On 25th August 2015, the Brussels Blog of the Financial Times contained a link to a leaked proposal for a Regulation on a European framework for simple, transparent and standardised (STS) securitisation. The proposal itself appears to have been dated 12 August 2015 but due to the manner of its release, it took some time for the market to become aware of its existence, finally being picked up by Creditflux on 1 September 20151. After some alarmed responses to the initial leak a second leak followed on 24th September 2015, clearly reflecting a number of changes that had been unofficially fed back. Finally, on 30th September 2015 the European Commission officially released a securitisation package – which included a proposal for an STS securitisation Regulation (the Proposal) and a proposal to amend the Capital Requirements Regulation2 (CRR) to capture and reflect the features of STS securitisation. It now remains to be seen whether a flood of STS securitisation will follow, something that the European Commission has been desperate to promote.
The Proposal is broadly split into two parts. The first part of the Proposal is aimed at providing a common core of rules that apply to all securitisations, including STS securitisation. The second part contains the criteria which define what STS securitisation is.
At first glance the Proposal looks very positive. It recognises that a framework for high-quality EU securitisation can promote further integration for EU financial markets, help diversify funding sources and unlock capital, making it easier for banks to lend to households and businesses, all of which are important to the European Commission’s priority of creating jobs and growth. The Proposal rightly notes that the EU securitisation market lags behind its US counterpart, despite having performed better historically. The Proposal has a number of commendable aims and practical changes but, as always, it is the execution and actual drafting which at times lets it down and creates more questions than it, at times, answers.
AIM OF THE PROPOSAL
The Proposal aims at:
- Restarting markets on a more sustainable basis, so that STS securitisation can act as an effective funding channel to the economy;
- Allowing for efficient and effective risk transfers to a broad set of institutional investors as well as banks;
- Allowing securitisation to function as an effective funding mechanism for some longer term investors as well as banks; and
- Protecting investors and managing systemic risk by avoiding a resurgence of the flawed ‘originate to distribute’ models.
In order to achieve these aims the European Commission recognises that it needs to identify clear eligibility criteria for STS securitisation, and also adjust the existing regulatory framework. The intended end result is a framework which instils confidence in investors and allows them to evaluate the risks in STS securitisation. However, it is important that investors understand that the aim of the framework is not to eliminate risk, particularly in relation to the underlying assets, but to give investors confidence in the structure of the securitisation. Investors must continue to carry out due diligence.
The Proposal also refers to the support for STS securitisation by both the European Council and the European Parliament, which is particularly encouraging given that the European Parliament has in the past been an adversary of the EU securitisation market.
PROBLEMS WITH THE EXISTING REGULATORY FRAMEWORK
The current framework for the regulation of risk retention, disclosure and the prudential treatment of securitisation in the context of EU securitisation is set out in a number of EU legal acts, which include the CRR, Solvency II Directive3, UCITS4, AIFMD5, the Credit Rating Agency Regulation III6 (CRA3), the Prospectus Directive7 and the Liquidity Coverage Ratio Delegated Regulation8. Some of these acts were preliminary in nature, and some implement similar measures in different ways. The Proposal aims to harmonise the existing legal framework in addition to stipulating the criteria for a sustainable STS securitisation market. The Proposal also sets out a plan for additional measures in the future that will be necessary, such as the introduction of a securitisation regulation, amendments to Solvency II, to allow non-senior tranches of securitisation to benefit from an adapted capital charge and amendments to the Liquidity Coverage Ratio to align it with the proposed securitisation regulation and allow the current Level 2B assets concept to be amended in light of the new STS securitisation criteria.
ISSUES INTRODUCED BY THE CURRENT PROPOSAL
As mentioned earlier, the Proposal has a number of commendable aims and practical changes. However, some of the provisions of the Proposal have already lead to some confusion – a number of which are set out below.
