On 10 June 2020 the High Level Forum on the Capital Markets Union (the “HLF”) published its Final Report (the “Report”) on “A New Vision for Europe’s Capital Markets”. The Report includes several recommendations for reviving the securitisation market in Europe. If implemented, these recommendations would be a significant boost to the European securitisation market. The Report proposes:
- simplifying the process for significant risk transfer (SRT) assessments;
- adjusting the prudential treatment of securitisation for banks and insurers;
- supporting the development of synthetic securitisation;
- reconsidering the eligibility of securitisation for liquidity purposes; and
- simplifying disclosure and due diligence for private securitisations.
The HLF was set up by the European Commission in late 2019 to propose measures to the European Parliament and the Council to re-start and complete the EU’s Capital Markets Union (“CMU”) initiative. The Report notes that securitisation has played a very limited role in Europe over the last decade and that the European securitisation market has not rebounded after the 2008 financial crisis. The STS initiative, although a positive step, has not produced the anticipated recovery in the European securitisation market. The contrast with the revival of the securitisation market in the United States since 2008 is striking.
In large measure, the relative underperformance of the European securitisation market can be attributed to anomalies in the prudential treatment of securitisation exposures relative to other products and sectors such as corporate and covered bonds. The Report describes the regulatory reform of securitisation since the financial crisis as an “overreaction” and urges that, while financial stability reforms should not be unravelled, “excessive conservatism” should be moderated and overlapping regulations streamlined.
The Report recognises that securitisation is core to the real economy in Europe and that re-launching and scaling up securitisation is an essential component of the CMU. The Report lists the anticipated benefits of a fully-functioning securitisation market, including: (i) reducing the EU’s over-reliance on bank funding; (ii) maintaining banks’ capacity to lend to borrowers that do not have direct access to capital markets, such as SMEs; (iii) expanding banks’ asset and capital management options; (iv) contributing to the de-risking the European banking system through the management of non-performing exposures and the dispersion of risk; (v) financing specialist lenders who lend to types of borrowers for which banks do not provide coverage; and (vi) providing investors with a broader range of investment options in a low-interest rate environment.
Freeing up of banks’ balance sheets has become even more urgent with the pressures on the EU banking system arising from the COVID-19 economic measures and with the need to facilitate lending for energy transition and other green and sustainable assets.
The recommendations in detail
The HLF makes seven key recommendations for reviving securitisation in Europe. The recommendations are specific and detailed and include drafting for the proposed legislative amendments. A particular focus is on establishing a level playing field for the regulatory capital and prudential treatment of securitisation positions versus other comparable products.
1. Unlocking the Significant Risk Transfer Assessment Process
Achieving regulatory significant risk transfer (“SRT”), and the associated regulatory capital relief, is one of the primary considerations for originator banks when structuring securitisations. Given the significance of SRT in structuring securitisations and the growth in SRT transactions, regulatory and supervisory certainty is a crucial element. Articles 244 and 245 of the Capital Requirements Regulation (“CRR”) permit banks to make their own determinations as to whether SRT requirements are satisfied, based on specified quantitative and qualitative tests. However, these articles also permit national competent authorities to decide, on a case-by-case basis, if the reduction in risk-weighted exposure amounts is commensurate with the risk transferred. The question is whether this transaction-by-transaction assessment should be applied to all SRT transactions (including simple, repeat transactions) or only to more complex transactions. Currently, competent authorities generally review each transaction ex-ante, that is before that transaction completes, and can raise last-minute queries or require changes. This causes planning difficulties for banks, particularly in relation to the timing and execution of large transactions with potentially significant regulatory capital impact.
The HLF recommends that when the quantitative and qualitative criteria are met and for transactions in line with standard market practice, an ex-ante review by the competent authority should not be necessary. It proposes that such a review should only be required for more complex transactions which include structural features that diverge from generally accepted market standards and/or regulatory qualitative and quantitative criteria.
2. Recalibrating capital charges applied to senior tranches, in line with their risk profile, under CRR2
As part of the STS reforms, capital calibrations for both STS securitisations and non-STS securitisations were significantly increased from their previous levels. Under CRR2, the capital requirements for a bank holding a pool of assets in securitised form is a multiple of the capital requirements of the assets held in unsecuritised form on balance sheet (for a mortgage pool, over 2.5 times greater when securitised).
