European Union: The Road Ahead – Practical Perspectives On STS And UK Auto ABS Transactions

Last Updated: 11 July 2019
Article by Julian Craughan and David Palmer

In this article we consider some hot topics that are relevant to UK auto ABS transactions seeking STS eligibility.

This article is not intended to be an exhaustive analysis of the requirements for a UK STS securitization, but rather to focus on some perspectives gained from STS applications in the UK ABS auto market. Much of the analysis in this article will also be relevant to equipment financings intending to seek STS treatment.

STS securitizations

The EU Securitization Regulation (Regulation (EU) 2017/2402) (the Sec Reg) is a key feature of EU's efforts to establish a capital markets union. It establishes a general framework for securitizations entered into on or after 1 January 2019 and creates a specific framework for simple, transparent and standardised (STS) securitizations.

The Sec Reg distinguishes between securitizations which meet the STS criteria and those that do not. A significant advantage of a securitization complying with the STS criteria is the preferential regulatory capital treatment for bank investors and insurers in STS securitizations.

STS securitizations include the following features driven by the Sec Reg:

  • Simplicity: Simple transaction structure and homogeneous securitized exposures.
  • Transparency: Availability of sufficient information in relation to the securitization.
  • Standardization: Comprehensible and comparable securitisation transactions.

The final Guidelines on STS criteria for non ABCP securitizations were published by the EBA on 12 December 2018 and apply from 15 May 2019 (the Guidelines).

  • Although the Sec Reg has come into force, the other technical standards essential to interpret the Sec Reg are not yet in effect. In particular, the RTS on homogeneity (ensuring STS securitizations include homogenous exposures) has been adopted by the European Commission but has not yet been published in the Official Journal, the RTS on risk retention (applicable to the risk to be retained by the originator, sponsor or original lender) has not been adopted by the European Commission, and the final RTS on reporting (disclosure of information relating to the securitization and the underlying exposures) is subject to approval by the European Commission.

In this article we focus on the following hot topics.

Residual Values (Article 21(13)) Background

Types of finance

In the UK auto finance market, motor vehicle purchases generally take the form of hire purchase agreements (HP Agreements) or personal contract plans (PCP Agreements) or motor vehicles can be leased from the finance company (Lease Agreements). In summary:

  • HP Agreements involve the amortisation of the entire cost of the vehicle and the cost of financing over a fixed period. At the end of that period title to the vehicle passes from the finance company to the customer. As such residual value risk is taken by the customer.
  • PCP Agreements are very similar to HP Agreement. The main difference is that at the end of the contract the customer can elect whether or not to purchase the vehicle. As such residual value risk is taken by the finance company (or the investor in the securitization).
  • Leases can be characterised as either finance or operating leases. In some respects these are similar to PCP Agreements. Title to the vehicle does not pass to the customer under the lease although, particularly with finance leases, customers may have the option to purchase the vehicle. With operating leases this is usually not the case and, often, maintenance services will also be provided to the customer. Residual value risk is taken by the finance company (or the investor in the securitization).

Auto ABS transactions

In UK auto ABS transactions the seller assigns to the SSPE the customer receivable (comprising the payments due by the customer) and may also assign the seller's right to the residual value (the RV Claim). The RV Claim represents the right to receive the sale proceeds of the vehicle following (1)its return by the customer at the end of the financing contract or lease or (2) repossession of the vehicle on enforcement against the customer (the element of the receivable relating to the RV Claim being the RV Exposure).

Issues

The STS criteria require that the repayment of the securitization cannot be structured to depend predominantly on the sale of assets securing the underlying customer exposures. The final draft Guidelines clarifies that during the revolving period (if a revolving securitization) or on the closing date (if an amortising securitization):

  • The contractually agreed outstanding principal balance, at contract maturity of the underlying exposures that depend on the sale of assets securing those underlying exposures to repay the principal balance corresponds to a threshold test of no more than 50% of the total initial exposure value of all securitization positions of the securitization.
  • The maturities of the underlying exposures should not subject to material concentration and are sufficiently distributed.
  • The aggregate exposure value to a single customer does not exceed 2% of the aggregate exposure value of all underlying exposures in the securitizatio

UK perspectives

Sizing the risk

In respect of the STS treatment of UK auto ABS:

  • PCP Agreements fall within the scope of the threshold test in Article 20(13) as they contain RV Exposure.
  • Regulated HP Agreements and PCP Agreements also fall within the scope of the threshold test in Article 20(13) due to the voluntary termination rights under sections 99 and 100 of the Consumer Credit Act 1974 (as amended). This is a statutory right to terminate the agreement and return the vehicle once the customer has paid more than 50% of the amounts due under the contract without any obligation to pay the remaining balance. This right is exercisable at any time. Voluntary termination rights apply to regulated HP Agreements and regulated PCP Agreements.
  • Lease Agreements fall within the scope of the threshold test in Article 20(13) as they contain RV Exposure. Note that in respect of regulated lease agreements, lessees have a right of voluntary termination exercisable at any time but such rights do not apply if the payments in any year exceed £1,500. Regulated lease agreements with payments below this threshold are not generally securitized given the uncertainty as to the potential cashflows.

Identifying the RV Exposure

In terms of ascertaining whether Article 20(13) applies, we suggest:

  • Step 1: Ensure the outstanding principal balance of all receivables proposed to be included in the portfolio can be identified. Only considering the total contractually agreed outstanding principal balance on maturity and ignoring any embedded interest element.
  • Step 2: Identify any CCA regulated HP Agreements and PCP Agreements. Note those with corporates, with "high net worth" individuals or individuals entering into the contract for business purposes where the credit is over £25,000 do not need to be included.
    • If any CCA regulated PCP Agreements have a RV Exposure greater than 50% of the principal amount on maturity, this higher amount is relevant for the purposes of the threshold test in Article 20(13).
    • All other regulated PCP Agreements and all regulated HP Agreements have an RV Exposure of 50% of the principal amount on maturity for the purposes of the threshold test in Article 20(13).
  • Step 3: Identify any non-CCA regulated HP Agreements and PCP Agreements and check for any non-statutory termination rights. Record this RV Exposure for the purposes of the threshold test in Article 20(13).
  • Step 4: For any non-CCA regulated PCP Agreements record the final balloon for the purposes of the threshold test in Article 20(13).
  • Step 5: Measure the RV Exposure identified under Steps 2-4 against the principal value of the securitization positions. Note that if Receivables are sold at a discount to face value in order to generate overcollateralisation then, if the discounting includes the principal element, it is more likely the threshold test in Article 20(13) applies.

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