PRIMER: STS securitisations
With seven months to go, STS transactions are anything but simple, transparent and standardised
What qualifies as a simple, transparent and standardised securitisation?
One component of the EU’s Capital Markets Union project is to ensure that securitisations are carried out in a transparent and risk-reflective manner, and that they are of high quality. As with many other financial instruments, this more cautious approach is a direct reaction to practices that were brought to light by the financial crisis.
Two new regulations take effect in January 2019 that aim to introduce a consolidated framework for securitisations in the EU: the Securitisation Regulation and an accompanying framework outlining the capital treatments of different types of asset-backed deals (known as the Capital Requirements Regulation or CRR). These have been in the pipeline since 2015.
"I am an optional ABS buyer, not a forced one"
The Securitisation Regulation introduces rules for simple, transparent and standardised (STS) securitisations which cover all asset-backed transactions, without differentiating according to the type of investor - as was the case under the previous framework where investment firms and insurance companies, for example, were subject to different rules.
All securitisations, including those that want to qualify as STS will be subject to the same disclosure, risk retention and due diligence requirements. STS transactions will also have lower capital requirements than other types of asset-backed deals, which is believed could have a positive effect on issuances going forward.
What are the capital requirements for STS transactions?
The CRR incorporates recommendations set out in the Basel III framework on securitisation and sets out that STS transactions benefit from lower capital requirements. There are two methods: internal (based on an originator’s own risk ratings) and standardised (approved at regulator level) to determine the risk associated with the underlying assets used in the securitisation.
How is STS determined?
Transactions have to meet multiple requirements to qualify as STS: the label refers to how a transaction is structured so will focus on elements like homogeneity of the underlying assets, clear historical performance data for these assets or a defined framework for rates, risks or conflict resolution.
“Getting an STS label is not just a box ticking exercise which then allows investors to mechanistically invest in a securitisation,” said a London-based lawyer. “Everyone has to do their due diligence properly.”
It’s up to the originators, sponsors and special purpose vehicles to notify regulators have to be notified of the STS label. The European Supervisory Markets Authority will also be informed.
Some types of securitisation will not meet STS criteria: securitisations of non-performing loans (NPLs), managed collateralised loan obligations or commercial mortgage-backed securities are some examples. For NPLs, this is because of a lack of transparency associated with the underlying loans.
Is it easy for a transaction to qualify for the STS label?
In theory it is. Some of the criteria used to determine whether a transaction will be awarded the STS label are likely to be used for securitisations outside of that new framework as well: for instance, the need for a true sale. A true sale happens when assets have been effectively transferred from the seller and are therefore protected from claims made in the event of the seller’s insolvency.
“The parties to a securitisation will generally want to ensure that the deal is structured as a true sale regardless of the STS label,” said Mayer Brown counsel Merryn Craske. “It’s very likely that securitisations that many will consider to be high quality will exist out of the STS sphere as well.”
"Getting an STS label is not just a box ticking exercise which then allows investors to mechanistically invest in a securitisation"
But even though the Securitisation Regulation hasn’t yet been implemented, some criticism has already targeted the STS framework for being everything but simple. There are multiple criteria an asset-backed transaction (ABS) needs to comply with to be classed as STS – this is where problems could start. The European Banking Authority is currently consulting on how to interpret the criteria until July.
The simplicity criterion alone has several tens of requirements and may ultimately not even have the same interpretation depending on the member states. When it comes to the standardisation element, factors such as mitigation of interest rates and currency risks, adequate references for interest payments or the requirements for the transaction documentation could turn out as equally complex.
“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 and could STS become a niche product?”
This thought is echoed by a London-based compliance participant. “If the regulator wants to work to make one asset too complex, then I think that many in the market will focus on other ones, there is enough liquidity elsewhere,” they said. “I am an optional ABS buyer, not a forced one.”
Craske mentioned asset-backed commercial paper (ABCP) programmes which she said would be unlikely to qualify as STS securitisations.
“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, which will be very difficult if not impossible to achieve,” she said.
Are there sanctions for using the STS label wrongly?
The proposed Securitisation Regulation sets out penalties in the event its requirements are breached. These could be as high as €5 million ($5.9 million approximately) for individuals or 10% of the total annual turnover for legal entities. Criminal sanctions are possible too depending on how member states apply the regulation.
“The penalties for getting it wrong could be quite severe but the benefit of having these sanctions could be to incentivise market participants to build transactions properly,” said the London lawyer.