Securitisation as a Credit Risk Diffuser
In securitisations, the structural and contractual arrangements aim to isolate the credit risk of the securitised assets from the credit risk of the originator. The delinking of the credit risk of securitised assets is principally accomplished through the incorporation of one or more insolvency-remote entities referred to in Regulation (EU) 2017/2402 (the Securitisation Regulation) as securitisation special purpose entities (SSPEs), and the transfer of ownership of the financial assets from the originator to the SSPE. As a result, the originator insulates the assets in case of insolvency and ensures that the noteholders will receive principal and interest payments from the collateralised assets. As such, noteholders are typically exposed only to the credit risk of the underlying obligors.
Typically, said delinking of credit risk is achieved through a sale of assets from the originator to the issuer (true sale), but it can also be achieved by way of an assignment or transfer with the same legal effect. Upon completion of the transfer, the assets cease to belong to the originator’s insolvency estate. The Securitisation Regulation requires that the transfer to the SSPE should not be subject to severe (emphasis added) clawback provisions in the event of the seller’s insolvency (Article 24 of the Securitisation Regulation). Severe clawback provisions comprise:
However, notwithstanding this general prohibition of severe clawback provisions under the Securitisation Regulation, clawback risks deriving from national insolvency laws continue to exist in cases of fraudulent transfers – as is the case with transactions at an undervalue, unfair prejudice to creditors or transfers intended to improperly favour particular creditors over others.
The transfer should not be recharacterised as a secured loan since that would place the transfer within the sphere of insolvency and its subsequent legal checks and constraints. This risk could materialise in the event that:
Pursuant to Article 2(2) of the Securitisation Regulation, an SSPE is an SPE that is established with the sole purpose of issuing securities collateralised by the transferred assets (receivables) and selling them to investors. In addition, pursuant to Article 4 of the Securitisation Regulation, an SSPE cannot be established in a third country that is listed as a high-risk and non-cooperative jurisdiction by the Financial Action Task Force (FATF) or that has not signed an agreement with a Member State to ensure compliance with the OECD’s Model Tax Convention and Agreement. Within said legal boundaries, the legal form of the SSPE is left to the discretion of the originator; the SSPE might take the form of a limited partnership, a limited liability company, a trust, or any other corporate form, depending on national specificities, such as the national legal and tax treatment of the SPE.
SSPEs are typically structured as orphan limited liability companies. The SSPE’s activities are typically confined by negative covenants, which prohibit the entity from engaging in further activities, hiring employees, creating subsidiaries, incurring indebtedness, or granting securities beyond the scope of the securitisation transaction. SSPEs are typically off-balance sheet SPEs, which are thinly capitalised and have their assets segregated by transferring them to a trustee. This happens with the view of reducing the substantive consolidation risk, or the risk of piercing the corporate veil, as it is referred to in some EU jurisdictions where said doctrine applies, which permits the pooling of the assets and liabilities of distinct corporate entities. This doctrine may materialise in cases where the SSPE appears to have been structured in a fraudulent manner, as is the case where the SSPE is owned by or connected to the originator, and may allow domestic courts to disregard the legal separation of the corporate entities and treat them as one entity for liquidation purposes.
Credit rating agencies – namely entities involved in the procedures to ensure the securitisation parties' compliance with the criteria set out in the Securitisation Regulation (see 4.5 Activities of Rating Agencies) – commonly request the appointment of at least one independent director in the SSPE’s board of directors, whose vote is required for the SSPE to initiate solvent or insolvent liquidation or winding-up proceedings, or to amend the articles of association. This requirement aims to protect investors’ interests from the risk of the originator taking control of the SSPE and gaining access to its assets. The constitutive documents shall also ensure that the delegated independent director is not an employee or otherwise affiliated with the originator.
A key consideration in securitisation transactions is ensuring that the transfer of the assets to the SSPE will be effected as a true sale or assignment or transfer with the same legal effect, in a manner that is enforceable against the vendor and any third party. EU securitisations may typically be structured as “true sale” securitisations, where the exposures are removed from the originator’s balance sheet and are effectively transferred to the SSPE, or as assignments of assets, where the originator’s beneficial rights, titles and interests in and to the exposures evidenced by the underlying contracts are legally transferred to the SSPE but the originator remains the holder of the legal title and the lender of record.
