A special securitisation framework in the EU

I. Introduction

The EU aims to equip its domestic economy with a broad and sustainable financial base by means of the Investment Plan for Europe (the “Investment Plan”). The Investment Plan promotes an investment friendly environment by establishing a true single market for capital, the so-called Capital Markets Union (the “CMU”). In June 2017, the European Commission unveiled its mid-term review of the CMU action plan (the “Action Plan”), which was launched in September 2015 and comprises a package of measures, including the implementation of a harmonised securitisation framework for a uniform European securitisation label called Simple, Transparent and Standardised (“STS”), comparable to the well-established EU UCITS or AIF “trademarks”.

II. Simple, transparent and standardised securitisation

Securitisation is the process where a lender (e.g. a bank) issues a tradable security through a securitisation special purpose entity (“SSPE”) by bundling assets that can subsequently be acquired by investors. The tradable security can originate from a synthetic or “true sale” securitisation, the latter being the traditional securitisation process whereby assets are legally transferred in whole to the SSPE. By contrast, “synthetic” securitisation is carried out by transferring solely the credit risk, whereas the lender remains the owner of the securitised exposures.

Escalating securitisation involving US sub-prime loans led, among other things, to the financial and economic crisis starting in 2007. Subsequent regulatory reforms strived to mitigate securitisation-related risks. STS does not aim to reverse those reforms, but targets an increase in liquidity by releasing capital from the banks for new lending in order to provide the wider economy with a suitable funding channel, reduce due diligence burdens and promote investors’ confidence. Yet STS products – supported by adequate regulatory measures – are intended to protect the market from exposure to high-risk products. In this context, the provisional edition of the adopted texts for the European framework for STS securitisation (“STS Regulation”) limits STS securitisation to the “true sale” type. According to the recitals, however, dedicated provisions for synthetic securitisation could be inserted at a later point by means of a legislative proposal by the Commission in order to extend the scope of the STS Regulation.

The below key points of the STS Regulation apply to long-term securitisations as well as short-term securitisations (ABCP), the latter subject to some specific provisions.

1. General provisions:

• Institutional investors and retail investors (under certain conditions, subject to suitability tests under MIFID II) will be permitted to invest in STS vehicles.
• Originators and original lenders have to be regulated entities, financial institutions with dedicated corporate objectives or multilateral development banks.
• Sponsors can be credit institutions (in and outside the EU) or investment firms (both terms as defined in MIFID II).
• SSPEs are prohibited from being established in certain third countries (offshore financial centres; application of FATF rules).
• Originator, sponsor and SSPE involved in a securitisation-considered STS shall be established in the EU.
• Due diligence/assessment measures to be taken by institutional investors in order to assess the eligibility of the originator and the exposures based on information provided by sponsors, originators or SSPEs.
• Risk retention (“material net economic interest”) on behalf of the originator/lender/sponsor of at least 5% (measured at level of origination and determined by the notional value for off-balance sheet items); implication of European Systemic Risk Board.
• Transparency requirements such as disclosure of information on the exposures, a transaction summary and a dedicated STS notification along with recurring investor reports; setting up a securitisation repository system with ESMA for securitisations to provide a high level of transparency and make available reliable and accessible information on securitisation for EU supervisory authorities, investors and potential investors.
• Originators, sponsors and original lenders should apply, with respect to the exposures to be securitised, the same criteria for credit-granting that they apply to non-securitised exposures.
• Ban of “black boxes”: prohibition of re-securitisation.
• Option for sponsors, originators and SSPEs to have recourse to third parties in order to assess compliance of an intended securitisation with the legal provisions.
• Preferential capital treatment for STS securitisation (Capital Requirements Regulation), including an updated hierarchy for risk calculation methods preferring STS over non-STS securitisation.
• Sanctions for intentional or negligent infringements.

2. Simple securitisation:

• Mandatory acquisition of securitisation exposures by SSPEs that are easily enforceable against the seller (by way of “true sale” securitisation).
• Warranties given by the seller ensuring the assignability/ saleability of the exposures.
• No active management of the exposures.
• Exposures consisting of homogenous assets originating from ordinary business (no transferable securities (cf. MiFID II), no securitisations).
• At the time of the transfer of the exposures to the SSPEs, at least one payment by the debtors has to be made and no exposures in default are permitted.

3. Transparent securitisation:

• Obligation of originator/sponsor/SSPE to grant (potential) investor and competent national authorities access to data on securitisation, such as static and dynamic historical default and loss performance data.
• External verification of exposures prior to issuance within the securitisation process.
• Originator or sponsor has to make available to investors a clearly documented liability cash flow model.
• If underlying exposures are residential loans, or auto loans or leases, the originator and sponsor shall publish available information on the environmental performance of the underlying assets.
• Joint responsibility of originator and sponsor to respect the general transparency requirements.

4. Standardised securitisation:

• Compliance with risk retention requirements.
• Appropriate mitigation of interest rate and currency risks; related measures have to be disclosed; hedging limited to certain activities.
• Referenced interest payments shall be based on general market interest rates and not reference derivatives or formulae.
• Dedicated rules for liquidation where securitisation does not have a revolving period.
• Appropriate early amortisation events/triggers for termination in case of revolving period.
• Specific information has to be included in the transaction documentation.

The criteria set out in the STS Regulation will be supported by guidelines and recommendations on the harmonised interpretation and application issued by EBA, in close cooperation with ESMA and EIOPA. Once all requirements as set out above are met, the originator, sponsor and SSPE have notified ESMA and the envisaged securitisation is officially listed, a dedicated “STS” label for the securitisation can be obtained to make it more attractive for potential investors. This allocation of power to a European supervisory authority demonstrates EU’s line of approach for the realisation of the Action Plan and the CMU.

III. Adoption of STS Regulation

Following a political agreement on 30 May 2017 between the Council, the European Commission and the European Parliament, the latter voted in favour of an amended version of the STS Regulation, which will soon be published in the Official Journal of the European Union and ultimately enter into force 20 days after its publication. According to article 48, the Regulation shall apply to securitisations whose securities are issued as of 1 January 2019, and the Regulation is – due to its legal nature – binding in its entirety and directly applicable in all member states of the European Union.

IV. Impact on Luxembourg legislation

The law dated 22 March 2004 on securitisation, as amended (the “2004 Law”), will most likely be amended further following the entry into force of the STS Regulation. The Luxembourg legislator will have several options and ultimately two securitisation regimes may coexist: first, the labelled and special STS securitisation, and, second, a national, more flexible and non-harmonised securitisation regime. Please note that the 2004 Law already provides for the option for SSPEs to be supervised by Luxembourg’s financial services supervisory authority, the CSSF. These entities may wish to convert to the upcoming STS label in order to distribute their securities to institutional investors on a pan-European basis. By contrast, non-supervised entities could adopt a lighter regulatory approach to be more attractive, such as a listing on the Euro MTF market or access to the prospectus framework.