Securitisation Regulation - all change?

The proposed Securitisation Regulation (the Regulation) forms one of the main pillars of the European Commission’s Capital Markets Union (CMU) package of reforms. The idea is for the Regulation to identify ‘high quality’ securitisations that pose less risk and could qualify for more relaxed capital rules than other securitisations.

The aim is also to make securitisation more appealing by consolidating the current patchwork of securitisation rules. This means that originators and sponsors of asset-backed products will have a single set of rules for offering their products to institutional investors, including EU-regulated credit institutions, insurers, investment fund managers and occupational pension funds. If enacted in its current form, the Regulation will represent a sea change for European securitisation, since it creates a new compliance regime with its own set of administrative sanctions and remedial measures.

The substance of the Regulation is still set to change, and technical details have yet to be produced. Currently, the proposal awaits the rapporteur’s report to the European Parliament, where a committee vote is scheduled for November 2016. Following Parliament’s adoption of the report, negotiations between the Commission and Council will continue and a new compromise text produced. Considering that the draft report quotes Michael Lewis in his book ‘The Big Short’, the Regulation may still be in for a bumpy ride. We are cautiously optimistic that a more final version and draft technical details will be available later in 2017.

The Regulation creates a new category of simple, transparent and standardised (STS) asset-backed securitisations (ABS) and short-term asset-backed commercial paper (ABCP) for favourable capital treatment. Eligibility criteria for the STS designation include requiring the underlying assets to be homogeneous by type and in most cases limiting eligibility to true sale transactions only. Re-securitisations will be ineligible. At the moment, it is under consideration whether the STS designation process will include authorised third-party certification or involve self-reporting by originators and sponsors only.

A second ‘STS Regulation’ is under development in parallel, which sets out the mechanics by which credit institutions can receive a more favourable capital treatment for their STS securitisation positions. We expect that the capital treatment for STS securitisation positions will be extended to other investor types such as insurers after the Regulation enters into force.

The Regulation will ensure that originators, sponsors or original lenders continue to maintain a 5 per cent net economic exposure to their securitisations (as is the case under existing legislation). This promotes the alignment of their interests with the interests of investors.

Under existing rules, the onus is on credit institutions, insurance companies and fund managers to police compliance with the risk retention requirement where they invest in securitisations. Market practice is to include contractual provisions to that effect in the transaction documentation.

The current proposal imposes a direct risk retention requirement and reporting obligation on the originators, sponsors or original lenders. Currently, the penalty for non-compliance is a punitive capital charge against investors’ balance sheets. Under the new regime, originators could face a myriad of administrative (or even criminal) sanctions depending on how the Regulation is implemented by national governments (although capital charges remain for investors that fail to conduct proper due diligence). In addition, where originator/sponsors are located outside the EU, EU-based institutional investors will still be required to ensure that the 5 per cent retention requirement is met for fear of a regulatory capital hit. The result is that investors and originators will need to ensure that they satisfy this dual-compliance regime.

Under the Regulation, institutional investors will need to have (and observe) clearly defined criteria and processes for making investment decisions and ensuring that the risk retention requirement is satisfied. They will also need to establish procedures for monitoring asset performance and compliance by the originator, sponsor or original lender of the securitisation. They will need to be able to demonstrate to their regulators that they have a comprehensive and thorough understanding of the securitisation investments and their management.

Granular information on the transaction and underlying assets ranging from credit quality to performance data and cash flows must be provided to investors on a quarterly basis for ABS or a monthly basis for ABCP. There is a dual responsibility on the originator to produce the information and on the investor to request it. The fine details of the transparency and due diligence requirements will need to be worked out in technical standards which will follow.

As with all major regulatory changes, initially there will be some compliance headaches, but there will also be new opportunities. Originators and sponsors should involve their compliance teams closely, who will need to grapple with the sanctions regimes arising under the Regulation. At this stage, it is too early to start thinking about changing transaction documentation, because the legislation still has too many moving parts. We imagine that representations and covenants relating to risk retention will need to be tweaked slightly to reflect the new rules.

Originators and sponsors may want to keep an eye on the STS eligibility criteria as they develop, with a view to identifying assets that might be suitable for securitising under the new STS regime. We see a growing role for multilateral development and export credit agencies, who by providing guarantees will be able to bring otherwise ineligible ABS into the STS framework. This may especially be the case for ABS backed by loans to SMEs. As a result of other CMU initiatives in the pipeline, we also see the potential for issuance and investment in asset-backed products on a more pan-European scale.

This article was published by LexisPSL Banking & Finance on June 8, 2016.