The Securitisation Regulation opens its doors to NPEs and synthetic securitisation

In brief…

A review of the recently published amendments put in place to manage the risks of an increasing number of non-performing exposures following the COVID-19 crisis.

Regulation (EU) 2021/557 of 31 March 2021 (the Amending Regulation) – which was published on 6 April 2021 in the Official Journal of the EU – introduced a number of amendments to the provisions of Regulation (EU) 2017/2402 of 12 December 2017 (the Securitisation Regulation) to, inter alia, manage the risks of an increasing number of non-performing exposures (NPEs) following the COVID-19 crisis. The targeted changes to the Securitisation Regulation should ensure that the EU securitisation framework provides for an additional tool to foster economic recovery in the aftermath of the COVID-19 pandemic.

The provisions of the Amending Regulation - which will apply from 9 April 2021 (the New Provisions) - are aimed namely to:

• remove regulatory obstacles to securitisations of NPEs;
• extend the STS securitisation framework to synthetic securitisations; and
• start to develop a sustainable securitisation framework.

We briefly summarize below the content of the New Provisions.

Removing regulatory obstacles to securitisations of NPEs

• Definition of NPE securitisation (Article 2 of the Securitisation Regulation): a definition of “NPE securitisation” has been inserted in Article 2, being “a securitisation backed by a pool of non-performing exposures (being the exposures that meet any of the conditions set out in Article 47a(3) of Regulation 575/2013¹ (CRR), including, without limitation, (a) an exposure in respect of which a default is considered to have occurred, (b) an exposure which is considered to be impaired in accordance with the applicable accounting framework, and (c) an exposure under probation, where additional forbearance measures are granted or where the exposure becomes more than 30 days past due) the nominal value of which makes up not less than 90 % of the entire pool’s nominal value at the time of origination and at any later time where assets are added to or removed from the underlying pool due to replenishment, restructuring or any other relevant reason.”
• Requirements for SSPEs (Article 4 of the Securitisation Regulation): as a result of the amendment to Article 4, the securitisation special purpose entities (the SSPEs) shall not be established in a third country if, inter alia, the third country is listed (i) as a high-risk third country having strategic deficiencies in its regime on anti-money laundering and counter terrorist financing, or (ii) in the EU list of non-cooperative jurisdictions for tax purposes.
• Due diligence requirement (Article 5 of the Securitisation Regulation): in Article 5(1) a due diligence requirement in the case of NPEs is added, being to verify that "sound standards are applied in the selection and pricing of the exposures." However, quite surprisingly and differently from the amendments made to Article 9 of the Securitisation Regulation, referred to below, this is not said to be in place of (or by way of derogation from) the requirement in (a) and (b) of Article 5 (i.e. to verify that the originator or original lender used sound and well-defined credit-granting criteria and clearly established processes).
• Risk retention (Article 6 of the Securitisation Regulation): by definition, the risk retention requirement aligns the interests of originators, sponsors and original lenders that are involved in a securitisation and investors in the performance of the underlying assets. Typically, in securitisations of performing assets, the prevalent interest on the sell-side is that of the originator, who is often also the original lender. In NPE securitisations, however, originators seek to offload the defaulted assets from their balance sheets, as they may no longer wish to be associated with those defaulted assets in any way. In those cases, the servicer of the assets has a greater interest in the debt workout for the assets and in value recovery.

  In addition, the risks associated with the assets backing NPE securitisations are economically distinct from those of securitisations of performing assets. The NPEs are securitised at a discount to their nominal or outstanding value and reflect the market’s assessment of, inter alia, the likelihood of the debt workout process generating sufficient cash flows and asset recoveries. The risk for investors is, therefore, that the debt workout process of the assets does not generate sufficient cash flows and asset recoveries to cover the net value at which those NPEs have been purchased. The actual risk of loss for investors does, therefore, not represent the nominal value of the portfolio, but the discounted value, net of the price discount at which the underlying assets are transferred.

  In light of the above, Article 6 on risk retention has been amended by providing that:

