European Commission report on the functioning of the Securitisation Regulation
On 10 October 2022, the European Commission (Commission) published its long-awaited Report on the functioning of the Securitisation Regulation (Report).
The Report covers mostly non-prudential matters, as mandated under Article 46 of the Regulation (EU) 2017/2402 (Securitisation Regulation). In particular, the Report fulfils the Commission's requirements under Article 45a (3) to report on a specific sustainable securitisation framework, taking into account the relevant European Banking Authority (EBA) report. The Commission also addresses certain legal interpretation issues raised by the European Supervisory Authorities’ (ESAs) opinion of 26 March 2021 to the Commission on the jurisdictional scope under the Securitisation Regulation (the Joint Committee Opinion). It also takes into account the recommendations made by the high-level forum on the Capital Markets Union, created by the Commission in 2019.
Whilst the Targeted consultation on the review of the EU securitisation framework included a call for evidence on prudential matters, these do not form part of the Report. We therefore still await the detailed report on prudential matters under Article 519(a) of the Capital Requirements Regulation (CRR), as well as possible legislation on the significant risk transfer framework pursuant to Articles 244(6) and 245(6) of the CRR.
The United Kingdom's HM Treasury published its equivalent Review of the Securitisation Regulation: Report and call for evidence response on 13 December last year.
Key Points from the Report
No changes have been proposed but the EBA will monitor the use of risk retention and in particular the rationale for usage of different methods.
Transparency and due diligence
It is encouraging that ESMA is tasked with reviewing the disclosure templates which have been widely considered unfit for purpose and too prescriptive for private securitisation, especially given that the transaction parties usually benefit from a close working relationship and funders routinely request the level of detail and granularity of information they require from originators without resorting to the reporting templates. Disproportionate reporting has a cost impact for private securitisations which is certainly more than negligible. Indeed, our experience is that investors do not consider the statutory loan level reporting in any detail, and it is unclear to what extent any supervisors rely on this. We are optimistic therefore that ESMA will, as part of its review, be pragmatic in removing unnecessary information and adopting a more proportionate approach.
One of the biggest disappointments in the Report is the approach on private securitisations. Given recent market volatility and the important role private securitisations have played to date (including during the Covid-19 pandemic), it is a missed opportunity not to promote this segment of the market more fully and lighten its regulatory burden, particularly given its positive potential for the wider economy. A separate regime for private securitisations, not subject to prescriptive templated disclosure requirements, might have opened up this market, for which the current rules have provided overly prescriptive and inflexible for smaller market players and transactions.
The Commission, perhaps suspicious that private deals might be circumventing transparency requirements, wants more time to assess whether there has been a disproportionate rise in private deals. Consequently, the definition of private securitisation remains unchanged as the Commission believes that this issue can be dealt within the existing rules and templates. Instead, ESMA will be tasked with drawing up dedicated templates for private securitisations. It had been proposed that private transactions should not be subject to such template-based disclosure as the requirements are not justified by the nature of the risks and parties to bespoke private deals.
Consideration will also be given as to whether reporting for private transactions should be made via a repository. Some participants may welcome this, given that some originators and sponsors have opted to provide notifications of private transactions as public deals, driven by firms wanting to provide a detailed record of information that firms may want to be public but it is another hurdle for private transactions to overcome.
Another disappointment in the Report is the lack of movement on STS equivalence meaning that EU investors will continue take a greater capital hit for non-EU STS transactions. No equivalence regime is proposed at this time as the Commission is not confident that there are any other regimes, other than in the United Kingdom, which can match the Basel standards, despite there being other jurisdictions that may have, or are considering adopting equivalent standards. The Commission will, however, keep STS equivalence under review so the door has been left ajar on this point.
Third party verification of STS Criteria
No changes have been proposed for third party verification which is seen to be functioning well.
It is welcome that the Commission has adopted the EBA position1 that, for now, no dedicated sustainability label for securitisations is required and proposed that the European Parliament and the Council take into consideration the EBA recommendation in the context of the ongoing negotiations on the EU Green Bond Standard. The devil, as always, will be in the detail of the sustainability regulatory technical standards; an overly prescriptive approach will not be appropriate for the securitisation market. Unfortunately the Report does not provide more clarity on the relevant disclosure obligations of the Sustainable Finance Disclosure Regulation (SFDR)2 and how this will apply in the context of securitisation, which is not a financial product within Article 2 of the SFDR. For more information on sustainable securitisation see our article Talking about a revolution - making ESG securitisations mainstream.
We are pleased to see that the proposal for a system of limited-licensed banks to perform SSPE functions was rejected by the Commission. This proposal was widely rejected by market participants, fearing it could jeopardise independence in control and management of the SSPEs and lead to a higher concentration of risk.
