This article was originally published in the Journal of International Banking and Financial Law (JIBFL) in February 2018.
On 17 January 2018, two EU Regulations setting out a new framework for European securitisations entered into force. However, market participants still have time to prepare, as most provisions will apply to securitisations issued after 1 January 2019. In the meantime, the European Supervisory Authorities (ESAs) are consulting on related “level II” technical standards that will provide details on how the legislation will be implemented.
Regulation (EU) 2017/2402 (the STS Regulation) consolidates the patchwork of legislation governing European securitisations, and introduces the long awaited rules for issuing simple, transparent and standardised (STS) securitisations. Regulation (EU) 2017/2401 (the Securitisation Prudential Regulation) replaces certain provisions of the Capital Requirements Regulation (CRR) and sets out the framework under which institutional investors (eg banks and investment firms) can benefit potentially from more favourable regulatory capital treatment for STS securitisation exposures. While the legislation will apply to securitisations completed after 1 January 2019, legacy securitisations outstanding on that date will also be able to use the STS designation, provided that the structure complies with certain procedural requirements at the time of notification to the European Securities and Markets Authority (ESMA), and for other requirements (such as criteria for credit-granting) at the time of origination.
With primary legislation now in place, market participants need to keep an eye out for developments relating to implementing measures throughout 2018. Two areas to watch closely will be risk retention rules and the homogeneity requirement for asset pools backing STS securitisations. On 15 December 2017, the European Banking Authority (EBA) launched consultations in respect of each.
Risk retention is a well-established regulatory response to the financial crisis, which is intended to align originators’ and investors’ interests for securitisations. Under the CRR’s risk retention provisions (to be repealed in January 2019), institutional investors must ensure that originators retain a 5% economic stake in the viability of a transaction. While risk retention levels will be maintained at 5%, the STS Regulation departs from the existing CRR approach, and imposes direct risk retention and reporting obligations on the originators, sponsors or original lenders.
Currently, the penalty for non-compliance with risk retention is a punitive capital charge against investors’ balance sheets. Under the new rules, originators could face a myriad of administrative (or even criminal) sanctions depending on how the STS Regulation is implemented in each member state (although capital charges remain for investors that fail to conduct proper due diligence).
In its consultation paper on risk retention, the EBA proposes keeping the technical standards consistent with existing rules wherever possible. However, the proposal includes some targeted amendments. It provides further colour as to when an entity is deemed to have been established for the sole purpose of securitising exposures, making it ineligible to retain risk. It also sets out the conditions under which the retainer of risk can transfer its remaining retained exposure to a new entity where it becomes ineligible to retain risk due to legal reasons beyond its control.
The STS Regulation has been criticised for the vague nature of its eligibility criteria relating to the homogeneity of underlying asset pools. One common question has been how granular the homogeneity requirement will be, i.e. will asset pools need to be grouped by class, or according to sub-sets exhibiting common characteristics.
The EBA is consulting on an approach that would specify a list of asset categories as well as list of “risk factors” to be considered when determining whether an asset pool is sufficiently homogeneous. Risk factors include type of obligor, type of credit facility and collateral, repayment mechanics and industrial sector. Under this approach, not all risk factors would be relevant to each category. For example, it makes no sense to describe the type of immovable property relating to an auto loan securitisation (for which there is none), or type of obligor for owneroccupied residential loans (who are obviously individuals). In an effort to tick off each relevant risk factor, originators may struggle to pool together enough sufficiently similar assets to benefit from economies of scale.
The EBA is also expected to publish its final advice to the European Commission in early 2018 relating to significant risk transfer (SRT) rules, which will shape the Commission’s draft delegated legislation. Originator institutions will want to follow SRT developments closely, as achieving SRT and associated regulatory capital relief may be an important consideration when structuring securitisation transactions.
In addition, ESMA is consulting on draft technical standards that focus on procedural aspects to the STS Regulation, including:
- contents and format of reporting templates;
- operational standards for submitting reports to and for accessing information held by securitisation repositories;
- contents and format of the notification to ESMA of a securitisation’s STS status; and
- application requirements for third party entities seeking authorisation to provide third party STS certification services.
ESMA expects to publish a final report in July 2018 for the STS notification and third party application requirements and by the end of 2018 for the reporting requirements and operational standards/access conditions. The coming into force of the STS Regulation and Securitisation Prudential Regulation has provided some much needed clarity as to the direction of travel for European securitisations. However, 2018 will also be a definitive year with respect to what the final framework will look like.