The severity of the regulatory capital treatment of securitisations is largely a function of two factors. First, regulators determined that securitisation risk weights should be higher than for the underlying assets because of “agency risk” (i.e. risks inherent in the structure of securitisations). To offset these agency risks, the Basel Committee on Banking Supervision (“BCBS”) introduced an additional ‘p’ factor to the calculations for the capital required to hold a securitisation position. Secondly, as part of the STS reforms, the capital floors for senior tranches were significantly increased: the floor for senior STS tranches of 10% is more than a 40% increase over the previous requirements and for non-STS, the floor has more than doubled to 15%.
The capital charges for senior securitisation positions are widely seen by market participants as disproportionate to their risks, particularly since, in the case of STS securitisations, the STS criteria and the transparency requirements in Article 7 of the Securitisation Regulation should largely mitigate securitisation agency risk.
The Report proposes that the Commission addresses these concerns by assessing the need to: (i) recalibrate capital charges to senior securitisation tranches in line with their risk profile and reduce the risk-weighted capital floors, especially for originator and sponsor banks; (ii) establish adequate and risk-sensitive calculation of the weighted average maturity (WAM) for both cash and synthetic securitisations; (iii) review the loss-given-default (LGD) input floors; and (iv) encourage further development of the European non-performing exposures (NPE) securitisation market.
3. Recalibrating capital treatment for securitisation tranches under Solvency II
Following the implementation of the STS initiative, capital requirements under Solvency II were reduced for the senior tranches of STS securitisations held by insurance and reinsurance companies. However the capital requirements for insurance companies remain significantly higher when compared with the capital charges for banks investing in securitisations. In particular, the level of capital charges for non-STS securitisations and for non-senior STS securitisations remain penal, and many insurance companies have stopped investing in European securitisations as a result.
The Report invites the Commission to assess the need for further recalibration of capital treatment for securitisation for insurers under Solvency II. The HLF recommends that the capital charges for securitisation positions under Solvency II should be recalibrated to reduce the current gap and, in some cases, realign the capital charges between STS securitisations and covered/corporate bonds, between STS and non-STS securitisations and their respective non-senior tranches. The HLF proposes that the stress factors for senior securitisation tranches should be commensurate with their risk and in principle lower than those applied to the respective underlying exposures on a stand-alone basis.
4. Reducing the costs of SME financing
Regulators have recognised for many years that diversified funding sources such as securitisation could boost SME funding, limit the exposure of SMEs to banking-sector difficulties, help ensure the flow of credit to viable companies and enhance financial sector stability by enabling dispersion of risk from banks.
In the Report, the HLF focusses on reducing the cost of SME financing through data collection and disclosure. It invites the Commission to promote SME financing via securitisation by (i) including credit information on EU companies in the scope of the European Single Access Point (ESAP) and (ii) continuing efforts to improve credit underwriting standards and NPL reduction.
5. Applying equivalent treatment to cash and synthetic securitisations of all asset classes, and including their STS execution
The CRR currently allow benefits equivalent to those afforded by STS to certain synthetic securitisations involving SMEs. However at the time of the STS reforms, the European Parliament also requested the Commission to produce a report on how the STS regime could be extended to balance-sheet synthetic securitisations. This resulted in the recent EBA report on the framework for STS synthetic securitisations. The EBA concluded that there is no technical or policy reason why (with adaptations) the rules of STS cannot provide a robust standard for synthetic balance-sheet securitisation.
In its Report, the HLF invites the Commission to assess the need to (i) further expand the scope of STS synthetic securitisations and (ii) apply the same regulatory treatment to synthetic and cash securitisation, including the preferential capital treatment. This recommendation supports the EBA report on the framework for STS synthetic securitisations.
6. Upgrading eligibility of senior STS and non-STS tranches in the LCR ratio
The liquidity coverage ratio (LCR) refers to the proportion of highly liquid assets held by financial institutions, to ensure their ongoing ability to meet short-term obligations. This ratio is essentially a generic stress test that aims to anticipate market-wide shocks. There are three categories of liquid assets with decreasing levels of perceived quality: Level 1, Level 2A, and Level 2B. For bank investors, the current LCR regime treats securitisation unfavourably. Even if a securitisation meets all the criteria to qualify as Level 2B securitisations within the high-quality liquid asset (HQLA) buffer, it will face lower allotments and higher haircuts than covered bonds and high-quality corporate bonds. This results in the lack of a level playing field with comparable financial assets and is likely to discourage investment in STS securitisations.
The Report invites the Commission to assess the need for further amendments to the eligibility criteria for the LCR and more specifically to consider: (i) upgrading HQLA-level eligibility of large senior tranches of STS securitisations; and (ii) maintaining former eligibility for HQLA Level 2B of senior securitisation tranches that do not meet the higher requirements for the upper HQLA level.
