European Union: Securitisation Regulation: Application Of Disclosure Requirements To Non-EU CLOs

BACKGROUND

The EU Securitisation Regulation (the "Securitisation Regulation")1 will apply to securitisations issued on or after 1 January 2019 and will introduce a number of changes to the European risk retention regime for CLO transactions2 .

With the application date of the Securitisation Regulation fast approaching, one of the key questions that arrangers, managers and institutional investors are focused on is what impact the Securitisation Regulation will have on CLOs that have a non-EU issuer and a non-EU manager (and neither of which is a subsidiary of an EU bank3 ) (a "Non-EU CLO"). Of particular interest and importance is the extent to which those Non-EU CLOs will need to comply with the Securitisation Regulation to be able to market to EU investors.

APPLICATION OF THE SECURITISATION REGULATION TO NON-EU CLOS

It is clear that Non-EU CLOs that market to EU investors will still be required to comply with the indirect retention requirement (i.e. in practice the originator, sponsor or original lender must retain a 5% economic interest in the CLO) 4 . What is less clear is the extent to which those Non-EU CLOs will also need to comply with the other requirements in the Securitisation Regulation.

In this Client Alert we focus on Article 7 of the Securitisation Regulation, which will increase the scope and nature of the transparency and disclosure requirements applicable to originators, sponsors and issuers of CLO transactions, and, in particular, whether or not NonEU CLOs that are marketed to EU investors will be required to produce underlying exposure reports and investor reports using the reporting templates currently being prepared by ESMA once they are finalised.

ARE NON-EU CLOS REQUIRED TO COMPLY WITH ARTICLE 7?

Is there a direct requirement for non-EU CLOs to comply with article 7?

There is no express statement in Article 7 of the Securitisation Regulation that it only applies to originators, sponsors and issuers established in the EU, which would initially suggest that Article 7 has extra-territorial effect.

When read in isolation, Article 5(1)(e) appears to support this view as it states that institutional investors must verify that "the originator, sponsor or SSPE has, where applicable, made available the information required by Article 7". This might suggest that all CLO transactions will be required to comply with the requirements of Article 7.

However, when these provisions are read in the wider context of the full Securitisation Regulation, a stronger case can be made that in fact there is no direct requirement for NonEU CLOs to comply with Article 7.

Articles 5(1)(c) and (d) of the Securitisation Regulation, which set out certain due diligence requirements that institutional investors must comply with, draw a clear distinction between originators, sponsors and original lenders that are established in the EU and those that are not. Article 5(1)(c) applies to those established in the EU and requires the 5% retention to be retained "in accordance with Article 6" and the disclosure to have been made "to institutional investors in accordance with Article 7". In contrast, Article 5(1)(d) applies if the originator, sponsor or original lender is established in a non-EU country, and simply requires the amount of the 5% retention to be "determined in accordance with Article 6" and the disclosure to have been made "to institutional investors", and omits any explicit reference to Article 7.

This distinction indicates that, consistent with other European legislation, Articles 6 and 7 are not intended to have extra-territorial effect and when Article 5(1)(e) is read in conjunction with the remainder of Article 5(1), the alternative (preferable) interpretation of that provision emerges. The reference therein to "where applicable" is the key, suggesting that institutional investors are only required to verify this point for transactions to which Article 7 actually applies (i.e. transactions where the originator, sponsor or issuer is established in the EU) rather than in all cases.

This view is supported by both the EBA, who confirmed in its responses to the consultation on its Draft Regulatory Technical Standards published on 31 July 2018 that Article 6 should only apply to "originators, sponsors and original lenders established in the EU" 5 , and the Commission who expressed the same view in the Explanatory Memorandum6 to its original proposal for the Securitisation Regulation. We think there is a reasonable basis to infer that if Article 6 was not intended to apply to entities outside of the EU, neither was Article 7.

