Although markets have long adapted to provisions contained in the 2018 Draft RTS, market participants should note that the old RTS published in Chapters I, II and III and Article 22 of Delegated Regulation (EU) No 625/2014 (the "CRR RTS") pursuant to Regulation (EU) No 575/2013 (the "Capital Requirements Regulation") still apply by virtue of Article 43(7) of the EUSR until such time as the EU Commission adopts the Final Draft RTS proposed by the EBA. The Final Draft RTS will become effective 20 days after it is published in the EU Official Journal.
As further expanded on below, following Brexit, the Final Draft RTS will not apply, at the time of writing, to transactions under the UK Securitisation Regulation.
Key highlights of the Final Draft RTS
We highlight the main changes from the 2018 Draft RTS below. A number of these changes reflect the amendments made to the EUSR in 2021 (the capital markets recovery package) which created a new framework for synthetic STS securitisations and facilitated securitisations of non-performing loans or non-performing exposures ("NPE").
- Synthetic Retention
The Final Draft RTS specifies a retention method for originators of synthetic securitisations via Article 6(3)(d) using the exposure value of the synthetic excess spread (which will be subject to capital charges) as long as the synthetic excess spread provides credit enhancement to all tranches, including the first loss tranche. This synthetic excess spread can then be taken into account in addition to any actual retention of the first loss tranche.
- NPE retention
The Final Draft RTS addresses forms of retention for servicers of NPEs following amendments to the EUSR. Article 2(1)(d) and Article 9 of the Final Draft RTS confirm that servicers of NPEs may act as retainers (in line with Article 6(1)(4) of the EUSR), provided that they comply with requirements as to “expertise” laid down in Article 18 of the Final Draft RTS. These requirements include that i) members of the management body and senior staff of the servicer should have adequate knowledge and skill in servicing NPEs, ii) the business of the servicer or its consolidated group has included servicing NPEs for at least 5 years, iii) at least two members of the management body and senior staff have at least five years' experience in servicing NPEs and iv) the servicing function is backed-up by a back-up servicer.
Where multiple servicers fulfil the retention criteria, the risk retention must take place via either i) the servicer with the predominant economic interest, or ii) each servicer on a pro rata basis. The EBA did not provide any clarity however as to what happens when a servicer wishes to transfer its role as servicer or no longer acts as servicer.
- Asset selection
Article 6(2) of the EUSR protects investors against the risk of reverse cherry-picking assets by requiring originators not to select assets for sale to an SSPE with the aim of rendering losses on the assets transferred (measured over the life of the transaction or over 4 years if the transaction is longer than 4 years) higher than losses over the same period on its balance sheet. Article 17 of the Final Draft RTS builds on the guidance provided in the original draft RTS by providing further clarity regarding what constitutes "comparable assets", stating that any non-securitised asset held by the originator which meets the eligibility criteria of the securitisation is deemed to be a comparable asset (so long as the expected performance is determined by similar relevant factors and non-securitised assets are not reasonably expected to perform significantly better than securitised assets). The assessment should take into account any internal policies and controls preventing exposures of a worse-than-average credit quality being securitised.
- Sole purpose of securitising exposures
The Final Draft RTS provides clarification in Article 2(7)(a) by confirming that a retainer can be an entity which uses income derived from the securitised exposures, so long as such income is not its sole or predominant source of revenue. Given the other requirements of Article 2(7) as to material support from capital, assets or fees and the historic criticisms from the EBA on thinly capitalised retainers we do not think this will significantly change current market practice. It is interesting to note that the language used in Article 2(7)(a) includes “sole or predominant”, whereas Article 6(1) of the EUSR refers just to the “sole purpose”. It remains to be seen to what extent these Final Draft RTS might vary the previous interpretation of the EUSR.
- Retention of randomly selected exposures
Where the retainer elects to retain a portfolio of at least 100 randomly selected exposures in accordance with Article 6(3)(c) of EUSR, there is a new requirement in Article 6(4) of the Final Draft RTS that the selection of exposures should not lead to a deterioration in the servicing standards applied by the retainer on the transferred exposures relative to the retained exposures, to the extent the retainer is also the securitisation's servicer. This builds on the existing requirement in Article 6(2) of EUSR not to adversely select assets. This requirement can be satisfied by the retainer confirming that transferred exposures and retained exposures are both serviced in accordance with the retainer’s credit and collection policies.
