Tackling COVID-19 Fallout through Securitisation: Key Changes to the European Regime
26 May 2021 | 5 min read ⧖
The EU’s securitisation regime, comprised in Regulation (EU) 2017/2402 (the Securitisation Regulation or SR) and Regulation (EU) 575/2013 (the Capital Requirements Regulation or CRR), proposed as part of the European Commission’s COVID-19 capital markets recovery package, has been updated by two amendment regulations that came into force on 9 April 2021. 
In this article, we discuss the key changes to the SR and CRR, the ‘amended SR’ and the ‘amended CRR’ respectively, focusing on non-performing exposures (NPEs), STS securitisations, prohibited jurisdictions relating to special purpose entities (SSPEs) and the development of a sustainable securitisation framework.
The amended SR includes new definitions for NPE and 'NPE Securitisation'. For an NPE securitisation, the requirement to retain a net material economic interest of 5% can now also be fulfilled by the servicer, provided it can demonstrate it has adequate servicing expertise, and well-documented policies, procedures and controls in place. This is in recognition of the role performed by the servicer in managing NPEs.
Acknowledging that NPEs often trade at a discount to their market value, the net value rather than the nominal value of the NPE will be used to calculate the risk retention. The net value is calculated by deducting the non-refundable purchase price discount of the NPE from its outstanding value at the time of origination. Further detail on the risk retention requirements for NPEs will be proposed in regulatory standards from the European Banking Authority (EBA) to the Commission in October.
The SR originally required that the same ‘sound and well-defined’ criteria for credit-granting applied to non-securitised exposures should be applied to exposures to be securitised. The amended SR introduces different criteria concerned with soundness of pricing and selection standards to be specifically applied to NPEs that are purchased from third parties for the purpose of being securitised. These criteria are better suited to this asset class than the standard credit-granting criteria.
Finally, the amended CRR includes new provisions to clarify how risk weighting for a securitisation of NPEs should be calculated.
As had been proposed by the Commission, the STS regime has been extended to on-balance-sheet synthetic securitisations. These are securitisations where the originator transfers the credit risk of its exposures, such as a portfolio of loans, by means of credit derivatives or guarantees to investors in the capital markets. But the exposures themselves remain on the originator’s balance sheet, i.e., the securitisation is not being used for arbitrage opportunities. While the amended SR refers to ‘STS on-balance-sheet securitisation’, it is not a defined term but a designation that can be obtained by fulfilling the relevant STS criteria. These criteria are similar to those applied to traditional securitisations, but with some important differences.
In a traditional securitisation, the achievement of a true-sale is fundamental and the STS framework is designed to reflect this. However, this concept is irrelevant for synthetic securitisations, where the exposures are not sold but remain on the balance sheet of the originator.
The STS criteria for synthetic securitisations are focused on the specific characteristics of the synthetic exposures, particularly to ensure that arbitrage synthetic securitisations do not qualify for STS treatment. For example, underlying exposures must be originated as part of the core business activity of the originator. The originator must not hedge its exposure to the credit risk of the underlying exposures of the securitisation, beyond the protection obtained through the credit protection agreement. The representations and warranties required of originators are more granular and include, among other things:
Having full legal title to the exposures and retaining the credit risk associated with them on balance sheet
That they are eligible for applicable credit protection payments, and
That their underlying obligors are not in material breach or default
The criteria for disclosing interest rate and currency risks, and measures to mitigate them, are more detailed. Originators are now required to maintain an up-to-date reference register to identify underlying exposures and their details at all times. There are also new requirements in respect of the credit protection agreement, the third-party verification agent and the synthetic excess spread.
The amended SR introduces the concept of ‘synthetic excess spread’ (SES). SES is defined as, the amount designated by the originator to absorb losses of the securitised exposure that might occur before the maturity date of the transaction. The amended CRR requires the SES to be risk weighted as another tranche of the securitisation, to prevent SES from being used for regulatory arbitrage purposes. However, this will only apply from 10 April 2022 and the EBA is developing technical standards to specify how to determine the exposure value of a synthetic excess spread.
Finally, the amended CRR only extends STS eligibility to retained senior tranches, so that it is more restrictive than traditional securitisations.
Prohibited Jurisdictions for SSPEs
The amended SR requires that SSPEs can only be established in third countries that are not listed on the EU list of non-cooperative jurisdictions for tax purposes. In addition, the amended SR states that they must not feature on the list of high risk third countries which have strategic deficiencies in their regimes on anti-money laundering and counter terrorist financing in accordance with Article 9 of Directive (EU) 2015/849 (the 4th Anti-Money Laundering Directive).
Development of sustainable securitisation framework
The amended SR mandates the EBA, in close cooperation with ESMA and EIOPA, to publish a report on developing a specific sustainable securitisation framework. This is for the purpose of integrating sustainability-related transparency requirements into the Securitisation Regulation. This is consistent with the EU’s drive towards green and sustainable finance in its recent legislative proposals, particularly those included in its COVID-19 recovery measures.
The amendments to the NPE and STS regime are likely to be welcomed by market participants, and to achieve the European Commission’s stated aim to make it easier for banks and other financial institutions to use securitisation as a tool to free their balance sheets and lend to the real economy. This is much needed to help Europe to recover from the impact of the pandemic. That said, the STS treatment of synthetic securitisations is still fairly conservative, and the development of further guidance on determining synthetic excess spread exposures is one to watch out for. Also, as these changes have come into force after Brexit completion day, they are not applicable in the UK and it will be interesting to compare the European regime with any further developments of the UK securitisation regulation for signs of convergence or divergence.
 Regulation (EU) 2021/557 (for the SR) and Regulation (EU) 2021/558 (for the CRR)
For more information on this development, contact a member of our Debt Capital Markets & Listing team.
The content of this article is provided for information purposes only and does not constitute legal or other advice.