The European Banking Authority (the "EBA") recently published a consultation paper (the "Consultation Paper") in relation to the draft regulatory technical standards (the "Consultation Draft RTS")1 with respect to the risk retention requirements for originators, sponsors, original lenders and servicers pursuant to the EU Securitisation Regulation.2
Risk retention is a key component of the regulatory regime in respect of securitisation transactions. Originally put in place in response to the financial crisis, it is aimed at aligning the interests, and risk, of sell-side parties with those of investors, by ensuring that the relevant entity has some "skin in the game". The EU Securitisation Regulation introduced a direct obligation on the originator, sponsor or original lender to maintain the required minimum material net economic interest, in addition to the "indirect" obligation on institutional investors to verify that the risk retention requirements are satisfied.
Under Article 6(7) of the EU Securitisation Regulation, the EBA was required (in close cooperation with the European Securities and Markets Authority and the European Insurance and Pensions Authority) to prepare draft regulatory technical standards ("RTS") to specify in greater detail the risk retention requirements set out in Article 6 of the EU Securitisation Regulation. The EBA submitted a final draft of the regulatory technical standards to the European Commission on 31 July 2018 (the "2018 Draft RTS"). However, the 2018 Draft RTS have not yet been adopted by the European Commission, and have therefore not yet come into force. Under the transitional provisions of the EU Securitisation Regulation, certain provisions of the technical standards put in place under the Capital Requirements Regulation (as amended, the "CRR") continue to apply until the new RTS come into effect. In the meantime, various amendments were made to the EU Securitisation Regulation and the CRR earlier this year as part of the so-called "Capital Markets Recovery Package" (the "Amendment Regulations")3 and, since some of those amendments relate to risk retention, the EBA is now required to submit draft risk retention regulatory technical standards to the European Commission by 10 October 2021. As a result, a new public consultation has been launched as set out in the Consultation Paper.
Consultation Draft RTS
The Consultation Draft RTS include the majority of the provisions from the 2018 Draft RTS and now also include a number of proposed new provisions resulting from the Amendment Regulations, together with a number of questions about such provisions. In addition, they make some proposed further changes. Below are some of the key proposed changes compared with the 2018 Draft RTS.
NPE securitisations The Amendment Regulations introduced some amendments to the risk retention regime with respect to securitisations of non-performing exposures ("NPEs").
In such securitisations, the servicer is permitted to act as the risk retainer (instead of the originator, original lender or sponsor), provided that it is able to demonstrate that it has expertise in servicing exposures of a similar nature to those being securitised and has well-documented and adequate policies, procedures and controls in place. The Consultation Draft RTS include wording clarifying the expertise which is required.
In addition, the Amendment Regulations permit the risk retention in a NPE securitisation to be sized based on the net value of the NPEs, being their nominal value less any non-refundable purchase price discount agreed at the time of the securitisation. The Consultation Draft RTS contain proposed wording setting out in more detail how the net value should be calculated.
Synthetic excess spread The Amendment Regulations also implement an STS (simple, transparent and standardised) framework for balance sheet synthetic securitisations. The Consultation Draft RTS allow for synthetic excess spread which is subject to capital requirements under the applicable prudential regulation (and provided certain other conditions are fulfilled) to be used as an acceptable form of risk retention in such synthetic securitisation transactions.
Fees Pursuant to the Amendment Regulations, a new provision has been added to Article 6 of the EU Securitisation Regulation, requiring risk retainers to take any fees "that may in practice be used to reduce the effective material net economic interest" into account when measuring the retained interest. The Consultation Draft RTS provide that the retained interest should not be prioritised in the allocation of cashflows and that any fees payable to the retainer for provision of services in priority to other items will only be deemed to be compliant with the requirements if they are on an arm’s length basis and represent genuine consideration for the provision of the relevant services.
Securitisation of own liabilities The Consultation Draft RTS provide that the risk retention requirements are deemed to be complied with in the case of securitisations solely of the issuer’s own covered bonds or similar debt instruments.
Resecuritisations While resecuritisations are generally prohibited under Article 8 of the EU Securitisation Regulation, permission may be granted by a competent authority for a resecuritisation for certain specified legitimate purposes. In such circumstances, the required material net economic interest must be retained at each level of the transaction, except where the originator of the resecuritisation is also the originator and retainer of the underlying securitisation, the resecuritisation is backed by solely by exposures or positions retained by the originator in excess of the required minimum net economic interest and there is no maturity mismatch.
Adverse selection Article 6(2) of the EU Securitisation Regulation provides that originators shall not select assets to be transferred to the securitisation special purpose entity with the aim of rendering losses on those assets, measured over the life of the transaction, or over a maximum of 4 years where the life of the transaction is longer than 4 years, higher than the losses over the same period on comparable assets held on the balance sheet of the originator. The Consultation Draft RTS amend the wording from the 2018 Draft RTS and provide that, in assessing whether the originator has complied with the provisions against "cherry-picking", the originator's actions should be taken into account, including any internal policies, procedures and controls. The requirements shall be deemed to have been complied with whether there are no exposures left on the originator's balance sheet which are comparable to the securitised exposures and where this is clearly communicated to investors.
Sole purpose test Article 6(1) of the EU Securitisation Regulation provides 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. The wording with respect to the "sole purpose test" in the 2018 Draft RTS has been amended in the Consultation Draft RTS and now states that, for the purpose of assessing whether an entity has been established or operates for the sole purpose of securitising exposures the following should be taken into account:
- the entity has a strategy and the capacity to meet payment obligations consistent with a broader business model that involves material support from capital, assets, fees or other sources of income, by virtue of which the entity does not rely on the exposures to be securitised, on any interests retained or proposed to be retained in accordance with this Regulation or on any corresponding income from such exposures and interests as its sole or predominant source of revenue;
- the responsible decision makers have the necessary experience to enable the entity to pursue the established business strategy, as well as adequate corporate governance arrangements".
Master trusts The retention of the "originator's interest" is a common method of risk retention for master trusts. This is now permitted under option (b) of Article 6(3) of the EU Securitisation Regulation. However, under the previous CRR regime, the equivalent option did not contain reference to "revolving securitisations" and retention was instead achievable under option (a). The 2018 Draft RTS contained some clarificatory wording stating that retention under option (a) could be achieved by way of the originator's interest, which was helpful with respect to pre-existing master trusts, but that wording has now been deleted in the Consultation Draft RTS. It is not clear what the effect of such deletion is, but market participants will want to ensure that retention is still possible with respect to new issuances under pre-existing master trust securitisations which have risk retention pursuant to option (a), without falling foul of the requirement that the retention option should not be changed during the life of the securitisation.
We expect that market participants will be generally pleased that progress has been made with the development of the risk retention RTS and that they are a step closer to being finalised after a significant period of inactivity. However, the proposed wording of the draft RTS and the questions in the Consultation Paper will need to be considered carefully. Responses to the consultation by interested parties are required to be submitted by 30 September 2021.