APS 120 – Revisions to the prudential framework for securitisation

What you need to know

• Date-based calls allowed for funding-only securitisations.
• Increased flexibility for funding-only securitisations and revolving securitisations, with technical clarifications required in respect of the “seller interest” in revolving securitisations.
• Simplified approach to regulatory capital relief.
• Revised regulatory capital framework with surprise removal of IRB approach.
• Simplified approach to warehouse securitisations.
• Proposed risk retention requirements dispensed with.
• Eligible facility provisions in APS 120 to apply to all liquidity facilities and funding facilities.
• APRA will, at a later date, give further consideration to securitisation and encumbrance limits.
• Transitional provisions for originating ADIs and servicing ADIs but not for investor ADIs.

Next steps

• Written submissions due by 1 March 2016.
• Proposed draft prudential practice guide (PPG) and reporting standards/forms (including for Covered Bonds) in first half of 2016 with a final PPG and reporting standards/forms by the end of 2016.
• Proposed effective date 1 January 2018 (although APRA has left open the door for earlier implementation of certain aspects of the reform).

Introduction

Following on from the Australian Prudential Regulation Authority’s (APRA) proposed revisions to Prudential Standard APS 120 – Securitisation (APS 120) in its April 2014 discussion paper (April 2014 Discussion Paper), APRA released a draft APS 120 together with a related discussion paper “Revisions to the prudential framework for securitisation” (November 2015 Discussion Paper) on 26 November 2015. The revised APS 120 takes into account submissions to the April 2014 Discussion Paper and the proposed implementation of the Basel Committee on Banking Supervision’s Basel III securitisation framework (Basel III), released in December 2014.

In general the approach taken by APRA in draft APS 120 has made interpretation and compliance with the requirements simpler. The general consensus is that the amended proposals will, with some technical clarifications described below, aid the further development of the Australian securitisation market. The current draft prudential standard is seen as the outcome of consultation and meaningful dialogue between APRA and industry participants.

The following is a summary of the main points of interest that arise from APS 120 and the November 2015 Discussion Paper.

Date-based calls

The ability to include date-based calls in securitisations was at the top of ADI wish lists on the basis that date-based calls can expand the universe of real money investors, including offshore investors, and potentially reduce swap costs through the reduction of extension risk.

Date-based calls are available for funding-only securitisations and there are specific requirements for date-based calls in draft APS 120:

• The call date must be set at inception of the securitisation.
• The ADI must have full discretion as to whether it exercises the date-based call.
• The date-based call is not structured to avoid allocating losses to credit enhancements provided to the SPV or its investors, or positions held by investors or otherwise structured to provide credit enhancement.
• Any securities repurchased by the ADI are done at market value.

The simplicity and certainty around the date-based call requirements should allow ADIs to easily include this feature in their funding-only securitisations. In the standard, APRA requires that an ADI must address the liquidity risk associated with date-based call options through their liquidity risk management framework.

Revolving securitisations

Although there is no mention of the much asked for Master Trusts in draft APS 120, the framework for Master Trust structures is present in the funding-only provisions of the standard.

It is hoped that references to “seller interest” in APS 120 will be clarified so that a reference to seller interest is to the senior securities held by an originating ADI in a funding-only securitisation (and not to any subordinated notes held by that originating ADI in the securitisation). The proposed definition of seller interest in APS 120 effectively captures all securities held by the originating ADI and in a funding-only revolving securitisation an originating ADI would likely hold the junior securities. Such junior securities would provide credit enhancement and be subordinated to senior exposures with respect to payments and losses. Similarly the requirement that the originating ADI and investors must be paid out pro rata should also be clarified by reference only to senior securities held by the ADI. Given the references in the funding-only provisions of APS 120 to junior and senior securities being held by an originating ADI as well as the discussion on the treatment of the seller’s interest in the November 2015 Discussion Paper, it is hoped this is only an issue for technical clarification and not a fundamental difference in approach to revolving funding-only structures.

As well, the requirements in the early amortisation provisions of the revolving securitisation provisions of APS 120 will also need to be taken into consideration in securitisation structures so that in an amortisation, there is no increase in the originating ADI’s exposure to losses and so that the originating ADI is not adding new exposures to the pool. In the November 2015 Discussion Paper, APRA makes it clear that neither an accelerated reduction of investors’ interests to the detriment of the ADI nor a scenario where the ADI may end up absorbing more credit risk through structural subordination is acceptable.

Capital relief – a simplified approach

Capital relief will only be available for term securitisations under draft APS 120. Revolving securitisations and ABCP securitisations are treated as funding-only securitisations and therefore are not eligible for capital relief.

APRA has retained the significant credit risk transfer approach to determining capital relief for an originating ADI. Draft APS 120 includes a simple yardstick for deemed significant credit risk transfer which is that the originating ADI group must not:

• hold more than 20 per cent of the junior securities issued in the securitisation, or more than 20 per cent of any tranche of junior securities issued in the securitisation; and
• hold junior securities and hold or provide other loss positions or credit enhancements, which represent more than 20 per cent of the loss cover provided in the securitisation to support senior securitisation exposures.

