The 2021 amendments to the EU Securitisation Regulation: Stockpiling ammunition ahead of the next wave of NPEs

Introduction

On 6 April 2021, the EU Securitisation Regulation¹ (SR) was amended pursuant to the Regulation (EU) 2021/557 of the European Parliament and the Council²  (SR Amendment Regulation) and the Regulation (EU) 2021/558 of the European Parliament and the Council³ (CRR Amendment Regulation) (together, SR Amendments) with effect as of 9 April 2021.

The recently introduced amendments extend the scope of the Simple, Transparent and Standardised framework (STS framework) from “true sale” securitisations⁴ to on-balance sheet synthetic securitisations (see below) and remove existing regulatory barriers to the securitisation of non-performing exposures (NPEs) (see below). Overall, the SR Amendments put in place amendments that aim to reduce regulatory costs when securitising NPEs to help EU banks in their efforts to tackle the increasing NPE levels on their balance sheets caused by the pandemic.

It is important to note that the significance of a securitisation to qualify under the STS framework relates to the preferential regulatory capital treatment provided for the senior position that is held by the originator (eg the EU bank).

An STS framework for synthetic securitisations

The STS framework for “true sale” securitisations has formed the basis for the STS framework for synthetic securitisations to which certain adjustments have been made.

In light of the above, the SR Amendments cover the below areas:

• In terms of scope, synthetic securitisation may be labelled as STS only when carried out by EU banks. Moreover, the STS framework does not apply to arbitrage synthetic securitisation, where the objective is to profit from movements on the credit risk price rather than to obtain credit risk protection relating to actual exposures of the originator.
• As regards simplicity (Article 26b SR), the STS framework introduces criteria according to which the underlying exposures need to have been originated as part of the core business activity of the originator and must be held on the originator’s balance sheet (or a member of its group). The originator must not hedge its exposure beyond the protection obtained through the credit protection agreement that forms part of the relevant synthetic securitisation. Additional representations and warranties are required from the originator regarding compliance with the requirements of Article 26b SR.
• In relation to standardisation (Article 26c SR), the STS framework introduces additional criteria relating to the disclosure of hedging and currency risks, sequential amortisation shall apply (though, by way of derogation non-sequential amortisation may also apply) and the originator is now required to maintain a reference register with respect to the underlying exposures.
• In terms of transparency (Article 26d SR), the originator is required to disclose data on static and historical default and loss performance for at least five years. A verification agent needs to confirm a sample of the underlying exposures, but investors may seek verification in relation to individual underlying exposures where they consider the sample-basis verification to be unsatisfactory.
• In terms of new requirements (Article 26e SR), most importantly:
• New collateralisation requirements are put in place; while cash collateral usually has to be held with a third-party bank with a credit quality step 3 or above, it shall be possible for originator banks in credit quality step 2 to hold such cash collateral directly. Originator banks in credit quality step 3 may also be able to hold cash collateral directly if they can prove they are facing difficulties with holding other forms of collateral. Moreover, additional collateralisation requirements have been put in place when collateral is held in the form of securities.
• There is a new definition of synthetic excess spread (Article 2(29) SR). The amendments in the CRR Amendment Regulation mean that synthetic excess spread will have to be risk-weighted, thus the spread will be weighted as another tranche of the securitisation. The rationale behind this amendment is to ensure synthetic excess spread is not used for regulatory arbitrage purposes. The EBA is expected to draft technical standards as to how this exposure will be calculated in terms of risk-weighted assets.

Amendments to NPEs

The SR Amendments introduce amendments to the rules governing NPEs to remove existing regulatory impediments and reduce regulatory costs. To begin with, the SR Amendments apply to NPE securitisations that are defined as securitisations “backed by a pool of NPEs, the nominal value of which makes up for not less than 90% of the entire pool’s nominal value at the time of origination, and at any later time when assets are added to or removed from the underlying pool” (Article 2(25) SR). In particular:

• The SR Amendments permit the servicer of an NPE securitisation to act as the risk retainer, provided that the servicer demonstrates it has the required expertise as well as adequate policies, procedures and controls in place to perform these tasks (Article 6 SR). This amendment is justified by the fact that the servicer is expected to have a more substantial interest in the recovery value of the NPE portfolio.
• Before the recent amendments, the SR required that the originator holds risk retention positions linked to the face value of the NPE exposures. Given that the nominal value of an NPE does not often reflect its market value, the SR Amendments allow for the risk retention in an NPE securitisation to be calculated on the basis of the net value of the NPEs, which is the outcome of their nominal value minus any refundable purchase price discount agreed at the time of the securitisation (Article 6 SR). The EBA is expected to provide further clarity through the risk retention regulatory standards that it is expected to issue.
• As regards NPE securitisation where an originator has purchased NPEs from a third party, the SR Amendments amend the applicable pricing and selection standards by replacing the requirement to assess those standards at the time of creation of the exposure with the requirement to perform this assessment at the time of their acquisition (Article 9(1) SR). The rationale of this amendment is that in the case where NPEs are acquired from a third party then what matters the most are the criteria for selection and pricing at the time of the purchase instead of at the time of their origination. This amendment reduces the due diligence burden for an acquired NPE-portfolio. This might mean that an originator holding an NPE portfolio since its origination (where there may be missing historical data at the time of origination) may even find it more difficult to securitise the latter portfolio than a recently acquired NPE portfolio.

Conclusion

The SR Amendments introduce amendments that aim at reducing regulatory costs for securitising NPEs. This issue was already flagged in 2019 by the EBA in its opinion on the regulatory treatment of NPE securitisation⁵, where it argued that the risks inherent in NPE securitisations are different to the securitisation of performing assets. And, in its 2020 report, the EBA proposed a framework for STS synthetic securitisation⁶. In light of the above, the EU decided to move quickly on these amendments, notwithstanding the fact that the SR is expected to undergo a comprehensive review by January 2022, to facilitate EU banks that are trying to clean up their balance sheets in light of the new NPEs that are piling up due to the pandemic.

Overall, the amendments are expected to satisfy market participants. The revised SR is expected to deliver on its promise by making it easier and more attractive for market participants to enter into balance sheet synthetic securitisation transactions and to securitise NPE portfolios. Nevertheless, there are certain elements (such as the risk weighting of synthetic excess spread) which market participants should be aware of and should be further clarified once the EBA provides additional guidance, especially during the post-pandemic period where the need for revival of the economy will create a number of new securitisation transactions across the EU.