- Prohibition on selling the retained interest
By of derogation from the general prohibition to sell, transfer or otherwise surrender all or part of the rights, benefits or obligations arising from the retained interest, Article 12(3)(b) and (c) of the Final Draft RTS provide two additional grounds under which an originator may cease to be the risk retainer. These additional grounds are: (i) where the retainer is unable to continue acting as retainer for legal reasons beyond its control, and (ii) in case the retainer is no longer included in the scope of supervision on a consolidated basis where the retention requirement is to be transferred to one of the remaining entities within the scope of consolidated supervision in accordance with Article 14 of the Final Draft RTS.
- Fees payable to risk retainers
Of particular note is the addition of Article 15(2) to the Final Draft RTS, which states that any arrangements on fees payable to a retainer on a priority basis to remunerate that retainer for services of any kind provided to the securitisation will be in breach of the requirement that there shall be no arrangements or embedded mechanisms in the securitisation by virtue of which the retained interest at origination would decline faster than the interest transferred unless i) the amount of the fees is set on an arm’s length basis having regard to comparable transactions in the relevant market (or in the absence of such comparable transactions by reference to fees payable in similar transactions in other markets or by using appropriate valuation metrics, taking into account the type of securitisation and the service being provided) and ii) the fees are structured as consideration for the provision of the service and do not create a preferential claim in the securitisation cash-flows which effectively reduces the retained interest faster than the transferred interest.
In particular, fees are prohibited where they are guaranteed or payable up-front, in full or in part in advance of the service being provided, and where the effective material net economic interest after deduction of such fees is lower than the minimum required retention amount.
This addition could have an impact on some retention models available in the market.
Even market-standard fees payable to the originator/servicer as servicing fee (usually paid as a senior item in the priority of payments) may now need to be disclosed or arm's length nature evidenced to demonstrate compliance with Article 15(2)(a). It had been hoped that the EBA would be more flexible, especially on pre-closing and closing fees and would clarify that the breadth of Article 15(2)(a) would not encompass standard fees (such as underwriting or arranger fees); it could have been helpful to relate prohibited fees should more directly to the securitised assets and we expect that this may remain an area of continued debate in the market.
More generally, market participants will also want to ensure that their transaction documents are clear on this point, and should avoid inadvertently characterising any servicing fee or other fee payable to the originator as a retention fee in an effort to fall squarely outside Article 15(2).
- Disclosure of the level of commitment to retain a material net economic interest
The initial disclosure requirements as to the level of retention (as required under Article 15 of the 2018 Draft RTS and Article 22 of the CRR RTS) have been deleted on the basis that these provisions overlap with the Delegated Regulation (EU) 2020/1224 on disclosure under Article 7 of the EUSR. However, the requirement on the retainer to disclose to investors that it will maintain a material net economic interest in the securitisation on an on-going basis has been retained, as this is not otherwise covered by the Delegated Regulation (EU) 2020/1224.
- Synthetic or contingent form of retention
The retainer must explicitly disclose in the final offering document, prospectus, transaction summary or overview of the main features of the securitisation that it will retain, on an ongoing basis, a material net economic interest in the securitisation through a synthetic or contingent form. Information required includes the methodology used in its determination and an explanation on which of the options of Article 6(3) of Regulation (EU) 2017/2402 the retention is equivalent to.
In addition, the previous collateralisation requirements have been modified so that all institutions (as defined in Article 4(1) point (3) of the Capital Requirements Regulation) (other than an insurance or reinsurance undertaking as defined in Article 13, points 1 and 4, respectively of Directive 138/2009/EC), who retain an economic interest through a synthetic or contingent form of retention are not required to fully collateralise the retained interest. This should facilitate investment by other institutions who might previously have been restricted by the collateral requirements. This was previously limited to just credit institutions.
