Securitisation 2024

An Overview of Securitisation

The year 2023 proved that securitisation remains a robust funding tool for the global finance markets, even in times of economic turmoil and continued uncertainty. Although global issuance figures in the early part of 2023 got off to a slow start, the securitisation market remained resilient with increased securitisation activity seen later in the year, evidenced by sharp rises in the US asset-backed securities (ABS) and European residential mortgage-backed securities (MBS) markets. This is despite central banks arming themselves against rising inflation by hiking interest rates globally, and despite several economies teetering on the edge of recession, leading forecasters to fear that unemployment figures would begin to join interest rates on a slow creep upwards. The war in Ukraine also continued to wreak havoc on commodity prices.

However, securitisation continues to remain a vital product and the positive news as we look forward is that there is now a widespread belief that US interest rates have peaked, with many market participants predicting that the Federal Reserve Board will not lift borrowing costs any further. This is supported by recent US economic data showing a further slowing in inflation, which fell more than expected to 3.2% in October 2023, marking the first decline in four months. As a result, US Treasuries have recovered significant ground; alongside this, both the European Central Bank and the Bank of England have continued to keep borrowing costs steady at their latest policy meetings. This has prompted investors to move into both stocks and bonds, with average cash levels falling from 5.3% to 4.7%, which is a healthy sign of rising investor confidence with regard to deploying their cash. Stabilising interest rates and the slowing of inflation are key factors in promoting both originator and investor confidence in the securitisation markets, which should result in increased issuance figures and a more competitive securitisation market.

Securitisation continues to be a versatile global product, covering multiple asset classes across a variety of industries. This introduction touches on a selection of interesting global, cross-asset statistics to demonstrate how the securitisation markets have been performing, together with views on delinquency impact – a topic on everyone’s mind in this economic environment – and the changes to certain regulatory frameworks.

Issuance statistics

The US securitisation market remains the largest in the world and ABS remained strong in the US though it was down 21.3% year-on-year. The vast majority of issuances this year were backed by auto loans.

Interest rates were, and continue to be, the economic story of the year, and had a dramatic effect on the housing market, with significantly less mortgage activity than usual. This, of course, had a knock-on effect on the securitisation market. Over the first four months of 2023, global MBS issuance stood at USD100 billion (the lowest since 2000). Although higher mortgage rates are largely to blame for this, the collapses of Silicon Valley Bank and Signature Bank, each of which held large amounts of MBS, as well as general market uncertainty, are also likely to have had an impact on prospective issuers’ and investors’ appetites. That said, although Europe’s market also began slowly, Q2 saw European issuance up 173% compared to Q2 of 2022. However, this was primarily driven by a significant French retained residential MBS deal issued in May 2023, without which issuance would have increased by only 32.8% year-on-year.

On the CMBS side, the pandemic’s impact on office demand, as well as the related impact on valuations and credit, continues to affect issuance. However, outside the US, Q3 of 2023 did see the first signs of life in the European CMBS market since April 2022, with the first transaction of this kind since then. Given the potential risk of default in this asset class, particularly in the US market, it is likely that the CMBS markets will face similar challenges in 2024.

Interestingly, the Australian securitisation market tells a story of growth. Q1 of 2023 saw a healthy total issuance figure of almost AUD10 billion, the second most successful Q1 of the past six years. Industry participants noted that the market had shifted significantly since 2022, with investors far more open to risk, making transaction structuring and participation far easier.

There were also glimpses of growth outside of the more established securitisation markets. In India, securitisations topped INR1.15 trillion in the first nine months of 2023, representing a 42% increase year-on-year. Small finance banks, in particular, have been acting as originators, increasing securitised issuances to access incremental liquidity.

The increasing demand for ESG investment products also points towards significant potential for growth in this area. This is particularly the case in Europe, where ESG securitisation accounted for only 1.4% of total ESG issuances between 2019 and 2022, compared to 8.1% in China and 32.3% in the US over the same period. AFME and S&P Global Ratings predict that potential securitisable green lending to households across eight major European markets could exceed EUR300 billion annually by 2030. This is inclusive of the growth of gross green mortgage lending of EUR125 billion. Other areas of potential growth include the electric vehicles market, where substantial growth for securitisable financing of new battery electric vehicles is predicted to reach EUR80 billion annually across five major European economies. This is in addition to a further EUR30 billion in predicted growth of annual financing for used electric vehicles. Generally, securitisation of ESG-related asset classes has grown at different paces. In particular, there has been a much greater level of ESG activity in the green RMBS and green auto ABS segments compared to other asset classes.