7. Differentiating between disclosure and due diligence requirements for public and private securitisations
Under Article 7 of the Securitisation Regulation, originators, sponsors and securitisation special purpose entities (SSPEs) must make available to holders of a securitisation position, competent authorities and, upon request, to potential investors, certain initial and ongoing information on the transaction and underlying exposures. These rules apply to private securitisations as well as public securitisations. The requirements are expensive and time-consuming for issuers of private securitisations, particularly the requirement to provide ongoing reporting in the form of the disclosure templates prescribed by ESMA. The ESMA templates require significant amounts of information and have proved difficult to complete, particularly for synthetic securitisations.
There is a risk that regulatory arbitrage may arise as a result of the market participants wishing to avoid disclosure and/or due diligence requirements for private securitisations. Issuers and investors may turn to less effective structures that are not technically securitisations. The result may be less attractive products which will drive some of the market away from securitisation, thereby undermining an aim of the Securitisation Regulation to create a safer and more transparent market.
The Report proposes (i) differentiating between the disclosure requirements for public securitisations and for private bilateral cash and synthetic securitisations and (ii) establishing the principle of proportionality in the application of disclosure and due diligence requirements. It also suggests allowing for long-term use of ND (“no data available”) fields in the ESMA templates and for a transition period for the reduction of ND fields, where this is practically possible to achieve.
The Securitisation Regulation and third-country securitisations
The HLF takes the opportunity to include in its Report recommendations on two provisions of the Securitisation Regulation which have caused difficulty for market participants.
The first point relates to Article 5(1)(e) of the Securitisation Regulation. This requires institutional investors to verify that “the originator, sponsor or SSPE has, where applicable, made available the information required by Article 7 in accordance with the frequency and modalities provided for in that Article”. The highlighted words have been a source of significant legal uncertainty as to whether Article 7 applies indirectly to non-EU transactions. This would mean that a UK investor in a US CMBS transaction must require the US originating bank to make EU-style disclosures under Article 7 of the Securitisation Regulation, which US banks do not typically do .
The Report recommends allowing an EU-regulated investor in third-country securitisations to determine whether it has received sufficient information to meet the requirements of Article 5 of Regulation (EU) 2017/ 2402 to carry out its due diligence obligation proportionate to the risk profile of such securitisation.
The Securitisation Regulation and credit-granting standards
The second point relates to the securitisation of NPE pools. Article 9(3) of the Securitisation Regulation requires a person that securitises exposures purchased for its own account from a third party to verify that the entity that was directly or indirectly involved in the original agreement creating these exposures complied with the requirements of Article 9(1) of the Securitisation Regulation. Article 9(1) requires originators, sponsors and original lenders: (a) to apply to exposures to be securitised the same sound and well-defined criteria for credit-granting, and the same processes for approving, amending, renewing and refinancing such exposures, as they apply to non-securitised exposures; and (b) to have effective systems in place to apply such criteria and processes in order to ensure that credit-granting is based on a thorough assessment of creditworthiness.
Article 9(3) creates difficulties for a securitiser in determining how it may in practice comply with the verification requirement of Article 9(3) in certain circumstances, including (i) where the original lender is not involved in the securitisation and has no incentive to cooperate; (ii) where the asset no longer exists at the time of the securitisation or (iii) where so much time has passed between the origination of the exposures and the securitisation that the information necessary to complete the verification no longer exists.
The HLF proposes to facilitate the securitisation of legacy portfolios and allow the development of an active market for buying and selling pool of assets in Europe by amending Article 9(3) to explicitly allow the practice of re-underwriting the loans in cases where an entity acquires legacy and NPE pools.
Will the recommendations be implemented and, if so, when?
The recommendations in the Report are simply that: recommendations. Regulators, politicians and industry bodies have given high-level support to securitisation reform on many previous occasions, but only piecemeal reform has resulted.
However there are grounds for optimism on this occasion because it has become clear to regulators and politicians that, without significant additional reform, the EU securitisation market is unlikely to revive. The recommendations were also the result of a Commission-sponsored initiative, which must increase the likelihood of them being considered.
The measures proposed in the Report would require changes (i) to the EU legislative framework; (ii) to technical guidance from EU authorities; and (iii) in international standards (i.e. the Basel securitisation requirements). Implementing the recommendations would require amendments to various pieces of legislation, including the CRR, Solvency II and the Securitisation Regulation. Potential actions would need to be taken at different levels of the competent authorities, regulatory framework and legal systems.
Given the multiple changes required and the various parties involved, it is clear that the recommendations are unlikely all to be implemented at the same time.
