This update outlines the implementation of transparency and disclosure obligations under European securitisation legislation. In particular it considers:
- the recent European Securities and Markets Authority (ESMA) announcement on delays to the establishment of the Structured Finance Instruments (SFI) reporting website; and
- the impact of the Securitisation Regulation currently under consideration by the European Parliament.
EU Regulation 462/2013 of the European Parliament and of the Council of May 21 2013 ('CRA 3') introduced a new Article 8b into EU Regulation 1060/2009 of the European Parliament and of the Council of September 16 2009 on credit rating agencies (the 'CRA Regulation'). Under Article 8b, the issuer, originator and sponsor of a structured finance instrument established in the European Union must jointly publish information on:
- the credit quality and performance of the underlying assets of the relevant structured finance instrument;
- the structure of the securitisation transaction;
- the cash flows and any collateral supporting a securitisation exposure; and
- any information that is necessary to conduct comprehensive and well-informed stress tests on the cash flows and collateral values supporting the underlying exposures.
ESMA was tasked with developing regulatory technical standards with respect to the above obligation specifying the information that must be published in order to comply with that obligation, the frequency with which that information was to be updated and the form of presentation of that information by way of a standard template. Those regulatory technical standards were adopted by the European Commission on September 30 2014 as Commission Delegated Regulation EU2015/3 (the 'RTS Regulation'), and were published in the Official Journal of the European Union on January 6 2015.
The RTS Regulation entered into force on the 20th day following its publication. It will apply from January 1 2017 to structured finance instruments issued after the date of its entry into force where the issuer, originator or sponsor is established in the European Union. The requirements under the RTS Regulation are expressed to apply to all structured finance instruments that fall within the above criteria, irrespective of whether they are public or private securitisation transactions, and whether they are rated, offered to the public or admitted to trading in the European Union. Although only referenced in a recital to the RTS Regulation and not in the body of the text, and expressed as being without prejudice to its scope, the regulation does specify that until reporting obligations have been developed by ESMA and adopted by the European Commission, the standardised disclosure templates and all reporting obligations under the RTS Regulation will apply only to structured finance instruments that are backed by underlying assets which are included in the list of underlying asset class categories specified in the regulation, and which are not of a private or bilateral nature (although this is not defined).
Key items subject to the disclosure obligations under the RTS Regulation include:
- where a prospectus has not been drawn up in respect of the structured finance instrument in compliance with the EU Prospectus Directive (2003/71/EC), a transaction summary or overview of the main features of the structured finance instrument;
- certain named transaction documents applicable to the structured finance instrument, including any other underlying documentation that is essential for the understanding of the transaction and a detailed description of the applicable payment waterfalls;
- loan-level information through standardised templates and investor reports, in each case to be provided on a quarterly basis no later than one month following the due date for payment of interest on the structured finance instrument; and
- event-based reporting, whether reflecting disclosures required to be made under European insider dealing and market abuse legislation or, where that does not apply, upon any significant change or event in respect of obligations set out in the applicable transaction documents, structural features affecting performance of the structured finance instrument or the risk characteristics of the structured finance instrument or any of the underlying assets.
All such disclosure is to be made via a website to be set up by ESMA. Under the RTS Regulation, ESMA was tasked with publishing technical instructions for the submission of required information by July 1 2016 at the latest. Although Article 8b expressly states that the obligation to publish information will not extend to situations where such publication would breach national or EU law governing the protection of confidentiality of information sources or the processing of personal data, there is nothing in the RTS Regulation to suggest that information that is so disclosed (and so does not fall within this narrow exemption) would not be publicly available.
On March 20 2015, ESMA launched a call for evidence in relation to the extension of the disclosure requirements under the RTS Regulation to private and bilateral transactions for structured finance instruments. This included questions relating to the definition of 'private and bilateral transactions' and the varying levels of disclosure that might apply in respect of such transactions; responses were to have been received by May 20 2015. To date, there has been no draft regulation or other formal legislation published that would seek to reflect the outcome of that call for evidence, whether by amendment of the RTS Regulation or a separate applicable regime falling within the scope of Article 8b.
On April 27 2016, ESMA published a press release noting that it had encountered several issues in setting up the SFI website, including the absence of a legal basis for its funding. Consequently, ESMA stated that it was unlikely that the SFI website would be available to reporting entities by January 1 2017 and, similarly, it was unlikely that ESMA would be in a position to publish the technical instructions by July 1 2016.
