Insights

As of January 2019, a general EU framework for securitisation was established by means of the enactment of Regulation (EU) 2017/2402 (the “Securitisation Regulation”) together with a number of updates to Regulation (EU) 575/2013 (the “CRR” ), aimed at promoting a safe, deep and robust market for securitisation in order to attract an extensive and stable investor base to help channel sufficient capital to where it is most needed in the economy.

The European Commission’s summer 2020 economic forecast had pointed to a very deep recession as economic activity collapsed in the first half of 2020. This is why the immediate emergency measures should be complemented by targeted measures of more medium-term effect that can support a speedy economic recovery. On the 24 July 2020, new legislative amendments to the Securitisation Regulation and to the CRR were proposed to this end.

The scope behind these proposals is to encourage the use of securitisation in financing SME lending, whilst aiding businesses to recover from the economic backlash faced during this current year.  Securitisation is an effective tool for funding and risk diversification for financial institutions. By transforming loans into tradable securities, securitisation could free up bank capital for further lending and allow a broader range of investors to fund the economic recovery.

The proposals comprise two amendments aiming mainly at increasing the overall risk sensitivity of the EU securitisation framework that would make the recourse to the securitisation tool more economically viable for institutions;

Expansion of the simple, transparent and standardised (“STS”) framework to include on-balance-sheet synthetic securitisation.

This proposal is based on a report by the European Banking Authority (“EBA”) published on the 6 May 2020 which provides for the necessary data and technical analysis to justify the establishment of this framework. The STS synthetics report is mandated by Article 45(1) of the Securitisation Regulation, which asked the EBA to analyse the feasibility of a specific framework for STS synthetic securitisation, albeit limited to on-balance-sheet synthetic transactions.

In its analysis, EBA makes three recommendations:

1. The establishment of a cross-sectoral framework for simple, transparent and standardised synthetic securitisation, limited to balance-sheet securitisation;
2. To be eligible for the ‘STS’ label, synthetic securitisation shall comply with the proposed criteria on simplicity, standardisation and transparency;
3. That the risks and benefits of establishing a differentiated capital treatment for STS balance sheet synthetic securitisation should be considered.

By extending the STS Framework, it can be expected that the STS label with its additional (simple, transparent and standardised) requirements will stimulate a more extensive use of the EU securitisation market. The aim of this is to create an incentive for securitisation to take place more often within the EU and help banks find ways to share risk together with capital market actors. This is indeed one of the objectives of the European Commission’s Capital Markets Union project.

In addition to this, the European Commission also drew up a report confirming EBA’s analysis.

Removal of the existing regulatory constraints to the securitisation of non-performing exposures (“NPEs”) embedded in the current framework.

The EBA also put forward an opinion on NPEs, as it examined the role of securitisation as a funding tool for removing NPEs from the balance sheets of banks. The EBA analysis pinpointed  a number of constraints in the Securitisation Regulation and in the Capital Requirements Regulation that restrict the market capacity to absorb non-performing assets from the balance sheets of banks, thus largely limiting the market to bilateral sales only.

Consequently, the proposal seeks to amend the risk retention and credit granting requirements found in the Securitisation Regulation in order to clarify the verification duties on originators when it comes to securitising non-performing exposures.

It is acknowledged that the proposed amendments to the Securitisation Regulation alone are not sufficient to achieve the objective of optimising the role that securitisation can play in the economic recovery. It is for this reason that such proposals must be accompanied by a new prudential treatment, including in the area of capital requirements, in order to better reflect on the specific features of these types of securitisations, which is why the amendments to the CRR are also being proposed.

The CRR has been amended on several occasions to tackle residual weakness in the regulatory framework. The proposals to amend the CRR relate to changes designed to make the regime for STS on-balance sheet synthetic securitisations and NPE securitisations more risk sensitive. The changes aim on maintaining and possibly enhancing the institution’s lending capacity in two ways;

1. by facilitating the recourse to this technique to offload NPEs that can be expected to grow in the aftermath of the crisis – by means of this, institutions will be able to better spread the risk to other financial actors and ultimately reduce regulatory capital constraints that come about due to the high number of NPEs; and
2. by implementing a more risk-sensitive treatment of the senior tranche in case of STS on-balance-sheet securitisation whereby the senior tranche of a traditional NPE securitisation would be subject to a flat risk weight of 100% and other trances of both traditional and on-balance sheet synthetic NPE securitisations that are subject to the general framework for calculation of risk weights will be subject to a floor of 100%.

An additional amendment being proposed to the CRR is to introduce a minimum credit rating requirement for almost all types of unfunded credit protection. This proposal differs extensively from the current mitigation rules set out in the CRR and the new international standards set by the revised Basel III framework.

While the Securitisation framework is scheduled to be reviewed in January 2022 the current proposals lay out targeted amendments that could be considered earlier given the urgent need for economic recovery. Nonetheless, these proposals in no way undermine the official review process that is to take place.

The author would like to thank Gianella Vella, Intern at GA, for her help in preparing this article.