Existing Regulatory Technical Standards
Although the assumption is that the provisions of the existing regulatory technical standards (RTS) in respect of the CRR9 would continue to apply, this is not clear in the Proposal. This raises questions, inter alia, as to the provisions of the RTS in relation to risk retention where there are multiple originators and sponsors.
Direct or Indirect Approach
The existing sector-specific regulations already provide for risk retention requirements, but use the so-called ‘indirect approach’ which puts the burden on the investor. Article 4 (Risk retention rules) of the Proposal would impose a ‘direct’ risk retention requirement on the originator, sponsor or the original lender and a reporting obligation. The direct approach should allow investors to be able to simply check whether these entities have retained risk. Although this corresponds with the EBA Report published in December 2014 (eba report)10, Article 3 (Due diligence requirements for institutional investors) still puts an obligation on investors to ‘ensure’ that the originator, sponsor or the original lender makes the required retention and disclosures. The result seems to be an onerous requirement on both the investor and the relevant retainer. This change of approach has also given rise to concerns for originators that rely on limb (b) of the definition of “Originator” as the ‘direct approach’ now raises liability concerns for such entities for non-compliance.
Additional Originator requirements
Article 4(2) of the Proposal provides that “an entity shall not be considered to be an originator if it has been established or operates for the sole purpose of securitising exposures.”
This is a new concept and it is clear that the provision was introduced in relation to perceived abuses of the “Originator” definition. The initial leak had referred to a ‘primarily’ standard which had caused concern. The EBA Report had already proposed a number of practical measures regarding substance, capital and seasoning that the market was already factoring into securitisation structures. The introduction of a “primary purpose” standard gave rise to a number of questions for certain structures even though originators structured within the spirit of the CRR and which had carefully considered the issues raised in the EBA Report would have had less of an issue with this requirement. Clearly, the inclusion of ‘sole purpose’ is a better outcome and assuming an originator performs a number of activities (e.g. asset management), it should be able to satisfy this requirement.
Article 28 (Transitional Provisions) of the Proposal provides that the risk retention requirements will apply from the date on which the regulation enters into force but the due diligence requirements will apply to 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 initial leaks suggested that the risk retention requirements could have been implemented retrospectively; clearly, this lack of grandfathering was a cause for concern particularly for originators, sponsors or the original lenders who could have had additional liability under the direct approach and particularly given these could have extended to criminal sanctions in certain jurisdictions.
Article 5 (Transparency requirements for originators, sponsors and SSPEs) requires the originator, sponsor and SSPE of a securitisation to make a whole raft of information available on the underlying exposures. This is designed to ensure that investors have all the relevant information on securitisations at their disposal. However it is unclear how this requirement will work with the existing template requirements prescribed in CRA3 which has already had a lot of industry input.
The Proposal contemplates two types of STS requirements, one for long-term securitisations and one for short-term securitisations (ABCP). To a large extent the requirements are similar. In addition to the issues discussed above there are number of issues with the proposed STS criteria itself, such as:
- The definition of “true sale” referring to an underlying exposure acquired “by means of a true sale by a SSPE in a manner that is enforceable against any third party” rather than a sale to the SSPE;
- The restriction on interest rates to those “based on generally used market interest rates” not appearing to cater for banks’ standard variable rates as used in mortgage lending;
- The requirement for the seller to “have sufficient experience in originating exposures of a similar nature to those securitised” raising the question of what constitutes “sufficient experience” and how this should be measured;
- The exclusion of exposures to ‘credit-impaired debtors’ being too general and possibly requiring more parameters.
A FLOOD OF STS SECURITISATION?
The Proposal now lies in the hands of the Council of Ministers and the European Parliament, for finalisation of the text and publishing in the Official Journal. Despite the nature of the leaks, ultimately the EU securitisation market will benefit from well drafted, comprehensive legislation on STS securitisation, however, given the Proposal is not expected to enter into force until the second half of 2016 and the EU securitisation market currently dwindling, the question is whether the securitisation market will be in any state to act as a catalyst for jobs and growth by the time STS securitisation and risk retention have been finally enacted.