Further support for this argument can be found in Articles 29(2), (3) and (4) of the Securitisation Regulation, which designate which competent authority is responsible for supervising compliance by sponsors, originators, original lenders and issuers with Articles 6, 7, 8 and 9 of the Securitisation Regulation. These provisions only specify who the competent authority will be for such entities established in the EU. No supervisory entity is appointed to supervise compliance by entities that are established outside of the EU. This, in our view, is a further indication that it was only intended that originators, sponsors, original lenders and issuers established in the EU will be required to comply with Articles 6, 7, 8 and 9.

On the basis of the above, we consider that there is no direct requirement for Non-EU CLOs to comply with the requirements of Article 7. If there were such a requirement, all Non-EU CLOs, whether or not they were being marketed to EU investors, would be required to comply with the Securitisation Regulation, which is counter-intuitive and in our view was not the intention of the legislature.

Is there an indirect requirement for non-European CLOs to comply with Article 7?

The justification given by the EBA and the Commission for Article 6 not having direct effect with respect to Non-EU CLOs is that the indirect requirements set out in Article 5, that are applicable to European institutional investors, create a level-playing field7 . This means that while Non-EU CLOs do not need to comply with the specific requirements of Article 6, they cannot be marketed to EU institutional investors without the retention of a 5% economic interest in the CLO by an appropriate entity.

The same argument could be made in respect of Article 7, that while there is no direct requirement on Non-EU CLOs to comply with Article 7, by virtue of Article 5 Non-EU CLOs will have an indirect requirement to ensure that a certain level of information is provided to EU investors.

The crucial question is therefore whether investors can get comfortable that their due diligence requirements under Article 5 can only be satisfied via provision of the underlying exposure reports and investor reports provided for in Article 7. The answer to this question largely depends on whether the requirements under Article 5 expand significantly on the due diligence requirements set out in Articles 405 to 409 of the Capital Requirements Regulation8 (the "CRR") and Article 17 of the Alternative Investment Fund Managers Directive9 (the "AIFMD"), as implemented by Section 5 of the AIFMD Level 2 Regulation10 , as the precursors to the Securitisation Regulation that investors are already having to comply with.

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Footnote

1 Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017.

2 The Securitisation Regulation is of general application to "securitisations"; however, this Client Alert confines our observations to particular effects on the CLO market.

3 This is relevant because Article 14 of the CRR as amended by Article 1(11) of Regulation (EU) 2017/2401 of the European Parliament and of the Council of 12 December 2017 ("CRR Amendment Regulation") applies the transparency obligations under Article 7 of the Securitisation Regulation (together with the other requirements in Chapter 2 of the Securitisation Regulation) to EU institutions subject to the CRR on MILBANK CLIENT ALERT: CLO Group Client Alert, 12 December 2018 6 a consolidated basis. The consequence of this being that non-EU subsidiaries of an EU bank could be required to comply with Article 7 of the Securitisation Regulation. However indicative relief on this point has been provided by a statement from the Joint Committee of the European Supervisory Authorities advising that the European Supervisory Authorities expect this to be amended as part of the proposals to amend the CRR (known as "CRR 2") so that Article 14 of the CRR will only apply the Article 5 due diligence requirements in the Securitisation Regulation on a consolidated basis. It is not clear however when these further changes to Article 14 of the CRR will be made. The procedure files for the Capital Requirements Regulation indicate that the European Parliament will debate and vote on the proposals at its plenary session to be held between 15 and 18 April 2019 with any finalisation, agreement and publication of the resultant legislation likely to follow several months thereafter.

4 This "indirect" approach to risk retention has been a deliberate feature of legislators' approach ever since the introduction of Article 122a of Capital Requirements Directive II and was intended to ensure a level playing field for EU investors in EU CLOs and Non-EU CLOs.

5 See page 27 of the EBA Fund Draft Regulatory Technical Standards published by the EBA on 31 July 2018.

6 See page 14 of the Explanatory Memorandum published by the European Commission on 30 September 2013.

7 See page 14 of the Explanatory Memorandum published by the European Commission on 30 September 2015.

8 Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June 2013.

9 EU Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011.

10 EU Commission Delegated Regulation (EU) No 231/2013 of 19 December 2012 supplementing the AIFMD.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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