Conflict of Laws
The validity, perfection and enforceability of the transfer of financial assets are a matter of the applicable national law determined in accordance with national conflict of law rules, which, in turn, may depend on the types of assets being transferred.
With regard to the assignment of, or security over, receivables, Article 14 of Regulation (EC) 593/2008 (Rome I Regulation) provides that:
However, the Rome I Regulation does not provide for any rules in relation to the enforceability of an assignment of receivables as regards third parties; hence, such rules are jurisdiction-specific.
Regarding financial assets other than receivables, notwithstanding any relevant agreement of the parties, the creation, perfection and enforcement of a security interest over, or transfer of, assets is governed by the law where such asset is located.
Perfection requirements are governed by the national applicable law. However, with regard to cases where the transfer is performed by means of an assignment and perfected at a later stage than the closing of the transaction, the triggers to effect such perfection should include at least the following events:
True Sale Securitisations
As far as “true sale” securitisations are concerned, the transfer of the assets is typically ascertained on the basis of certain criteria that demonstrate that the assets have indeed been isolated from the originator’s balance sheet. More specifically:
The fulfilment of these conditions is usually confirmed through a true sale legal opinion, which credit rating agencies (see 4.5 Activities of Rating Agencies) typically request in order to ascertain the transaction risk and the insolvency and bankruptcy remoteness of the SSPE from the originator.
A securitisation is the more typical way to construct a bankruptcy-remote transaction. When the assignment is performed under general contract laws, there may be exposure to general insolvency constraints, including claw-back rights.
Covered Bonds Transactions
Apart from securitisations, in some jurisdictions credit institutions have another tool in their arsenal to engage in bankruptcy-remote transactions and become isolated from the insolvency risk of the originator. Pursuant to Directive 2013/36/EU (Directive CRD IV), as transposed into national laws, covered bonds are commonly issued by credit institutions to achieve a cheaper source of financing for offering mortgage loans or to finance sovereign debt in some countries. Covered bonds feature the following characteristics:
Covered bond transactions may be structured as follows:
Upon registration of the relevant pledge and the issuance of covered bonds, related transactions and payments to covered bondholders and other secured creditors are not impacted by the insolvency of the issuer.
Other Alternatives to Securitisation
Legal practitioners seeking alternatives to securitisation should look into national laws, which tend to provide for jurisdiction-specific alternatives.
An issue of utmost importance in securitisation transactions is preserving “tax neutrality”. This means ensuring, to the extent feasible, that the parties involved in the securitisation processes will not incur additional tax liabilities that could raise the tax cost of the transaction. Achieving tax neutrality is also an essential element for the favourable rating of the issued securities by the credit rating agencies (see 4.5 Activities of Rating Agencies). To this end, credit rating agencies typically require an indemnity from the originator to cover unforeseen tax charges that may arise for the issuing SSPE.
The domestic legislation of certain EU Member States may impose certain tax liabilities on the transfer of assets and the execution of payments by the originator, the SSPE and the investors. Additionally, with regard to cross-border securitisation transactions, tax treaties are also taken into consideration for the tax determination. In general, the tax considerations that are mostly encountered in securitisation transactions are the following:
The avoidance of any additional tax liabilities that parties in securitisation transactions may incur is contingent on the initial structuring of the transaction, the selection of a favourable tax jurisdiction for the incorporation of the SSPE, and close co-operation with the local tax authorities for the obtainment of necessary tax clearances for the execution of the deal.
Potential taxes on SPEs would generally entail transfer taxes, taxes on profit and withholding taxes; see 2.1 Taxes and Tax Avoidance for further information. However, the taxes payable by the SPE are jurisdiction-specific.
The taxes on cross-border transfers are jurisdiction-specific. Such cross-border transfers may entail:
The actual taxes on cross-border transactions depend on the applicable law and the existence of any applicable double tax treaties.
Each securitisation transaction may give rise to its own jurisdiction-specific tax implications relating to the structure of the securitisation transaction, including the type of the originator and receivables, the seat of establishment of the issuer, the type of financing provided to the issuer, and the agreement for the provision of any relevant factoring services.
