Numerous international and national regulators have proposed, and in some cases implemented, a dizzying array of new laws. These new laws try to fix the defects in the regulatory framework that failed to prevent the excesses that led to the financial crisis. In particular, rules have been made following the approval of the Dodd-Frank Act in the US, and the effects of similar directives by the European Union (such as the Capital Requirements Directive and Banking Consolidation Directive)..
These rules have raised a host of issues about the local application of rules that affect the global capital markets for securitisation. The political and legislative process for implementing these new laws brings to mind the adage that “All politics is local”. However, the effects of the credit crises are a stark example of the impact of our interconnected financial markets that may require the new aphorism “All politics is local, but the consequences are global.”
What are the reforms about?
Significant new regulation of the securitisation market is a central component of the regulatory reform efforts of many jurisdictions. The degree of convergence or divergence among the national regulators and multinational organisations will be a key driver in the recovery of the securitisation market, and the shape of the securitisation market in the future.
The regulatory reforms of the securitisation market focus on several main categories:
- Aligning the interests of originators and investors through the various methods of risk retention. These are the so-called “skin in the game” provisions.
- Ensuring investors have access to information, the ability to assess this information and time to analyse risk through greater due diligence obligations. Also ensuring increased transparency through more loan level information or modelling and a longer offering process.
- Reducing over-reliance by investors on credit ratings and regulating the perceived conflicts of interest associated with the “issuer pays” rating agency business model.
- Setting up objective benchmark standards for underlying asset origination that would qualify as a “gold standard” to improve investor confidence in asset underwriting standards and encouraging more simplified structures.
- Enhanced regulatory capital treatment for banking institutions with exposure to securitisation transactions.
Clearly these new regulations will touch on all areas of the securitisation market including investors, issuers, rating agencies and service providers. In many of these areas subtle differences are emerging as to how local regulators are implementing laws to deal with these common issues.
Risk retention and Article 122a
For example, what is now Article 122a of the Banking Consolidation Directive (Directive 2006/48/EC as amended) as inserted by the second Capital Requirements Directive (CRD2) (Article 122a) imposed (among other things) a 5 per cent risk retention requirement. The requirement applies to EU regulated credit institutions that invest in securitisation transactions, or that are exposed to credit risk of a securitisation. Such EU regulated financial institutions may suffer punitive capital treatment for those positions unless the originator, sponsor, or original lender has explicitly disclosed that it will keep a material economic interest of not less than 5 per cent Article 122a allows four forms of risk retention:
- Retention of no less than 5 per cent of the nominal value of each tranche sold or transferred to the investors.
- For securitisations of revolving exposures, retention of the originator’s interest of no less than 5 per cent of the nominal value of the securitised exposures.
- Retention of randomly selected exposures, equivalent to no less than 5 per cent of the nominal amount of the securitised exposures, where these exposures would otherwise have been securitised in the securitisation. However, this only applies if the number of potentially securitised exposures is no less than 100 at origination.
- Retention of the first loss tranche and, if necessary, other tranches having the same or a more severe risk profile, and not maturing any earlier, than those transferred or sold to investors. This retention must equal, in total, no less than 5 per cent of the nominal value of the securitised exposures.
EU Member States had to implement this provision into national laws by the end of 2010. Article 122a applies to EU credit institutions. However, consolidated regulatory supervision may have the effect of extending it to non-EU subsidiaries of EU credit institutions. Therefore it is likely to have a global impact for EU regulated institutions as well as for originators and issuers looking to access these institutions as investors or as transaction counterparties. The then Committee of European Banking Supervisors (CEBS–now the more powerful European Banking Authority) issued guidance to help Member States apply Article 122a requirements consistently. However, there is still much uncertainty about application of this new rule.
While Europe gets to grips with the CRD2 changes, the US Government is establishing its own set of risk retention rules. These rules may or may not match those of Article 122a. The differences that arise in the local implementation of these sweeping new laws will no doubt create opportunities and challenges for market participants that operate in the global securitisation market.