Last Friday, the revised LCR delegated act (under the CRR) was adopted by the EC. This incorporates STS into the LCR, ahead of its becoming effective on 1st January 2019. As readers know, the LCR requires banks to maintain a certain amount of liquid assets, and a limited proportion of these can be made up of high quality securitisation notes (and since these yield more than cash, banks would be expected to try to maximise this holding for obvious reasons).

Statistics show that post-GFC there were liquid markets into which securitisation notes could be sold by willing sellers but, despite lobbying, securitisation holdings remain classified as Level 2B or lower, and so treated less favourably than covered bonds and subject to bigger haircuts – even though a key aim of CMU is to revive this market. Furthermore, there is no grandfathering: at present, Article 13 of the LCR defines what securitisation assets can quality as Level 2B, but the revised Article 13 will be amended and only extend to STS securitisations, so existing Level 2B assets could be declassified! Issues between now and next January can be structured in a way that anticipates what we know about the STS criteria so that after 1st January 2019 they can be notified as such and so be eligible, but since the level 2 detail (e.g. the RTS on homogeneity or STS notification) are still in draft – and, as regards homogeneity, going to be substantially revised apparently – issuers cannot, in many cases, be confident that their deals will meet the STS criteria. Deals being done now can contain the maximum of flex wording to allow tweaks to get over some of the potential hurdles that may appear once the level 2 detail is known, if investors are happy with that, but even then, a non-bank holder actually has a disincentive to agree to any changes, because if an issue ceases to be LCR-eligible and the bank holders have to sell their notes, non-banks can buy them up – at forced sale prices! And would a bank risk buying a deal between now and next year to count as Level 2B knowing that it might not qualify after 1st January 2019?

The EC explanatory memorandum says “As regards the alignment with the definition of STS securitisations, the impact is expected to be quite marginal as the total amount of securitisations held as liquid assets is limited due to the cap on Level 2B assets in the liquidity buffer and to diversification requirements”, which may indicate that the EC has missed the point, despite the lobbying. Perhaps it thinks the Solvency II revisions will bring back insurers as buyers of ABS in such large numbers that it will not harm the securitisation market if a few banks find STS assets unattractive?. But as readers know, the EC’s Solvency II Delegated Act (not yet approved by the EP or the Council either) leaves non-senior STS and non-STS transaction holdings unattractive, and perversely encourages insurers to invest in the underlying assets in an un-securitised and illiquid format rather than liquid securitised form.

It’s not law yet – next it goes to the EP for scrutiny, and then to the European Council. It can’t be amended by the EP but it can be rejected – this is not unknown but it is rare.