EU Securitisation Market Reforms

The European Commission has proposed reforms to the EU securitisation framework to address specific impediments to bond issuance and (non-bank) investment.

The proposed changes aim to remove investment barriers in the EU securitisation market, specifically by:

• reducing undue operational costs for issuers and investors, balancing with adequate standards of transparency, investor protection and supervision; and
• adjusting the prudential framework for banks and insurers, to better account for actual risks and remove undue prudential costs when issuing and investing in securitisations, while at the same time safeguarding financial stability.

This proposal for a new EU Regulation will necessitate changes to existing EU securitisation law, including amendments to:

• Regulation (EU) 2017/2402 of the European Parliament and of the Council (the "Securitisation Regulation"), which sets out product rules and conduct rules for issuers and investors;
• Regulation (EU) No 575/2013 of the European Parliament and of the Council (the "Capital Requirements Regulation"), which sets out the capital requirements for banks holding and investing into securitisation; and
• two delegated Regulations; the Commission Delegated Regulation (EU) 2015/61 (the "Liquidity Coverage Ratio (LCR) Delegated Act"), governing the eligibility criteria for assets to be included in banks' liquidity buffer, and the Commission Delegated Regulation (EU) 2015/35 (the "Solvency II (SII) Delegated Act"), governing the capital requirements for insurance and reinsurance undertakings.

The elements of the package address both the supply and demand side of the market and reinforce each other to produce the desired impact. Streamlining reporting requirements and lowering capital requirements will both lower entry barriers and make it cheaper for banks to originate securitisations.

Simplifying due diligence and amending the capital charges and liquidity treatment will make it easier and more attractive to invest in securitisation. A larger and more dynamic investor base will also incentivise more issuance. Relaunching the EU securitisation market is a complex issue that requires changes to be made in various parts of the framework to foster supply and demand in the securitisation market.

Due Diligence

The proposals seek to introduce a more principles-based and proportionate approach to due diligence for EU securitisations. EU institutional investors will no longer be required to verify certain information when the sell-side party is established and supervised in the EU (as competent authorities already oversee compliance).

The detailed list of structural features of a securitisation, that must currently be checked as part of an institutional investor's due diligence assessment, is removed, with the intention that the assessment should instead be proportionate to the risk profile of the securitisation.

For secondary market transactions, investors will be allowed a "reasonable period of time" (not exceeding 15 days) to document the due diligence assessment and verifications they have undertaken.

Where securitisations are fully guaranteed by multilateral development banks due diligence requirements for institutional investors are waived. In addition, where the first loss tranche (at least 15% of the nominal value) in a securitisation position is held or guaranteed by certain public entities, due diligence requirements are lightened.

Where an institutional investor delegates certain authority and functions to another investor, the draft regulations clarify that the delegating investor will remain liable for any failure to comply with due diligence requirements. Failure to meet due diligence requirements is to be added as a basis on which administrative sanctions can be applied against an investor.

Risk Retention

The standard 5% risk retention is waived where a securitisation includes a first loss tranche that is guaranteed or held by a narrowly defined list of public entities and where that tranche represents at least 15% of the nominal value of the securitised exposures.

For private securitisations, a new lighter reporting template will be introduced, focused on supervisory needs. Private transactions will be reported to securitisation repositories but data will not be disclosed to investors or potential investors.

If a securitisation meets any of the following conditions then it will be a "public securitisation":

• a prospectus is drawn up;
• notes constituting securitisation positions are admitted to trading in specific trading venues; or
• the securitisation is marketed generally to investors and the specific terms are not negotiable among the parties, meaning that the transaction is offered to investors on a take-it or leave-it basis.

A "private securitisation" is one that does not meet any of the above criteria. Clarifying the definition of public and private securitisations is particularly relevant for the application of transparency requirements.

Transparency

To reduce the reporting burden on issuers, a distinction will be made between mandatory and voluntary reporting fields, with a reduction of at least 35% in the complexity of the templates for public securitisations. Loan-level data will not be required for highly granular, short-term exposures (such as credit card receivables).

Securitisation repository

The obligation to report to a securitisation repository will be extended to cover private securitisations, with a result that a variety of EU authorities will have access to the repository. However, access for potential investors to private securitisations will be restricted to protect the confidentiality of sensitive transaction data.

STS requirements

The proposal amends the homogeneity requirement under the Securitisation Regulation. It introduces a new threshold: a securitisation where at least 70% of the underlying exposures consist of small and medium-sized enterprise ("SME") loans are deemed to comply with that requirement. This is a relaxation from the current 100% threshold and is expected to facilitate broader use of STS securitisations for SME financing.

For on-balance-sheet (synthetic) securitisations, there are a number of proposed changes, including the possibility of using unfunded guarantees by insurance or reinsurance undertakings that meet certain requirements as credit protection.

Commentary

While some of the changes are to be welcomed, the new definition of "public securitisation" will capture a wider range of transactions. This is not unexpected in the case of widely offered securitisations, such as collateralised loan obligations (CLOs), that are currently considered to be "private" securitisations simply by virtue of where they are listed.

However, the proposed definition would also bring within its scope other transactions which are typically thought of as private securitisations. For example, some market participants are concerned that transactions that only obtain a listing on an EU trading venue in order to obtain the benefit of the quoted Eurobond exemption will fall within the "public securitisation" definition.

In addition, some of the wording in the definition could benefit from some clarification, even if it is understood that the Commission's intention to include transactions where the investors have no direct contact with the originator(s) or the sponsor and which are offered to investors on a "take it or leave it" basis.

While the reduction in investor due diligence and monitoring requirements will likely be seen as helpful, many market participants may be disappointed that the Commission has not gone further with respect to the requirement that EU Investor's check compliance by an originator, sponsor or SSPE which is not established in the European Union with the reporting requirements under Article 7 of the Securitisation Regulation.

The Commission could have explored the option of broadening the definition of "sponsor" in the proposals, to allow regulated entities other than credit institutions and EU investment firms to hold the risk retention as sponsors. There is no proposal to clarify the territorial scope of the Securitisation Regulation or to change to the definition of "securitisation.

Next Steps

The proposals to amend certain aspects of EU securitisation law are just the beginning of a legislative process which will take until at least 2027 to be fully implemented. It is very likely that amendments will be made to the proposals before they are enacted into law.

It will be interesting to see whether it will actually increase securitisation activity in the EU and whether financial institutions will use the liquidity to accommodate lending to households and SMEs.