Report by the Joint Committee of the European Supervisory Authorities on the EU Securitisation Regulation

Introduction

The Joint Committee of the European Supervisory Authorities¹ (the "Joint Committee" and the "ESAs", respectively) has published a report on the implementation and functioning of the EU Securitisation Regulation² (the "EUSR") on 17 May 2021 (the "Report").³

The Report has been published pursuant to Article 44 of the Securitisation Regulation, which required the Joint Committee to publish a report by 1 January 2021 (and every three years thereafter) on (a) the implementation of the requirements for "STS" (simple, transparent and standardised) securitisations, (b) an assessment of the actions taken by the EU competent authorities on material risks and vulnerabilities and the actions of market participants to further standardise securitisation documentation, (c) the functioning of the due diligence requirements of Article 5 and the transparency requirements of Article 7 of the EUSR, and the level of transparency of the securitisation market, and (d) the risk retention requirements of Article 6 including compliance by market participants and the methods of risk retention.

The Report will be used by the European Commission (the "Commission") for the preparation of its report to the European Parliament and the Council of the European Union on the functioning of the EUSR, which is due by 1 January 2022, pursuant to Article 46 of the EUSR, and which may be accompanied by a legislative proposal.  It is therefore an important step in relation to the regime for EU securitisations which was established by the EUSR when it became applicable on 1 January 2019.

It is worth noting that the Report will not be applicable to the UK Securitisation Regulation⁴ regime, which will be the subject of a separate review and report by the UK Treasury by 1 January 2022.

In this Legal Update, we summarise the main issues identified by the Report and some of its recommendations and key messages.

Due Diligence Requirements

Article 5 of the EUSR sets out detailed due diligence and monitoring requirements that institutional investors must comply with before and while holding an exposure to a securitisation.

Issues identified

The Report identifies several issues in relation to the operation of Article 5:

• jurisdictional scope: there is significant legal uncertainty as to whether certain aspects of Article 5 apply to transaction parties located outside the EU. In particular:

• it is unclear how Article 5 applies to non-EU alternative investment fund managers; and
• Article 5(1)(e) requires an investor to verify that the originator, sponsor or securitisation special purpose entity ("SSPE") has, where applicable, made available the information required by, and in accordance with, Article 7 (which sets out certain disclosure requirements, including reporting using specified templates).  However, it is unclear whether this obligation applies where the originator, sponsor and SSPE are located outside the EU;

• adequate and proportionate due diligence: several provisions of Article 5 require a determination to be made as to whether information is "adequate" or "proportionate", but the EUSR does not specify how this may be determined in practice, the extent to which investors may rely on the information provided or what level of analysis of loan level data is required; and
• supervision of due diligence requirements: the Joint Committee notes that supervision by competent authorities of the due diligence requirements has so far been limited, due to the recent implementation of the requirements, limited issuance in certain jurisdictions, the absence of a specific supervisory framework and the lack of resources.

Recommendations and key messages

The Report sets out the following recommendations and key messages in relation to the operation of Article 5:

• jurisdictional scope: the Commission should amend the EUSR or provide interpretative guidance to clarify the jurisdictional scope of Article 5. The Report endorses the opinion of the Joint Committee on the jurisdictional scope of the EUSR (the "ESAs' Opinion"), which concluded that it seems very unlikely, or at least very challenging, that EU investors could comply with Article 5(1)(e) with respect to third country securitisations, and instead proposed that the feasibility of a third country equivalence regime should be assessed;⁵
• adequate and proportionate due diligence: further technical standards or guidelines should be issued to clarify how adequacy and proportionality requirements are to be satisfied in the context of due diligence, in particular with respect to STS transactions, and to specify how investors should carry out loan level due diligence; and
• supervision of due diligence requirements: competent authorities should take steps to improve the effectiveness of supervision of the due diligence requirements, including by sharing experiences and by considering developing a common EU best practices supervisory guide. 

While the Report helpfully recognises the ambiguity identified with respect to the drafting of Article 5(1)(e), market participants have expressed significant concerns about the recommendations made in the ESAs' Opinion with respect to this provision.  EU investors have been faced with a difficult decision of how to interpret the Article 5(1)(e) wording in order to continue to invest in third country securitisations, given the practical challenges in obtaining the specified reporting templates, or in some cases, asset-level data.  Some market participants have expressed a preference for a proportionate and risk-based approach, as recommended in the report of the High Level Forum on Capital Markets Union.⁶ We would also note, however, that if Article 5(1)(e) is interpreted in such a way that means that asset-level data is required, this would likely result in certain transactions, e.g. US credit card securitisations and 144A deals which do not provide asset-level data, not being capable of being sold in the EU.  Furthermore, depending on how the requirements are interpreted, there is a risk that EU banks will no longer be able to invest in warehouse transactions, where they would typically receive some asset-level data but only in the form of a pool spreadsheet or tape from the non-EU originator in the form generated by the originator’s system rather than under the EU templates.

