As we outlined in a Feature Piece in Edition 13 of this SCM Briefing, the European Central Bank (ECB) issued detailed eligibility criteria to be met by asset-backed securities (ABS) eligible for purchase by the ECB under its ABS Purchase Programme (ABSPP). Taking into account the ECB's experience in conducting due diligence and approving ABSPP transactions since November 2014, and seeking to impart that knowledge to market participants, the ECB has developed this new set of "Guiding Principles" on Eurosystem-preferred eligible ABS, which are said to be high-level, non-binding and non-exhaustive (and relate only to ABSPP purchases of ABS, focusing on newly-issued ABS). The seven Guiding Principles (and some of the examples given for each of them) may be summarised as follows:
- The collateral should be a diversified pool of granular and performing assets
- Examples include that (at the time of its inclusion in the securitisation) a loan should not be in dispute, default or unlikely to pay and the borrower not deemed credit impaired. The pool should show a significant degree of diversification and granularity and exhibit good performance in terms of delinquencies and defaults relative to credit enhancement. Where applicable, only a small share of the loan pool should be constituted of second-lien loans whose first-lien is not included in the pool. For SME and leasing ABS, at issuance, the majority of the portfolio should not be concentrated in a single industry.
- The underlying exposures are originated according to sound underwriting criteria
- Examples include that the exposures should be originated in the course of the originator's ordinary business and in accordance with the "sound and prudent credit granting" criteria of the Capital Requirements Directive IV and Regulation (CRD IV / CRR), which include a creditworthiness assessment. The pool should only contain a small number of loans to unemployed borrowers at closing. For RMBS, the number of interest-only or bullet loans in the pool, and the weighted average loan-to-income and loan-to-value ratios of the pool should not deviate from the norm in that jurisdiction.
- The transaction structure is straightforward and robust
- Examples include that the pool is static, with no revolving or ramp-up arrangements (unless the collateral is short-term in nature such as credit cards), there is sequential pre- and post-enforcement priority of payments (or clearly defined triggers for changes to the waterfall and/or switch back to sequential payment), that there is sufficient credit enhancement for the senior notes, clear disclosure of performance and rating triggers, and/or other clearly-defined mechanisms for trapping funds. The responsibilities of Trustees must be clearly-defined. Call options should be structured in line with best market practice, and the Terms and Conditions of the notes should provide that the originator's holdings are not taken into account for the purposes of establishing a quorum or majority.
- The originator is in good financial health and has ideally demonstrated (or intends to have) a regular presence in the ABS markets. The interests of originators and investors should be clearly aligned
- Examples include that the originator is currently in compliance with all applicable supervisory requirements, is not under special administration, has passed the applicable regulatory stress tests and does not currently need government support.The transaction must also comply with CRD IV / CRR risk-retention requirements.
- If applicable, interest rate risks are mitigated and the transaction documentation clearly specifies the mitigation measures for these risks
- Examples include that hedging arrangements should be simple and transparent and can easily be replaced in the case of trigger events, and should not implicitly provide credit support for the transaction. Counterparties (and the hedging arrangements themselves) must be in compliance with the provisions of the European Market Infrastructure Regulation (EMIR).
- The transaction documentation should clearly specify the processes and responsibilities necessary to ensure that:
- Default or insolvency of the current servicer should not lead to disruption of the servicing of the assets (but this does not imply that back-up entities must be in place).Upon default and specified events, the replacement of certain parties (hedge counterparty, liquidity facility provider etc) must be provided for in the documentation. A high degree of de-linkage is desirable to counterparty risk to ensure that weaker transaction parties do not negatively affect future performance.
- The transaction displays a high degree of transparency
- Examples include that the transaction structure and documentation is clear and not misleading, with all underlying transaction documentation (including investor reports) available in English. Definitions must be clear and the data necessary to assess the transaction's performance should be available in the transaction documentation. Rating trigger breaches should be documented and at least one liability cash-flow model should be made available (with the transaction complying, where possible, with the Prospectus Directive and Regulation).Loan-level data is required to the 'A1' level (high compliance), and loan-level data and investor report pool cut-off dates should be identical, with the data easily reconcilable.
The ECB makes clear that these Guiding Principles are distinct from international efforts to develop a global set of "qualifying securitisation" principles, but notes that they do take into account the current status of wider regulatory discussions. They are also separate from the detailed eligibility criteria for ABS used as collateral in ECB repo operations which are contained in the "General Documentation" / Guideline ECB/2014/60 (for an update on the recent release of those rules in consolidated form, please see Edition 15 of this SCM Briefing), although ABS to be purchased under ABSPP must also meet those criteria as an initial starting point.
European Central Bank Guiding Principles