As of 1 January 2019, a new EU framework for securitisations is directly applicable in EU member states. The framework is primarily comprised of Regulation (EU) 2017/2402 (the Securitisation Regulation) and Regulation (EU) 2017/2401. The new regime repeals many of the existing EU rules for securitisations and replaces them with harmonised, cross-sectoral requirements.
Post 2008, the volume of securitisations in the EU dropped significantly. However, the EU considers securitisation to be an important element of properly functioning financial markets. This is because it facilitates the diversification of funding sources and allocation of risk across the EU’s financial system. This should result in higher volumes of cheaper business and consumer lending.
The Securitisation Regulation is an integral part of the EU’s objective to implement a high-quality and stable securitisation market in the EU. We highlight six key aspects of this important regulation.
1) Scope of the new regime
The Securitisation Regulation applies to securitisation transactions where securities are issued on or after 1 January 2019. Pre-existing securitisations will, in general, continue to be subject to previous rules unless new securities are issued or a new position is created in that securitisation transaction.
The definition of ‘securitisation’ largely replicates the earlier definition from the Capital Requirements Regulation. However, ‘specialised lending exposures’ are now excluded. The definition is wide and should be scrutinised even if no debt securities are being issued where, for example, tranching together with subordination, is included in a loan structure.
2) Due diligence (Article 5)
The Securitisation Regulation establishes new due diligence requirements which an ‘institutional investor’ (other than the ‘originator’, ‘sponsor’ or ‘original lender’) must apply prior to holding a securitisation position. These enhance the requirements that already applied under previous rules.
For example, institutional investors must verify that:
- Sound and well defined credit granting standards have been applied, unless the originator or original lender is a ‘credit institution’ or ‘investment firm’.
- Risk retention requirements have been fulfilled.
- Information about the securitisation transaction has been made available as required by the regulation’s transparency rules.
Institutional investors must also assess the risks involved and verify that a ‘simple, transparent and standardised (STS) securitisation is compliant with the criteria set out in the regulation.
The definition of institutional investor is expanded to include undertakings for collective investment in transferable securities (UCITS) management companies, internally managed UCITS, pension funds and pension fund managers. Credit institutions, investment firms, insurers, re-insurers, and AIFM’s were required to comply with due diligence obligations previously but must now apply the new rules also.
3) Risk retention (Article 6)
The Securitisation Regulation maintains the risk retention level at 5%. It introduces a new “direct” risk retention obligation on originators, sponsors and original lenders to comply with the risk retention rules. This is in addition to the existing ‘indirect’ obligation for institutional investors.
4) Transparency (Article 7)
Originators, sponsors and securitisation special purpose entities must make available certain information on an ongoing basis to holders of a securitisation position, competent authorities and, upon request, potential investors. Underlying exposures should also be made available on a quarterly basis, which should enable institutional investors to comply with their ongoing due diligence obligations.
5) Other key points
The Securitisation Regulation prohibits re-securitisation except in limited circumstances. Furthermore, there is a restriction on the sale of positions to MIFID retail clients unless a suitability and appropriateness test has been conducted in accordance with MIFID II.
6) STS Securitisation
One of the key objectives of the Securitisation Regulation is to better differentiate simple, transparent and standardised products from complex, opaque and risky instruments and apply a more risk-sensitive prudential framework.
Chapter 4 of the Securitisation Regulation set out the criteria for STS securitisations. For a securitisation to qualify as an STS securitisation, the criteria must be satisfied which simplify and standardise the transaction terms while ensuring transparency. Notification also needs to be provided to ESMA and specific disclosures made to competent authorities in order to avail of the STS designation. STS securitisation investors will also benefit from more favourable regulatory capital requirements under the amended Capital Requirements Regulation.
Certain securitisations, including synthetic securitisations, are excluded from the scope of the regulation.
The new framework signals the EU’s overall endorsement of securitisation as a financing structure. It should result in an increase of securitisations. In the Irish market, securitisation could be used as a means of diversifying the investor base on previously sold loan portfolios. It could also assist in the continued deleveraging activities of the domestic banks. In this regard, it worth noting that there is a securitisation carve out in Consumer Protection (Regulation of Credit Servicing Firms) Act 2018. More information on the Act is available here.