On October 10, 2022, the European Commission (EU Commission) published its long-awaited Report on the functioning of the Securitisation Regulation1 (EU Report)2. The EU Report covers non-prudential matters3, as mandated under Article 46 of the Regulation (EU) 2017/2402 (Securitisation Regulation). In particular, the EU Report fulfils the EU Commission's requirements under Article 45a (3) to report on a specific sustainable securitisation framework, taking into account the relevant European Banking Authority (EBA) report4. The EU Commission also addresses certain legal interpretation issues raised by the European Supervisory Authorities’ (ESAs) opinion5 of March 26, 2021 to the EU 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 EU Commission in 2019.
A separate report6 on prudential matters under Article 519(a) of the Capital Requirements Regulation (CRR) was published on December 12, 2022 (Prudential Report).
Key Points from the Report
No changes were proposed but the EBA will continue to 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 has been tasked with reviewing the disclosure templates; these are 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 EU 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 EU 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 EU 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 how information about private transactions should be made available and in the long term this could be via securitisation repositories though this would require a change to the level one text of the Securitisation Regulation. Some participants may welcome this, given that some originators and sponsors have opted to provide notifications of transactions which are technically private as public deals. This is driven by firms wanting to provide a detailed record of information that firms may want to be public but it would be another hurdle for private transactions to overcome if applied to all private transactions.
Another disappointment in the EU 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 EU Commission is not confident that other regimes can match the Basel standards, despite there being other jurisdictions that may have, or are considering adopting equivalent standards. The EU 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 were proposed for third party verification which is seen to be functioning well.
It is welcome that the EU Commission adopted the EBA position7 that, for now, no dedicated sustainability label for securitisations is proposed. Since the EU Report was published, we have seen that the EBA recommendations were taken into account in the final compromise text of the Regulation on European Green Bonds (EuGB), which allows for a “use of proceeds” model relating to the originator or sponsor of a securitisation and also the with the publication of regulatory technical standards pursuant to Articles 22(6) and 26d(6) of the Securitisation Regulation (Sustainability RTS)8. The importance of environmental, social and governance (ESG) in European securitisations, and how to incorporate it within current and future frameworks, is clearly a focus for regulatory bodies and inevitably will result in heavier disclosure obligations. The regulators are cognisant of the existing reporting requirements to which securitisations are subject; whilst it may be that additional standardisation for disclosure in the market might assist in increasing market share for a product that has some way to go in meeting its full potential in contributing to the ESG agenda a careful, proportionate approach is needed so as not to create such a burden that it deters the ESG securitisation market from developing. It is worth noting that incorporation of ESG data could be included in the disclosure templates as part of the ESMA template review9.
We are pleased to see that the proposal for a system of limited-licensed banks to perform SSPE functions was rejected by the EU 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 was 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 EU Commission has clarified, as discussed below, that in some circumstances non-EU entities, whilst not subject to the Securitisation Regulation, 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 EU 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.10
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 EU 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 EU 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 EU 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 EU 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 EU Commission did not choose to provide needed clarity on Article 5(1)(e)11, 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 remain and means that EU participants continue to be at a significant competitive disadvantage.
The EU Commission may have felt constrained in this area as changes may have required modification to the level 1 text of the Securitisation Regulation and 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 market may have to rely on amendments to the technical standards relating to Article 7 to facilitate the provision of information from non-EU sell-side parties and any additional guidance. Until such time as any private securitisation templates are finalised however, investors in third-country securitisations are at a significant disadvantage with potentially material repercussions for the wider market.
In light of this, further guidance has been sought by joint associations in their letter12 “Request for guidance to national competent authorities to use enforcement powers in a proportionate and risk-based manner” dated 9 December 2022. AFME has also highlighted a number of issues, more generally, with Article 5 due-diligence requirements in its “Article 5 Issues Report Due-diligence requirements for institutional investors under Article 5 SECR” dated 14 June 2023.13
- Buy-side obligations – Alternative Investment Fund Managers (AIFMs) 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
Another hope was that reporting systems could be improved, considering different supervisory practices. The EU 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 Securitisation Regulation with effect from January 1, 2021 (UKSR) with minimal changes. HM 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 response14 (HMT Report) on 13 December 2021. Generally HMT believed that the UKSR functions well with the HMT Report making similar observations in relation to the use and growth of private securitisations, SSPEs, third party verifiers, and sustainability. A few changes were recommended and some of these are included in proposals for the replacement of the UKSR (New Framework)15 as part of a new regime for the regulation of securitisation in the UK.
Of particular interest, in the context of the EU Report, we highlight below some of the areas mentioned in the HMT Report that are reflected in the proposed New Framework where there is some difference of approach with the EU.
- Transparency and due diligence. No changes are proposed at this time but a further consultation in this area is contemplated, including as to changes to the private and public disclosure templates, taking into account points discussed in the HMT Report. We will watch this space with interest and particularly for areas of divergence between the EU and UK regimes as they develop.
- Private securitisations. The FCA has mooted whether transactions defined as private securitisations should be subject to a less stringent, more proportionate reporting regime and a further consultation will consider which securitisations should be considered public and be required to report via a securitisation repository (unlike the EU Report which does not propose changes to the definition of private transaction).
