Like most financial engineering techniques, securitisation is not without risk. The complexity inherent in securitisation can impair investors' ability to monitor risk, and competitive securitisation markets are prone to sharp declines in underwriting standards. Furthermore, off-balance sheet accounting treatment for securitisations coupled with guarantees from the issuer can make it challenging to assess exposures, encouraging issuers to take on excessive credit risk. Even the most ardent advocates of securitisation would accept that securitisation played an important role in the US subprime mortgage crisis that led to the global financial crisis of 2008.
As part of its project to safeguard the stability of financial markets and improve investor protection, in 2017, the EU enacted a package of legislative measures regulating securitisation and imposing minimum requirements. The central measures are Regulation (EU) 2017/2402 (Securitisation Regulation, or SR) and the ancillary Securitisation Prudential Regulation (EU) 2017/2401 (SPR), which amends the Capital Requirements Regulation (CRR). Together the SR and SPR are referred to as the updated risk retention rules.
The SR has had direct effect throughout the EU since January 1 2019, imposing due diligence, transparency, and risk retention rules on a range of institutional investors, which are broader than under the previous regime. The SR replaces the sector-specific regulatory approach that previously applied with a framework of rules which apply to all European securitisations. The SPR replaces the provisions of the CRR, which were relevant to the regulatory capital context of securitisation exposures held by EU credit institutions and investment firms.
For a transaction to qualify as a simple, transparent and standardised (STS) securitisation under the regulation and, thus, to enjoy preferential regulatory capital treatment, it must satisfy the requirements set out in the SR. These relate to issues such as homogeneity of the underlying assets and the availability of reliable historical performance data for the assets.
A fundamental principle that characterises the new regulatory framework is that the institutional investors must ensure that the originator, sponsor or original lender of a securitisation retains at least a five percent net economic interest in the securitisation.
The due diligence requirements which are included in provisions of various pieces of sectoral legislation (CRR, Solvency II Delegated Act and AIFMD) are replaced by a single provision requiring all regulated institutional investors to undertake the same prescribed due diligence procedures (Article 5(1) SR).
The regulation includes direct disclosure obligations (Article 7 SR), which apply irrespective of the regulatory status of the originator, sponsor or issuer. Investors must be provided, among other things, with regular reports on the credit quality and performance of underlying exposures, details of any important developments, and information about the risk retained.
Moreover, the Securitisation Regulation prohibits re-securitisations, subject to grandfathering provisions and limited exceptions (Point 8, preamble, Article 8 SR), (that is, asset-backed commercial paper structures). The new framework does not allow an originator to select assets for securitisation on the basis of a possible bargain on their prospective loss-making.
Undertakings for collective investments in transferable securities (UCITS) and non-EU alternative investment funds (AIFs) are also included in the regulated securitisation positions (Articles 2 and 29 SR). The SR replaces the provisions of the AIFMD (2011/61/EU) on due diligence, monitoring, and internal reporting requirements concerning securitisation positions. Under the new rules, AIFMs are deemed institutional investors (Article 2.12.d SR). Managers of Ucits may also be treated as institutional investors (Article 2.12.e SR) and are required to satisfy the due diligence, monitoring, and reporting requirements on securitisation positions. These include the establishment of sound and well-defined criteria, with effective systems to apply those criteria.
The STS framework has attracted some criticism for being vague and complicated. For example, there are various criteria that an asset-backed security (ABS) must satisfy to be classified as STS. There are concerns that the new European regulations risk creating conditions where issuance for some market sectors could cease. There is a disappointment expressed by some market players that a large number of securitisations, despite having a satisfactory record of performance (such as some synthetics), may continue to encounter some negative discrimination, compared to the more conventional security forms.
It would not be an exaggeration to say that there might also be problems for non-performing loans (NPLs). The level of disclosure is quite high and, in some cases, (that is, where the originator is not the original lender) the information can be entirely unavailable, a situation that is further complicated when the original lender becomes bankrupt.
In the case of new securitisations and legacy STS securitisations, compliance with the Securitisation Regulation will induce difficulties and challenges in the relevant field. Adaptations to pre-existing securitisations are considered to be quite time/cost-consuming and often subject to substantial expenses to be undertaken by the originator or sponsor.
The introduction of the regulation is, without doubt, an encouraging step towards financial stability in the EU. In the context of this new regulatory effort, the creation of a single market for investment services and the achievement of a high degree of harmonised protection for investors in financial instruments are fundamental in establishing a capital markets union. However, the fact that there are issues still pending is disappointing for a framework of legislation which has been drafted with the intention of promoting the recovery of the EU financial markets. The uncertainty created by those outstanding issues, and the vague and complex provisions referred to above, may be counterproductive. Policymakers and the industry should be encouraged to ensure that regulatory initiatives in this area do not have the effect of discouraging investors and securitising entities from engaging in securitisation deals and instead promote a more stable and transparent regime for the implementation of securitisation transactions.
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