The market for simple, transparent and standardised (STS) securitisations could be under threat before it even kicks off officially in January 2019. Some market participants feel waiting for the European Banking Authority’s (EBA) consultation on the interpretation of STS criteria to conclude in July could have a chilling effect on transactions.
According to a source involved with asset-backed securities (ABS) at an EU bank, the delay associated with the EBA’s clarification onto what makes up the STS label is becoming prohibitive. Many issuers are increasingly looking at alternative areas of financing rather than risk losing the STS status for current deals when the criteria are officially outlined.
“Do you put everything on hold until the EBA confirms everything?” they said. “Issuers would rather spend their money and time on other funding avenues rather than to go back and pay their lawyers again, and do the analysis again for STS deals, once everything is clear.”
“If we decide to reorganise the STS team because of this, and then exit the market, the likelihood of us re-entering is small,” they added.
Two new regulations which aim to introduce a consolidated framework for securitisations in the EU take effect at the start of 2019. Both the Securitisation Regulation, which introduces rules for STS transactions, and an accompanying framework outlining the capital treatments of different types of asset-backed deals, have been in the pipeline since 2015. They cover all asset-backed transactions regardless of the type of issuer.
"There are 50 to 100 investors in student loan ABSs in the US, but only maybe four in the EU – in the latter case, there is hardly anyone to buy you out if you decide to exit your position. Are we creating something similar with STS?"
The regulators’ stated aim was to make the securitisation more transparent and sustainable and this has been praised by many in the market - the criteria underpinning the STS framework have not received the same reception. They have initially been called out for being too generic and difficult to fulfil, and member states’ differing interpretations could lead to a fragmented approach across Europe.
It’s worth noting that the Securitisation Regulation includes provisions for third party verification of STS compliance, which is expected to be widespread at least for initial deals. The European Securities and Markets Authority has also released draft regulatory technical standards on firms providing STS verification services.
“Is it worth building a new IT infrastructure to capture STS deals or do we continue focusing on areas where there is actual clarity?" said an in-house at an EU bank. "This is a legitimate question: will investors be put off by the difficulty of doing STS and could it become a niche product because of this?"
Because of the expected amount of groundwork issuers need to do to get STS up and running, the market is expected to be small – at least for the foreseeable future. This could potentially put off issuers, leading them to focus on other types of assets to meet their financing or capital needs.
“If you think about it, there are 50 to 100 investors in student loan ABSs in the US, but only maybe four in the EU – in the latter case, there is hardly anyone to buy you out if you decide to exit your position,” said the ABS source. “Are we creating something similar with STS?”
As a result, there may be only two or three top players in this market in the short-term until the market is mature enough and builds up enough liquidity in the next three to four years.
“I expect large issuers will take advantage of the label first by retrofitting their existing deals to make them STS compliant,” said Clifford Chance's Andrew Bryan. “They are the ones who have the resources to do the kind of analysis needed to comply quickly, and to mobilise their internal systems accordingly.”
- One in-house notes that the delay in the EBA clarifying what makes up the STS label is becoming prohibitive;
- Many issuers are increasingly looking at alternative areas of financing rather than risk losing the STS status for current deals when the criteria are officially outlined;
- The market may shrink to only a handful of the larger issuers, which can absorb the costs and time needed to implement STS in-house;
- STS may over time become reserved for certain asset classes only, in spite of it being applicable to all.
But building critical mass is expected to take some time. The global securitisation market is expected to reach in excess of $1 trillion by the end of 2018, with residential mortgage-backed securities issuances in the US set to spearhead growth. The STS market could maybe reach 10% of that amount. “Do regulators want this market to be small, to deliberately make it difficult?” said the ABS source. “I am expecting some revisions to the framework down the line as the current criteria aren’t sustainable.”
Part and parcel
In a November 2017 speech, European Central Bank executive board member Yves Mersch said that when used well, securitisation ‘can transfer risk away from the banking sector, which may support monetary policy as it can help banks free up bank capital, allowing them to extend new credit to the real economy’.While in principle, STS should be applied across asset classes, it’s expected that it won’t necessarily be in practice. Prime RMBS, credit card and auto loans securitisations may tick all the relevant boxes but sub-prime RMBS or arbitrage synthetic collateralised loan obligations won’t. Assets that comply with the STS criteria attract lower regulatory capital levels, and because these exposures have a lower risks and risk weightings, they are often associated with less complex structures.
“If you’re doing prime RMBS, the expectation is that these will generally be designed or amended to be STS compliant over time,” said Bryan.
In a previous article, asset-backed commercial paper (ABCP) programmes were highlighted as instruments which would be unlikely to qualify as STS because of the sheer difficulty of getting them to comply with the multiple criteria. According to London-based counsel at Mayer Brown Merryn Craske, for an ABCP programme to qualify, the entire programme, the sponsor and every single transaction in the programme (except for temporary non-compliance with certain criteria for a maximum of five percent of the aggregate amount of the underlying exposures) would have to meet the STS requirements.
“This would be very difficult if not impossible to achieve," she said.
A question also arises over the role US investors can play in this new framework. Getting a US asset in an STS securitisation would prove difficult as the originator, sponsor and issuer in the deal would all have to be established in the EU. While the STS framework will lower capital requirements for EU-based investors, their US counterparts won’t benefit from the same treatment as they are subject to US rules. This could potentially have a negative impact on the pricing of EU STS transactions and drive away US investors.
According to one lawyer, Ucits fund managers are anxious about this because of a lot of their success was to track the market, so they won’t be able to invest if US securitisations don’t comply with the EU market rules.
PRIMER: STS securitisations
STS agreement good for EU securitisation