Securitisation involves transactions that enable a lender – typically a credit institution or a corporation – to refinance a set of loans, exposures or receivables by transforming them into tradeable securities. Examples of such loans are residential loans, auto loans or leases and consumer loans. The lender pools and repackages a portfolio of its loans, and organises them into different risk categories for different investors, thus giving investors access to investments to which they normally would not have access. Returns to investors are generated from the cash flows of the underlying loans.
Securitisation is important to the functioning of financial markets. It acts as a bridge between credit institutions and capital markets, providing businesses and individuals with wider investment options. It may help to diversify lending risk away from traditional banking sources.
After the financial crisis, securitisations played a diminished role in the capital markets. This was partially due to a loss of investor confidence but also due to regulatory burdens as securitisations were subject to unfavourable treatment by the Capital Requirements Regulation (“CRR”).
In 2014, the European Commission announced its intention to support high-quality securitisation markets. The new Securitisation Regulation will apply from 1 January 2019. It will replace the existing fragmented regulation of securitisations which is currently set out in the CRR, Solvency II, AIFMD, the Credit Ratings Regulation and the Prospectus Regulation. The timing of the new Securitisation Regulation coincides with a recent increase in demand for securitisations by investors as they chase higher yields amid historically low interest rates.
Securitisation Regulation seeks to provide standardised rules on risk retention, due diligence and transparency/disclosure which will apply to all securitisations. Securitisation Regulation also sets out new rules/eligibility criteria in relation to simple, transparent and standardised (“STS”) securitisation transactions. For transactions that are deemed STS, investors will be allowed to hold less capital against their positions.
Securitisation Regulation applies to securitisation entities (entities whose sole business activity is to engage in securitisation transactions), sponsors, originators, original lenders and institutional investors. It should be noted that AIFMs, internally managed UCITS and UCITS management companies are covered by the regulation under the term “institutional investors”.
Prior to the introduction of Securitisation Regulation, there were existing risk retention rules in place. Securitisation Regulation retains many of these rules, and provides further clarification in relation to risk retention. Important points include:
- A continuation of the requirement that originators, sponsors or original lenders must retain a 5% net economic interest over the life of a securitisation transaction.
- A new requirement that securitising entities themselves must retain risk. This means that an EU securitising entity will need to meet the new requirements even where its investors are not required to do so, for example, where its investors are non-EU entities.
- As is currently the case, securitisations with underlying assets that are guaranteed by governments, central banks or local authorities are exempt from the risk retention rules.
As institutional investors, UCITS management companies and AIFMs must continue to verify that the risk retention requirements are being complied with.
As institutional investors, UCITS management companies and AIFMs must ensure that their portfolio managers undertake due diligence processes before an investment in a securitisation position is made and on an ongoing basis thereafter. The due diligence processes shall include, amongst other items:
- A verification check that risk retention requirements are being adhered to.
- A due diligence assessment to review the risks involved before making a securitisation investment. This should include an assessment of the exposures of the underlying assets in the securitisation.
- Ongoing risk assessments. During the life of the securitisation transaction, the institutional investor should monitor the performance of the securitisation instrument and its underlying exposures. Stress tests should also be conducted and there should be documented internal reporting outlining material risks involved.
Originators and sponsors of a securitisation must make certain information in relation to underlying exposures available to holders of a securitisation position and, if requested, to potential investors. This information must be included in investor reports. On 22 August 2018, ESMA published draft regulatory and implementing technical standards specifying the details of a securitisation to be made available by the originator, as well as the format and templates for doing so.
UCITS management companies and AIFMs will need to verify that the originator has made this information available in the prescribed fashion.
STS Eligibility Criteria
The STS framework differentiates between STS securitisations which benefit from preferential regulatory capital treatment and more complex securitisations. Certain types of securitisations cannot qualify as STS including actively managed portfolios of assets, commercial mortgage backed securities and residential mortgage backed securitisations.
To be considered an STS, a securitisation must have a number of characteristics. A non-exhaustive list of these is outlined below.
- Simplicity: There must be homogeneous asset types, cash flows which are not dependent on the sale of assets and an absence of active management.
- Transparency: Historical record (five years or more) of default and loss performance data must be available and a sample of exposure must be independently verified.
- Standardisation: Risk retention requirements must be satisfied by the originator, sponsor and original lender, and remedies and actions in the case of default of debtors must be predefined.
The new rules will apply to securitisations issued on or after 1 January 2019. Securitisations existing prior to this date will need to continue complying with the rules which are currently in place.
Download your copy of The New EU Securitisation Regulation here
KB Associates’ Services
KB Associates offers a range of services to investment funds and management companies including:
- The provision of UCITS/AIF management company services.
- The provision of designated persons to perform UCITS business plan and AIFMD programme of activity managerial functions.
- The provision of UCITS/AIF operational support.
If you would like to discuss any issues raised in this article or related to KB Associates’ services in general, please feel free to contact Mike Kirby (+353 1 667 1980), Peter Northcott (+44 203 170 8813) or Mike Parton (+1 345 946 4224).