Legal opinions may be obtained on the following taxation matters:
The requirements for a transfer of financial assets to be treated as a true sale for accounting purposes are determined in line with the International Financial Reporting Standards (IFRS), as adopted by the EU and applied by credit institutions across the continent. However, accounting issues relating to securitisation transactions should be addressed by accountants, as the respective analysis falls outside the legal scope.
Legal opinions do not generally cover accounting matters, but may include certain qualifications or assumptions that may feed into other legal opinions or risk assessments.
The Securitisation Regulation is the main piece of EU legislation regulating EU securitisations, and introduced a framework of simple, transparent and standardised (STS) securitisations in the EU. The Securitisation Regulation has revised the disclosure, due diligence and risk retention rules encapsulated in the Capital Requirements Regulation, the Alternative Investment Fund Managers Directive and the Solvency II Directive, and has inaugurated a set of harmonised rules applicable to all forms of EU securitisation, thus offering cross-sectoral application.
Establishment of a Reporting Entity
As regards securitisation disclosure obligations, Articles 5 and 7 of the Securitisation Regulation have imposed specific disclosure requirements on the originator, the sponsor and the SSPE. The parties shall designate one entity from among themselves to be the first point of contact for investors and competent authorities, and to carry out the disclosure requirements under the Securitisation Regulation. The European Commission has specified these obligations by laying down implementing technical standards comprising formats and niche templates to help standardise the reporting procedures for stakeholders.
The method of disclosure varies depending on whether the requisite information pertains to public or private transactions. In public securitisations, information transparency is achieved through filings with a securitisation repository, or by registering an entity online to act as a securitisation repository. In private securitisations, the required information should be provided directly to investors, upon request, and to the competent authorities by the reporting entity.
Prior to pricing, the reporting entity is responsible for disclosing information related to the following aspects to investors, upon request:
Supervision and Sanctions Regarding Disclosure Obligations
Pursuant to Articles 22 and 32 of the Securitisation Regulation, non-compliance with the transparency obligations stipulated by Article 7 of the Securitisation Regulation might be penalised with administrative sanctions and remedial measures, without prejudice to the right of Member States to impose criminal sanctions pursuant to Article 34 of the Securitisation Regulation. Member States shall inflict sanctions in the event of negligence or intentional infringement of disclosure obligations, which should be effective, proportionate and dissuasive. In particular, the competent authorities designated by Member States are entitled to impose:
Moreover, the Securitisation Regulation confers supervisory responsibilities over the securitisation activities upon the European Securities and Markets Authority (ESMA). ESMA carries out the determination and design of the reporting requirements, forms the content of the STS notification, maintains a list of all STS securitisations, and oversees securitisation repositories and co-operation between the competent authorities.
As discussed, the Securitisation Regulation provides for a harmonised set of rules. Nevertheless, rules falling outside the scope of the Securitisation Regulation are still applicable in public securitisations. In particular, Regulation (EU) 2017/1129 (Prospectus Regulation) is applicable in the case of public offerings in regulated markets.
The Prospectus Regulation comprises mandatory principles and rules regulating the content, format, approval and publication of securities that are offered to the public. Through its implementation, the EU has attempted to grapple with divergent approaches on information disclosure which could fragment the internal capital market and protect investors by removing information asymmetries between them and the issuers. The Prospectus Regulation has direct applicability to EU Member States and ensures that public offerings are executed in a uniform manner throughout the EU.
Risk Retention Requirement under Article 6 of the Securitisation Regulation
The risk retention requirement set out in Article 6 of the Securitisation Regulation applies to all types of securitisations and works to align the interests of the parties involved in the securitisation processes and the institutional investors. The article requires, as a minimum, the originator, sponsor or the original lender to retain, on an ongoing basis, a material net economic interest in the securitisation of not less than 5%. That interest shall be measured at the origination and shall be determined by the notional value for off-balance sheet items.
For the purposes of risk retention:
The risk retention requirement can be achieved through a variety of methods by which the net economic interest can be calculated, as follows:
Amendments to the Existing Risk Retention Provisions
Article 6 of the Securitisation Regulation has updated the risk retention provisions embedded in Articles 405–410 of the Capital Requirements Regulation (CRR). Compared to the existing framework, the new rules have introduced some nuances relating to the following:
Lastly, it should be noted that Regulation (EU) 2021/558 – by virtue of which the regulatory barriers to securitisations of non-performing exposures (NPEs) have been lifted – has extended the risk retention obligation from the originator, the sponsor or the lender to the servicer specifically for NPE securitisation transactions. According to Article 6(1) of the Securitisation Regulation, to qualify as a risk retention holder, the servicer will need to be able to demonstrate that it has expertise in servicing exposures of a similar nature to those securitised and that it has well-documented and adequate policies, procedures and risk management controls in place relating to the servicing of exposures.