  • in the case of traditional NPE securitisations, the servicer is permitted to hold the risk retention, but it may only do so if it can demonstrate that it has expertise in servicing exposures of a similar nature to those securitised and has well-documented and adequate policies, procedures and risk-management controls relating to the servicing of exposures. In measuring the material net economic interest the retainer shall take into account any fees that may in practice be used to reduce the effective material net economic interest;
  • by way of derogation from paragraph 3 of Article 6, in the case of NPE securitisations, where a non-refundable purchase price discount was agreed, the retention of a material net economic interest shall not be less than 5% of the sum of the net value of the securitised exposures that qualify as NPEs and, if applicable, the nominal value of any performing securitised exposures. The net value of a NPE shall be calculated by deducting the non-refundable purchase price discount agreed at the level of the individual securitised exposure at the time of origination or, where applicable, a corresponding share of the non-refundable purchase price discount agreed at the level of the pool of underlying exposures at the time of origination from the exposure’s nominal value or, where applicable, its outstanding value at the time of origination. In addition, for the purpose of determining the net value of the securitised NPEs, the non-refundable purchase price discount may include the difference between the nominal amount of the tranches of the NPE securitisation underwritten by the originator for subsequent sale and the price at which these tranches are first sold to unrelated third parties.
• Criteria for credit-granting (Article 9 of the Securitisation Regulation): the requirement to verify the credit granting standards used in the creation of the securitised assets was introduced to prevent assets of inferior quality being selected for securitisation to the detriment of investors. For NPE securitisations, however, the credit granting standards applicable at origination of the securitised assets are considered to be of minor importance due to the specific circumstances including the purchase of those NPEs and the type of securitisation. Instead, the application of sound standards in the selection and pricing of the exposures are considered to be more important factors with respect to investments in NPE securitisations. Therefore, Article 9 has been amended to specify that, by way of derogation from the first subparagraph, with regard to underlying exposures that were NPEs at the time the originator purchased them from the relevant third party, sound standards shall apply in the selection and pricing of the exposures.

Extending the STS securitisation framework to synthetic securitisations

Synthetic securitisations involve transferring the credit risk of a set of loans, typically large corporate loans or SME loans, by a credit protection agreement where the originator buys credit protection from the investor. The credit protection is achieved by the use of financial guarantees or credit derivatives while the ownership of the assets remains with the originator and it is not transferred to an SSPE, as is the case in traditional securitisations.

To extend the STS securitisation framework to synthetic securitisations, the New Provisions have provided specific requirements for STS on-balance sheet securitisations (BSS). The requirements for STS BSS should be highly consistent with the STS criteria for traditional true sale securitisations, so no regulatory incentives are provided to originators to prefer synthetic securitisations over traditional securitisations. However, there are certain requirements for STS traditional securitisations that are not appropriate for STS BSS due to inherent differences between those two types of securitisation, in particular due to the fact that in synthetic securitisations the risk transfer is achieved via a credit protection agreement instead of a sale of the underlying assets. In this sense, the New Provisions introduced a new Section 2a, providing for a regime and a set of new requirements (e.g. simplicity (Article 26b), standardisation (Article 26c) and transparency (Article 26d)) specific to BSS only, which shall ensure, inter alia, that the credit protection agreement is structured to adequately protect the position of both the originator and the investor.

We briefly summarize below only certain parts of the new specific framework for BSS. For the full detail of the aforementioned requirements, please refer to the provisions of the Amending Regulation.

• Article 26b “Requirements relating to simplicity” provides, inter alia, that the “object of the credit risk transfer” are the exposures originated or purchased by an EU regulated institution within its core lending business activity and held on its balance sheet or, in the case of a group structure, on its consolidated balance sheet at the closing date of the transaction. This requirement of the originator to hold the securitised exposures on the balance sheet might exclude arbitrage securitisations from the scope of the STS label.
• The 5% risk retention requirement also applies to STS BSS.
• Credit protection:
  • According to Article 26b paragraph 5, in order to ensure its robustness, the credit protection agreement shall meet the credit risk mitigation requirements laid down in Article 249 of the CRR that have to be met by institutions seeking significant risk transfer through a synthetic securitisation.
  • Credit events triggering payments under the credit protection agreement should include at least those referred to in Part Three, Title II, Chapter 4 of the CRR, as such events are well-known and recognisable from a market perspective and should serve to ensure consistency with the prudential framework.
  • According to Article 26c “Requirements relating to standardisation,” inter alia, to avoid conflicts between the originator and the investor and to ensure legal certainty in terms of the scope of the credit protection purchased for underlying exposures, the originator shall maintain an up-to-date reference register to identify the underlying exposures at all times. That register shall identify the reference obligors, the reference obligations from which the underlying exposures arise, and, for each underlying exposure, the nominal amount that is protected and that is outstanding.
  • As the right of the originator, as protection buyer, to receive timely payments on actual losses, should be adequately protected, the transaction documentation shall provide for a sound and transparent settlement process for the determination of actual losses in the reference portfolio, to prevent the originator from being underpaid. Furthermore, as provided in paragraph 2 of Article 26e, there shall be a final adjustment mechanism to ensure that interim payments cover actual losses and to prevent that those interim losses do not overpay to the detriment of investors. Moreover, paragraph 3 underlines that the loss settlement mechanism should also clearly specify the maximum extension period that should apply to the workout process for those exposures and such extension period should be no longer than two years. That loss settlement mechanism shall, thus, ensure the effectiveness of the credit protection arrangement from the originator’s perspective, and give investors legal certainty on the termination date of their obligation to make payments, contributing to a well-functioning market.
  • Paragraph 4 of Article 26e provides that the originator shall appoint a third-party verification agent before the closing date of the transaction to carry out a factual review of the correctness and accuracy of certain aspects of the credit protection when a credit event has been triggered. The agent shall be independent from the originator and investors, and, where applicable, from the SSPE.
  • As provided in Article 26e, paragraph 3, credit protection premiums shall depend only on the outstanding size and credit risk of the protected tranche. Non-contingent premiums and other arrangements, such as up-front premium payments, rebate mechanisms or overly complex premium structures, shall not be permitted in STS BSS as they could be used to undermine the effective risk transfer from the originator as protection buyer to the protection sellers.
• The early termination of an BSS by the originator is only possible in certain limited, well-defined circumstances. STS BSS should not feature complex call clauses for the originator, in particular very short-dated time calls with the aim of temporarily changing the representation of their capital position on a case-by-case basis.

