The Situation: The extraordinary circumstances of the COVID-19 pandemic and its unprecedented effects on the European economy triggered a call for immediate action by the European Parliament to give lending institutions the ability to channel sufficient funds to businesses to help them absorb the economic shock caused by the COVID-19 pandemic. At the same time, the pandemic has increased the need for lending institutions to manage and deal with their non-performing exposures ("NPEs").
The Action: The European Parliament recently adopted the long-awaited amendments to Regulation (EU) 2017/2402 (the "Securitisation Regulation") and corresponding changes to Regulation (EU) 2013/575 (the "CRR") in order to inter alia (i) remove some regulatory obstacles to the securitisations of NPEs and (ii) extend the framework for simple, transparent and standardised ("STS") securitisations to balance-sheet synthetic securitisations. The amendments to the Securitisation Regulation and the CRR are not yet in force and still need to be approved by the Member States and published in the Official Journal of the European Union. Given the severity of the subject matter, a quick implementation can be expected.
Looking Ahead: Once adopted, the amendments to the Securitisation Regulation and the CRR will facilitate the use of securitisations in the EU's economic recovery in an effort to maintain or even improve the lending capacity of lending institutions and to face the effects of the expected increase in NPEs caused by the COVID-19 pandemic.
The amendments to the Securitisation Regulation will correct some unintended consequences of the original legislation and will facilitate the implementation of NPE securitisations by introducing the following changes to the existing framework:
- Introduction of a definition of NPE securitisation as a securitisation backed by a pool of NPEs, the nominal value of which makes up not less than 90% of the entire pool's nominal value at the time of securitisation and at any later time where assets are added to or removed from the underlying pool;
- Possibility for the servicer to act as the risk retainer in NPE securitisations. This change recognises the fact that the servicer has a more substantive interest in the workout of the assets and value recovery than the originator or the original lender;
- Possibility to calculate the size of the retention not by reference to the nominal value of the securitised NPEs but by reference to their "net value" (i.e., nominal value or outstanding value less than the nonrefundable purchase price discount agreed at the time of securitisation); and
- Amendments to the verification of the credit-granting standards provide that where the originator is an entity that purchases a third party's exposures on its own account and then securitises them, the credit-granting standards applicable at the time of securitisation of the exposures are of minor importance. Instead, the application of sound standards in the selection and pricing of the exposures is a more important factor with respect to investments in NPE securitisations. This amendment takes into account that, in most cases, the portfolio of NPEs has changed hands and that the original lender/originator is no longer involved in the transaction. The amendment is limited in scope as it applies only to securitisations of third party-originated assets, while assets originated by the originator itself will, of course, not benefit from the amendment.
STS Synthetic Securitisations
Currently, securitisations using credit derivatives or guarantees and where the securitised exposures remain on the balance-sheet of the originator (the "Synthetic Securitisations") are beyond the scope of the STS framework.
The Securitisation Regulation will also extend the STS to Synthetic Securitisations subject to compliance with a specific set of STS criteria.
The STS criteria are based on the existing STS criteria, with the following adaptions to take into account the particular nature of Synthetic Securitisations:
- Simplicity: additional representations and warranties, borrower creditworthiness and originator expertise;
- Transparency: specific data on historical defaults;
- Standardisation: specific risk retention requirements, documentation and servicer expertise; and
- Other specific requirements: credit events, credit protection payments and verification agents.
While the definition of "excess spread" for traditional securitisations can be found in Regulation (EU) 625/2014, so far no official definition of "synthetic excess spread" exists. The new legislation will introduce the definition of "synthetic excess spread" to mean the amount that is contractually designated by the originator to absorb losses of the securitised exposures that might occur before the maturity date of the transaction.
Amendments to the CRR
The European Parliament also passed consequential amendments to the CRR to amend risk weight of securitisation positions in line with the new securitisation rules. In particular:
- With respect to NPE securitisations, the senior tranche would be subject to a flat risk weight of 100%, provided the exposures in the pool backing the securitisation have been transferred with a nonrefundable price discount of at least 50% on the nominal amount of the NPEs; and
- With respect to Synthetic Securitisations, the benefit of the STS risk weights is extended to include senior positions in Synthetic Securitisations complying with the relevant STS criteria.
Finally, the legislative proposal mandates the European Banking Authority to publish, by November, 1, 2021, a report on the development of a specific framework for sustainable securitisations, which should assess the introduction of sustainability factors, the implementation of proportionate disclosure and due diligence requirements, the content, methodologies and presentation of information in relation to environmental, social and governance-related adverse impacts, and any potential effects on financial stability and on the scaling up of the EU securitisation market and of bank lending capacity. The report is to be followed by a legislative proposal on the creation of a specific sustainable securitisation framework.
Applicability of the Amendments in the United Kingdom
The amendments to the EU securitisation regime will not automatically apply to the UK securitisation regime, and we are not aware of any plans by the UK government to introduce similar amendments in the UK Securitisation Regulation.
Three Key Takeaways
- The amendments to the NPE securitisation framework will remove some of the restrictions that to date have served as a hindrance to a well-functioning NPE securitisation market and will increase the role of securitisation as a tool for removing NPEs from banks' balance-sheets.
- The extension of the STS label to Synthetic Securitisations will create an incentive for securitisations to take place more often within the EU and help banks to find ways to share risk with other capital market actors.
- The above changes will ultimately allow credit institutions to free up capital and enable them to lend to corporates and SMEs impacted by the COVID-19 pandemic.