The EU Securitisation Regulation (2017/2402) comes into force on 1 January 2019 and applies to securitisations issued on or after this date. The aim of the regulation is to replace and consolidate the rules that exist in this area across different sectors, such as under AIFMD and Solvency II. This is to further address the risks inherent in highly complex and risky securitisations (by distinguishing these from more simple and standardised products, amongst other things), and to make the securitisation market work more effectively for investors in, and originators of, securitisations.
What types of securitisation are covered?
The regulation recitals describe securitisations as transactions that enable a lender or creditor to refinance a set of loans, exposures or receivables, such as car or consumer loans, by transforming these into a tradable security (e.g. a collateralised debt obligation). These loans are repackaged by the lender and organised into different risk categories (e.g. AAA to NR) for investors, who are thus able to access loan investments and other exposures that they would not typically be able to access. Returns are generated from the cash flows of the underlying exposures.
The following are the key components of a securitisation as defined in the regulation:
- the credit risk associated with the investment is tranched;
- investor returns are dependent upon the performance of the underlying exposures; and
- the ranking or subordination of the different tranches determines the distribution of losses throughout the life of the transaction.
Furthermore, an addition to the pre-existing definition carves out specialised lending exposures, such as property financing schemes.
What does the Securitisation Regulation mean for my firm?
There are two principal ways in which the regulation could impact you:
- if you are an investor (including, but not limited to, an AIFM or UCITS ManCo that manages AIFs or UCITS that invest in securitisations - defined as “institutional investors” in the regulation), you will be subject to prescriptive due diligence requirements (more on these below); or
- if you are an originator, sponsor or original lender of a securitisation (i.e. you were involved in the original agreements that created the securitisation), you will need to comply with disclosure requirements to regulators, investors and potential investors and you will need to retain a material net economic interest in the securitisation of at least 5% (the risk retention requirement). You may also be able to avail yourself of the simple, transparent and standardised (“STS”) regime for any securitisation positions that adhere to certain detailed criteria set out in the regulation – and benefit from preferential capital treatment for such positions under revised prudential requirements.
So, what do I need to do as an institutional investor?
The securitisation requirements under the AIFMD, previously only applicable to full scope AIFMs, have now been bolstered and extended to all AIFMs, including sub-threshold AIFMs, and to UCITS ManCos. There is some uncertainty as to whether the requirements will apply to non-EU AIFMs that market their AIFs in the EU under Article 42, and it is hoped that ESMA will clarify this in a Q&A, but, as it stands, if you manage or market AIFs in the EU or manage a UCITS and are planning to invest in securitisations issued post-January 2019, you will need to undertake due diligence before you do so. This includes, but is not limited to:
- verifying that the originator has disclosed its compliance with the 5% risk retention requirement and has granted the credits giving rise to the underlying exposures on the basis of sound, well-defined criteria;
- undertaking an assessment of the risks of the securitisation and the underlying exposures; and
- undertaking an assessment of all the elements of the securitisation that could materially impact its performance, including contractual priorities of payment, market value triggers, and definitions of default specific to the transaction.
Once invested, you will need to have written procedures in place to monitor compliance of the securitisation with pre-investment due diligence criteria, as well as the performance of the securitisation and the underlying exposures. You will also need to do the following:
- perform regular stress tests on the cash flows and collateral values supporting the underlying exposures;
- ensure internal reporting to your management body, so that it is aware of the material risks arising from the securitisation – and so that these risks can be adequately managed; and
- be able to demonstrate to the regulator that you have a comprehensive and thorough understanding of the securitisation and its underlying exposures, have established written procedures for the risk management of the position, and that you keep records of the verifications and due diligence undertaken prior to investing.
Where you are investing in a securitisation designated as STS by the originator and sponsor, you may rely for due diligence purposes to an “appropriate extent” on the STS designation and on the information provided by the originator or sponsor on its compliance with the STS requirements, provided that you do not “solely or mechanistically” rely on this. This implies that some additional due diligence will be required on the part of the investor.
If the securitisation no longer complies with the requirements of the regulation, you will need to undertake corrective action in the best interests of AIF investors. Such action might include hedging, selling or reducing the exposure to that position.
What about delegated managers?
Where a firm is defined as an “institutional investor” and manages portfolios on a delegated basis, including AIFs or UCITS, that invest in securitisations, it is not subject on the face of it to the investor requirements, but the Regulation provides for the investor to be able to instruct such investment managers managing portfolios on its behalf to fulfil these due diligence obligations in respect of securitisations held in those portfolios. Therefore, if you are managing an AIF or UCITS on a delegated basis and intend to invest in securitisations, you should be prepared to undertake the necessary due diligence.
I am the originator or sponsor of a securitisation – what are my obligations?
To comply with the risk retention requirement noted above, you will need to maintain a 5% stake in the securitisation and will need to disclose this as part of your disclosure requirements.
You will need to provide an information pack to investors in the securitisation, the regulator and to potential investors on request. Such information will include a transaction summary and all underlying documentation essential to understanding the transaction, such as asset sale agreements, derivatives and guarantee agreements and cash management agreements.
On a quarterly basis, you will need to provide the following:
- investor reports containing information on the credit quality and the performance of the underlying exposures and on trigger events causing changes in the priority of payments, data on cash flows generated by the underlying exposures, and information on the risk retained;
- any significant events relating to the securitisation, such as material breaches of the obligations in the underlying documentation; and
- any material amendments to transaction documents.
If you are seeking the STS designation for the securitisation, you will need to ensure it complies with detailed requirements set out in the regulation pertaining to “simplicity”, “transparency” and “standardisation” and make a joint notification as such to ESMA. The STS notification and disclosure as to whether the securitisation ceases to meet the STS requirements at any point will form part of your disclosure requirements.
Investors planning to invest in securitisations from January 2019 onwards will need to implement policies and procedures to monitor compliance with the due diligence requirements and manage the risks associated with investment in the securitisation - or update existing policies, where they have previously been subject to the AIFMD securitisation requirements. The regulation is forward-looking, so there is no need to retroactively comply in respect of securitisations that pre-date the requirements coming into effect.
Originators and sponsors will need to ensure they can comply with the risk retention requirement and will need to obtain appropriate accounting and legal advice in respect of their prudential and contractual obligations in respect of securitisations. They will also need to start compiling the information required to be disclosed on such securitisations and sign up with a securitisation repository (or tweak their websites) to make sure they can disclose this appropriately to the regulator and all position holders.