It is also unclear whether the suggestion of a third country equivalence regime in the ESAs' Opinion would be achievable in practice.  While the UK regime is currently very similar, and so might conceivably be deemed to be of an equivalent standard, it is not clear whether the regimes in other jurisdictions, for example the SEC requirements for asset-level data in Regulation AB, will be considered to be sufficient for compliance with the EU due diligence requirements.

Risk Retention Requirements

Article 6 of the EUSR requires that the originator, sponsor or original lender of a securitisation transaction retain on an ongoing basis a material net economic interest in the securitisation of at least 5%.  Risk retention requirements were originally put in place as a result of the 2007 financial crisis, in order to ensure a proper alignment of interests between the parties and impose an obligation on the relevant entity to have some "skin in the game", and have been carried across in the various regulations since then.  The EUSR introduced a direct obligation for the originator, sponsor or original lender to comply with the risk retention requirements, in addition to the indirect requirement on investors to verify compliance with risk retention as part of their due diligence obligations under Article 5.  The concept of the sole purpose test was also incorporated in the EUSR (previously this was based on a recommendation in a report by the EBA), and a prohibition on adverse selection of assets was added.

Issues identified

The Report identifies various issues in relation to the operation of Article 6:

• jurisdictional scope: Article 6 does not specify its jurisdictional scope, i.e. whether it allows for retention by an entity located outside the EU;
• risk retention regulatory technical standards: the new risk retention technical standards ("RTS") have still not been finalised.  The EBA published its final draft RTS on risk retention on 31 July 2018 (the "Draft RTS"), but they have not yet been adopted by the Commission. Furthermore, since the amendments to the EUSR as part of the Capital Markets Recovery Package ("CMRP")⁷ include some changes in relation to risk retention which apply in certain circumstances, a revised draft of the RTS is now required to be delivered by the EBA to the Commission by 10 October 2021. Until the draft RTS is adopted, certain aspects of the RTS put in place under the previous CRR⁸ risk retention regime are applicable (the "CRR RTS").  This, however, is an imperfect solution as certain provisions in the EUSR are not addressed by the CRR RTS.  The Report notes that it is possible that some transactions would need to be unwound if the new RTS are more stringent; and
• supervision of risk retention: the supervision of the risk retention requirements by competent authorities has been limited, for the same reasons as identified in relation to the supervision of the Article 5 requirements. However, the Report considers that there are no indications that the Article 6 requirements are not sufficient to ensure a proper alignment of interests and to avoid the risk of "moral hazard".

Recommendations and key messages

The Report sets out the following recommendations and key messages in relation to the operation of Article 6:

• jurisdictional scope: the Commission should amend the EUSR or provide guidance to clarify the jurisdictional scope of Article 6.  In this respect, the Report again endorses the recommendations in the ESAs' Opinion, meaning that where there is an EU originator, original lender or sponsor, an EU entity would be responsible for risk retention.  However, no other changes to the text of the EUSR are required with respect to risk retention;
• risk retention RTS: the new risk retention RTS should be adopted as soon as possible; and
• supervision of risk retention: competent authorities should take steps to improve the effectiveness of supervision of the risk retention requirements, including by sharing experiences and best practices and by reporting on measures taken to ensure compliance.

Market participants will no doubt be pleased that there is no change to the required percentage or methods of risk retention.  However, the proposed clarification of the jurisdictional scope of Article 6 has raised significant concerns.  It is clear from Article 5 that non-EU entities may retain the required material net economic interest, and it is difficult to understand why different rules should be put in place for transactions involving EU and non-EU "sell-side" parties.  The proposed changes also conflict with the wording in the Draft RTS (and which is also similar in the CRR RTS), which provide that in transactions with multiple originators, each originator should retain risk on a pro rata basis, with reference to the proportion of the securitised exposures it has originated, but which also allow for the retention to be held by a single originator if certain requirements are satisfied.  This would be a significant departure from the established market position and would mean that the risks may not be appropriately aligned, contrary to the principles underlying the rules.  It could also mean that in practice certain transactions would simply not be feasible and that some EU entities would not be able to obtain funding.

