On 30th September, 2015, the European Commission published its much anticipated Action Plan on building a Capital Market Union (CMU). As a part of its implementation of the Action Plan, two draft regulations on securitization were issued. This was followed by launch of a green paper named ‘Building a Capital Market Union’ along with a consultation paper on creation of high-quality securitization market.
The “Securitisation Regulation” (“Regulation”) has been framed with the motive to harmonize rules on risk retention, due diligence and disclosure across different categories of European institutional investors who are currently governed by separate regulations. Securitization will also come under the ambit of the proposed regulation, subject to grandfathering provisions and will provide a new framework for simple, transparent and standardized (STS) securitisations. The extant provisions will be replaced, which would otherwise reiterate the legislations applicable to banking, asset management and insurance sector.
The “Amending Regulation” will implement the revised Basel framework for securitization in the European Union and employ a more risk sensitive prudential treatment for STS securitsations similar to that recommended by European Banking Authority.
The Securitization Regulation draws a distinction between STS securitization and non STS securitization. Currently only ‘true sale’ securitisation can be considered as STS securitization. Re-securitisation cannot be termed as STS securitization. However, the European Commission has not yet decided on whether ‘synthetic securitization’ should be treated as STS securitization. The aforesaid STS criterion is the prime deciding factor in differentiating between the STS and Non-STS securitisation transactions. The key benefit of securitisation complying with the STS criteria will be preferential regulatory capital treatment for investors. However, originators, sponsors and SSPEs of STS securitisations will be jointly responsible for determining whether a securitisation transaction complies with the STS criteria and whether it will be liable for any loss or damage resulting from incorrect or misleading STS notifications.
The fog does not seem to have cleared out completely with regard to the positioning of grandfathering transactions by institutional investors on securities issued between 1st January, 2011 and before the Regulation becomes effective. It seems that they may be exposed to the new diligence rules in the Securitisation Regulation and the risk retention rules under the current regulations.
The European Supervisory Authorities (ESA) will have a period of 12 months after the Regulation comes into force to provide further details of the information to be provided in the STS notification. European Securities and Markets Authority (ESMA) will be required to maintain a list of both the compliant and the non-compliant STS securitisations. However, the securities issued before the Regulation comes into force will be permitted to be categorized as STS securitization only if they comply with the STS criteria.
Unlike the regulatory technical standards (“RTS”) on disclosure requirements for structured finance instruments, file audit would be required to be done by an independent party with a 95% confidence level for all STS transactions. For this, the originator or sponsor shall be required to provide a liability cash flow model to investors and to maintain this on an ongoing basis.
The definition of “originator” has been amended in the proposed regulation which is reproduced below:
"an entity shall not be considered to be an originator where the entity has been established or operates for the sole purpose of securitising exposures".
This change will be relevant for those market participants involved in issuance of securitisations involving portfolio sales and platform lending.
The Regulation does not confirm that the new RTS should be prepared in relation to the new due diligence requirement. But it is clear that the new RTS should be prepared in relation to risk retention and disclosure standards. For maintaining the confidentiality of securitization transactions and market-sensitive information of private entities, it is necessary to maintain disclosure requirements for securitisation including and bilateral securitisation. However, there arises concern that until the new regulatory technical standards are developed, the current RTS will apply to new transactions. This could create a bottle-neck in complying with requirements under two sets of RTS.
There is an amendment relating to alignment of the treatment of Over the Counter (OTC) derivatives entered into by SSPEs with those entered into by covered bond entities. After the Regulation comes into force, STS securitisations will be able to avail exemption for satisfying the clearing requirement and maintenance of margin requirement.
On the recommendation set out in the revised Basel framework for securitisations, which was published by the Basel Committee on Banking Supervision in December,2014, the Amending Regulation will aid in implementing the three approaches as set out for calculation of capital requirements. As applicable on qualifying secuiritisations, the Amending Regulation will also adopt a more risk-sensitive prudential treatment for STS securitisations. It will also make the capital treatment of securitisations for banks and investment firms more risk-sensitive and will be able to reflect properly the specific features of STS securitisations. For generating lower capital charge for transactions qualifying as STS transactions, the three approaches have been recaliberated. Senior positions in STS securitisations will have an advantage of lower floor of 10% instead of 15% which is applicable to non-senior positions in STS securitisations and Non-STS securitisations.
The proposed revisions to regulatory capital charges for STS securitisations have been welcomed in the European securitization market. These revisions if implemented are likely to have a positive impact on the securitization market far beyond the borders of Europe as the issuers and investors in the U.S., Canada, Australia and other countries grapple with the consequences of two- track securitization regime. Thus, the draft regulation is expected to bring a major change in the securitization market if implemented.
Reported by: Surbhi Mohata
Dated: 16th December, 2015