_Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012 (Securitisation Regulation) became directly applicable across the European Union (EU) on 1 January 2019. It consolidates the previous patchwork of legislation governing European securitisations, applies more widely and introduces new rules for issuing what are known as simple, transparent and standardised (STS) transactions.
This note aims to summarise some of the key points in relation to the Securitisation Regulation.
Broader Scope of Application - Institutional Investors
The Securitisation Regulation replaces the previous sector-specific approach to securitisation regulation with a new set of rules that apply to all European securitisations, regardless of who invests and whether the transaction is private or public.
Previously, what determined the applicable set of securitisation rules that applied depended on the type of investor, with some investors being exempt from the application of any rules whatsoever. For example, the securitisation provisions for alternative investment fund managers (AIFMs) in article 17 of Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/201 (AIFMD) applied to EU AIFMs managing or marketing EU or non-EU alternative investment funds (AIFs) but did not apply to non-EU AIFMs managing or marketing EU or non-EU AIFs. Similarly, there were no rules applicable to undertakings for collective investment in transferable securities (UCITS) or their management companies (UCITS management companies).
The application of the Securitisation Regulation to UCITS is one of its more notable features, and UCITS management companies and self-managed UCITS will now be subject to all of the requirements applicable to Institutional Investors as defined in Article 2(12) of the Securitisation Regulation, as will non-EU managers of AIFs managed or marketed in the EU.
It should be noted that the definition of Institutional Investor does not include EU AIFs that have not appointed an AIFM, nor does it apply to any natural persons insofar as they may be permitted to invest in securitisations.
What is a Securitisation?
For the purposes of the Securitisation Regulation, a “securitisation” is a transaction or scheme, where the credit risk associated with an exposure (or a pool of exposures) is tranched, and where:
- payments in the transaction or scheme are dependent upon the performance of the exposure or of the pool of exposures; and
- the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme.
It is worth noting that the definition expressly excludes specialised lending transactions, being transactions structured specifically to finance or operate physical assets, as defined in the Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (Capital Requirements Regulation).
New Risk Retention Rules
Under the Capital Requirements Regulation (and Article 17 of AIFMD as it applied to EU AIFMs), the onus was on investors to ensure that risk retention requirements were satisfied; the requirement being that investors had to ensure that the originator, sponsor or original lender of a securitisation retained a five percent net economic interest, meaning it was compliant and therefore an eligible investment. This would typically be managed through contractual provisions in the transaction documentation.
The Securitisation Regulation replaces the existing risk retention requirements laid down in the various pieces of sectoral legislation and provides that Institutional Investors can only hold a securitisation where the originator, sponsor or original lender retains five percent. However, it also goes further to also bring in additional rules for originators, sponsors and original lenders that ensures that they are also under a positive obligation to retain a five percent net economic interest in securitisation transactions.
Due Diligence Rules
Institutional Investors must undertake a due diligence processes before becoming exposed to a securitisation and on an ongoing basis for as long as they remain exposed to a securitisation. The new regime requires an Institutional Investor to undertake certain steps, which can be summarised as follows:
- verify that that the structure is compliant with the five percent risk retention requirement;
- ensure that the assets were originated on the basis of certain credit-granting standards and that the securitising entity complies with its disclosure obligations;
- carry out a due diligence assessment and assess the risks involved in relation to the exposures underlying the securitisation and the structural features of the securitisation;
- on an ongoing basis during the life of the securitisation, establish written procedures proportionate to the risk profile of the securitisation position and Institutional Investor’s trading position to monitor the performance of the securitisation and its underlying exposures and compliance by the originator, sponsor or original lender;
- perform stress tests, ensure there is an adequate level of internal reporting of material risks and be able to demonstrate that it has a comprehensive and thorough understanding of the securitisation investments, underlying exposures and management.
It should be noted that these due diligence requirements are mirrored by new transparency requirements on originators, sponsors and original lender to facilitate compliance.
Applicability and Grandfathering
The Securitisation Regulation applies to securitisations issuing securities or creating new securitisation positions from 1 January 2019.
Pre-existing securitisations that already existed on that date will continue to be subject to the existing rules applicable to them (unless they create new securitisation positions). AIFMs and other previously in-scope investors will therefore be subject to a dual regime for the time being.
UCITS management companies and internally-managed UCITS are able to purchase non-compliant securitisations that were issued before 1 January 2019 but cannot purchase non-compliant securitisations issued after 1 January 2019. Should a formerly compliant securitisation cease to be compliant, then they will be obliged to consider “corrective action”.
Where Institutional Investors are exposed to a securitisation that no longer meets the requirements of the Securitisation Regulation they must, in the best interest of the investors, act and take corrective action, if appropriate.
It is not an obligation to immediately sell a position, although divesting may be the cleanest solution. Managers have flexibility to consider other solutions that consider investor protection, which may include working with the sponsor, original lender or originator to request remediation on all non-compliant securitisations, allowing them to become compliant, hedging or seeking compliance by documenting why holding a non-compliant position is the best option available to investors. Or, of course, corrective action may include a disposal.
What is an STS? What’s the benefit?
Finally, the Securitisation Regulation introduces the concept of STS transactions. This is a designation that can be applied to securitisations that meet certain requirements. The name is somewhat misleading, as they not particularly simple or indeed standardised.
They are subject to the same risk retention requirements, due diligence and transparency rules described above, but the advantage of meeting the requirements of being an STS securitisation is that it will have lower capital requirements than other securitisations. This will benefit certain classes of Institutional Investors (e.g. pension funds) more than others. It is worth noting that the applicability and scope of benefit of investing in STS securitisations is still in its infancy.
Achieving an STS designation is complex and includes an analysis of the underlying asset type and maturity; there are exclusions, such as commercial mortgage-backed securities (CMBS), securitisations of non-performing loans (NPL) and synthetic products. Originators, sponsors and issuers will be jointly responsible for assigning the STS designation, and assessing the risk of portfolio assets using either their own internal risk ratings, or standardised ratings approved at a National Competent Authority (NCA) level.
Historical (pre-January 2019) securitisations will be able to go back and assessed as STS. There are penalties for incorrect designation as an STS, which will vary based on the applicable NCA.