On 16 December 2020, the legislative proposals of the Capital Market Recovery Package, also known as "quick fixes", were approved by the EU Council and have thus successfully passed the trilogue procedure. In addition to amendments to the MiFID II Directive and adjustments to the Prospectus Directive, the package includes in particular the extension of the STS criteria to synthetic balance sheet securitisations as well as regulations on NPL securitisations. It is positive to note that some critical counter-proposals were not taken into account, as they would have massively impaired the implementation of synthetic securitisations and jeopardised the intended goal of supporting the credit and real economy. From a securitisation perspective, several sets of issues are affected:
STS for synthetic securitisations
During the political negotiations, counter-proposals were made on four points that would have jeopardised successful implementation. Fortunately, they were mostly resolved positively in the final agreement:
- Early amortisation and non-sequential amortisation: despite proposals to the contrary, these will be allowed.
- Time calls: again, time calls will be allowed despite proposals to the contrary. However, as a compromise, the originator must explain to the relevant supervisor why the exercise of a time call is not due to asset deterioration. In other words, why the bank does not call its credit insurance just when it is needed.
- Collateralisation: If individual securitisation tranches are funded by external investors (i.e. the investor provides cash collateral) and this cash remains with the originator, then this originator must meet minimum rating requirements. Proposals were made that would have been exceptionally burdensome for Southern European banks whose ratings are capped by low sovereign ratings. However, a compromise was reached that allows lower-rated banks to hold the collateral if they receive permission from their supervisor.
- Synthetic excess spread: There were proposals under discussion to ban the use of synthetic excess spread (SES) in STS transactions. The final text moves away from such draconian measures and allows SES subject to limits to be set by the EBA. The SES must be a fixed percentage limited to the one-year "expected loss" for the pool (a figure that is precisely defined in the CRR). But in return for allowing the SES, the rules now require that a yet to be determined amount of additional capital under the CRR be allocated to the SES amount.
In addition to the amendments to the STS Regulation, amendments are made to the Capital Requirements Regulation to allow lower capital weights for senior tranches of synthetic securitisations where they achieve STS.
The agreed draft legislation effectively replaces the current Article 270, which was an exception to the principle that synthetic securitisations cannot benefit from the lower capital requirements applicable to true sale STS securitisations. However, this exception was limited to narrowly defined SME transactions and could hardly be applied in practice. The new rules would allow any synthetic transaction that meets the STS criteria (subject to our comment below) to benefit from these lower capital requirements. In other words, Article 270 will now be extended to all asset classes (except NPLs).
Additional CRR requirements
In the existing CRR rules for True Sale STS securitisations, it is not sufficient for a transaction to be STS to benefit from the lower capital requirements. Additional criteria beyond STS must also be met. These criteria, when added to the other STS criteria, are sometimes referred to by market participants as STS+. This requirement for additional criteria will be retained for synthetes seeking lower capital requirements under the proposed new rules. STS+ will remain relevant.
Synthetic Excess Spread
As mentioned above, the political compromise around SES provides for the EBA to submit a draft regulatory technical standard (RTS) defining the amount of capital that a bank using SES in a synthetic securitisation must hold against that SES. Apart from the peculiar notion that a bank must set aside capital for an off-balance sheet future return rather than an asset, it is unclear at this stage how this additional capital will be calculated. Depending on the outcome of the EBA's work, it may well be that few, if any, synthetic securitisations with SES could be issued. This therefore casts a shadow over securitisations that want to use SES. The EBA's drafts on this remain to be seen.
Grandfathering is clear under the proposed legislation. For a synthetic securitisation issued before the new law comes into force to become STS, that transaction only needs to meet the STS requirement at the time of notification to ESMA. The likelihood that the current draft will not be passed in the plenary of the Parliament is probably low. Therefore, it should be possible for banks to structure and issue synthetic securitisations already now with the legitimate expectation that they will be able to benefit from the lower capital requirements in the second half of the year. To avoid existing Article 270 SME securitisations issued since January 2019 losing the benefit of the lower capital requirements due to the addition of new criteria for synthetic STS, the draft law sensibly grants automatic grandfathering for these transactions as well.
Further classification of the legislative proposals
It is worth noting that when it comes to securitisation, this bill also changes generally applicable rules. The bill amends rules relating to the securitisation of non-performing loans, including a new definition of NPL securitisation and new - and more meaningful - rules on NPL securitisation retention. It also amends and tightens restrictions on where securitisation special purpose vehicles can be located (in all cases, not just for STS).
Sustainability and ESG
Regardless of the actual objectives (STS for synthetes, NPL), the EBA will be asked to explore how new rules around sustainability for securitisations could be designed by 1 November 2021.
Next steps and timetable
It seems likely that the law will not come into force until May/June 2021. In addition to the parliamentary decision expected on 8 March, translation work is ongoing and subsequent publication in the Official Journal will be followed by a 20-day period until the law comes into force. It is to be hoped that the EBA will quickly present the regulatory technical standards on synthetic excess spread as well as on triggers for non-sequential amortisation, at least in draft form.