On 13 July 2009, the Basel Committee announced enhancements to the Basel II framework1 (the Basel II Enhancements) approved during its meetings on 8 and 9 July 2009. Among other things, the Basel II Enhancements introduce specific capital requirements for re-securitisation exposures.
On the same date, the European Commission adopted a proposal for a directive amending the Capital Requirements Directives2 (the CRD Amendment Proposal). In the CRD Amendment Proposal, the Commission proposes, inter alia, to increase the capital requirements for re-securitisation positions.
What is re-securitisation?
Re-securitisations can be defined as securitisations that have underlying securitisation positions. In case of CDO’s, the term “CDO squared” or “CDO²” is also used.
The Basel II Enhancements define re-securitisation as follows: “541(i) A re-securitisation exposure is a securitisation exposure in which the risk associated with an underlying pool of exposures is tranched and at least one of the underlying exposures is a securitisation exposure. In addition, an exposure to one or more re-securitisation exposures is a re-securitisation exposure.”
If banks are uncertain as to whether a particular structured credit position should be considered a re-securitisation exposure, they are encouraged to consult with their national supervisors. In making their evaluation, supervisors should take into consideration the exposure’s economic substance.
The Basel II definition of re-securitisation captures, among others, CDOs of asset-backed securities, including CDOs backed by residential mortgage-backed securities, instruments linked to re-securitisation exposures (e.g. a credit derivative providing credit protection for a CDO² is a re-securitisation exposure) and ABCP programmes in which one ore more pools contain securitisation or re-securitisation exposures. Even if only one of the underlying exposures is a securitisation exposure (e.g. a securitisation exposure where the pool contains many individual mortgage loans and a single RMBS), the transaction will qualify as a re-securitisation exposure.
The CRD Amendment Proposal adds the following definition to Directive 2006/48/EC: “‘re-securitisation’ means a securitisation where one or more of the underlying exposures meet the definition of a securitisation position3 ;” and “‘re-securitisation’ position means an exposure to a re-securitisation;”
The Basel II Enhancements on re-securitisation
Changes to Pillar 1
Among others, the Basel II Enhancements have made changes to Pillar 1 (minimum capital requirements), introducing higher risk weights applicable to re-securitisation exposures. Further to such changes, re-securitisation exposures will require up to three and a half times more capital than normal securitisations.
In particular, under the internal ratings based (“IRB”) approach, the ratings based approach (“RBA”) risk weight tables were modified adding two additional columns for re-securitisation exposures. For AAA rated senior notes, the floor risk weight is 7 per cent for securitisation exposures and 20 per cent for re-securitisation exposures. To maintain consistency between the RBA and the supervisory formula approach (“SFA”), the SFA floor risk weight is set at 20 per cent for re-securitisation exposures, while it remains at 7 per cent for other securitisation exposures.
Deeming the rationale for applying higher risk weights to re-securitisations under the IRB approach equally applicable to the standardised approach (“SA”), the Basel II Enhancements have added specific risk weights for re-securitisation exposures applicable in the SA. For instance, The risk weight for AAA to AA- long-term rating notes will be 20 per cent for securitisation exposures and 40 per cent for re-securitisation exposures.
Changes to Pillar 3
The Basel II Enhancements also provide for changes to be made to the disclosure requirements under Pillar 3, adding a number of specific references to re-securitisation exposures in the disclosure requirements. For instance, banks shall disclose: (i) the type of risks assumed and retained with re-securitisation activity; (ii) how the processes in place to monitor changes in the credit and market risk for re-securitisation exposures differ from those in place for securitisation exposures; (iii) the bank’s policy governing the use of credit risk mitigation to mitigate the risks retained through securitisation and re-securitisation exposures; and (iv) the aggregate amount of re-securitisation exposures retained or purchased. Banks are encouraged to differentiate between valuation of securitisation and re-securitisation exposures.
Banks are expected to comply with the new Pillar 1 capital requirements and the new Pillar 3 disclosure requirements by 31 December 2010.
The CRD Amendment Proposal
The CRD Amendment Proposal envisages introducing in the Capital Requirements Directives specific minimum capital requirements for re-securitisations that are higher than those for straight securitisation positions. The proposed minimum capital requirements are in line with the relevant minimum capital requirements for re-securitisations contained in the Basel II Enhancements.
Furthermore, the CRD Amendment Proposal proposes to introduce a stricter supervisory process for particularly complex re-securitisations. Indeed, pursuant to the CRD Amendment Proposal, banks shall apply a 1250 per cent risk weight to highly complex re-securitisation positions, unless they demonstrate to their regulator for each such re-securitisation position that they have complied with the applicable due diligence requirements for banks that invest in such re-securitisations4 .
The CRD Amendment Proposal, which has been passed to the European Parliament and the Council of Ministers for consideration, provides that the EU member states should implement the amendment directive by 31 December 2010.