On 30 September 2015 the European Commission published its proposal for a new EU regulation establishing common rules on securitisation and creating a European framework for simple, transparent and standardised securitisation (the Proposed Regulation). This proposal comes as part of the Commission’s action plan for building a Capital Markets Union.
This briefing summarises the key changes that would be made by the Proposed Regulation to the current EU regulatory framework for securitisation, if it were to be enacted in its current form.
1. Risk Retention
Direct risk retention: A direct risk retention requirement, placed directly on originators, sponsors and original lenders, will be added alongside the current indirect requirement placed on investors. This means that EU originators would have to satisfy the requirements even where all the investors in a securitisation are unregulated or non-EU entities. Where the originator, sponsor and the original lender cannot agree who should act as retainer, it is the originator who must effect the retention.
New RTS: The EBA is tasked with developing a new set of regulatory technical standards to provide further detail on the risk retention requirement. Accordingly, there will be another opportunity to refine the risk retention rules to address uncertainties which have arisen in relation to their interpretation and application.
Originator: In response to the EBA’s recommendation to close a potential loophole in the definition of “originator”, the Proposed Regulation specifies that, for the purpose of the risk retention rules, “an entity shall not be considered to be an originator where the entity has been established or operates for the sole purpose of securitising exposures”. The Commission’s commentary adds that an entity retaining as originator would need a broad business purpose and should “have the capacity to meet a payment obligation from resources not related to the exposures being securitised”. Careful consideration will need to be given to this new “sole purpose” test.
2. Due diligence requirements for institutional investors
Harmonised requirements: The Proposed Regulation includes due diligence requirements applicable to all types of institutional investors. This would harmonise rules currently set out across a number of EU directives and regulations.
Institutional investors: The proposed definition of “institutional investors” brings UCITS management companies, internally managed UCITS and institutions for occupational retirement provision (IORPs) into the scope of the securitisation due diligence requirements, as well as credit institutions, investment firms, insurers, reinsurers and alternative investment fund managers (to whom similar rules already apply).
Diligence capabilities: There is some concern that these diligence requirements will deter institutional investors who do not have the capability to conduct such analysis. However, if the revised capital requirements for STS securitisations are sufficient to create an economic incentive for such institutions to invest in the required personnel and infrastructure, this would be a positive outcome for the market.
3. Transparency requirements for originators, sponsors and SSPEs
Disclosure requirements: The Proposed Regulation sets out certain information which the originator, sponsor or securitisation special purpose entity (SSPE) of any securitisation would have to disclose, similar to Article 8b of the Credit Rating Agency Regulation (Article 8b). There is no indication in the Proposed Regulation that Article 8b would be repealed, which leaves it unclear as to how these two sets of requirements would sit together. Hopefully, the Proposed Regulation will be amended to clarify the position as part of its finalisation.
Sensitive information: In contrast to Article 8b, the Proposed Regulation only requires information to be provided to holders of a position in a securitisation and to the competent authorities. This would avoid the controversial issue of having to publicly disclose commercially sensitive information when entering into a private securitisation transaction (so long as Article 8b is then repealed or amended accordingly).
Transaction summary: Somewhat unhelpfully, an obligation to provide a transaction summary for transactions where no prospectus is required by the Prospectus Directive would apply to privately placed securitisations. This would, in our view, impose an unnecessary burden and cost on businesses borrowing via the non-public securitisation market.
4. Simple, Transparent and Standardised securitisation
Criteria: The Proposed Regulation will introduce a concept of simple, transparent and standardised (STS) securitisation into legislation, setting out separate criteria for term STS securitisations and STS ABCP.
Excluded classes: As well as certain categories of securitisation which the Commission intentionally sought to exclude (actively managed CLOs, synthetic securitisations (for now) and most CMBS), we fear that certain types of securitisation may be unintentionally excluded. More work therefore needs to be done to ensure that the criteria do not have this effect.