Furthermore, and contrary to traditional STS securitisations where the net economic interest to be retained is calculated on a nominal value, the risk retention requirement in NPE securitisations is to be determined on the basis of the discounted value, according to the following principles:
Penalty for Non-Compliance with Risk Requirement Obligation
Please see 4.1 Specific Disclosure Laws or Regulations regarding the imposition of penalties for non-compliance with the risk retention requirement.
Article 7 of the Securitisation Regulation imposes a number of periodic reporting obligations upon the originator, sponsor and issuer, which shall be principally executed on a quarterly basis. In particular, the reporting entity shall make the following information available to holders of securitisation positions and investors:
Furthermore, the article stipulates reporting obligations on inside information that should be made available to the public as soon as possible in accordance with Article 17 of Regulation (EU) 596/2014 (Market Abuse Regulation). These obligations take effect when significant events transpire, such as:
The mechanisms for disclosure depend on the type of the transaction:
Please see 4.1 Specific Disclosure Laws or Regulations regarding the penalties imposed for non-compliance with the periodic disclosure requirements.
Under Article 28 of the Securitisation Regulation, the originator, sponsor or SSPE may use the service of a third party to assess and confirm the compliance of the securitisation with the STS criteria. These services are typically provided by credit rating agencies (CRAs) which that have been registered or certified in accordance with Regulation (EC) 1060/2009 on CRAs (CRA Regulation) and shall be authorised by the Member States’ competent authorities to engage in compliance assessments. The CRA Regulation focuses on three aspects that aspire to secure the integrity of the final assessment and a high level of investor protection. In particular:
Moreover, the issuer, sponsors and originators in a securitisation transaction must appoint at least two CRAs to provide independent ratings, and should consider appointing one CRA with a market share lower than 10% total market share, subject to the condition that such a small CRA is capable of rating the relevant issuance or entity.
Pursuant to Article 32 of the Securitisation Regulation, in the event of a CRA failing to notify material changes or any other changes that could reasonably affect the assessment of the competent authority, the latter is entitled to temporarily revoke the respective CRA’s authorisation.
Financial institutions hold capital on the basis of their risk-weighted assets (RWAs). Financial entities engaged in securitisation transactions typically have to abide by certain capital requirement rules that provide for a certain amount that should be held in the entities’ reserves in respect of the securitisation exposures. This amount is calculated as the market value of the securitisation position multiplied by a defined stress factor, which is determined on the basis of the duration, the credit rating and the type of the securitisation position.
Capital Requirements Applicable to Banks
Pursuant to the CRR, the risk-weighted exposure amount for securitisations might be limited through the recognition of a significant risk transfer (SRT) to third parties. The SRT principle is applicable to both traditional and synthetic securitisations, and is subject to the fulfilment of either of the following conditions:
Conversely, the competent authorities may grant the originator institution the permission to reduce the amount exposure where such institution demonstrates that a commensurate transfer of credit risk to third parties has been achieved and adequate internal risk management policies and methodologies to assess the transfer of credit risk are in place. The permission is contingent on similar conditions for both traditional and synthetic securitisations, with the additional requirement of the exposures having to be placed beyond the reach of the institution and its creditors in synthetic securitisations. The authorities shall inform the European Banking Association (EBA) of their decision.
Capital Requirements Applicable to Insurance Companies
Insurers and reinsurers are subject to specific capital requirements pursuant to the Solvency II Regulation (EU) 2015/35 (Solvency II) when investing in securitisations. For this purpose, Solvency II has divided securitisation positions into three categories by which different capital requirements apply. In particular:
In accordance with Article 21 of the Securitisation Regulation, the use of derivative contracts shall be limited to the purpose of hedging the SSPE’s fluctuating exposures, meaning the interest rate or currency risk. These derivatives shall be underwritten and documented. The SSPE shall not enter into derivative contracts with a swap provider for any other reason and shall ensure that the pool of underlying exposures does not include derivatives.
