The European Commission recently published its long-anticipated report to the European Parliament and the Council of the European Union on the functioning of the EU Securitisation Regulation. The report contains important conclusions that are relevant for entities established in the European Union and involved in securitisations, and for non-EU entities involved in securitisations with EU entities.
The European Commission’s (the Commission’s) report on the functioning of the EU Securitisation Regulation (Regulation (EU) 2017/2402, as amended) (the Report) includes the following key points:
- No proposed changes to the risk retention requirements
- The European Securities and Markets Authority (ESMA) should review the reporting templates
- No change to the definition of private securitisation
- ESMA should draw up a dedicated reporting template for private transactions
- EU investors will need to obtain reporting templates in transactions with non-EU entities, as for those with EU entities
- No introduction of a simple, transparent and standardised (STS) equivalence regime
- Endorsement of the conclusions of the European Banking Authority (the EBA) in relation to amendment of the proposed EU Green Bond Standard with respect to securitisations
Article 46 of the EU Securitisation Regulation required the Commission to submit a report on the functioning of the EU Securitisation Regulation, to be accompanied, if appropriate, by a legislative proposal. The Report follows the consultation launched by the Commission on the EU securitisation framework in July 2021 (the Consultation), which sought feedback from market participants concerning the operation of the EU securitisation framework.
The Commission acknowledged that securitisation issuance is still muted. However, it noted that insufficient information was available in relation to legacy securitisations and private securitisations (i.e., those that do not require a prospectus in accordance with the Prospectus Regulation) and that it was difficult to assess the impact of the regulatory regime as against other factors. On a positive note, the Commission was not aware of any particular concern about credit quality and considered that the use of the STS designation is helpful in identifying high-quality securitisations.
The Commission concluded that the EU Securitisation Regulation is overall fit for purpose and that no major legislative changes are necessary. However, it acknowledged some of the concerns that had been expressed and suggested fine-tuning certain aspects relating to due diligence and transparency, and in particular reporting obligations for private securitisations.
The Report concluded that the available risk retention methods are adequate, and consequently no changes to the current risk retention requirements are necessary. This is likely to be well received by market participants.
It was noted that the new regulatory technical standards in relation to risk retention are still to be adopted by the Commission (following the publication of a final draft by the EBA on 12 April 2022), but there was no indication of when they will be adopted. The EBA was asked to monitor the application of the risk retention requirements and may consider the rationale for choosing one method of risk retention over another as well as the effectiveness of each method.
DUE DILIGENCE AND TRANSPARENCY
The Commission noted the feedback in the responses to the Consultation that the transparency obligations are disproportionate and too prescriptive. Respondents had particular concerns about the application of the requirements to private transactions and the lack of proportionality and uncertainty with respect to transparency in the case of third-country securitisations.
The Commission acknowledged that the reporting of information which is not used by investors provides little benefit and incurs unnecessary costs. It has asked ESMA to review the existing disclosure templates for underlying exposures, focusing in particular on addressing technical difficulties in completing certain fields, removing unnecessary fields, and aligning the information more closely with investor needs, including considering whether loan-by-loan data should be provided for all asset classes. This review is likely to be welcomed by market participants.
The Commission considered whether there had been a disproportionate increase in private securitisations and, if so, whether this had resulted from a desire to avoid the transparency obligations. It concluded that it was too early to reach a clear conclusion on this point, and that the Joint Committee of the European Supervisory Authorities (the Joint Committee) should continue to monitor the situation.
In our experience, it seems unlikely that market participants are structuring transactions as private in order to avoid the reporting requirements for public transactions. The key differences between those requirements for public and private transactions are that in the case of public transactions, information needs to be provided to a repository, and templates need to be completed with respect to the required disclosures relating to inside information and significant events. It is worth noting that the apparent increase in private STS transactions is partly due to the fact that for transactions that are funded by more than one ABCP (asset-backed commercial paper) conduit, a separate STS notification is required with respect to each conduit, resulting in an artificially inflated number of STS transactions on the STS register held by ESMA.
The Commission acknowledged the views expressed by some respondents to the Consultation that the templates were not useful for private transactions. This is certainly in line with our understanding with respect to truly private transactions, where the investors are closely involved in structuring the transaction, liaising with the originator to obtain the information they need, and putting in place their own reporting requirements.