Some helpful clarification has been included to address the significant market concern that has surrounded the extra-territorial impact of the Securitisation Regulation. In particular Articles 6 (risk retention), 7 (disclosure and transparency) and 9 (credit-granting criteria) and the inconsistency between Articles 5(1)(b) and 9 have been the source of some confusion.
The benefit of the Joint Committee Opinion was limited as the ESAs could not fully deal with matters of interpretation, change the legislation or give official guidance. This uncertainty has been an unsatisfactory position for the securitisation market, resulting in the EU securitisation market being less appealing to non-EU entities by subjecting them to EU obligations and resulting in lengthy negotiations between non-EU originators and EU financial institutions seeking to comply with their Article 5 obligations.
The Commission has clarified, as discussed below, that in some circumstances non-EU entities, whilst not subject to the EUSR, may fulfil certain requirements, given that EU investors are required, nevertheless, to verify that the requirements of Articles 5, 6 and 7 have been fulfilled.
- Risk retainer: we now have clarity that a non-EU entity may act as risk retainer, though no amendment to the Securitisation Regulation is proposed on this point. This is a positive clarification given situations where it is not appropriate for an EU entity to act as retainer from a commercial perspective. If the Commission had required an EU entity to act as retainer in all circumstances this would limit a substantial proportion of transactions and might have required existing transactions to restructure or terminate, which would be counter to improving the securitisation market and less beneficial to the economy as a whole.3
A non-EU-based originator, sponsor or SSPE can report but liability remains jointly with any EU-based entities: a non-EU originator, sponsor or SSPE may be designated to fulfil the obligations of Article 7 of the Securitisation Regulation, which is sensible given that a non-EU entity may be the most appropriate entity. However, any EU-based originator, sponsor or SSPE nevertheless retains the joint legal obligation to disclose all the information requested by Article 7.
Credit-granting criteria may be met by a non-EU entity: very helpfully, the Commission has clarified that, whilst the optimum scenario would be that an EU entity would fulfil these requirements, the credit-granting criteria "can only be meaningfully met by the credit-granting entity in the process, regardless of whether or not it is located in the EU". The Report notes that, in any event, an "EU-based investor is only allowed to invest in transactions for which it can be verified that they comply with the obligations of Article 9" and EU investors must be appropriately informed
Article 5(1)(b): the Commission notes the inconsistency between Article 5(1)(b) and Article 9, whereby Article 5(1)(b) imposes on investors the obligation to ensure that the originator or original lender complies with the requirements of Article 9, whereas Article 9 applies to sponsors too. The Commission intends to resolve this matter in the next revision of the Securitisation Regulation but considers that this is not a problem that requires an urgent fix on the basis that if the sponsor "does not apply any credit-granting standards since it does not grant credit on its own account, Article 9(1) cannot in practice impose a valid direct obligation on the sponsor".
- Buy-side obligations – availability of disclosures
It is a shame that the Commission did not choose to provide needed clarity on Article 5(1)(e)4, which has been a bone of contention on cross-border transactions for some time. An equivalence regime ensuring that EU investors would not be disadvantaged and could have relied on information in a different format would have been a fitting solution in our view. This is all the more surprising given that the ESAs had been in favour of an assumption of compliance for third-country securitisations, notwithstanding that not all of the Article 7 requirements would be fulfilled and recommended a ‘third-country equivalence regime for transparency requirements’. Unfortunately market concerns as to the additional administrative burdens this places on both EU and non-EU parties will continue and could mean that EU participants potentially continue to be at a significant competitive disadvantage. Once amendments to the technical standards are agreed this will need to be considered in the context of specific transactions.
The Commission may provide clarifications in a future amendment of the Securitisation Regulation. For now, however, on the basis of affording the same protections for investments in non-EU securitisations, the Commission will instead rely on amendments to the technical standards relating to Article 7 to facilitate the provision of information from non-EU sell-side parties.
- Buy-side obligations – AIFM investors
The Commission confirms that non-EU AIFMs and "sub-threshold" AIFMs are within the scope of the requirements but that the Securitisation Regulation should only apply to funds that a third-country AIFM markets and manages in the EU. The Commission will consider amending the wording of Article 2(12)(d) to specifically remove any kind of legal uncertainty in a future proposal to amend the Securitisation Regulation.
Supervision of securitisation
The Commission considers that the overall supervisory framework is satisfactory but taking into account various matters raised in the review, considers that there is room for future guidance and co-ordination between supervisors.
Relevance for the United Kingdom
The United Kingdom on-shored the EU Securitisation Regulation with effect from 1 January 2021 (UKSR) with minimal changes. His Majesty’s Treasury (HMT) undertook its own Article 46 review under the UKSR and published its equivalent Review of the Securitisation Regulation: Report and call for evidence response (HMT Report) on 13 December last year. Similarly, whilst making proposals, few significant changes were recommended, pending determination of the overall regulatory framework review in the UK.
