Introduction

The Bank of Italy has recently published an amended version of the "New Regulations for Prudential Supervision of Banks" (the "Regulations").

Most of the innovations introduced in the Title II, Chapter 2, Part 2, of the Regulations, entitled "Credit Risk Mitigation Techniques and Securitization Transactions - Securitization", (the "Securitization Supervisory Rules") are intended to implement in Italy the new Article 122a of the Capital Requirements Directive which requires, inter alia, that EU regulated credit institutions (i) may only invest in asset-backed securities in respect of which the originator, sponsor or original lender of the securitization will retain, on an ongoing basis, a net economic interest of not less than 5% in respect of certain specified credit risk tranches or asset exposures and (ii) comply with certain continuing due diligence duties in respect of the securitization transaction in which they have invested.

The Bank of Italy has taken this opportunity to also reform the minimum requirements for the recognition of securitization transactions for regulatory capital purposes. This Client Alert is intended to provide a preliminary analysis of such new requirements.

The New Requirements for the Recognition of the Transfer of Credit Risk

In a "traditional securitization transaction"1, an originator may exclude securitized assets from the calculation of its credit risk-weighted exposure amount and, where applicable, expected losses if the relevant securitization transaction meets certain requirements.

The Standard Requirements

Under the current regime set out in the Securitization Supervisory Rules, the securitization shall be recognized for regulatory capital purposes if "significant" credit risk associated with the securitized assets has been transferred to third parties2 and if certain additional requirements3 have been met.

The transfer of credit risk associated with the securitized assets shall be deemed "significant" when:

  1. the weighted value of the mezzanine securitization positions held by the originator does not exceed 50% of the total weighted value of all the mezzanine securitization positions within the relevant securitization transaction (where "mezzanine securitization positions" shall mean the securitization positions which (i) are subject to a risk weight lower than 1,250% and (ii) are subordinate to (a) any other position which has the highest degree of priority in the repayment of principal as well as (b) any other position assigned a credit assessment (rating) corresponding to credit quality step 1 for banks which adopt the standardized approach or to credit quality step 1 or 2 for banks which adopt an internal ratings based (IRB) approach4);
  2. or the originator holds not more than 20% of the weighted value of the securitization positions subject to a 1,250% risk weight or to euro by euro deduction provided that (i) there are no mezzanine securitization positions and (ii) the originator is able to demonstrate that, on the basis of a reasonable appraisal of the expected losses on the underlying assets, the value of the securitization positions subject to a 1,250% risk weight or to euro by euro deduction exceed by a significant amount such expected losses;

the requirements set out in paragraphs (i) and (ii) above being hereinafter referred to as the "Standard Risk Transfer Requirements".

It is worth noting that the Bank of Italy has retained the right to refuse the recognition for regulatory capital purposes in respect of those securitization transactions where, notwithstanding compliance with the Standard Risk Transfer Requirements, there proves to be a significant mismatch between the credit risk associated with the securitized assets which is effectively transferred to third parties and the reduction of the credit risk-weighted assets.

The "IRB" Requirements

In addition to the Standard Risk Transfer Requirements, as an alternative method available solely to banks which adopt an internal ratings based (IRB) approach, the credit risk associated with securitized assets may be deemed transferred to third parties for regulatory capital purposes if both the following conditions are met:

  • the originator has established adequately formalized policies and methodologies which ensure that the reduction (if any) in the capital requirement resulting from the securitization is justified on the basis of a corresponding transfer of risk to third parties5; and
  • the transfer of the credit risk associated with the securitized assets to third parties is recognized for the purposes of the relevant bank's internal risk management and capital allocation.

Conclusion

The regulatory capital regulations setting out the requirements for a "significant credit risk transfer" in the context of securitization transactions have traditionally been in line, in principle, with the derecognition requirements applicable to transfers of financial assets pursuant to the relevant accounting standards.

Interestingly, at a time when hopes for an imminent adoption of new derecognition requirements under the IAS 39 by the IASB have faded, the Bank of Italy appears to have moved forward in order to grant some flexibility to Italian banks willing to dismiss the non-performing assets still in their balance sheets.6

The most attentive players in the Italian market will certainly develop securitization structures capable of taking the opportunities that new supervisory capital regime seems to offer.

Footnotes

1 That is a securitization through which credit risk is transferred by selling the securitized assets to a special-purpose vehicle that issues securities (ABS) that do not represent payment obligations of the originator.

2 Please note that the securitization shall also be recognized for regulatory capital purposes in cases where only the additional requirements mentioned in footnote no. 3 below have been met and the originator holds only "junior" securitization positions (i.e. positions subject to a 1,250% risk weight or to euro by euro deduction).

3 Such other requirements being:

  1. the securitization documentation reflects the economic substance of the transaction;
  2. the securitized assets are not subject to claims by the originator and its creditors, including in the event the originator is subject to bankruptcy proceedings or receivership. Compliance with this condition shall be supported by the opinion of legal counsel with specific experience in the sector. Securitizations carried out in accordance with Law 130/99 satisfy this requirement;
  3. the transferee is a special-purpose vehicle;
  4. the securities issued by the special-purpose vehicle do not represent payment obligations of the originator;
  5. the originator does not maintain effective or indirect control over the transferred assets. The originator shall be considered to have maintained effective control over the transferred assets if it – except as provided for in paragraph (vi) – has the right to repurchase the assets from the transferee in order to realize the related benefits or is obliged to re-assume the transferred risk. The originator bank's retention of servicing rights or obligations shall not in itself constitute indirect control of the assets sold;
  6. clean-up call options shall be permitted, provided that:
    - they are exercisable at the discretion of the originator;
    - they are only exercisable when the unamortized amount of the securitized assets is 10% or less of the lower of the nominal value of the securitized assets and the sale price;
    - they are not structured to avoid losses to credit enhancement positions or other positions held by investors, other than the originator or the sponsor;
    - they are not otherwise structured to provide credit enhancement;
  7. the contracts that govern the securitization do not contain clauses (except for certain early amortization provisions for securitizations of revolving assets), that:
    - require the originator to improve the credit quality of securitization positions by, for example, altering the securitized assets or increasing the yield payable to investors, other than the originator and the sponsor, in response to a deterioration in the credit quality of the securitized assets;
    - increase the yield payable to holders of securitization positions in response to a deterioration in the credit quality of the securitized assets;
  8. the originator and the sponsor comply with the requirements set out in the Regulations regarding the granting and management of financing.

4 In broad terms, the aforementioned credit quality steps should approximately correspond to a "BB-" rating.

5 The reliability and effectiveness of such methodologies and their consistency with the applicable laws and regulations and with the relevant bank's operations shall be internally assessed by a special unit of the bank specifically entrusted with this task.

6 Even though, in principle, the accounting treatment and the regulatory capital regime applicable to securitization transactions are independent, it is possible that the new requirements for the recognition of the transfer of credit risk associated with securitized assets for regulatory capital purposes may have de facto an impact on the accounting treatment of the relevant securitisation transactions. Although the Bank of Italy has clarified that "[t]he accounting treatment of the securitisations is not relevant for the purposes of their recognition for supervisory capital purposes", it is not possible to exclude that, in light of the new approach followed by the Bank of Italy, the accounting firms may consider interpreting more loosely the "transfer of substantially all the risks and rewards" test set out in the IAS 39 than they have done in the past.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.