The Commission has asked ESMA to draw up a dedicated reporting template for private securitisations, tailored to the information that supervisors need in order to obtain an overview of the market and the main features of private securitisations, and at the same time simplifying considerably the reporting requirements for private transactions. At some point the relevant information for private deals may need to be provided to a repository, but at present this was not recommended.
Finally, the Consultation had asked respondents to consider whether the definition of private securitisation should be amended. Although this suggestion was supported by many market participants, the Commission rejected the idea of amending the definition of private securitisation, concluding that the best solution was to review the reporting templates in the context of private transactions instead.
The Commission acknowledged the difficulties which had been widely noted in relation to the jurisdictional scope of the EU Securitisation Regulation.
First, the Commission rejected the Joint Committee’s suggestions that, in transactions with both EU and non-EU sell-side parties, only an EU entity should be responsible for (a) retaining risk in accordance with the risk retention requirements, (b) acting as the designated reporting entity, and (c) ensuring compliance with the credit-granting requirements. The Commission concluded that this was not supported by the legal text and there were other protections available. Market participants are likely to be pleased with this outcome.
Second, the Commission considered the difficult question of how Article 5(1)(e) of the EU Securitisation Regulation should be interpreted. Under Article 5(1)(e), institutional investors, as part of their due diligence obligations, have to verify prior to holding a securitisation position that, where applicable, information is made available to them in accordance with Article 7 of the EU Securitisation Regulation, which sets out the transparency obligations for originators, sponsors, and securitisation special purpose entities (SSPEs). The information to be made available pursuant to Article 7 includes the key transaction documents; a prospectus or transaction summary, as applicable; the provision of periodic reports on the underlying assets and investor reports, in each case using reporting templates prescribed by ESMA; and information in relation to certain inside information or significant events. One interpretation of Article 5(1)(e) had been that the words “where applicable” could imply that an EU investor did not have to obtain such information where an originator, sponsor, or SSPE was not directly subject to Article 7.
The Commission expressed the view that differentiating between the information to be provided by EU and non-EU entities would not be in line with the legislative intent of the EU Securitisation Regulation. The Commission acknowledged that this would de facto exclude EU investors from investing in certain third-country securitisations if the sell-side parties did not provide the relevant information. However, the Commission considered that its recommended review of the reporting requirements could help mitigate against any competitive disadvantage for EU investors.
This conclusion is likely of concern to many EU investors investing in non-EU transactions, as well as arrangers of such transactions where there are likely to be EU investors. It is worth noting that securitisations with non-EU issuers and originators generally fall into the category of private transactions, and consequently should benefit from the proposed new private reporting template. Market participants are considering the consequences of the Commission’s conclusion for new transactions, including during the interim period before the new template comes into effect, as well as the impact on existing transactions.
The Commission also considered the question of whether non-EU alternative investment fund managers (AIFMs) that manage or market alternative investment funds in the European Union should be considered to be institutional investors under the EU Securitisation Regulation. It concluded such non-EU AIFMs should be subject to the due diligence rules. However, in the Commission’s view, this should apply only with respect to funds which are being marketed and managed in the European Union, and not to managing and marketing activities outside the European Union. It will consider an amendment to clarify this in the future. In addition, the Commission determined that “sub-threshold” AIFMs should also fall within the definition of institutional investor.
In their responses to the Consultation, many market participants expressed the view that they were in favour of recognising other regimes as being equivalent to the EU STS regime. However, supervisors were opposed to this. The Commission concluded that it would be premature to introduce an STS equivalence regime at this time, as no securitisation regime was close to being equivalent to the EU regime, with only the United Kingdom having an STS regime. The Commission noted that the EU STS regime is still evolving and EU supervisory practices are still being developed and have not yet fully converged.
It seems unfortunate that there could not be an assessment of whether the UK STS regime could be seen as equivalent. While on-balance sheet synthetic securitisations are not capable of being STS under the UK regime, it is difficult to see why there could not have been an assessment of whether UK true sale STS securitisations might be recognised as equivalent to those securitisations which meet the EU STS requirements, given the closeness of the two regimes. Market participants are likely to be disappointed by this outcome, particularly as UK STS transactions can no longer be treated as STS by EU investors.
In addition to the responses to the Consultation with respect to sustainable securitisation, the Commission considered the conclusions of the EBA’s report on developing a framework for sustainable securitisation, published on 2 March 2022 (the EBA Report). The Commission agreed with the EBA’s conclusion in the EBA Report that there is currently no need to create a dedicated framework for sustainable securitisation, and that the proposed EU Green Bond Standard should be adjusted with respect to securitisations in order to apply a use of proceeds approach at the originator level instead of the SSPE level. This is likely to be welcomed by market participants.