Transparency Requirements

General challenges in relation to transparency requirements

Article 7 of the EUSR requires that the originator, sponsor and SSPE of a securitisation make available certain information to investors, competent authorities and, upon request, potential investors.  This information includes reports on the underlying assets and investor reports, in each case in the form of the required templates.⁹

Issues identified

The Report identifies various issues in relation to the operation of Article 7:

• reporting for private securitisations: while it is clear under the EUSR that reporting under Article 7 for public securitisations¹⁰ must be made available by means of a securitisation repository (or, until a securitisation repository has been approved by ESMA, a website meeting certain conditions), the EUSR does not specify how reporting should be performed for private securitisations.¹¹ The Report considers whether securitisation repositories should also be used for such transactions to provide a single and uniform source of information for investors;
• different methods of supervision: the Report notes that supervision of the transparency requirements has been performed in different ways across competent authorities, using different supervisory tools, albeit experience to date on supervision of Article 7 requirements is not likely to be representative of the regime going forward given that the technical standards in relation to reporting only came into effect in September 2020; and
• amount and complexity of data to be reported: it was also noted that there are concerns among reporting entities about the quantity and complexity of data to report under Article 7, in particular among less sophisticated issuers.

Recommendations and key messages

The Report sets out the following recommendations and key messages in relation to the general functioning of the transparency requirements under Article 7:

• supervision: measures should be taken to ensure supervisory convergence and coordination amongst competent authorities and to promote data quality; and
• reporting: it is too early to evaluate the reporting templates and it is important to allow time to adapt to the templates before making radical changes.  However, potential improvements can be considered.  In particular, a new reporting template could be developed for trade receivables.

The extent to which changes to the reporting templates will be welcomed remains to be seen, and certainly any increase in the reporting burden will not be popular.  However, the introduction of a specific template for trade receivables transactions could be helpful (assuming that it does not result in increased reporting requirements), given that these transactions currently need to be reported using the esoteric assets template and a number of aspects of that template are not relevant to trade receivables. 

Private Securitisations

Private and/or bilateral securitisations represent an important segment of both STS and non-STS securitisation markets in the European Union, a trend which has significantly increased during and as a result of the COVID-19 pandemic.

Issues identified

The Report identifies certain issues in relation to the transparency requirements applicable to private securitisations:

• definition of private securitisation: the definition of a private securitisation (given that it means transactions where a prospectus does not need to be prepared in accordance with the Prospectus Regulation) covers a broad range of transactions.  The Report considers whether different categories of private securitisations could be distinguished, and identifies three sub-categories of private securitisations in particular: (a) private and bilateral securitisations, where investors are typically one or more institutional investors or sophisticated professionals, (b) private and supported transactions, where the securitisation is supported by the sponsoring institution and (c) private and intra-group transaction, where the only investor is the originator or sponsor (or a related or consolidated entity) and where there should be no concern as to access by investors to the relevant information;
• reporting for intra-group securitisations: the Report considers whether  certain private securitisations could be exempted from the transparency requirements.  However it identifies certain difficulties which would arise as a result, noting that (a) the risk of regulatory arbitrage should be avoided, particularly if that limited the possibility of such transactions being accessible to a broader range of investors and (b) it could result in a dual STS framework, since Article 7 reporting is a component of the STS criteria; and
• awareness and access of competent authorities: it is difficult for competent authorities (a) to become aware of private securitisations if they are not notified, and (b) to access the relevant information.

Recommendations and key messages

On the subject of private securitisations, the Report sets out the following recommendations and key messages:

• definition of private securitisation and reporting: the EUSR should contain a narrower definition of private securitisation to better identify which securitisations are required to provide the reporting templates and to provide reporting via a repository. The Report suggests that, for example, private securitisations involving no third party investors should not be required to comply with such requirements.  However, further consideration with respect to regulatory arbitrage and STS compliance is required; and
• securitisation repository: given the increased issuance of private securitisations, the EUSR should be amended to require information to be provided by means of a securitisation repository, to allow competent authorities to access such information in an easier way and to ensure that checks are carried out for completeness and consistency of the information by the repository.

Many market participants will welcome the prospect of a reduced reporting burden for private transactions.  However, the benefit of this will be limited if the types of transactions which are excluded are too narrowly defined.  In addition, the prospect of those transactions no longer being capable of being STS will mean that in practice this will have the effect of limiting the ability for such transactions to benefit from the reduced reporting requirements, given the increased trend towards making transactions STS. 

Moreover, we anticipate that the recommendation that private securitisations (unless they are exempted from the reporting requirements) would have to report via securitisation repositories will be perceived as unnecessary, given that competent authorities could already receive the relevant information, although in practice the mechanism for providing such information is not yet clear in a number of jurisdictions.  It is also likely to be seen as disproportionately burdensome with respect to many private transactions.