ABCP: While the addition of separate criteria for ABCP is welcomed, the current proposals risk excluding the majority of the ABCP market.Guidance: There is no provision in the Proposed Regulation for regulatory technical standards to be drawn up to give more detail on the practical application of the STS criteria. This is a major flaw; without more formal guidance, significant divergences in approach may develop between national authorities, leading to uncertainty for investors and unwanted regulatory arbitrage.
Responsibility for STS designation: The Commission has (as expected) placed responsibility for determining whether a securitisation meets the STS criteria on the originator, sponsor and SSPE, who must then jointly notify ESMA of the STS status. Investors may place “appropriate” reliance on that notification, but must also conduct their own due diligence into whether it is correct. Given the significant support from the industry for independent third parties to play a formal role in verifying STS status, it will be interesting to hear from the investor community whether self-attestation will offer sufficient comfort.
Regulatory capital treatment: The Commission has proposed amendments to the Capital Requirements Regulation (a) to implement the capital calculation approaches set out in the revised Basel framework and (b) to provide a more risk-sensitive capital treatment for STS securitisations. Specific proposals for amending the treatment of STS securitisations under Solvency II and the Liquidity Coverage Ratio Delegated Act have not yet been made but are due to follow later. It remains to be seen whether these proposals would make STS securitisations sufficiently attractive for this initiative to be a success.
Non-STS securitisation: It will be interesting to see if the market develops into a system where STS transactions and non-STS transactions coexist. It could be that two systems develop successfully because they offer different risk, pricing and trading propositions to participants. If the STS model is successful, its reach may increase over time to cover a wider range of products.
An immediate challenge is the unclear nature of certain STS criteria. Already, market participants are scrutinising the criteria and there is concern due to imprecision and lack of guidance. Certainty is key to the success of the STS model. Participants who are considering redesigning existing transactions and structuring future transactions will be concerned that due to the lack of clarity, STS compliance is not free from doubt. We expect participants to demand more detailed guidance so that they can be confident that their transactions can satisfy the criteria.
5. The scope of the Proposed Regulation
The very wide definition of “securitisation” currently used in the Capital Requirements Regulation has been copied, unchanged, into the Proposed Regulation. However, commentary included in the recitals may help clarify some areas of uncertainly. No doubt, the market will debate this during the coming months.
6. Grandfathering and transitional provisions
The general position is that the Proposed Regulation would apply to securitisations issued on or after the date it enters into force. This includes the direct risk retention requirements, and the “originator” restriction, contained in Article 4 (although, until new regulatory technical standards on risk retention take effect, originators/sponsors/original lenders should apply the provisions contained in the current regulatory technical standards for the Capital Requirements Regulation).
However, there are two key exceptions:
- The due diligence requirements set out in Article 3 would apply to all securitisations issued on or after 1 January 2011 and to securitisations issued before that date, where new underlying exposures have been added or substituted after 31 December 2014. The draft proposals contain no exemption from this retrospective effect for UCITS and IORPs, despite these rules being entirely new for them. However, investors regulated under the CRR, AIFMD and Solvency II should continue to be able to apply the guidance under those regulations (and respective delegated regulations) to securitisations outstanding at the date the Proposed Regulation enters into force.
- Originators, sponsors and SSPEs may designate a securitisation issued before the Proposed Regulation enters into force as STS, provided that securitisation meets the criteria and ESMA is notified accordingly. We may see a flurry of amendments to bring existing securitisations in line with the criteria.
These transitional provisions are helpful (and represent an improvement from the position in earlier leaked drafts of the Proposed Regulation) but the drafting will need some adjustment to ensure they function as intended.
7. When will the new rules come into force?
The European Parliament and the European Council will now discuss the proposals. Amendments are likely to be made to the Proposed Regulation before a final version can be agreed and enacted. We understand that the Commission is hoping to achieve this by summer 2016, but the process may well extend later into next year.