In recent years there have been numerous regulatory developments affecting the securitisation market, including the introduction of risk retention requirements and changes to regulatory capital requirements. While these regulations have primarily been aimed at reducing the potential risks relating to securitisation transactions which were identified following the 2007/8 financial crisis, there has also been growing recognition of the role securitisation can play in providing a funding source and in reallocating risk in the financial markets.
The two new regulations discussed in this article are the culmination of several years of discussions, lobbying and negotiations. One of them, Regulation (EU) 2017/2402 (the Securitisation Regulation) consolidates and amends the existing rules for securitisation transactions, as well as creating a new framework for "simple, transparent and standardised", or "STS", securitisations. The other, Regulation (EU) 2017/2401 (the CRR Amendment Regulation) amends the Capital Requirements Regulation (the CRR) to revise the regulatory capital requirements for EU banks holding positions in securitisations. Both will apply from January 1, 2019.
Investor due diligence
One important aspect of the Securitisation Regulation is investor due diligence. Before investing in a securitisation, investors will be required to check that the credit-granting, risk retention and transparency requirements have been complied with and to carry out a due diligence assessment of the risks and structural features of the securitisation. They will also need to carry out ongoing monitoring, stress tests and internal reporting.
The risk retention requirements are based on the current rules in Article 405 of the CRR. Investors will need to obtain disclosure from the originator, sponsor or original lender that it will retain a material net economic interest of at least 5 percent in the securitisation using one of five possible methods. The definition of securitisation is broad and is based on the concept of "tranching" rather than the issuance of securities and payments to investors must be dependent on the performance of the underlying exposures, with different tranches (or segments of the credit risk) bearing losses depending on their level of seniority.
As well as applying to credit institutions and investment firms (as they do now under the CRR), the new rules will also apply to regulated alternative investment fund managers and to insurance and reinsurance undertakings (currently subject to similar requirements under the Alternative Investment Fund Managers Directive and the Solvency II Directive and the related regulations respectively), and in addition they will apply to two further classes of investors, i.e. certain investment companies authorised in accordance with, and management companies as defined in, the Undertakings for Collective Investment in Transferable Securities Directive, and institutions for occupational retirement provision and related investment managers and authorised entities.
In addition, the Securitisation Regulation introduces a direct requirement on the originator, sponsor and original lender to retain the material net economic interest in the securitisation of not less than 5 percent. It is worth noting that this means that securitisations with non-EU investors and an EU originator will need to be structured as risk retention compliant due to this direct requirement on the EU originator.
There are also new requirements aimed at preventing adverse selection of assets, although the draft regulatory technical standards indicate that it will be possible to securitise assets with a higher than average risk profile than retained assets provided that this has been communicated to investors in advance.
The transparency requirements are based upon those set out in the amendments to the Credit Rating Agencies Regulation under the regulation known as CRA3. Originators, sponsors and special purpose vehicles will need to disclose the prospectus (or if no prospectus has been prepared, a transaction summary) and the main transaction documents, to provide quarterly investor reports (or monthly investor reports in the case of securitisations funded via asset-backed commercial paper (ABCP)), and to notify investors of certain matters, via a securitisation repository, or if no securitisation repository has been registered, via a website meeting certain requirements.
In the case of certain private transactions (i.e. transactions where a prospectus is not required under the Prospectus Directive), the information will not be required to be provided to a securitisation repository or a website but will be required to be disclosed to investors.
The Securitisation Regulation also includes a ban on resecuritisation, meaning that the exposures in the securitised pool may not themselves include any securitisation positions. While investments in resecuritisations are already subject to punitive capital requirements, this prohibition puts an additional onus on the parties to ensure that a transaction is not a resecuritisation, although it is not specified who would be liable for any breach.
In addition, the Securitisation Regulation provides that originators, sponsors and original lenders will need to comply with the applicable credit-granting standards and there are restrictions on special purpose vehicles being established in certain jurisdictions.
Technical standards are being prepared to provide more detail for certain aspects of the requirements, including with respect to risk retention and transparency.
In addition to the expansion and consolidation of the rules relating to securitisation transactions, the Securitisation Regulation also puts in place a new framework for securitisations which meet the specified requirements to be considered STS. This framework establishes a separate set of criteria for non-ABCP securitisations and for ABCP securitisations. The STS requirements for ABCP transactions are similar to the criteria for non-ABCP securitisations; however, there are also additional requirements which will need to be met for ABCP sponsors and programmes to be STS.
Securitisations which meet the STS requirements will, provided they also meet certain additional criteria set out in the CRR Amendment Regulation, be subject to lower regulatory capital requirements, as well as benefitting from other advantageous regulatory treatment.
Given the substantial increases in the required regulatory capital for most tranches under the new rules, this could be significant. Some transactions, such as managed CLOs and CMBS transactions, will not be capable of being STS and some securitisations will be excluded because they will not meet the requirement that each of the originator, sponsor and SPV are in the EU.
There are numerous requirements to be met under the STS criteria, and while guidelines are being prepared to clarify them, a number of criteria may remain unclear or the requirements may be too onerous for certain types of transactions. It also seems unlikely at this point that many ABCP programmes will be classified as STS, since (apart from certain limited and temporary exceptions) all transactions in an ABCP programme will have to be STS in order for the programme to be STS.
The penalties for non-compliance with the requirements set out in the Securitisation Regulation could be severe, including administrative sanctions (although the breach will need to result from negligence or be intentional) with maximum fines of at least 5,000,000 euros or up to 10 percent of annual net turnover, and other remedial measures, and EU member states may also impose criminal penalties.
The Securitisation Regulation contains grandfathering provisions and will apply to securitisations the securities of which are issued or (or where the securitisation positions are created) after the application date of January 1, 2019. Securitisations entered into before that date may still become subject to the new rules in certain circumstances.
The effects of the Securitisation Regulation and the CRR Amendment Regulation remain to be seen. Market participants will need to adapt to the new rules and questions of interpretation will need to be ironed out. The STS regime may not be available or may prove too onerous or complex for many transactions, even though they might be considered by those involved to be of good quality and appropriately structured, and therefore this may not give the securitisation market the boost it needs. But the finalisation of the new rules will provide much needed certainty after this period of regulatory change and it is to be hoped that this will result in increased market confidence to allow the securitisation market to develop further.
This article refers to the law and regulation as at the date this article was written. It is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. You should seek specific legal advice before taking any action with respect to the matters discussed in this article.