This update considers the requirements for compliance with the European Central Bank (ECB) collateral rules relating to asset-backed securities, and some areas where potential issues can arise.
The ECB's open market operations allow it to manage liquidity and provide refinancing facilities to the financial sector. The volume of asset-backed securities being repurchased with the ECB has increased in recent years. Two advantages to banks structuring deals to be eligible as ECB collateral are that:
- ECB-eligible securities held by a regulated institution are treated as liquid securities for the purposes of Basel III (although not all ECB-eligible collateral will fall within that definition); and
- the holders of such securities can obtain short-term finance by entering into a repurchase agreement with the ECB.
Counterparties should also consider where they can use a national central bank liquidity scheme in relation to their proposed structure and whether such scheme may offer better value funding. For example, the Bank of England's Discount Window Facility does not require additional haircuts for sterling denominated securities, and therefore may be better suited to securitisations involving underlying sterling receivables.
On April 2 2015 the latest version of the ECB's Guideline on the Implementation of the Eurosystem Monetary Policy Framework was published in the Official Journal. It came into force on May 1 2015, with the exception of the revised rules on liquidity support for asset-backed securities, which came into force on November 1 2015. The guideline has subsequently been amended to include further revisions to the collateral criteria for asset-backed securities, which came into force on January 25 2016. These amendments to the guideline exclude asset-backed securities backed by lease receivables (including personal contract purchase (PCP) agreements) with residual values.
Any institution wishing to access ECB funding must:
- be required to maintain minimum reserves with the ECB;
- be subject to at least one form of harmonised EU/European Economic Area (EEA) supervision by national authorities in accordance with the EU Capital Requirements IV Directive and the EU Capital Requirements Regulation or be a publicly owned credit institution subject to supervision of a standard comparable to supervision under the directive or the regulation. However, institutions subject to non-harmonised national supervision of a comparable standard can also be accepted as counterparties;
- be financially sound; and
- satisfy the ECB that it will fulfil any operational criteria specified in the relevant contractual or regulatory arrangements applied by the respective national central bank (or the ECB).
The ECB accepts asset-backed securities for use as ECB collateral under its general (permanent) and temporary frameworks. The temporary framework allows the ECB to derogate from the permanent framework by implementing temporary measures in response to prevailing market conditions and regulatory developments. The permanent and temporary frameworks co-exist, and therefore the requirements of one framework do not override the other unless they specify otherwise.
The table below sets out the main eligibility requirements for asset-backed securities (there are separate requirements for eligibility of straight debt and syndicated loans, credit claims, debt instruments backed by credit claims and covered bonds).
Securities must be admitted to trading on a regulated market or traded on an eligible non-regulated market and held/settled in the euro area. For asset-backed securities, the issuer, originator and any intermediary (eg, a mortgage trustee or receivables trustee) must be established in the EEA. Receivables must derive from creditors incorporated or resident in the EEA and the related security must be located in the EEA.
Securities must be issued in the EEA with a central bank or central securities depository that fulfils ECB standards. Securities must be issued in the euro area where the issuer is a non-financial corporation not rated by an accepted rating agency.
|Clawback rules||Asset-backed securities must not be subject to clawback rules deemed severe by the Eurosystem where the originator is not incorporated in either the United Kingdom or a non-euro area country.|
|Close links restrictions||Collateral cannot be submitted if the counterparty (or a third party with which it has close links) provides a currency hedge to the issuer of the asset-backed securities or provides liquidity support above prescribed limits. On November 1 2015 the rules relating to liquidity support were enhanced and draw a distinction between liquidity support in the form of cash reserves and liquidity facilities. Collateral issued or guaranteed by the counterparty is also prohibited.|
Asset-backed securities must have at least two single 'A' ratings from any accepted rating agency for the issue. However, the temporary framework provides for the eligibility of some asset-backed securities with ratings of 'BBB' subject to a number of conditions. Haircuts for asset-backed securities with at least two ratings of single 'A' are usually 10%. Haircuts for asset-backed securities with ratings below this are set at 22%.