Delinquencies

In times of uncertain economic outlook, investors may understandably take interest in the quality of the underlying assets and delinquency rates on securitised products. In some cases, this is not a surprise; in the US commercial MBS space, defaults were on the rise throughout Q2 of 2023, although it should be noted these remain well off their pandemic peaks. Increased default rates have led to ratings actions being taken, resulting in more downgrades than upgrades in this space, particularly in securities backed by underperforming retail malls.

Delinquencies in the auto ABS market remain consistent with pre-pandemic levels for the time being, and investors will be monitoring unemployment figures and interest rates to determine whether they will likely remain low.

European delinquency rates, however, tell a more positive story. The more traditional ABS, RMBS and leveraged collateralised loan obligation (CLO) sectors have seen lifetime default rates of no more than 1.5% since the 1980s. Since the 2008 financial crisis, the lifetime default rate has been only 0.2% across about 7,500 tranches. Even in tough economic times, European securitisations remain a reliable product for both originators and investors.

Regulation updates

Ensuring securitisation default rates remain low requires constant vigilance by financial regulators and complex regulatory regimes. The year 2023 saw regulatory reforms proposed and implemented across Europe, the UK and the US. In the US, the Securities and Exchange Commission proposed stricter rules on securitisation participants engaging in transactions that may represent conflicts of interest with respect to ABS investors. These are likely to affect participants engaging in MBSs, synthetic securitisations and CLOs, and are intended to prohibit transactions that amount to a “bet” against the securitisation.

Financial regulators around the globe continue to steer the transition away from LIBOR, the benchmark interest rate used in many securitisation transactions that is being phased out. The date of 30 June 2023 represented an important date, as the remaining five USD LIBOR settings ceased to be published on a representative basis. This date, however, presented a problem for legacy contracts governed by US state laws which do not include clear and practicable provisions for replacing USD LIBOR. The Federal Reserve Board responded to this by adopting a rule late last year that replaced USD LIBOR with SOFR-based rules in these kinds of contracts. The UK’s Financial Conduct Authority (FCA), however, did not have jurisdiction to deal directly with US-governed contracts of this sort. Instead, the FCA was required to extend the publication of three USD LIBOR settings on an unrepresentative synthetic basis. Despite regulators’ best efforts, it appears LIBOR will continue in 2024.

Within the EU, Luxembourg (second only to Ireland as the most popular jurisdiction in which to incorporate special purpose entities (SPEs)) saw regulatory reform in late 2022, with the introduction of four new legal forms in which a securitisation can be established. These reforms have brought additional flexibility and confidentiality for prospective securitisation participants. By late 2023, they had been put into practice twice and are expected to bolster Luxembourg’s already-thriving securitisation market, which holds a market share of 28.9% in the EU.

Elsewhere, the EU introduced long-awaited risk retention reforms in early November 2023. Some notable changes include amending the definition of the sole purpose test and changing how risk retention on non-performing exposures is calculated. The UK also announced proposals for the new UK securitisation regime, which are largely in line with many of the EU changes but with some exceptions aimed at ease of access, and greater deal flow, for securitisations in the UK market.

Guide introduction

The regulatory changes touched on in this introduction merely scratch the surface given the vast and fluid securitisation regimes that span the globe. This Global Practice Guide (“Guide”) is therefore designed to arm practitioners with the knowledge they need to approach securitisations in 2024 and is intended to ensure that practitioners gain an understanding of the scope, structure, regulations and strategies behind the most popular kinds of securitisations in different jurisdictions. Efforts have been made to keep the Guide accessible and practical, walking the reader through the cycle of a typical securitisation transaction, with a focus on all of the “need to know” transaction features.

Each jurisdiction section begins with an overview of the jurisdiction’s most commonly securitised assets, listing the assets and what transaction structures are typically used. The Guide also covers the laws and regulations that apply to these structures, popular jurisdictions used for SPEs, and any material forms of credit enhancement used.

The Guide then deals with the parties to the transactions and their respective roles. Following this, the focus turns to the required documentation, together with explanations regarding bankruptcy-remote asset transfers, warranties, covenants, servicing provisions, indemnities, securities, derivatives and offering memoranda. Finally, and perhaps most importantly for practitioners given the ever-changing regulatory environment, the Guide addresses the various laws, regulations and other requirements directly relating to securitisations in each jurisdiction, such as disclosure laws, credit risk retention rules, rating agency and reporting requirements, and structural considerations. The Guide then deals with associated tax and accounting rules that affect transfers, profits and legal opinions.

The content on each jurisdiction has been prepared by experts in their field and their respective sections touch on far more detail than summarised above. We hope that the reader will find the rest of the Guide informative, engaging and helpful. If readers have any comments, questions or suggestions, these are welcomed as new editions of the Guide are published each year.