The primary piece of legislation applicable to EU over-the-counter (OTC) derivatives is the European Market Infrastructure Regulation (EU) 648/2012, as amended and in force (EMIR). Under EMIR, the parties entering a derivative contract are classified as financial counterparties (FCs) and non-financial counterparties (NFCs). The first category comprises institutional investors such as credit institutions, investment firms, insurers and pension funds, while the second category comprises entities that do not fall under the FC category. Pursuant to the classification, the derivative type and the trade date, the counterparties are subject to specific obligations, as follows:
Please see 4.1 Specific Disclosure Laws or Regulations regarding the potential penalties that could be imposed for non-compliance with the derivative limitations entailed in the Securitisation Regulation provisions.
The protection of investors’ interests in securitisations is achieved in numerous ways, including the following:
At the EU level, the main legislative framework that applies to securitising banks is the Securitisation Regulation, the CRR and national law.
Please see 2.1 Taxes and Tax Avoidance.
No such practice currently applies to EU securitisations. However, certain limitations on financial activities could be placed on cross-border securitisation transactions where a participating party is a US investor. In this case, the Volcker Rule under the US Investment Company Act of 1940 applies and prohibits the investing bank from conducting certain activities with its own accounts for the purpose of consumer protection – ie, short-term proprietary trading of securities, derivatives or commodity futures.
As a consequence of being structured as off-balance sheet SPVs, SSPEs face the risk of a shortfall of cash below what is obligated to pay to their investors. Against this backdrop, certain forms of credit enhancement have been utilised in the securitisation market. The most prominent method is credit risk tranching, by which the junior noteholders suffer the first losses on the portfolio due to default of the underlying borrowers. Typically, the holder of a junior security, also called a C note, is the originator (or an affiliate) performing under its obligations for risk retention. Other forms of credit enhancement comprise over-collateralisation, where the consideration paid for the transferred assets is in excess of the face value of the securities, credit letters, surety bonds or internal reserve funds.
In contrast to the USA, where government-sponsored entities are engaging in securitisation transactions, no such practice has been developed in the European market.
Investors in securitisations typically include hedge funds, pension funds, credit institutions and insurance and reinsurance undertakings.
Securitisation transactions are typically completed as a “true sale” of assets through a sale agreement concluded between the originator and the SSPE. The sale agreement encompasses the typical covenants concerning the transfer of the assets and the determination of an amount as consideration for the acquisition, as well as some high-level covenants pertaining to conditions precedent to the transfer, title perfection, the declaration of a trust over the proceeds arising under the assets, the repurchase of non-compliant receivables or ineligible assets, and undertakings, representations and warranties in favour of the acquiring SSPE.
As stated in 5.1 Bankruptcy-Remote Transfers, the sale agreement contains certain warranties provided from the originator to the acquiring entity in the form of corporate and asset warranties. Through corporate warranties, the originator guarantees that it has the full legal right, power and authority to enter and perform all of its obligations under the agreement acting in its capacity as the legitimate owner of the exposures. On the other hand, through asset warranties the originator pledges that the underlying exposures meet the eligibility criteria and are not encumbered or otherwise in a condition that can be foreseen to adversely affect the enforceability of the true sale or assignment or transfer with the same legal effect.
Breach of the corporate warranty would typically be considered as breach for misrepresentation, which, if not remedied, could culminate in the originator’s default and/or early amortisation of the notes, and possibly a claim for damages. Breach of an asset warranty, on the other hand, is typically remedied through the repurchase of the transferred assets by the originator or the payment of compensation by the latter.
The contracting parties in a securitisation can reach an agreement that the transfer of the underlying exposures performed by means of “true sale” or assignment or transfer with the same legal effect can be perfected at a stage later than the closing of the transaction. According to Article 20 of the Securitisation Regulation, the triggers to effect such perfection could be at least the following events:
Once the perfection event transpires, the issuer (or a nominee on its behalf) typically proceeds with giving notice to the underlying obligors of the event of the transfer, directs the obligors to pay the amounts outstanding directly to the issuer, and takes any necessary action to recover the amount outstanding in respect of the assets, or to protect or enforce its rights against the obligors (for further information, see 1.3 Transfer of Financial Assets).