The most likely candidates for rapid implementation are those measures whose implementation would require only guidance from regulatory authorities or amendments to Level 3 Regulations. As the Report notes, some measures could be effected very quickly.
In addition, the proposal to extend the STS regime to synthetic balance-sheet securitisations has the prior support of the EBA and accordingly this proposal must have a good chance of being implemented without significant delay.
The Report states that, depending on the implementation option chosen by the European authorities, the delivery timetable could be as short as 12-18 months for those recommendations which require Level 1 and Level 2 regulatory amendments. However, given the previous tortuous history of securitisation reform in the European Parliament, this timetable looks optimistic.
One of the most important proposed measures is the proposed recalibration of regulatory capital charges for bank holdings of securitisations. This measure will require consensus within the BCBS and close interaction between the Commission and the BCBS.
A short postscript on Brexit
Many pieces of European legislation such as Solvency II have been incorporated into UK law and, after the Brexit transition period, will remain part of UK law as on-shored retained legislation.
The United Kingdom could amend the retained legislation to implement the recommendations in the Report in a faster or more complete manner than the EU. For example, the UK regulations which onshore the Securitisation Regulation make various amendments to correct perceived deficiencies in the Securitisation Regulation. The issue regarding third-country securitisations (discussed above) has already been ‘corrected’ by these regulations.
However, if the United Kingdom seeks to maintain equivalence of financial services legislation in order to maintain rights of access to the EU single market, it is unlikely in the short term that significant amendments to the relevant retained legislation will be made in the absence of corresponding changes to the EU legislation.
Since the source of the CRR is not the EU itself but rather the Basel III Accord as promoted by the BCBS (which the United Kingdom is, and will remain, a part of), changes to the CRR will require a consensus of the BCBS.
The recommendations of the HLF for reviving securitisation in Europe are a welcome response to criticism of the current state of the European securitisation market and of the factors which, in the view of market participants, are inhibiting its revival.
If the recommendations are not substantially implemented – particularly the recommendations relating to recalibration of capital charges for banks and insurers - the EU securitisation market is likely to remain underutilised and its potential benefit to the real economy unfulfilled.
 ‘Simple, transparent and standardised’ securitisations under the EU Securitisation Regulation (EU) No. 2017/2402 (the “Securitisation Regulation”).
 Based on sources referenced in the Report, US private-label securitisation issuance in 2018 was US$787bn, in addition to US$1,700bn of agency MBS and US$290bn of agency CMO. In Europe EUR139bn of placed securitisations was issued in 2018 and EUR131bn in 2019.
 Regulation (EU) No. 575/2013.
Capital Requirements Regulation II - Regulation (EU) No. 2019/876 of the European Parliament and of the Council amending Capital Requirements Regulation or CRR (Regulation No. 575/2013).
; Regulation (EU) No. 2017/2401 amending Regulation (EU) No. 575/2013 on prudential requirements for credit institutions and investment firms.
CRR, Article 259 (SEC-IBRA) and CRR, Article 261(SEC-SA).
Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II).
 Commission Delegated Regulation (EU) No. 2018/1221 of 1 June 2018 amending Delegated Regulation (EU) No. 2015/35 as regards the calculation of regulatory capital requirements for securitisations and simple, transparent and standardised securitisations held by insurance and reinsurance undertakings.
 An EU-wide digital access platform for companies’ public financial and non-financial information proposed by the HLF in the Report and which would be accessible to the public free of charge.
 Regulation (EU) No. 2017/2401), Article 270.
 European Banking Authority, Report on STS Framework for Synthetic Securitisation under Article 45 of Regulation (EU) 2017/2402, 6 May 2020.
 See the Financial Markets Law Commission’s letter of 5 November 2019 to the European Commission on this point: http://fmlc.org/letter-to-european-commission-article-51e-of-the-e-u-securitisation-regulation-5-november-2019/
 I.e. guidelines required to be produced by the EBA relating to certain requirements set out in the Securitisation Regulation or the CRR.
I.e. the basic laws proposed by the Commission and adopted by the European Parliament and Council; often a complex and time-consuming process.
 Level 2 Regulations are delegated acts, regulatory technical standards (“RTS”) and implementing technical standards (“ITS”), which set out the technical details and clarify aspects of certain requirements set out in the Securitisation Regulation, for example, information to be provided to comply with Article 7 of the Securitisation Regulation and templates for reports and notifications.
 Securitisation Amendment (EU Exit) Regulations 2019, No. 660.
 Ibid., Article 7(2)(c).