The European Supervisory Authorities ("ESAs") have been hard at work fulfilling their mandates as to how to incorporate environmental, green and social ("ESG") requirements into securitisation. Swiftly on the heels of the long-awaited Article 45a report under the European Union Securitisation Regulation ("EUSR"), on 2 May 2022, the long-awaited draft regulatory technical standards ("RTS"), promised under Articles 22(4) and 26d(4) of the EUSR ("Draft RTS"), were published. The goal of the Draft RTS is to provide an alternative for originators of Simple, Transparent and Standardised Securitisations ("STS securitisations") in relation to disclosure of specific information regarding the consideration of adverse impacts on sustainability factors.
On 2 May 2022, the ESAs published a joint consultation paper ("Consultation") seeking input on draft RTS on the content, methodologies, and presentation of information about the principal adverse impacts on sustainability factors of the assets financed by the underlying exposures of STS securitisations. Please see the relevant announcement here.
The proposed Draft RTS has been drafted pursuant to requirements under Articles 22(4) and 26d(4) of the EUSR, as amended by the Capital Markets Recovery Package ("CMRP"). The Draft RTS applies only to STS non-ABCP traditional securitisations and on-balance sheet-securitisations where the underlying exposures are residential loans and auto loans and leases.
How do the Draft STS interact with other ESG regulations?
The central theme of the Consultation is whether stakeholders agree with the approach taken in the Draft RTS, which aims to draw upon, and ensure as much consistency as possible with, the ESAs’ work in respect of sustainability-related disclosures in financial services under the Sustainable Finance Disclosure Regulation ("SFDR"). As market participants will know, the SFDR imposes mandatory ESG disclosure obligations on asset managers and other financial market participants (other than banks and large corporates, which are governed by the combined provisions of the EU Taxonomy Regulation and the EU Non-Financial Reporting Directive).
Securitisations do not constitute a “financial product” under the rules of the SFDR and therefore the SFDR does not apply to securitisation transactions. Although originators of STS securitisations with residential loans or auto loans and leases as the underlying exposures were initially required to report on available environmental performance information of these underlying exposures prior to the CMRP, Articles 22(4) and 26d(4) now offer the possibility to derogate from this disclosure and follow the Draft RTS instead. As the ESAs have drafted the Draft RTS to align with the SFDR as much as possible, some originators may find that the Draft RTS suits their asset manager investors better.
It will remain possible for originators in STS securitisations to comply only with the initial disclosure requirements relating to environmental performance set out in first sentence of Article 22(4) and Article 26d(4) of the EUSR.
What impact will the Draft RTS have?
As with the SFDR, this Draft RTS is not intended to create a labelling regime and nor is it intended to create a framework for “sustainable securitisation”, i.e. to develop indicators, definitions or thresholds for when and how the originator(s) of a securitisation may characterise or market a securitisation as “sustainable”, socially or environmentally. This was further confirmed in the EBA's 2 March 2022 report, where the EBA ultimately does not currently recommend a specific framework for sustainable securitisation. This should not be a surprise.
The key aim of the Draft RTS is to provide more consistent information to assist investors with their due diligence on a product in a world where investors increasingly have to comply with their own ESG reporting requirements and need to be able to analyse the ESG aspects of their investments. By strongly aligning disclosures under the EUSR's STS regime with the SFDR, the ESA seek to create efficiencies in reporting (at least for residential loans and automotive loan and leases). This, along with the fact that this Draft RTS is entirely optional, is a welcome initiative as one of the problems plaguing the ESG market has been a lack of clarity around methodologies and characterisation of principal adverse impacts ("PAI") indicators. The Draft RTS is the ESA's response to this by enabling originators to disclose PAIs of STS Securitisations using reporting which closely aligns to the SFDR and disclosure of such PAIs might also help their investors to fulfill their own ESG reporting requirements.
For STS securitisations, which already are subject to heavy reporting obligations, this might be seen as yet another administrative burden. However, as we have seen in the securitisation market and capital markets generally, investors are seeking ESG information from originators about products. It may be that standardisation will help to facilitate due diligence as well as contributing to the combatting of greenwashing and bolster confidence in STS securitisations which have strong environmental credentials, such as ESG RMBS or potential electric vehicle securitisations in the future. Furthermore, given the optional nature of the Draft RTS, it is open to market participants not to align to this form of disclosure, albeit the market may require originators to disclose such information in the near future.
How does the Draft RTS operate?
The Draft RTS applies only to STS non-ABCP traditional securitisations and on-balance sheet-securitisations where the underlying exposures are residential loans or auto loans and leases. As with the draft SFDR RTS, the Draft RTS, where utilised by an originator, requires the use of all mandatory indicators and in addition, at least one of the additional social or governance indicators and at least one of the additional environmental indicators.
While the Draft RTS focuses only on residential loans and auto loans and leases, the Consultation seeks to gauge appetite for these optional application of PAIs to STS securitisations with other underlying exposures, including commercial real estate, SME loans, non-SME corporate debt, and trade receivables on an ‘opt-in basis’. These are set out in Annex II of the Draft RTS. This would expand PAIs to areas outside the scope of the EUSR but which might nevertheless prove useful for market participants wanting standardisation of environmental information.
Residential real estate (RRE) assets
For residential real estate, and consistent with the draft SFDR RTS, no social or governance indicators have been identified. RRE asset originators must include:
- all of the indicators included in Annex I Table 2 of the Draft RTS in relation to climate and other environment-related PAI indicators; and
- at least one of the climate and other environment-related PAI indicators included in Annex I Table 2 of draft SFDR RTS.
Auto loans and leases
Unlike for real estate, the draft SFDR RTS does not contain any specific PAI indicators for adverse impacts arising in relation to auto loans and leases. Therefore, indicators have been derived from other sources, principally from the disclosure requirements applicable to credit institutions under the delegated regulation of the EU Taxonomy Regulation. Auto loan and lease originators must include:
- at least one of the climate and other environment-related PAI indicators included in Annex I Table 2 of the Draft RTS;
- all of the indicators included in Annex I Table 2 of the Draft RTS in relation to social and governance indicators; and
- at least one of the social and governance indicators included in Annex I Table 3 of draft SFDR RTS.
What does this mean for UK securitisations?
The United Kingdom on-shored the EUSR with effect from 1 January 2021 with minimum changes ("UKSR"). The requirements relating to residential and automotive securitisations seeking STS treatment under the EUSR noted above apply through the UKSR. However, the Draft RTS does not form part of this onboarding and it is unclear to what extent the UK would seek to draw from the Draft RTS once published.
Once the Future Regulatory Framework Review: Proposals for Reform  is concluded later this year, there should be more clarity on proposed UK legislative measures.
What happens next?
The closing date for responses to the Consultation is 2 July 2022. The ESAs hope that the Draft RTS will be finalised this year. Given the time it has taken for the SFDR RTS to be processed, and the delays in producing this Consultation, this may be optimistic.
The importance of ESG in securitisation, and how to incorporate it within current and proposed frameworks, is clearly a focus for regulatory bodies. It is clear from the Consultation that the ESAs are cognisant of the existing reporting requirements to which securitisations are subject. The draft RTS do not impose compulsory requirements. Nevertheless, originators might feel an obligation to comply (whether for reputational, regulatory or market reasons); this will necessitate additional processes and costs in order to ensure compliance. Originators will need to determine to what extent this is optimal for both them and their investors but it may be that additional standardisation for disclosure in the market might assist in increasing market share for a product that has some way to go in meeting its full potential in contributing to the ESG agenda.