In securitisation transactions, certain covenants are provided by both the issuer and the originator. The issuer, the SSPE (as discussed in 1.2 Special-Purpose Entities (SPEs)), is typically constricted by negative covenants that ensure it is operating as an off-balance sheet SPE. The scope of these covenants restricts SSPEs from having independent management or employees, performing administrative functions concerning the receipt and distribution of cash, and generally engaging in financial activities that deviate from the scope of securitisation. On the other hand, the originator is bound by affirmative covenants relating to its corporate status, the ownership of the assets, and its obligation to perform under the transaction documents. In general, breach of any such covenant could lead to early amortisation or default under the notes.
A securitisation service provider can be appointed by the issuing SSPE to collect principal and interest payments from obligors and to transfer such amounts to the account(s) indicated by the issuer, initiate enforcement proceedings against the non-co-operative obligors and administer the asset portfolio after transaction closing on a day-to-day basis. The servicing agreement could also provide for responsibilities of default management, collateral liquidation and/or the preparation of monthly reports in relation to the assets. According to Article 21 of the Securitisation Regulation, the transaction documentation shall clearly stipulate:
Furthermore, it is contractually agreed that the servicer may subcontract or delegate the performance of all or any of its powers and obligations under the servicing agreement, provided that certain conditions are met.
The servicer is typically compensated for its services with a fixed servicing fee paid by the issuer out of the collections of payments from the obligors and in accordance with the priority of payments which is contractually agreed. Breach of the obligations of the servicer under the servicing agreement might lead to the appointment of a replacement servicer or early amortisation or default under the notes.
Events of defaults under the securitisation documentation could be principally divided into events that trigger early amortisation but not the right to enforce against the collateral and those that lead to both. Furthermore, certain events of default or termination could give rise to the SSPE’s right to replace the services, or another relevant party to the securitisation.
Typical events of default under the notes comprise:
At the outset of a default under the notes, senior noteholders will typically instruct the note trustee to declare all outstanding amounts under the notes immediately due and payable, and to enforce security over the securitised assets.
In securitisations, typical indemnification duties include indemnification for damages in the event that the seller or servicer fails to meet their commitments. In particular, the issuer (and the security trustee) may be entitled to indemnifications against the originator for losses incurred in connection with the sale of assets, and against the servicer for losses incurred as a result of the servicer's negligence in performing its services. The precise indemnities contained in each transaction are determined by the conclusion of the parties' agreements.
The issuers in EU securitisations are typically bankruptcy-remote SSPEs, as described in 1.2 Special-Purpose Entities (SPEs).
According to Article 2 of the Securitisation Regulation, a sponsor is defined as a credit institution, whether incorporated in the EU or not, or a MiFID-regulated investment firm that is separate from the originator and establishes and manages an asset-backed commercial paper (ABCP) programme or other securitised scheme from third-party entities. The sponsor can delegate the day-to-day active portfolio management involved in that securitisation to an entity authorised under the UCITS Directive, AIFMD or MiFID II to perform such activity.
An underwriter in a securitisation transaction is an investment bank that acts as an intermediary between the issuer and the investors by arranging the securitisation and marketing the securities in a public offering. The underwriter, which could also be the originator, structures the deal and might also underwrite the transaction.
Please see 5.5 Principal Servicing Provisions.
The issued securities are usually bought by institutional investors, such as credit institutions, investment firms, insurers and pension funds.
According to Articles 21 and 23 of the Securitisation Regulation, the transaction documentation should clearly state the contractual obligations, duties and responsibilities of trustees. Trustees are also referred to as “security trustees” or “collateral agents”, and are mainly responsible for holding and administering the security granted over the securitised assets on behalf of the investors. The trustee may also be delegated with other duties, such as enforcing the collateral in the event of default or receiving reports to verify the payment under the securities.
By way of definition, synthetic securitisations involve the transfer of risk of securitised exposures from the originator to the investors through a credit protection agreement. This agreement takes the form of a credit derivative – typically a credit default swap – or financial guarantee, whereby the originator agrees to pay the investor a credit protection premium and the investor agrees to pay the originator a credit protection payment if one of the contractually stated credit events occurs. The ownership of the securitised exposures remains with the originator.
