PRIMER: Japan’s proposed retention rule for securitisation

Author: Karry Lai | Published: 22 Feb 2019
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What is the proposed retention rule?

  Japan’s Financial Services Agency (FSA) has proposed more stringent capital requirements for Japanese banks that buy securitisation products such as collateralised loan obligations (CLOs) and asset-backed securities (ABS).

The proposal applies increased regulatory capital risk weighting unless the originator holds an exposure of less than five percent of the total underlying assets. Naoya Ariyoshi, partner at Nishimura & Asahi, said that in most deals with a Japanese originator, it will typically hold more than five percent.

For products like CLOs, which tend to be established in the US or elsewhere and sold to Japanese banks, the originators often hold less – and sometimes none.

What’s the anticipated impact?

As well as Japanese banks, the rule will affect originators and arrangers elsewhere in the world, especially in the US, which is a major securitisation issuer.

Under the proposed rule, it is practically impossible for an originator to hold less than five percent of an underlying asset exposure.

"Although it’s not typical for an originator to hold less than five percent in today’s market, we have actually seen some mortgage-backed securities without any risk retention at all," said Toshifumi Ueda, partner at Mori Hamada & Matsumoto.

The new rule would make these transactions practically impossible.

A senior official of a Japanese bank said that the FSA’s plans to carve out securitised products that originate in jurisdictions where risk retention is already required, such as CLOs, residential mortgage backed securities (RMBS) and other ABS that originate in the US, EU and China.

"We are opposing the FSA’s idea," he said. "This is clearly discrimination against Japanese domestic RMBS."

He added: "Unlike the EU, where bank capital requirements need to be passed by law, the FSA’s commissioner has the power to issue notices without any legislative procedures. This is complete nonsense."

How does the proposal compare to other jurisdictions’ approach?

Risk retention rules for securitised products are in place in the US and EU. However, in February, the US court ruled that open CLOs are not subject to risk retention rules.

The US’ Loan Syndications and Trading Association brought the case against the Securities and Exchange Commission and Federal Reserve.

How are banks preparing for the proposed rule?

  Japanese banks that invest in securitisation will need systems capable of capturing extensive risk-related information.

"In a case where a bank invests in securitisation products that do not satisfy certain risk retention requirements, the heavier risk weight under the capital requirements regulation would be adopted for these products," said Ariyoshi.

"That is, unless the bank determines that the securitised assets were not inappropriately formed on the basis of the relevant circumstances, such as the originator’s involvement in the securitised assets and the nature of them," he added.

What areas still lack clarity?

  There are still plenty of areas of ambiguity. For example, it is not clear under what circumstances a bank can determine that the securitised assets were formed appropriately. In addition, the treatment of securitisation products established in foreign countries remains unclear.

Under the FSA’s current proposal, even if a bank does not directly satisfy the risk retention requirement, it can avoid the stringent risk weights if it determines that the selection of underlying assets is appropriate.

"In this regard, the bank may consider such circumstances as the originator’s involvement in, and quality of, the underlying assets," said Ueda. "If the bank is duly satisfied, it is not required to apply the risk weight to its exposure. However, it is not clear under what situation the bank may actually rely on this exception."

Elliot Ganz, general counsel at the Loan Syndications and Trading Associaion (LSTA) in the US, said that the association has been engaged with the FSA, and is optimistic that the regulator will consider CLOs in the US appropriately formed.

"The primary focus for the FSA is to ensure the investor is comfortable with the deal and that the underwriting process is robust," said Ganz.

He added that the existing documentation is likely sufficient to give investors comfort that underlying assets were written in an appropriate way. However, further clarification will be needed from the regulator.

What are the next steps?

In their consultation response, the Japanese Banking Association and Securitisation Forum of Japan said that the current proposal should be withdrawn. The FSA has yet to present a response to these and other comments.

Comprehensive FAQs are expected by March 2019, and typically the rule would be implemented soon after.

See also

China needs legal certainty for securitisation to grow

Japan ramps up high-frequency trading oversight

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