European Commission publishes major changes to European securitisation rules

30 September 2015 - The European Commission (EC) today published its much anticipated Action Plan (Action Plan) on Building a Capital Markets Union (CMU).  The publication of the Action Plan follows the launch of a Green Paper: Building a Capital Markets Union, together with a consultation paper on the creation of a high-quality securitisation market and a further paper proposing a review of the Prospectus Directive on 18 February 2015. Responses were requested by 13 May 2015, following which a conference took place over the summer prior to today's publication of the agreed Action Plan.

As part of its implementation of the Action Plan, the EC has today issued two draft regulations on securitisations.  If implemented, these regulations will make some major changes to European securitisation rules.

The first regulation will harmonize rules on risk retention, due diligence and disclosure across the different categories of European institutional investors  which will apply to all securitisations (subject to grandfathering provisions) and will introduce a new framework for simple, transparent and standardised (STS) securitisations (the "Securitisation Regulation"). The Securitisation Regulation will also repeal existing provisions what would otherwise become overlapping in legislation relating to the banking, asset management and insurance sectors. 

The second regulation will implement the revised Basel framework for securitisation in the EU  and implement a more risk sensitive prudential treatment for STS securitisations similar to that recommended by the EBA (the "Amending Regulation").

Key points to note include the following:

  • Differentiation: The Securitisation Regulation draws a distinction between STS securitisations (which meet the STS criteria) and those securitisations which do not meet the criteria (non-STS securitisations).  The main benefit of a 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 that a securitisation complies with the STS criteria and will be liable for any loss or damage resulting from incorrect or misleading STS notifications.
  • Application and Grandfathering Arrangements: The position on grandfathering of existing securitisations is not entirely clear in the draft Securitisation Regulation. The Securitisation Regulation will apply to all securitisations the securities of which are issued on or after the date of entry into force of the Regulation. None of the provisions should apply to securitisations entered into before 1 January 2011 (where no new exposures have been added or substituted to the transaction after 31 December 2014).  The position for securitisations which do not fall into those categories is less clear.  It seems that institutional investors in securitisations entered into on or after 1 January 2011 (or to which new exposures were added or substituted after 31 December 2014) but before entry into force of the Securitisation Regulation may only be subject to the new due diligence rules in the Securitisation Regulation and the risk retention rules under the current regulations.  
  • Definition of "Originator": The Securitisation Regulation amends the definition of "originator" for the purposes of the risk retention provisions by providing that "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".  Although it appears that the EC has softened this provision during the course of drafting this legislative proposal, this definition of "originator" may well still be of concern to those market participants involved in issuance of securitisations involving portfolio sales and platform lending as well as CLOs.  
  • STS Criteria: There are separate but broadly similar STS criteria for term securitisations and asset backed commercial paper (ABCP), which take account of their structural differences; this differs from those criteria published by the Basel Committee on Banking Supervision (BCBS) and IOSCO, which did not take account of ABCP at this time.     Currently, only "true sale" securitisations can be STS securitisations. The EC is currently examining whether synthetic securitisations could meet the STS standard. Re-securitisations cannot be STS securitisations.  The understanding is that the LCR requirements will also be updated to reflect the final STS criteria.
  • STS Transparency: A file audit by an independent party will be required on all STS securitisations.  The originator or sponsor shall be required to provide a liability cash flow model to investors and maintain this on an ongoing basis.  This was removed, following consultation with the industry, from the CRA 3 regulatory technical standards on disclosure requirements for structured finance instruments. 
  • Determination of STS Status and Liability: Originators, sponsors and SSPEs will be jointly responsible for determining that a securitisation complies with the STS criteria and for notifying EMSA accordingly using a template created by the European Supervisory Authorities (ESAs).  The ESAs will have 12 months following the entry into force of the Regulation to provide further detail of the information to be provided in the STS notification and to determine the form of the template. Of greater concern is that originators and sponsors will be liable for any loss or damage resulting from incorrect or misleading STS notifications.   ESMA will be required to maintain a list of STS securitisations and a list of securitisations which have been determined to no longer be compliant with the STS criteria and will be under an obligation to inform ESMA as soon as a securitisation becomes non-compliant with the STS criteria. Securitisations issued before the Securitisation Regulation comes into force will only be permitted to be designated as STS securitisations if they comply with the STS criteria. 
  • Derivatives Transactions: The Securitisation Regulation has been amended to try to align the treatment of OTC derivatives entered into by SSPEs with those entered into by covered bond entities.  The exemption from the clearing requirement would apply to STS securitisations only and the nature of any exemption granted from margining requirements would also appear to only apply to STS securitisations.
  • Capital Requirements: The Amending Regulation will implement a new hierarchy of the three approaches for calculation of capital requirements, following the recommendations set out in the revised Basel framework for securitisations, which was published by the BCBS in December 2014. The Amending Regulation will also adopt a more risk-sensitive prudential treatment for STS securitisations, similar to that proposed by the EBA in its report on qualifying securitisations. The three approaches are re-calibrated in order to generate lower capital charges for positions in transactions qualifying as STS securitisations.  In addition, senior positions in STS securitisations will also have the advantage of being subject to a lower floor of 10% (instead of 15% which will remain applicable to non-senior positions in STS securitisations and to non-STS securitisations).

Commenting on the changes proposed to the securitisation regulations in the Action Plan, Julian Craughan, partner in Hogan Lovells' London office focusing on securitisation, said:
"The proposed revisions to regulatory capital charges for securitisations designated as simple transparent and standard (STS) are a welcome development for the European securitisation markets.  There are a number of less helpful proposals though that could actually introduce uncertainty into the market."

Lewis Cohen, partner in Hogan Lovells’ New York office focusing on securitisation added:
 “These revisions, if implemented largely as proposed, will likely have an impact on securitisation markets far beyond the borders of Europe, as issuers and investors in the U.S., Canada, Australia and elsewhere grapple with the consequences of a two-track securitization regime very different from what is and likely will be in place in their home countries.”

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