Structured Finance Alert: Proposed Changes to EU Requirements for Securitisations

Background

Paul Tang, MEP and Rapporteur for the Committee on Economic and Monetary Affairs (known as ECON) of the European Parliament, published his proposed amendments to the Capital Requirements Directive in relation to securitisation on 6 June 2016. The amendments propose a number of substantial and potentially far reaching changes to the draft directive produced by the European Commission in September 2015.

The European Process

The role of a Rapporteur within the EU is to present a report that has been adopted by one of the European Parliament’s committees, in this case ECON. These proposed legislative amendments will then be discussed by the entire parliament before being voted on. Rapporteurs produce their reports after consulting internal and external experts and debating the proposals within the committee. Consequently, Paul Tang’s report is simply a proposal rather than reflecting the thinking of the European Parliament as a whole.

Proposed Changes

The report aims to address what it calls the twin problems of securitisation: asymmetric information and moral hazard. It therefore proposes greater reporting, due diligence and rate-of-retention requirements, as well as restricting both the types of products and the participants in the market. The headline points are detailed below.

Risk Retention Requirement

One of the more eye-catching amendments is the quadrupling of the risk retention requirement from five percent to 20 percent. The report states that it is possible for the European Banking Authority (EBA), in cooperation with the European Securities and Markets Authority (ESMA) and European Insurance and Occupational Pensions Authority, to lower the rate of retention requirement for “certain sections of the market” providing the EBA justify any such lowering. However, it is not clear what this would mean in practice.

Data Repository

The report proposes establishing a data repository that details the underlying loans in securitisations. The repository is proposed to be based on similar, currently nonmandatory, databases such as the European DataWarehouse. ESMA will publish this information (anonymised) in accordance with data protection laws. This data repository will be funded through a charge on the originator, sponsor and special purpose entity of a securitisation (SSPE). The process of setting up such a database, especially given data protection concerns, is likely to be cumbersome and will require further detail to ascertain how feasible, or indeed beneficial, such a database would prove. Indeed, the report goes even further to suggest a public register of securitisations as well as of the underlying loans, which seems to envisage a register of the holders of securitisation positions.

Restrictions on Participants

Only regulated institutional investors “with large enough capital buffers” will be allowed to originate and issue securitisations, and indeed only regulated institutional investors will be allowed to take part in the securitisation market at all (as investor, sponsor, originator or original lender), in order to exclude the shadow banking market. This could mean that special purpose risk retainers would not be permitted in any circumstances, however well capitalised they may be. It is also currently unclear whether a “regulated institutional investor” for these purposes means only an EU-regulated entity. Furthermore, there is some internal inconsistency in the way that the terms “financial institution,” “credit institution,” “investment firm” and “regulated institutional investor” are used. This will cause further confusion as to who can participate in this market unless the terms are clarified.

SSPEs too will have to meet strict requirements, effectively banning the use of tax havens and promoting the use of companies within EU member states.

Restricted Activities

Re-securitisation will be banned. Arbitrage synthetic securitisations will not be allowed to be considered as simple, transparent and standardised securitisations (STS), which are intended to carry lower risk weightings. A report is proposed to be conducted on whether balance sheet synthetic securitisations can be brought within the STS framework.

Increased Regulatory Requirements

The report also proposes a number of new reporting and due diligence requirements. These include the following:

• notifying ESMA when an investor acquires a securitisation in the secondary market;
• originators, SSPEs and investors will have to provide quarterly investor reports (or for asset backed commercial paper (ABCP) monthly investor reports) containing the ultimate beneficial owner, the size of their investment and to which tranche of securitisation it relates;
• originators, sponsors or SSPEs of STS securitisations must disclose how the resulting capital has benefited the “real economy”, publish information on the long term sustainable nature of the securitisation for the investors and explain how the freed-up capital helped the original lender;
• the sponsor of a STS ABCP will have to demonstrate to its supervisor on a regular basis that in an extreme stress test its role will not endanger financial stability; and
• sponsors shall perform their own due diligence and verify that the seller meets sound underwriting standards; risk management controls are required to be well documented.

A number of these requirements would appear to require further guidance if they are to become workable given their vague and broad nature.

Progress of Report

The European Parliament still has to discuss the proposed amendments, with a vote unlikely to take place until the end of this year at the very earliest. Given the substantial nature of the reforms currently proposed, however, and their likely impact on a market which is still trying to come to terms with the last round of regulation, the progress of this report will need to be monitored closely.