The credit quality assessment must be based on a public issue rating explained in a publicly available new issue report. There is a requirement for external credit assessment institutions to publish regular surveillance reports no later than four weeks after the coupon payment date of the asset-backed securities.
|Haircut||Linked to rating of securities, maturity, interest basis, currency and underlying assets securing the collateral.|
|Denomination||Euro; also pounds sterling, US dollars and yen, but with applicable haircuts under the temporary framework.|
|Settlement||The securities must be transferable in book entry form with an account with the Eurosystem or a securities settlement system which fulfils the ECB standards. English law governed notes which are issued as new global notes or under the new safekeeping structure held through Euroclear or Clearstream will meet this requirement.|
The following criteria also apply:
- Provision of eligible assets – counterparties must provide eligible assets by the transfer of ownership in the form of a repurchase agreement or the creation of a security interest in the form of a collateralised loan.
- Tap issues – care should be taken as fungible tap issuances of asset-backed securities are treated as new issuances and must comply with the eligibility criteria in place at the time of the tap issue.
- No close links – a counterparty cannot submit as collateral any asset issued or guaranteed by itself or by any other entity with which it has 'close links', except in some circumstances in relation to covered bank bonds. 'Close links' mean that:
- the counterparty, directly or indirectly through one or more other undertakings, owns 20% or more of the capital of the issuer, debtor or guarantor, or vice versa;
- a third party owns more than 20% of the capital of the counterparty and more than 20% of the capital of the issuer, debtor or guarantor, directly or indirectly through one or more other undertakings; or
- the counterparty (or a party with which it has close links) has entered into a currency hedge with the issuer of the asset-backed securities.
From November 1 2015 the Eurosystem rules relating to liquidity support became more prescriptive and now draw a distinction between liquidity support in the form of cash reserves and liquidity facilities.
Close links between a counterparty and an EEA public sector entity which has the right to levy taxes, or where a debt instrument is guaranteed by such entity, and certain covered bonds (and certain debt instruments comparable to covered bonds), are currently exempt.
The national central bank of the country where the asset is admitted to trading is responsible for the assessment of the eligibility of the marketable asset.
The eligibility assessment process only begins once the asset is issued and all the necessary documentation (see below) is made available to the respective national central bank. The national central banks and the ECB will not confirm the eligibility of an asset before its issuance.
The following documents must be made available to the national central bank:
- letters of rating and pre-sale reports from the rating agencies rating the securities;
- the final prospectus for the security approved by the listing authority;
- the ISIN code and the Reuters/Bloomberg page codes for the security;
- confirmation that the security is in the new global note form, if applicable; and
- a copy (on a non-reliance basis) of a legal opinion confirming the true sale.
In some cases, copies of servicing agreements or liquidity provision agreements may also be required.
Once the assessment is complete, the asset will be included in the ECB's list of eligible assets, provided that it complies with the ECB's eligibility criteria.
On December 16 2010 the ECB announced the establishment of loan-by-loan information requirements for asset-backed securities in the Eurosystem collateral framework. This loan-level information is intended to increase transparency and contribute to more informed risk assessments of asset-backed securities and restore the weakened confidence in the securitisation markets.
The Eurosystem published the loan-by-loan information requirements on existing and newly issued asset-backed securities, first for residential mortgage-backed securities and gradually for other asset-backed securities thereafter (most recently for credit card receivables on September 19 2013). Loan-level data is submitted in accordance with an ECB specified template and at least on a quarterly basis on, or within one month of, the interest payment date for the relevant security. To facilitate reporting of loan-level data, the assets backing an asset-backed security must consist of a homogeneous pool. The asset-backed securities data supplied via the templates is processed, stored and disseminated by European DataWarehouse.
For further information on this topic please contact Julian Craughan or Rachel Pleming at Hogan Lovells International LLP by telephone (+44 20 7296 2000) or email (firstname.lastname@example.org or email@example.com). The Hogan Lovells International website can be accessed at www.hoganlovells.com.
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