STS Securitisations

The EUSR introduced the concept of STS securitisations, meaning that securitisations which meet the applicable STS criteria can achieve reductions in regulatory capital requirements and benefit from other favourable regulatory capital treatment. The STS label has been widely adopted.

The STS label

The Report considers the number of STS transactions with reference to public versus private securitisations, the underlying assets and the impact of Brexit resulting in UK transactions no longer being capable of being STS under the EUSR. Preferential capital treatment is perceived by market participants as the main advantage associated with STS securitisations, while the possibility of attracting a wider investor base, achieving better pricing, and transparency and standardisation are also seen as positive features of the STS label. 

Issues identified

The Report highlights certain limitations with the STS label, such as:

• complexity of the STS requirements: securitisations must meet numerous criteria in order to be designated as STS, and the complexity of the requirements together with the risk of penalties for non-compliance may act as a disincentive to seeking STS treatment;
• restrictiveness of the STS label: certain asset classes and structures, notably actively managed CLOs, RMBS with self-certified loans and CMBS securitisations, are excluded from the STS label.  Synthetic securitisations are now capable of being STS following the recent CMRP-related amendments to the EUSR;
• compliance costs: compliance costs may reduce the economic attractiveness of the STS label;
• investor base: it is unclear whether the STS label has broadened the investor base for securitisations;
• volume of issuance: there has not been a significant increase in the overall volume of the EU securitisation market following the introduction of the STS label, although the impact of the COVID-19 pandemic and Brexit is noted; and
• prudential treatment: the success of the STS label depends on the attractiveness of STS securitisation vis-à-vis other funding methods, which are not subject to the same regulatory capital and transparency requirements.  Covered bonds, for example have comparatively lower capital requirements and obtain better regulatory treatment under the LCR (liquidity coverage ratio).

Recommendations and key messages

The Report sets out the following recommendations and key messages in relation to the STS label:

• the STS label: the STS label is a workable standard;
• investor base and volume of issuance: adjustments might be needed given that there has not yet been a broadening of the investor base or an increase in issuance; and
• prudential treatment: the prudential treatment falls outside the mandate of the Report, but should be considered by the Commission as part of its review of the securitisation framework pursuant to Article 519a of the CRR.

The STS criteria

The report considers the STS criteria with respect to ABCP and non-ABCP securitisations.

Issues identified

The Report identifies the following issues in relation to the STS criteria:

• interpretation issues: a number of interpretation issues have been identified, notwithstanding the EBA Guidelines¹² and the RTS on homogeneity,¹³ such as the timing for making information available in retained deals, how to perform external auditing requirements in relation to the portfolio, questions regarding the liability cash flow model and the absence of a definition of performance triggers;
• restrictiveness of certain criteria:  it is noted that certain criteria are restrictive and may be difficult to comply with (e.g. the requirement for no defaulted exposures (within the meaning of Article 178(1) of the CRR) at the time of transfer, the requirement for there to be no credit-impaired obligors and the requirement for at least one payment to have been made);
• STS transparency requirements: historic data may not be available; and
• STS ABCP programmes: no STS programmes have as yet been designated as STS.

Recommendations and key messages

The Report sets out the following recommendations and key messages in relation to the STS label:

• STS criteria for non-ABCP transactions: no changes are deemed necessary at present.  However, further analysis could be done at a later date to consider how the STS criteria might be simplified without lowering the quality of the standards; and
• STS criteria for ABCP programmes: some amendments may be considered in the future but no changes should be made at present as there does not seem to be a strong business need to do so due to the limited prudential benefit.

We would note that one of the key barriers to obtaining STS treatment for an ABCP programme is the requirement for all transactions in the ABCP programme to be STS (except for a limited temporary exemption from certain requirements for up to 5% of the exposures), and some further flexibility would be helpful.  In addition, the requirement for the remaining weighted average life of the underlying exposures to be no more than two years has been identified by market participants as problematic.  It seems likely that the demand for STS ABCP programmes would increase if there were improved prudential benefits, and market participants will be keen that this aspect is considered further.

Supervision

Issues identified

The Report identifies various issues in relation to supervision by competent authorities of STS compliance, including the following:

• limited experience: in some jurisdictions there has been limited experience in relation to supervision of the STS requirements; reasons for this include no STS securitisations or low numbers of STS securitisations in those jurisdictions and delays in designating the competent authorities;
• different interpretations across jurisdictions: competent authorities may interpret the requirements differently, leading to fragmentation in the market; and
• lack of timely notification: in some cases competent authorities are only aware of the STS notification following publication on the ESMA website.