New Article 43a of the Securitisation Regulation provides for transitional provisions for STS BSS, specifying that, in respect of synthetic securitisations for which the credit protection agreement has become effective before the date of entry into force of the Amending Regulation, originators and SSPEs may, upon satisfaction of the relevant requirements specified therein, use the designation “STS” or “simple, transparent and standardised,” or a designation that refers directly or indirectly to those terms.

Further guidelines and recommendations on the harmonised interpretation and application of the requirements set out in Articles 26b to 26e of the Securitisation Regulation might be adopted by EBA, together with ESMA and EIOPA.

Starting the development of a sustainable securitisation framework

New Article 45a integrates sustainability-related transparency requirements in the Securitisation Regulation. By 1 November 2021, the European Banking Authority (EBA), in close cooperation with the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA), is mandated to publish a report on developing a specific sustainable securitisation framework for the purpose of integrating sustainability-related transparency requirements into the Securitisation Regulation. Thus, the report shall assess the introduction of sustainability factors, the implementation of proportionate disclosure and due diligence requirements, the content, methodologies and presentation of information in relation to environmental, social and governance-related adverse impacts, and any potential effects on financial stability, the scaling up of the EU securitisation market and bank lending capacity. Moreover, the Commission shall, based on the EBA report, submit a report to the European Parliament and the Council on the creation of a specific sustainable securitisation framework, together with a legislative proposal, if appropriate.

Disclosures of the integration of sustainability risks

In addition to the main amendments summarized above, the Amending Regulation has introduced a provision on disclosures of the integration of sustainability risks. Pursuant to Regulation (EU) 2019/2088, manufacturers of financial products and financial advisors to end-investors are obliged to consider the principal adverse impacts of investment decisions on sustainability factors, and to disclose how their due diligence policies take those principal adverse impacts into account. According to the New Provisions, originators of STS securitisations may, from 1 June 2021 onwards, decide to publish the available information related to the principal adverse impacts of the assets financed by underlying exposures on sustainability factors, giving particular attention to climate and other environmental, social and governance-related impacts. To harmonise information disclosure and to ensure consistency between Regulation (EU) 2019/2088 and the Securitisation Regulation, the Joint Committee of the European Supervisory Authorities should develop regulatory technical standards, building as much as possible on their work in the context of Regulation (EU) 2019/2088 and adapting it, where necessary and relevant, to the specificities of securitisations.

As a final remark, it should be noted that, contextually to the Amending Regulation, also Regulation (EU) 2021/558 of 31 March 2021 (the Regulation 558) has been enacted. Regulation 558 has introduced certain amendments to the CRR, providing for a specific treatment of NPE securitisations and the senior positions in STS BSS, as further summarized below:

• Treatment of NPE securitisations: a specific treatment for the securitisation of NPEs has been introduced, as the current prudential framework for securitisation set out in the CRR, when applied to securitisations of NPEs, led to disproportionate capital requirements because the Securitisation Internal Ratings Based Approach (SEC-IRBA) and the Securitisation Standardised Approach (SEC-SA) are not consistent with the specific risk drivers of NPEs. For this reason, it has been specified, inter alia, that:
  • the risk weight for a position in an NPE securitisation shall be calculated in accordance with Article 254 or 267 of the CRR, subject to a floor of 100% (except when Article 263 is applied);
  • by way of derogation from the paragraph above, institutions shall assign a risk weight of 100% to the senior securitisation position in a qualifying traditional NPE securitisation (except when Article 263 is applied); and
  • for the purpose of Article 268(1) of the CRR, expected losses associated with exposures underlying a qualifying traditional NPE securitisation shall be included after deduction of the non-refundable purchase price discount and, where applicable, any additional specific credit risk adjustments.
• Senior positions in STS BSS: a specific framework for STS BSS has been introduced, providing that an originator institution may calculate the risk-weighted exposure amounts of an STS BSS in accordance with Articles 260 (Treatment of STS securitisations under the SEC-IRBA), 262 (Treatment of STS securitisations under the SEC-SA) or 264 (Treatment of STS securitisations under the SEC-ERBA) of the CRR, as applicable, where both of the following conditions are met:
  • the securitisation meets the requirements set out in Article 243(2) of the CRR; and
  • the position qualifies as the senior securitisation position.