- STS equivalence. Unlike the EU Commission approach, the New Framework contemplates an equivalence regime, noted as being “desirable” in the HMT Report though to what extent HMT will be willing to recognise third-country transactions remains to be seen.
- Jurisdictional scope. As with the EU Report, there are some helpful clarifications relating to extra-territorial impact:
- Sell-side obligations: the New Framework clarifies that the rules only apply to UK entities but that UK investors need to ensure that, where an originator, sponsor or original lender is not established in the United Kingdom, that risk retention requirements, credit-granting and due diligence requirements are complied with.
- Sponsor obligations: the HMT report did not address the mismatch between Article 5 (1)(b) and Article 9 and this has not been addressed in the proposed New Framework.
- Buy-side obligations – availability of disclosures: the UK has adopted a different approach to the EU (which continues to require Article 7 transparency, including for investors in third-country securitisations as discussed above) with the New Framework taking into account recommendations of the HMT Report relating to third country disclosure and provided some clarifications aimed to limit disincentives for UK investors to invest in third-country securitisations. Requirements for verification that information provided in relation to non-UK securitisation is “substantially” the same as under Article 7 of the UKSR is replaced with a requirement for “sufficient” disclosures to assess risk, with access to further information. In terms of what is “sufficient”, the rules provide, in relation to Article 5(1)(e), information that must be included as a minimum and without the need for templated information.
The jurisdictional scope of the UKSR and ambiguities as to interpretation of what is “substantially” the same have been problematic for the market. There have been calls for a more principles-based approach or even an equivalence standard to apply; however, the HMT Report was clear that for investor protection the best outcome we could expect was clarification as to what information is required. Uncertainty in this area, and requirements that have not corresponded with those familiar to third-country originators, has often resulted in third country transactions not targeting UK or EU investors or including disclaimers in documentation that disclosure and on-going reporting may be non-compliant and that each relevant investor should make its own decision on whether to invest. Whether the UK approach will facilitate sufficient inroads for investment in third country securitisations remains to be seen but removal of the requirement for the templated information is a welcome development.
- Buy-side obligations – AIFMs: Similar to the EU Commission recommendations, due diligence requirements for AIFMs will only apply to UK authorised AIFMs which is a welcome clarification for the market.
What will happen next in the EU?
The current prudential treatment of securitisation is believed by the market to be a significant impediment to the development of the securitisation market. Awaited with great anticipation after the EU Report therefore was the Prudential Report which was published on December 12, 2023.
The ESAs recommended some targeted changes but, with the exception of significant risk transfer (SRT) transactions, the ESAs believe that the current framework is not a key obstacle to the improvement of the securitisation market. They believe this is, at least in part, due to a combination of factors, not least supply and demand issues and due diligence requirements. They recommended that areas not within scope of the ESAs’ mandate for the Prudential Report be investigated including monetary policy, the potential benefit of non-financial corporate activity in the market, the proportionality of current investor protection requirements and the overall “stigma” attached to securitisations.
Whilst encouraging that the ESAs intend to remain focussed on analysing how to address areas that can be improved to facilitate EU securitisation recovery and to review certain aspects of the framework, as with the EU Report, it was disappointing that they didn’t take a bolder approach.
The Prudential Report is now with the EU Commission to determine whether to implement any regulatory changes16.
We also await any proposed developments on SRT.17 This has been eagerly awaited by the market since the EBA published its report18 on SRT 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. The EU Report noted that the EU Commission is currently reviewing the requirements for SRT, including whether to introduce any delegated act.
Future legislation on non-prudential matters
No legislative changes are currently proposed but there are certain areas where the EU 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. Improvements to the regulatory and implementing technical standards for transparency requirements will be considered by ESMA, rather than modifying the Securitisation Regulation in this area at this stage.
The EU Commission agrees with the EBA that there is no need for a separate green securitisation label for the moment. Instead sustainability matters are being addressed as part the EuGB. We note that the same view was shared by HMT.
It is disappointing that, whilst the EU Commission acknowledged that the Securitisation Regulation has not facilitated the growth in the European market that had been expected, it wanted more time to fully consider what might be needed. We consider that an opportunity has been missed to propose changes now to the Securitisation Regulation, in particular in relation to private securitisations, extra-territoriality and disclosure. The clarity that has been provided in relation to the sell-side obligations and AIFMs is welcome however, although the market would have benefitted from a bolder approach or at least additional guidance.
More developments are in the pipeline; it will be interesting to see to what extent the EU and UK regimes move in parallel or diverge and, if there is further divergence, whether that has a practical impact on these markets.
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 Julian Craughan, Steven Minke, and Jane Griffiths.
3 A separate report on prudential matters under Article 519(a) of the Capital Requirements Regulation (CRR) was published on 9 December 2022.
10 The ESAs had a narrow interpretation of Article 6, that an EU-based entity should retain the risk.
11 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 concerns 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.
16 The ESAs will continue to monitor the securitisation market as a whole and raise prudential matters with the Basel Committee of Banking Supervision (BCBS) where relevant. There have also been some welcome developments in trilogue with the Commission on proposals for the capital requirements regulation (CRR3) but these issues will continue to be raised as areas for further debate, including at BCBS level.
17 The EU 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.