- Retention in respect of resecuritisations
Although broadly prohibited under the EUSR, Article 16 of the Final Draft RTS provides for retention methods for resecuritisations permitted under Article 8(1) of the EUSR. As a general rule, the first securitisation and the second repackaged level are to be treated as separate transactions for the purpose of risk retention with separate retention obligations at each level. However, where the same originator retained exposures of the first securitisation in excess of the retention requirements for that first securitisation, such originator should not have to retain an additional interest at the level of the resecuritisation (so long as no other exposures are added to the resecuritisation's underlying pool and there is no maturity mismatch).
CRR provisions that are no longer included in the Final Draft RTS
The provisions relating to exposure to the credit risk of a securitisation position by credit derivative counterparties and liquidity facility and conditions that holdings of securitisation positions by subsidiaries in third countries (previously contained in Article 2 of each of the 2018 Draft RTS and the CRR RTS) have been deleted as being outside the scope of the EBA’s mandate under the EUSR.
What happens next and when will the Final Draft RTS be adopted?
The Commission is expected to review the Final Draft RTS by July. Assuming that the Commission endorses them, then the EU Parliament and the Council have between one and six months (depending on whether any amendments have been made to the Commission adopted RTS) to object. Once it is clear that the Parliament and Council do not object to the RTS, they will be published in the Official Journal and enter into force after 20 days of being published in the Official Journal.
What impact with the Final Draft RTS have on UK securitisation transactions?
The Final Draft RTS are currently only directly relevant for transactions subject to the EUSR. Following the end of the transition period on 31 December 2020, EU law is no longer directly applicable in the UK, save to the extent that it has been onshored by UK legislation. As the Risk Retention RTS had not been published in the Official Journal by the end of the transition period, the CRR RTS were the rules that were onshored in the UK (subject to changes made by the Prudential Regulation Authority as set out in Annex R of The Technical Standards (Capital Requirements) (EU Exit) (No. 3) Instrument 2019.
It is currently unclear whether HM Government will choose to align its own RTS under Article 6(7) of the EUSR as it forms part of domestic law of the UK by virtue of the European Union (Withdrawal) Act 2018 (the "UKSR") to the Final Draft RTS or instead choose the path of divergence and apply its own set of requirements.
On 13 December 2021, HM Treasury published its Review of the Securitisation Regulation: Report and call for evidence response (Report). In its Report, HM Treasury observed that the area of risk retention generally achieves its aims but noted a few areas where there could be some changes and that the Prudential Risk Authority intends to prioritise work on UK risk retention technical standards in 2022. Possible changes include: (i) transferring the risk retention manager (allowing changes to the risk retention holder if there is a change of manager would be logical); (ii) allowing eligible servicers to fulfil risk retention requirements in NPE securitisations (which could be similar to the provisions of the Final Draft RTS); (iii) and calculation of the risk retention on the transaction price (as opposed to the nominal amount) for NPE securitisations; (iv) allowing L- shaped risk retention (i.e. vertical and horizontal); and (v) allowing excess spread as an element of risk retention for synthetics (which could also be similar to the Final Draft RTS).
What should market participants do now?
Until the final risk retention RTS are published, market participants should consider aligning their transactions to the Final Draft RTS (while maintaining compliance with the CRR RTS) as it is quite possible now that the Final Draft RTS will be adopted by the Commission with minimal changes. As market participants will know, the EUSR grandfathering provisions operate such that any deal structured post-1 January 2019 would in theory need to comply with the final EUSR RTS once they are adopted (even though they have not entered into force yet) given that the final EUSR RTS would repeal the CRR RTS. As such, As such, to the extent a transaction is impacted by non-compliance with the final EUSR RTS at or before its adoption by the Commission (provided that such deal was structured after 1 January 2019) such transaction could theoretically need to be amended or wound up, save to the extent that the EBA determines to adopt a pragmatic approach and provides further guidance on this. Given the divergence between the EU and the UK rules, firms might consider it prudent to adopt the stricter interpretation of the rules for multi-jurisdictional transactions.
If you have any questions on this topic please speak to your usual Structured Finance contact at Hogan Lovells.
Authored by Julian Craughan, David Palmer, Sven Brandt, Sebastian Oebels, Jane Griffiths, and Steven Minke.