From a structural standpoint, on the one hand, the fact that the ownership remains with the originator constitutes the main advantage of synthetic securitisations compared to traditional, since the originator continues to benefit from the proceeds arising from the securitised portfolio while also benefitting from the RWA benefits of securitisation. On the other hand, the main risk of synthetic securitisations is that they do not essentially constitute insolvency-remote transactions since such securitisations continue to carry the insolvency risk of the originator.
Synthetic securitisations are permitted in the EU. Contrary to STS securitisations, and owing to their inherent differences, synthetic securitisations are contingent upon additional requirements aiming, inter alia, to secure the positions of both the originator and the investor under the credit protection agreement.
In terms of scope, synthetic securitisations can only be labelled as STS when they are carried out by EU banks. Furthermore, the STS framework does not apply to arbitrage synthetic securitisations, where the objective is to profit from credit risk price fluctuations rather than to obtain credit risk protection linked to the originator's actual exposures.
Article 26b of Regulation (EU) 2021/557 (Amendment Regulation) provides that the underlying exposures need to have part of the core lending business activity of the originator and shall be held on its balance sheet or, in the case of a group structure, on its consolidated balance sheet at the transaction's closing date. Furthermore, the originator shall not hedge its exposure beyond the protection obtained through the credit protection agreement. Because the originator must hold the securitised exposures on the balance sheet, arbitrage securitisations are excluded from the reach of the STS label.
Synthetic securitisations are similarly subject to the 5% risk retention rule.
As regards the credit protection agreement:
In accordance with the disclosure technical standards published by ESMA (see 4.1 Specific Disclosure Laws or Regulations), securitisations could be carried out in relation to a wide range of asset classes, such as commercial, real estate, corporate, auto, consumer, credit card and leasing, which are annexed therein. The transferred assets should be credit claims or receivables that have a homogenous asset type, jurisdiction, applicable law and currency.
The structure of securitisations remains the same regardless of the securitised underlying exposures. On a more detailed level, however, unique commercial and legal issues may result in structural disparities.
The European Banking Association (EBA) issued a series of statements and guidelines in response to the implementation of a wide range of support measures by EU Member States aiming to grapple with the medium- and long-term economic impact of the COVID-19 pandemic. These measures have foreseen some forms of moratoria on the payment of credit obligations in order to support the affected businesses and private individuals with their operational and liquidity challenges. In particular, the authors refer to the EBA Guidelines on legislative and non-legislative moratoria on loan repayments applied in the light of the COVID-19 crisis of 2 April 2020 (the “EBA Guidelines”). Although the EBA Guidelines applied to legislative and non-legislative moratoria before 30 September 2020 and have been phased out since then, the EBA has stated that these may be extended at a later stage, should this be considered necessary.
In addition, the liquidity threat due to deferred loan payments accelerated the revision of the Securitisation Regulation in 2021 in order to explicitly allow the securitisation of non-performing loans (NPLs). The adoption of NPL securitisations in turn enables EU banks to dispose of their non-performing assets and thus preserve their liquidity to economically support the affected individuals and businesses through the COVID-19 crisis. The amendments to the Securitisation Regulation have been covered above.
Legal Issues Arising from the Implementation of the GPM
On 2 April 2020, the EBA issued a set of guidelines specifying the conditions that payment moratoria shall meet to avoid triggering a forbearance classification and/or the distressed restructuring of the relevant loans in accordance with Articles 47b and 178(3)(d) of Regulation (EU) 2013/575. The EBA Guidelines introduced the notion of a “general payment moratorium” (GPM) along with six criteria that a legislative or non-legislative moratorium shall fulfil to be considered as a GPM within the meaning of the EBA Guidelines.
However, the forbearance measures entailed in the applicable GPMs had, in most cases, an impact on the transactions’ cash flow and led to breaches of certain financial covenants stipulated by the securitisation documentation; ie, those pertaining to the asset quality and cash-flow generation.
Depending on the nature of the securitised assets and the structure of the transaction, the following indicative issues have occurred:
In response to the adverse effects of the forbearance measures mentioned above, certain amendments and waivers were drawn to the contractual documentation in order to protect the interests of market participants engaging in securitisation transactions. However, following the slowdown experienced in 2020 and partly in 2021, securitisations have recovered, creating a market with an excess of liquidity in which investors seek to invest in fixed-income products with high returns.
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