It is unclear where this delay leaves issuers, originators and sponsors of structured finance instruments that fall within the scope of Article 8b and the RTS Regulation. Although, by the terms of the regulation itself, disclosure must be made from January 1 2017, without a means to make such disclosure, affected entities will be unable to comply with their obligations under the RTS Regulation. Although it is to be hoped that any such failure will not, in the absence of the SFI website and related technical instructions, be treated as a breach of the RTS Regulation by the relevant affected parties, this has not yet been formally confirmed. In addition, no guidance has been issued as to whether, once the SFI website is set up, affected parties will be required to provide disclosure (in particular in respect of items such as loan level information and investor reports) dating back to January 1 2017 or will merely have to provide such information going forward from the date on which the SFI website is operational.
Market participants may take some comfort from the pragmatic approach adopted by the relevant supervisory authorities with regard to delays that arose on the implementation of portfolio reconciliation and trade reporting requirements under EU Regulation 648/2012 of the European Parliament and of the Council of July 4 2012 on over-the-counter derivatives, central counterparties and trade repositories (EMIR). However, the UK Financial Conduct Authority did couple its guidance given in the context of the delay in implementation of portfolio reconciliation requirements under EMIR with an expectation that firms that were unable to comply with the original deadline should have a detailed and realistic plan to achieve compliance within the shortest timeframe possible. It would therefore seem advisable for affected issuers, originators and sponsors to be putting such plans in place now before the SFI website and related technical instructions eventually become available. This is expected to be of value in countering any potential allegations of breach of Article 8b and in enabling the relevant entities to more readily comply with their obligations once the above-referenced delays are resolved.
The European Council's third compromise text in relation to the proposed regulation laying down common rules on securitisation was published on November 30 2015 (the 'Securitisation Regulation'). If the Securitisation Regulation is enacted in that form, it will have an impact on the application of the EU legislation referenced above. In a similar mould to such legislation, although it contains separate provisions that would be applicable only to securitisations that were to be designated as simple, transparent and standardised (STS), it does not currently seek to differentiate between public and private and bilateral securitisation transactions.
In particular, the current draft of the Securitisation Regulation would introduce the following changes:
- It would repeal Article 8b of the CRA Regulation. Without this, not only would the requirements of that article itself be repealed, but the RTS Regulation would seemingly no longer have a basis in law and therefore should equally cease to apply, although the Securitisation Regulation provides that, pending the adoption of requisite regulatory technical standards in relation to disclosure of information under the Securitisation Regulation, the templates provided under the RTS Regulation should be used. It is expected that, in spite of the similarities between the information requirements under the Securitisation Regulation and those under Article 8b and the RTS Regulation, there will be a period of uncertainty as market participants consider their compliance with provisions of that legislation which, though currently in force, are not yet applicable and may soon be repealed.
- The originator, sponsor and securitisation special purpose entity (essentially, the issuer) would be required to make at least information broadly equivalent to that currently specified as being required under the RTS Regulation available to holders of a securitisation position, to the relevant competent authorities and, upon request, to potential investors. As with the RTS Regulation, the relevant entities are entitled to designate one of their number to fulfil the information requirements. Unlike under the RTS Regulation, it is unclear whether such delegation is without prejudice to those entities' obligations in this regard. It is also unclear what, if any, link any of the affected entities or the investors must have to the European Union for these information requirements to apply. Although presumably, having regard to the other provisions of the Securitisation Regulation, its requirements would apply only to entities incorporated in (or subject to supervision in) the European Union, the same approach proved to be incorrect in the context of the RTS Regulation and its implementation under Article 8b.
- As for the RTS Regulation, the Securitisation Regulation would require the information to be made available via a website. However, in this case it is not expressly stated that there would be a single website for all transactions or that ESMA would set up that website – merely that ESMA would be required to provide regulatory technical standards relating to reporting templates and the website's structure and procedures. The website could also be password protected. The Securitisation Regulation would go a little further than Article 8b in that it also recognises the need to comply with confidentiality obligations relating to customer, original lender or debtor information (unless anonymised or aggregated), which would appear to include contractual confidentiality requirements and not just national or EU law governing the protection of confidentiality of information. This expanded recognition, combined with the permission of password protection and the requirement that information is to be made available only upon request to potential investors, might give comfort to market participants (in particular in respect of commercially sensitive information relating to private transactions) that the dissemination of information will be more readily monitored than it might under the RTS Regulation. However, such comfort may be short-lived in light of the proposals for a European Securitisation Data Repository made by the rapporteur to the European Parliament's Committee on Economic and Monetary Affairs (ECON; see below).
- In the case of STS, the Securitisation Regulation would require disclosure of the STS designation, the provision of expanded data (including default and loss data for comparable exposures to the securitised exposures), external verification of data and the provision by the originator or the sponsor of a liability cash-flow model to investors on an ongoing basis and to potential investors before pricing or, following pricing, upon request.