As the language in APS 120 expressly refers to the holding of junior securities at any time, this requirement would need to be taken into consideration in structuring the amortisation of senior and junior securities.

In addition, to achieve capital relief an originating ADI must hold regulatory capital against any securitisation exposure it retains and the securitisation must provide funding for the life of the underlying pool of exposures.

Funding-only two credit class structure

Although credit tranching of junior securities is permitted in a capital-relief securitisation (other than when switching from a funding-only securitisation), draft APS 120 does not permit such tranching in a funding-only securitisation.

In the April 2014 Discussion Paper APRA introduced a simple two credit class structure. This has not changed in draft APS 120 and APRA has indicated it expects the originating ADI to hold all of the junior securities. This will need to be considered further in the context of funding-only securitisations by some of the smaller ADIs that historically may have placed mezzanine or subordinated notes with third parties.

Draft APS 120 confirms that in respect of a funding-only securitisation, an originating ADI is not required to hold regulatory capital in respect of credit risk for facilities or exposures to the SPV held by the originating ADI and the ADI must include the underlying exposures in the securitisation pool in its regulatory capital calculations under APS 112 or APS 113.

Regulatory capital framework

In the November 2015 Discussion Paper APRA acknowledges that its objective is to materially reduce the incentives for ADIs to invest in any tranches other than senior securitisation securities. APRA views junior securities (regardless of rating) as equity-like and accordingly draft APS 120 applies a CET1 deduction for all non-senior securitisation exposures (as well as resecuritisation exposures). In respect of the new definition of “senior securitisation exposure” in draft APS 120 it is noted that if a senior tranche is itself retranched or partially hedged, only the most senior tranche or hedged portion would be treated as senior for regulatory capital purposes.

Draft APS 120 has removed the current internal ratings based (IRB) approach used by the larger ADIs. The impact of the removal of the IRB approach on funding costs, particularly in the context of securitisation warehouses provided by ADIs, remains to be seen.

The proposed regulatory capital framework provides for a hierarchy of approaches in determining risk weights for senior securities, with the External Ratings-based approach first and the Standardised Approach second. This revised approach emphasises the external ratings process and it may be that we see more transactions being rated as a consequence.

Warehouse arrangements

There are no express references to warehouse securitisations in draft APS 120 and APRA has indicated that warehouses may qualify as either capital relief or funding-only securitisations depending on how the arrangements satisfy the relevant requirements. APRA has indicated it is open to further consultation on the treatment of warehouse securitisations under APS 120, particularly in the context of limiting regulatory arbitrage while giving smaller ADIs improved access to term securitisation markets. Draft APS 120 does not include the previously proposed requirement to term out warehouse securitisations within one year.

Other points to note

Other points to note in the context of draft APS 120 are:

• The definition of securitisation in APS 120 has been amended and supports the proposition that a single tranche credit structure will not be a securitisation, regardless of whether it is a warehouse. The current version of APS 120 provides that a warehouse SPV is a securitisation even if it does not have at least two different tranches of creditors or securities.
• APRA has retained its approach to shared collateral in APS 120 and has indicated in the November 2015 Discussion Paper that it does not accept that trust-back provisions often contained in securitisation documents are sufficient to satisfy the formal second mortgage arrangement requirement.
• APRA has retained many of the provisions relating to facilities and services in Attachment E of the current APS 120. In line with the Basel III securitisation framework, the “eligible facility” distinction has been removed in Attachment D of draft APS 120 however APRA notes in the November 2015 Discussion Paper that it has retained and applied some of the requirements that applied to eligible facilities to all liquidity facilities and funding facilities (such as limits to when amounts may be drawn or the ranking of such facilities).
• A new provision regarding derivative transactions has been added to the facilities and services section of APS 120 which requires that such derivative transactions provided by an ADI in a securitisation must never be subordinated to any interest of any investor. A technical carve out for payments to defaulting swap counterparties as well as uncollected break costs will need to be considered further.
• The definitions of “asset-backed commercial paper securitisation” and “revolving securitisation” in APS 120 could benefit from minor clarifications to reflect market practice.
• Transitional arrangements are to be included for originating ADIs and servicing ADIs in relation to existing securitised exposures although not for investor ADIs. In the period between the release of the final standard and its effective date, APRA has indicated that it expects originating ADIs to structure new securitisations consistent with the final standard.

Conclusion

Draft APS 120 is largely a positive development for the securitisation industry in Australia. There are some technical points for clarification as noted above, and some ADIs may make submissions on the removal of the IRB approach from the regulatory capital framework, but generally the revised standard has achieved APRA’s stated objectives, namely to aid the further development of the Australian securitisation market and to assist ADIs to further strengthen their funding profile. It may be worthwhile for industry to request the earlier implementation of key aspects of the revised standard which will particularly facilitate the development of the Australian securitisation market, such as date-based calls and the revolving securitisation provisions.