Capital relief is welcome, but limited in scope
The Commission’s original aim was to help kick-start the European securitisation market, on the basis that by promoting a “high quality” form of securitisation, investors will get over the lingering bad taste left by the financial crisis. The idea is for the Securitisation Regulation to identity “high quality” securitisations that are “simple, transparent and standardised”, which therefore pose less risk and could qualify for more relaxed capital rules than other securitisations. The idea was to incentivise institutional investors to build up their portfolios of STS products since they will need to set less capital aside than they do now.
Not all STS securitisations will receive the preferential capital treatment. CMBS have been excluded from the STS eligibility criteria, due to perceived vulnerabilities arising from a strong reliance on the on the sale of the underlying loans in order to repay the CMBS obligations. While better capital treatment for some products is certainly welcome, it is discouraging that a large number of securitisations that have performed historically well (such as some synthetic or more actively managed structures) will continue to be disadvantaged relative to more traditional asset-backed securities (ABS) and ABCP.
In its 2015 report to the Commission on synthetic securitisation, the European Banking Authority (EBA) recognised that synthetic transactions that are used by credit institutions to transfer the credit risk of their lending activity off-balance sheet (i.e. balance sheet synthetics) have performed relatively well. The EBA recommended extending preferential regulatory capital treatment to senior retained tranches of synthetic transactions, provided that specific criteria are satisfied. Among other things, the transactions would need to be comprised of fully cash-funded credit protection provided by private investors in the form of cash deposited with the originator institution.
At the time, the Commission was reluctant to introduce eligible STS synthetic products on the basis that it lacked sufficient information to take a view. Currently, despite being armed with the EBA’s recommendations, the Commission appears to have compromised with the European Parliament on this issue. However, the SR does contemplate the possibility of including synthetic products in the future.
The SPR, which focusses on CRR-regulated credit institutions and investment firms, does not afford the same STS capital relief to other institutional investors such as pension funds, insurance and reinsurance undertakings. The Commission has made encouraging noises in respect of extending STS capital relief to insurers, the impact of the new STS framework will be muted if they are effectively locked out of the market.
There is a second hurdle to be met under the SPR, which is being developed in parallel. The SPR establishes a set of conditions and the process by which credit institutions and investment firms can determine whether such conditions are satisfied. The test for determining whether a transaction receives preferential prudential treatment is twofold: first, the transaction must pass the STS designation process according to the SR. Second, the transaction must meet certain credit risk criteria set out in the SPR.
If the two regulations come into force at the same time, then the STS framework could have a positive effect on the market. However, if they are staggered, with the SR’s additional reporting requirements coming before the SPR’s capital relief, then market participants may be put off STS securitisations before the new framework has a chance to take hold.
STS eligibility and the labelling process
The SR sets out the eligibility criteria for the STS designation, which are grouped under the virtues of simplicity, standardisation and transparency. There are separate but broadly similar STS criteria for term securitisations and ABCP. Examples of the criteria include requiring the underlying assets to be homogeneous by type and in most cases limiting eligibility to true sale ABS only. “Homogeneous” for these purposes means being in the same asset type where the contractual, credit risk, prepayment and cash-flow related characteristics are sufficiently similar. We expect further detail to be set out in the level two technical standards.
In respect of STS-eligible ABCP transactions, “homogeneous” also concerns the maturities of the underlying asset pool. STS-eligible ABCP must be backed by a pool of assets with a remaining weighted average life of no more than one year, and no such transactions may have a residual maturity of longer than three years. Following intense lobbying by the auto industry (one of the largest sectors to use ABCP), ABCP backed by auto loans, auto leases or equipment leases can have a remaining exposure weighted average life of up to three and a half years, provided that none of the underlying assets has a residual maturity of longer than six years.
Originators, sponsors and issuers will be jointly responsible under the SR for assigning the STS designation, and would face the consequences (yet to be determined) for falsely making such a designation.
The SR sets out an optional process whereby an authorised third party can attest to the satisfaction by of the STS criteria, using a “light touch” set of rules. In order for a third party to receive regulatory authorisation to assess satisfaction of STS criteria, it must be independent, be established for that sole purpose, operate on not-for-profit basis, charge only non-discriminatory fees on a cost-recovery basis, and have professional qualifications, knowledge and experience and a good reputation. Use of such third party certification, however, will not absolve originators, sponsors and issuers from liability for making STS assertions that turn out to be false.
It should be noted that publication by ESMA on the STS register is not intended to amount to a supervisory approval. Investors will still be expected to conduct their own due diligence based on the data provided under the transparency provisions of the SR.
If the originator or original lender of the underlying assets is not an EU regulated credit institution or investment firm, then it must include its credit criteria with the STS notification. The details on the exact information and format are likely to be included in the level two technical standards.