Overall the Commission approach is not inconsistent with that taken by HMT. HMT’s report determined that the UKSR generally worked well and that, whilst it might contemplate possible changes, it did not intend to do so for the time being. The HMT Report made similar observations in relation to the use and growth of private securitisations and took a similar stance on SSPEs, third party verifiers, AIFMs and sustainability. As with the Commission’s Report, prudential risk was not within the scope of the HMT Report but it does not contemplate changes to the significant risk transfer framework.
HMT indicated that it would be open to contemplating changes in other areas however, including:
- Public/private disclosure: HMT accepts it may be beneficial to review the private/public categorisation and what disclosure is appropriate and this will be subject to a separate consultation in due course.
- Extra-territoriality: HMT accept that there are difficulties and will consider clarifications so as not to restrict UK investors from investing in third-country securitisations. Similar to the Commission, HMT indicated that it would adjust the definition of institutional investor in the UKSR to exclude AIFMs that are not established in the UK so as to address uncertainty about how to regulate AIFMs that are marketing in a jurisdiction but otherwise have no connection with that jurisdiction.
- Risk retention rules: similar to the Commission, HMT thinks this area is broadly satisfactory. Whilst not a priority, areas of possible change include (i) collateralised loan retention (allowing changes to the risk retention holder if there is a change of manager), (ii) NPE risk retention i.e. based on acquisition price rather than nominal amount and allow servicers to retain the risk (the EU already adopted this approach); (iii) L shaped risk retention (i.e. vertical and horizontal); and (iv) excess spread for synthetics.
- STS equivalence: only UK originators or sponsors should be established in the UK for STS transactions but HMT plans to introduce an equivalence regime. The Financial Services and Markets Bill (Bill) has since introduced an equivalence framework for the recognition of STS equivalent non-UK securitisations, provided that HMT is satisfied that the law and practice of the country or territory in relation to such securitisation has equivalent effect to UKSR and any applicable UK law. The Bill is expected to receive Royal Asset in May 2023.
What happens next?
Awaited with great anticipation is the report as mandated under Article 519(a) of the CRR (Prudential Report) which is expected in the next few weeks. The current prudential treatment of securitisation is an impediment to the development of the securitisation market and the outcome of the Prudential Report could have a significant impact on progress for the market as a whole. Once the Prudential Report is available, the Commission will then further assess possible amendments to the securitisation prudential framework.
- Significant risk transfer (SRT) framework
We also await any proposed delegated legislation on significant risk transfer.5 This has been eagerly awaited by the market since the EBA published its report on significant risk transfer in securitisation under Articles 244(6) and 245 (6) of CRR in October 2020. Harmonisation and standardisation in this area could have a material impact and is long overdue.
- Future legislation on non-prudential matters
No legislative proposal is currently proposed but there are certain areas where the Commission has expressed a willingness to consider changes, namely in relation to clarifying (i) the inconsistency between Article 5(1)(e) and Article 7 and (ii) the wording of Article 2(12)(d) as discussed above.
The Commission acknowledges that the Securitisation Regulation has not facilitated the growth in the market that had been expected but needs more time to bed down in order to fully analyse any areas that will need changing and will continue to monitor this. The Commission also awaits the Prudential Report before making any further recommendations.
- Amendments to regulatory technical standards
Improvements to the regulatory and implementing technical standards for transparency requirements will be proposed by ESMA, rather than modifying the Securitisation Regulation in this area.
The Commission agrees with the EBA report that there is no need for a separate green securitisation label for the moment. Instead sustainability matters should be addressed as part of the current negotiations on the EuGBS. We note that the same view was shared by HMT.
It is disappointing that the EU Commission has not taken the opportunity to make changes now to the Securitisation Regulation, in particular in relation to private securitisations, extra-territoriality and disclosure. The clarity that has been provided on non-EU investors and third-country securitisations is welcome, although the market would have benefitted from a bolder approach. It may be, once the Prudential Report and any further proposals on SRT are published, that the Commission may be prepared to go further in its legislative proposals. We could expect that the Commission might cast its eyes to the UK also, and vice versa, in determining the direction of travel for any further legislative proposals.
This note is for guidance only and should not be relied on as legal advice in relation to a particular transaction or situation. Please contact your normal contact at Hogan Lovells if you require assistance or advice in connection with any of the above.
Authored by Jane Griffiths and Steven Minke.
3 The ESAs had a narrow interpretation of Article 6, that an EU-based entity should retain the risk.
4 Article 5(1)(e) requires that investors verify that, "where applicable", Article 7 disclosure and transparency information is satisfactory before investing in a securitisation. This has been subject to different interpretations and raised concern amongst EU investors that (i) non-EU originators, sponsors and SSPEs had to comply with Article 7 on an extra-territorial basis or (ii) EU investors could be prevented from investing in third-country securitisations.
5 The Commission is currently considering its powers to recommend delegated legislation pursuant to Articles 244(6) and 245(6) of the CRR to improve the current SRT framework.