European Commission's proposed reforms to securitisation framework will boost market

The reforms come at a time when the EU securitisation market has continued to lag significantly in size compared with the market in the United States. In its communication about the reforms, the European Commission has recognised the benefits of securitisation, observing in particular that by engaging in securitisation, banks free up their resources, allowing them to lend more to businesses and citizens, while making it possible to move portions of credit risk to interested investors beyond the banking system.

Summary of the proposed reforms

The reform measures include proposed amendments to the EU Securitisation Regulation, with a view to simplifying due diligence and transparency requirements for participants in securitisation transactions.

There are also proposed amendments to the Capital Requirements Regulation (CRR) and connected changes to the significant risk transfer (SRT) framework with a view to introducing more risk sensitivity in the prudential framework for banks issuing securitisations and simplifying the process for recognition of significant risk transfer.

Draft amendments to the Coverage Ratio (LCR) Delegated Regulation, to make more types of securitisations eligible for inclusion in banks' liquidity buffers have also been proposed, as well as a plan to amend the Solvency II Delegated Regulation, to enhance the insurance prudential framework for insurers when investing in securitisations.

Details of the proposed reforms

Under the proposed reforms, EU institutional investors will no longer be required to verify compliance with transparency requirements by EU sell-side parties, and will no longer be required to verify compliance with simple, transparent and standardised (STS) requirements, recognising that there are already other regulatory safeguards in place for these matters.

The requirements for institutional investors to assess the structural features of a securitisation and to establish appropriate written procedures for ongoing monitoring have been made principles based.

Due diligence requirements are waived where multilateral development banks fully guarantee the securitisation position. Lighter due diligence applies when a thick first loss tranche is guaranteed or held by certain public entities, while simplified due diligence applies for investments in repeat transactions and lighter due diligence applies for investments in senior tranches.

Reporting templates for public securitisations will be reduced by at least 35% in mandatory data fields, and a lighter reporting template will be introduced for private securitisation (but at the same time, fewer types of securitisations will qualify as "private securitisations", and private securitisations will be required to report to securitisation repositories).

Changes to CRR and the SRT framework

Among the main changes to CRR and the SRT framework, capital requirements will be adjusted by re-calibrating the risk weight floor and the "(p) factor", which are key parameters that banks must apply for the purposes of calculating the regulatory capital cost of exposures to securitisations. As a result of the adjustments, securitisations of less risky portfolios will be able to benefit from further capital reductions compared to securitisations which are deemed riskier. 

Capital reductions are granted for senior tranches in securitisations that are deemed "resilient", and which comply with a set of safeguards; and the SRT framework, which defines the conditions for supervisors to assess whether an originator bank transfers a sufficient amount of risk to third parties to qualify for a capital relief, is to be made clearer and more principles based.

The changes to the CRR prudential and SRT framework will be especially helpful for banks as issuers of securitisations, particularly when they hold the top-tier or "senior" positions, which is often the case in SRT transactions.

Changes to the LCR Delegated Regulation

The main changes include:

• eligibility to the LCR buffer will be extended beyond securitisations with AAA ratings, which are currently eligible, to securitisations with a ratings down to A-;
• a lower 15% haircut for liquidity buffer purposes will be granted to certain categories of 'resilient' STS securitisations;
• securitisations eligible for the LCR buffer will no longer be subject to maturity restrictions
• eligibility will be extended to all types of asset classes, provided that they meet the homogeneity requirements for STS securitisations.

Extending the eligibility of securitisation for inclusion in the liquidity buffers of banks should help attract investment in securitisations, not only by banks directly, but also by other market participants, who will be able to invest knowing that they have opportunities to trade on the secondary market with credit institutions.

Changes to insurance prudential rules on securitisation

This may include introducing new and lower capital requirements for senior tranches of non-STS securitisations, which currently attract the same capital requirements as non-senior tranches; and aligning the prudential treatment of senior tranches of STS securitisations more closely with those of covered bonds or corporate bonds.

Other measures

Other important aspects of the reforms include allowing pools composed of 70% (instead of 100%) of SME loans to be considered homogenous for STS purposes, which should help encourage SME financing, (ii) recognising unfunded guarantees from insurance and reinsurance companies as credit protection for STS synthetic securitisations, which should encourage the growth of the risk transfer market and (iii) enhancements to the functions and powers of securitisation supervisory and regulatory authorities, with a view to ensuring more effective supervision.

Outlook

The legislative proposal of the European Commission is now with the European Parliament and the Council. The adoption of the proposals will depend on how legislative negotiations evolve.

The reforms will reduce some of the barriers to securitisation, an important financing tool that can contribute towards investment needs and support growth. However, the extent to which the reforms will help revive the European securitisation market remains uncertain. The reforms do not respond to all of the concerns that have been raised by securitisation market participants, and some aspects of the reforms may be counterproductive. In particular:

• the proposed amendments to the supervisory regime include the introduction of heavy fines for contravention of investor due diligence obligations. This could be seen as a material disincentive to invest in securitisations;
• narrowing the types of securitisations deemed "private" and requiring private securitisations report to securitisation repositories will act as a disincentive to issuance of securitisations that have until now been deemed "private" (for example, if debt securities are admitted to trading on a Multilateral Trading Facility the securitisation will now be deemed to be a public securitisation and will therefore attract more onerous reporting requirements, but in reality transactions of this type are generally private deals)
• the re-calibration of risk weight floors and the p factor so that they become risk-sensitive could result in increases to capital charges beyond current levels in relation to exposures to asset classes that are deemed "riskier", such as lower rated corporate loans; and
• EU institutional investors are still not allowed to invest in non-EU securitisations unless those securitisations comply in form and substance with EU transparency obligations, putting EU institutional investors at a disadvantage compared to investors in other jurisdictions.

Although the legislative package is not as ambitious as some market participants had hoped, the reforms will nonetheless be a boost for the EU securitisation market. Issuers and investors will be monitoring the evolution of the reform package carefully in the coming weeks and months.

This article was originally published on 10 July in Thomson Reuters Regulatory Intelligence.