The Commission was also in favour of extending the requirements for sustainability disclosures. The EBA Report recommended that disclosures on the principal adverse impacts of sustainability factors be extended from STS securitisations backed by residential mortgage loans and auto loans and leases to non-STS securitisations of those asset classes, and in the medium term to mandatory disclosures for all securitisations. For a more detailed analysis of developments in relation to sustainable securitisation and the EBA Report, please see our previous LawFlash, ESG Securitisation Continues to Develop in the European Union.
THIRD-PARTY VERIFICATION AGENTS FOR STS SECURITISATIONS
The EU Securitisation Regulation allows authorised third-party verification agents (TPVAs) to be engaged to evaluate a securitisation’s compliance with the STS requirements. The Commission noted that the market finds this helpful and determined that it was not necessary to amend this regime. It encouraged dialogue between TPVAs and supervisory authorities to avoid inconsistencies in the interpretation of the STS criteria.
The Report rejected the suggestion of introducing a system of limited licensed banks to perform the function of SSPEs, following responses from market participants and supervisors that this was unnecessary and could be detrimental.
The Commission considered that the overall supervisory framework in relation to securitisations is satisfactory in general. However, it cautioned against divergent approaches and suggested that guidance should be provided to avoid differences in interpretation and, in particular, that there should be a more harmonised approach in relation to supervision of compliance with the STS requirements.
The Report does not address the feedback on the functioning of the EU prudential framework that was obtained as a result of the Consultation. The Commission noted that it is awaiting advice from the Joint Committee on whether the prudential framework has met its objective, and it is also assessing the calibration of regulatory capital requirements for insurers and reinsurers. Once the Joint Committee has provided its advice, the Commission will consider this together with the feedback from the Consultation. Given that many market participants consider that the regulatory capital requirements for securitisation transactions are disproportionately high, they will be keen to hear the outcome of this review.
In addition, the Commission is considering the SRT (significant risk transfer) framework, following recommendations by the EBA and feedback from market participants.
UK SECURITISATION REGULATION
It is worth noting that the Report applies only to the EU Securitisation Regulation.
Following the end of the Brexit transition period on 31 December 2020, there is a separate securitisation regime in the United Kingdom. It is based on the EU Securitisation Regulation regime, but there are some differences. HM Treasury published a report in December 2021 in response to the UK call for evidence with respect to the UK Securitisation Regulation (Regulation (EU) 2017/2402, as it forms part of domestic UK law as “retained EU law,” and as amended by certain UK regulations).
In particular, HM Treasury expressed a willingness to consider the categorisation of public and private transactions and flexibility as to the format and context of disclosures. In the case of third-country securitisations, the UK Securitisation Regulation provides that a UK institutional investor has to obtain information that is “substantially the same” as that which would have been required to have been provided had the originator, sponsor, or SSPE been established in the United Kingdom, although it is not clear exactly what this means. It is expected that the question of what disclosures will be required to be obtained by UK investors in relation to third-country securitisations will be clarified by HM Treasury and the UK regulators as a matter of priority.
It is therefore quite likely that UK and EU investors will be subject to different standards as regards the due diligence and transparency requirements in the case of third-country securitisations. In addition, it is expected that there will be a separate set of UK technical standards in relation to risk retention, and these are likely to differ from the EU regulatory technical standards in relation to risk retention in some respects. There is also recognition of EU STS for UK investors for a transitional period and HM Treasury considers that an STS equivalence regime is desirable.
Given the likelihood that the EU and UK securitisation regimes will diverge further in the future, both regimes will need to be considered carefully in transactions involving EU and UK entities.
The Report provides some useful clarity in a number of respects, and the fact that no major legislative changes have been proposed is likely to be generally helpful in providing certainty to the market. The review of the reporting templates, and in particular, the proposal for a dedicated template for private transactions, may well result in a positive outcome.
However, the Commission’s conclusion as regards Article 5(1)(e) with respect to obtaining the reporting templates in transactions with non-EU originators, sponsors, and SSPEs may prove challenging to many EU investors and may make it difficult for them to invest in such transactions. Market participants will no doubt be hoping that the new templates for private securitisations will be more streamlined and can be introduced quickly.