The new regime is a step in the right direction, but leaves many unanswered questions as the reform process continues.

The financial and regulatory framework of securitisation of credit risk is going through profound transformation. These changes in regulations are still in fieri, ongoing. The European Commission recently published a proposal to harmonise the overall securitisation environment and to set out a comprehensive and standardised framework for both securitising parties and investors. This regulatory effort is one of the most substantial and significant reforms of securitisation regulations, and essentially covers the subject matter of the securitisation of credit risk not originated by the issuer of the securitised instruments. Other fields of interest such as the securitisation of market risk, of insurance risk or derivatives is not object of this regulation.

The EU proposals recognise the need for reform and homogenisation of the existing rules and practices for due diligence, disclosure and risk retention, to establish coherence and consistency. At the same time, the proposals aim to create a precise framework for simple, transparent and standardised securitisations, the so-called STS criteria, which aim to benefit both investors and originators.

Although this regulation is still at the proposal stage, its implications for securitisation include potentially introducing key obligations for originators and regulated institutional investors. It’s therefore essential that asset managers are aware of these changes and their impact.

Parallel to this, the European Commission has also proposed a comprehensive capital requirements regulation (also known as the CRR amendment) that paves the way for a more prudential and risk-oriented approach toward securitisations, with a likely rationalisation of capital requirements for securitised exposures. The new CRR rules are still being debated, and further disclosure by the policymaker is thus needed in order to draw additional conclusions and avoid ambiguous interpretations.

Securitisation rules and practices under the Alternative Investment Fund Managers Regulation (AIFMR) and the CRR will be replaced by the content and provisions of the securitisation regulatory framework as presented in the EU draft. This is particularly important from a due diligence perspective, since investors must get up to speed on the level of internal reporting, risk characteristics and structural traits of the securitisation.

As evidenced by recent studies in this area, substantial discrepancies still persist between national competent authorities and EU regulation and practices. Article 16 of the current EU proposal seeks to fill the regulatory vacuum and the differences in the competences between regulators by requiring national competent authorities (NCAs) to analyse and review securitisation arrangements and verify whether they comply with the STS criteria.

More detailed guidance by the European policymaker is still needed in this area, although it is widely believed that the joint committee (comprised of the European Banking Authority, European Securities and Markets Authority and the European Insurance and Occupational Pensions Authority) will design and implement binding standards to ensure the trust of investors and a sufficient level of legal certainty and consistency in their interpretation by different regulators.

A consistent degree of novelty to current practices is also introduced with respect to risk retention. Under article four of the EU proposal: any one of the sponsor, originator and lender parties are required to retain a minimum of 5 percent economic interest in the issuance. In addition to this, both originators and investors are required to ensure legal compliance, meaning that that burden will no longer be exclusively carried by investors.

In this sense the establishment of a unique, organic, regulatory environment for securitisation, as presented in the EU regulation, is part of a comprehensive effort to enact a set of regulatory technical standards that facilitate compliance with these rules as well as establish a common ground for securitisation regulation. The moves allow for the creation of a framework more compatible with current US standards, thereby reducing conflicts among national regulations and facilitating interdependence between the two securitisation markets. Grandfathering provisions are also expected to apply to existing securitisations, so that EU risk retention requirements will not impact older deals.

Parallel to this, under article five of the EU proposed regulation, which is designed to build article 8b of the CRA regulation, securitising parties will be required to provide investors and regulators with more detailed information such as key transaction documents and underlying asset performance, together with information on potentially significant and price-sensitive events.

Although within the EU guidance there is no explicit mention of the obligation to render information publicly available on all transactions (and information on private deals may still remain private), the forthcoming regulatory technical standards will require information to be disclosed to both investors in the securitisation and to the competent authorities. A major innovation is new transparency criteria that hold originators, sponsors and special purpose vehicles (SPVs) jointly responsible for compliance with article five.

In addition to this, the policymaker is setting stricter and more defined limits for the eligibility of originators, which are now required to hold economic capital against the securitised exposures. It is still unclear whether this regulation will include minimum holding periods or real substance tests for securitised assets, although it is widely believed that the new EU guidance will make it clear that originators should not be constructed solely to act as originators for securitisation transactions.

The introduction of a more uniform and homogeneous regulatory environment for securitisation will facilitate the adoption of structured alternative investments on a large scale, argue many experts.

The application of the STS criteria, together with a broader adoption of a common regulatory framework for securitisations in the EU landscape, are intended to benefit not only investors, but also originators and sponsors. So although uncertainty still characterises the legislative process, better regulation will facilitate the growth of structured alternative investments. The regulation of securitisations has been recently prioritised by EU policy makers, and the approval of these norms is expected to take place shortly.

 

This article first appeared in the Private Debt Investor magazine in March 2016.