Recommendations and key messages

The Report sets out the following recommendations and key messages in relation to supervision:

• supervisory convergence: guidance should be provided to competent authorities to ensure consistent implementation of the STS requirements and competent authorities should consider how to share best supervisory practices and develop common supervisory tools.  The RTS on cooperation between competent authorities should be published without delay; and
• centralisation of supervision: the Report suggests that at a later stage (in the report due in 2024) it could be considered whether the STS requirements could be centralised or delegated, including the delegation of such supervision to the ESAs.¹⁴ 

Third Party Verifiers

Article 28(1) of the EUSR provides that a third party verifier ("TPV") may be authorised by a competent authority to assess the compliance of securitisations with the STS criteria. TPVs are seen by market participants as an additional source of guidance and analysis in interpreting the STS requirements, which is highly valued by investors and less experienced originators.  As of today, only two TPVs have been authorised to verify STS compliance: PCS and SVI.

Issues

The Report identifies certain issues with respect to TPVs, including the following:

• concentration in two TPVs: the knowledge in relation to the implementation of the STS requirements in practice is concentrated in the two authorised TPVs, in particular PCS; and
• risk of over-reliance on TPVs: it should be emphasised that the relevant parties to the securitisation remain responsible for verifying STS compliance, including through the life of the transaction.

Recommendations and key messages

The Report sets out various recommendations and key messages in relation to TPVs, including the following:

• further guidance and transparency: competent authorities should publish further guidance and Q&As on compliance with the STS criteria, to help facilitate the entrance of new TPVs in the market and to provide more guidance to market participants and institutional investors in performing their own assessments of compliance with the STS criteria.  More transparency from TPVs on how they apply the criteria could also be of benefit; and
• compliance through the life of the transaction: the EUSR should be clarified to the effect that the relevant parties to the securitisation have an ongoing obligation to check compliance with the STS requirements throughout the lifetime of the securitisation.

Other Considerations

The Report concludes that few material risks have been identified by competent authorities.  However, the Report notes that the impact of the COVID-19 pandemic is not yet fully apparent.

Next steps

As mentioned, the Commission are required to prepare a report on the EUSR, which should consider in particular the findings of the Report, and which may be accompanied by a legislative proposal. We anticipate that this will involve a consultation process, and this may begin shortly.  We would encourage market participants to make their views known on these important issues.

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¹ The European Banking Authority (the "EBA"), the European Securities and Markets Authority ("ESMA") and the European Insurance and Occupational Pensions Authority (EIOPA).

² Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012, as amended.

³ Joint Committee Report on the Implementation and Functioning of the Securitisation Regulation (Article 44), available at https://www.eba.europa.eu/esas-report-implementation-and-functioning-securitisation-regulation.

⁴ The EU Securitisation Regulation as it forms part of the domestic law of the UK as "retained EU law" by virtue of the European Union (Withdrawal) Act 2018, as amended, as such regulation was amended by the Securitisation (Amendment) (EU Exit) Regulations 2019 and as further amended.  For more details of the UK regime, please see our Legal Update – "The Revised Securitisation Regulation Regime in the UK".

⁵ See our recent Legal Update for a more detailed discussion on this: "ESAs' Opinion to the European Commission on the Jurisdictional Scope of Application of the EU Securitisation Regulation".

⁶ Please see our previous Legal Update on this for more details: "Recommendations for developing the EU securitisation market – Report by the High Level Forum on Capital Markets Union".

⁷ Please see our previous Legal Update on this for more details: "Amendments to the EU Securitisation Regulation – the new synthetic STS framework and adjustments in relation to non-performing exposures".

⁸ Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012, as amended, known as the Capital Requirements Regulation.

⁹ See the following Legal Update for more information: "Disclosure Technical Standards and Templates published in relation to the EU Securitisation Regulation".

¹⁰ i.e. a securitisation where a prospectus is required to be prepared in accordance with the Prospectus Regulation.

¹¹ i.e. a securitisation where a prospectus is not required to be prepared in accordance with the Prospectus Regulation.

¹² Final Report on Guidelines on the STS criteria for ABCP securitisation and Final Report on Guidelines on the STS criteria for non-ABCP securitisation, available at https://www.eba.europa.eu/eba-publishes-final-guidelines-on-the-sts-criteria-in-securitisation.

¹³ Commission Delegated Regulation (EU) 2019/1851 of 28 May 2019 supplementing Regulation (EU) 2017/2402 of the European Parliament and of the Council with regard to regulatory technical standards on the homogeneity of the underlying exposures in securitisation.

¹⁴ The Report also suggests that supervision could be delegated by jurisdictions with no or limited issuances to jurisdictions which have a higher number of issuances, although it is acknowledged that this would present certain challenges.