- Loan-level data and investor reports would have to be provided with a similar frequency to that applicable under the RTS Regulation, but would require underlying documentation and (if required due to no Prospectus Directive-compliant prospectus being issued) a transaction summary to be made available before pricing. This latter requirement is at odds with the current frequency envisaged under the RTS Regulation and will undoubtedly strike many participants as being contrary to market convention and potentially unduly burdensome (in particular insofar as it relates to underlying documentation on a public transaction).
The proposed regulation is still being reviewed by the European Parliament and it is expected that the European Parliament will vote on the proposals in December 2016. Once the European Parliament has finalised its preferred texts, trialogues between the European Council and the European Parliament will need to take place to reach a common position in relation to the wording of the Securitisation Regulation. It is now expected that agreement on the final text of the Securitisation Regulation will not be reached until Spring 2017 at the earliest. Some participants have suggested that the final text will be agreed during 2017 before coming into force in 2018.
The European Central Bank (ECB) issued its opinion on the Securitisation Regulation on March 11 2016, further to a request from the European Council. Broadly, the ECB's opinion reflects that the ECB agreed with much of the Securitisation Regulation as proposed by the European Council insofar as it related to information disclosure and transparency. Of particular note, the ECB:
- agreed with the European Council regarding the deletion of Article 8b and suggested that it be made expressly clear that the RTS Regulation will also be repealed;
- expressly recognised that transparency requirements need to be balanced against the confidentiality of private and bilateral transactions and would support the suggestion that information should be disclosed publicly only in the case of public transactions and otherwise should be disclosed only to the prospective investors to which a transaction is marketed. In addition to supporting the inclusion of prospective investors as in the European Council's proposal, the ECB would prefer to see reference made to institutional investors, rather than holders of securitisation positions. The reasons for this later suggestion are unclear from the face of the opinion. It may be an attempt to narrow the scope of parties to which disclosure will be required to be made and limit this to entities that would be subject to due diligence requirements under the Securitisation Regulation, but this is not evident from the opinion itself;
- recommended exempting certain securitisations from unnecessary disclosure burdens, such as intra-group transactions or transactions where there is a single investor or investor group, in respect of which the ECB has suggested that (unless a Prospectus Directive-compliant prospectus has been issued) the only information disclosure requirements that would need to apply would be those contractually agreed upon between the parties;
- provided specific drafting suggestions in respect of the application of transparency and disclosure provisions to asset-backed commercial paper programmes; and
- suggested that higher disclosure requirements in respect of underlying assets be mandatorily applicable in respect of STS and be expressly required to be contained in any investor reports.
On May 19 2016, Paul Tang (a rapporteur to ECON) published a working document on the common rules on securitisation and creating a European framework for STS. Although of somewhat wider scope than the Securitisation Regulation itself and its provisions relating to transparency and information disclosure, he noted a concern that the asymmetric levels of information available to issuers and investors could (and, prior to the credit crisis, did) preclude investors from properly understanding the risks of their investment.
Following publication of the working document, a draft report was published on June 6 2016. In addition to proposing a number of significant changes to the Securitisation Regulation which are outside the scope of this update,(1) the proposals made by the rapporteur include a number of changes relating to transparency and information disclosure under the Securitisation Regulation. Key changes would include the following:
- The information required to be provided by the originator, sponsor and issuer of a securitisation would be expanded to include information about the credit granting process followed for the underlying assets of the securitisation and information on the investors in the securitisation, their ultimate beneficial owner and the size and tranche of their investment. In the case of the former, the current proposal would apply regardless of whether a Prospectus Directive compliant prospectus had been issued, which could lead to a doubling-up of information and potential mismatch if differing standards were applied or a derogation were obtained in respect of obligations under the Prospectus Directive. In the latter case, the disclosure of investor details in this way would not reflect current market expectation and could give rise to concerns from investors that such disclosure would need to be made should they choose to invest in a securitisation. It is also not apparent from the report whether this requirement would be limited to public securitisations, how this requirement would be capable of being fulfilled by the originator, sponsor and issuer (on which the obligation to disclose would still rest), and what measures would need to be undertaken to enable this information to be updated should the relevant investments be traded in the secondary market following issue.
- A European Securitisation Data Repository would be introduced, which would need to be established by ESMA and provided with information by the originator, sponsor and issuer of a securitisation at the same time as information was required to be provided to the relevant authorities under the Securitisation Regulation. The European Securitisation Data Repository would include information on underlying loans, to be published in an anonymised way, taking into account the differences between public and private transactions, data protection rules and legitimate privacy and trade secret concerns. The explanatory statement at the end of the report suggests that the European Securitisation Data Repository would be a public register (akin to, and in replacement of, the SFI website), which would contain information that was comparable and based on uniform reporting standards, while respecting applicable data protection rules. This approach is in line with suggestions made in the working document that transparency would need to be made available to the whole market as well as the relevant supervisory authorities, and may give market participants particular concern given both the potentially sensitive nature of this information and the absence of any firm guidance as to what precise requirements would apply, and what derogations would be available, in the context of private transactions.
