provide certain disclosures to potential investors before pricing. The liquidity coverage ratio requirements and the treatment of securitisations under Solvency II will also need to be updated to reflect the final STS criteria once the Securitisation Regulation is finalised.
STS and ABCP
The criteria for ABCP, as currently drafted, contain issues of significant concern to the ABCP industry. There are extensive disclosure obligations, including those relating to the disclosure of information on the underlying exposures, which would threaten the ability of ABCP transactions to maintain anonymity in relation to underlying assets. In addition, the maturity limits and weighted average life limits will limit the types of underlying transaction in which an ABCP programme can invest. For an ABCP programme to meet the STS requirements, each transaction in the programme would have to be STS compliant – a test unlikely to be met by most (if any) ABCP programmes.
STS transparency requirements
In addition to the information which is currently required under the Credit Rating Agencies Regulation (CRA 3) regulatory technical standards, for STS securitisations the following transparency requirements will need to be observed:
- The originator, sponsor or SSPE must provide access to static and dynamic historical default and loss performance data for "substantially similar" exposures to those securitised in respect of a period of no less than five years for retail exposures and no less than seven years for non-retail exposures. Disclosure must also be made of the basis for claiming similarity. The requirements for the provision of historical data could mean that new types of ABS may struggle to achieve STS status.
- A file audit by an independent party to a 95% confidence level is required. Although common for some asset classes, file audits are not universally undertaken at present.
- The originator or sponsor must provide a liability cash-flow model to investors and maintain this on an ongoing basis. This was removed, following consultation with the industry, from the CRA 3 regulatory technical standards on disclosure requirements for structured finance instruments.
Determination of STS status
To the extent that STS status is claimed, the originators, sponsors and SSPEs will be jointly responsible for determining that a securitisation complies with the STS criteria and for notifying EMSA using a template created by the European supervisory authorities. The European supervisory authorities will have 12 months following the entry into force of the regulation to provide further details on the information to be provided in the STS notification and to determine the form of the template. Currently, the Securitisation Regulation provides that investors "may place appropriate reliance" on the STS notification and on the information disclosed by the originator, sponsor and SSPE on compliance with the STS requirements; but it does not clarify the extent of investors' due diligence obligations in this regard. Despite the inclusion of self-certification provisions regarding STS status in the Securitisation Regulation, there have been suggestions that a third-party certification regime would be more appropriate and may provide investors will greater levels of comfort.
Liability for STS status
Of greater concern is that SSPEs, originators and sponsors will be liable for any loss or damage resulting from incorrect or misleading STS notifications, particularly given the severity of the sanctions. ESMA will be required to maintain a list of STS securitisations and a list of securitisations which have been determined to be no longer compliant with the STS criteria. Originators, sponsors and SSPEs will be obliged to inform ESMA as soon as a securitisation becomes non-compliant with the STS criteria. Securitisations issued before the Securitisation Regulation comes into force will be permitted to be designated as STS securitisations only if they comply with the STS criteria.
STS and synthetic securitisations
The European Banking Authority is currently preparing draft criteria for synthetic securitisations for review by the European Commission. Re-securitisations cannot be STS securitisations
Application and grandfathering arrangements
Although there are strong arguments in favour of applying the new rules only to new transactions entered into after the Securitisation Regulation comes into effect, it does not currently provide for this. The position on grandfathering of existing securitisations is not entirely clear in the draft Securitisation Regulation - in particular, in relation to those securitisations entered into on or after January 1 2011 (or to which new exposures were added or substituted after December 31 2014), but before the entry into force of the Securitisation Regulation. Based on the current proposals, and assuming that the lack of clarity is resolved, it appears that the Securitisation Regulation will apply as summarised below.
|Date of issuance of securitisation or addition or substitution of new exposures||Relevant legislative provisions|
|Before January 1 2011 (assuming no new exposures have been added or substituted to the transaction after December 31 2014)||The Securitisation Regulation will not apply. Existing requirements under the Capital Requirements Regulation, the AIFM Directive, Solvency II and CRA 3 will apply|
|On or after January 1 2011 (or to which new exposures were added or substituted after December 31 2014) but before entry into force of the Securitisation Regulation||Institutional investors may be subject only to the new due diligence rules in the Securitisation Regulation and the risk retention rules currently applying under the Capital Requirements Regulation, Solvency II and AIFM Directive regimes|
|On or after the date of entry into force of the Securitisation Regulation (or to which new exposures were added or substituted on or after the date of entry into force of the Securitisation Regulation)||The Securitisation Regulation will apply|
The Amending Regulation will implement a new hierarchy of the three approaches for calculation of capital requirements, under the Capital Requirements Regulation, following the recommendations set out in the revised Basel framework for securitisations, which was published by the BCBS in December 2014. The Amending Regulation will also adopt a more risk-sensitive prudential treatment for STS securitisations, broadly similar to that proposed by the European Banking Authority in its report on qualifying securitisations. The three approaches are recalibrated in order to generate lower capital charges for positions in transactions qualifying as STS securitisations. In addition, senior positions in STS securitisations will have the advantage of being subject to a lower floor of 10% (a floor of 15% will continue to apply to non-senior positions in STS securitisations and to non-STS securitisations).
Next steps and timing
The proposed regulations have been sent to the European Parliament and the Council for review and adoption under the co-decision procedure. This process could be lengthy and could well take at least a year. Once adopted, the Securitisation Regulation and the Amending Regulation will be directly applicable in member states from the date of entry into force. Once the regulations are in force, the European supervisory authorities will be required to prepare the related regulatory technical standards.
For further information on this topic please contact Julian Craughan or Rachel Pleming at Hogan Lovells International LLP by telephone (+44 20 7296 2000) or email (firstname.lastname@example.org or email@example.com). The Hogan Lovells International website can be accessed at www.hoganlovells.com.
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