- In the case of STS, the originator, sponsor and issuer would additionally be required to disclose information describing how the securitisation contributed to real economy investments and in which way the original lender used the freed-up capital. The originator or original lender would also be required to disclose how the capital relief attained through STS securitisation helped to fund new lending. It is unclear how extensive or precise this disclosure would need to be, or what reliance investors would be expected to place on such disclosure or the consequences of such disclosure proving to be incorrect after the fact.
The above-referenced documents are in draft form, do not represent the agreed position of the European Parliament and will be subject to amendment. At present, however, the proposals suggested in the rapporteur's draft report to ECON represent a significant departure from the European Council's proposals for the Securitisation Regulation and the ECB's opinion. Thus, market participants should continue to monitor such proposals as they progress through ECON and the European Parliament.
Given the requirement that originators, sponsors and issuers comply with their terms from January 1 2017 in respect of all securitisation transactions issued since January 26 2015, it is to be expected that market participants are now seeking to include provisions in transaction documentation for new securitisations referencing disclosure obligations under the RTS Regulation. A difficulty arises in the degree of detail that can be provided for, in light of the considerable uncertainty discussed above.
Broadly, there appear to be three approaches:
- First, and least robust, is to provide for the issuer to appoint a delegate for the purposes of the RTS Regulation before January 1 2017 and to rely upon such delegate to comply with the disclosure requirements on the issuer's behalf. Given that these requirements apply not just to the issuer, but also to the sponsor and the originator, and that a delegation of this sort does not absolve them from their respective duties in this regard, sponsors and originators may themselves find this approach to be too uncertain from a compliance perspective. It is also likely to be of limited comfort to institutional investors subject to ongoing due diligence and monitoring requirements.
- The second approach is more common where the originator or sponsor continues to act in relation to the underlying assets on the issuer's behalf (whether as servicer or otherwise). This approach delegates the performance of those obligations at the outset to the originator or sponsor acting in the most relevant capacity in which such obligations could be performed. In these circumstances, as the originator or sponsor would already be bound by these obligations under the RTS Regulation, some flexibility is often permitted as to the nature of the obligations and so a reference to the RTS Regulation in general will often suffice, rather than seeking to break down each applicable provision to be complied with.
- The third approach delegates the role to a third party (often the cash manager) and tends to be adopted when there is no continuing involvement of the originator or sponsor in this way or where that entity cannot perform this role for whatever reason. As this entity will be a true third party and will not itself otherwise be subject to the information disclosure obligations under the RTS Regulation, it is to be expected that the tasks required to be undertaken as part of such delegation will be more specifically spelled out or will be limited by reference to the obligations such as they exist at a fixed point in time, with scope for revision subject to agreement.
As the RTS Regulation does not yet apply, it is not yet clear whether any of the above will be sufficient to enable originators, sponsors and issuers to comply with their terms.
There is considerable uncertainty with respect to the compliance by originators, sponsors and issuers with applicable European securitisation legislation relating to transparency and information disclosure. Although the RTS Regulation is expressed to apply from January 1 2017 to all securitisations issued after January 26 2015, compliance with its terms may well not be possible at such date due to a delay in establishing the relevant SFI reporting website. There has been little guidance as to what those parties would be expected to do in the interim.
Similarly, the parallel development of a separate information disclosure regime that would replace that applicable under the RTS Regulation can only add to the confusion and further erode what limited certainty there is available to market participants.
Although it will be of some comfort to market participants that parties are seeking to address the need to comply with European legislation insofar as it relates to information disclosure within the underlying documentation for recent securitisation transactions, these contractual measures have not yet been tested and may not be sufficient in all cases to ensure that originators, sponsors and issuers (and indeed investors) can comply with their obligations under applicable EU legislation.
Hopefully, as January 1 2017 approaches, some formal guidance will be issued, which may help to assuage any market participants' concerns in this regard. In the meantime, and given the likely implementation of similar disclosure requirements under the Securitisation Regulation, market participants should continue to prepare for disclosure requirements equivalent to those in the RTS Regulation.
For further information on this topic please contact Marc Mouton at Hogan Lovells International LLP by telephone (+44 20 7296 2000) or email (firstname.lastname@example.org). The Hogan Lovells International website can be accessed at www.hoganlovells.com.
(1) Including an increase in the minimum level of risk retention, a mandatory limitation on investment in securitisations to institutional investors only, a requirement that the originator, sponsor or original lender in respect of a securitisation be a regulated entity and an outright ban on re-securitisations.
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