CMU - fixing the European securitisation market at last?

On 10th June 2020, the High Level Forum (HLF) on the Capital Markets Union (CMU) published its final report (the "Report"). In the Report, the HLF set up by the European Commission (the "Commission") sets out a wide reaching vision for a strong and truly single capital market, noting that in the wake of the Covid-19 pandemic, an integrated capital market is more of a priority than ever.

The Report contains recommendations for a number of areas including plans for investment funds, insurers, digital assets and , importantly for this briefing , scaling up the European securitisation market. One of the most relevant suggestions will be of great interest to investors in non – EU originated securitisations struggling with the due diligence requirements (see below). 

Against the background of a desire for a simpler, more harmonised market, with single reference points/ approaches to e.g. withholding tax (often an issue in cross – border finance), strengthening the powers of regulators such as ESMA, the specific HLF recommendations on tackling the securitisation market are to be welcomed, although some participants may think that the proposals do not go far enough.

The Report's overall stated aim is to build and establish a good, responsible, prudentially sound and transparent securitisation market in the EU. To achieve this goal, the Commission is invited to address 7 key issues, which the HLF has identified as the main obstacles to the development of a robust securitisation market. The 7 key recommendations are:

1. Unlocking the Significant Risk Transfer Assessment process;
2. Recalibrating capital charges for senior tranches under CRR2;
3. Recalibrating capital charges for securitisation tranches under Solvency II;
4. Reducing the cost of SME financing;
5. Applying equivalent treatment to cash and synthetic securitisation of all asset classes;
6. Upgrading eligibility of senior STS and non-STS tranches in the LCR; and
7. Differentiating between disclosure and due diligence requirements for public and private securitisations.

Each of the key issues is accompanied by a rationale, as well as a detailed suggestion for how primary and secondary legislation/regulation should be addressed/amended. In the case of issue 7, the HLF also takes the opportunity to suggest correction to some of the unclear issues in the Securitisation Regulation¹, not least the extra-territorial effect of the due diligence requirements and the application of verification exercises to "Non Performing Exposure" (NPE) deals.

Below is a summary of and comment in relation to some of the key recommendations in context.

Significant risk transfer (SRT) 

In essence, the HLF suggestion is to allow for "standard" transactions to be completed without requiring a systematic ex–ante review on every single occasion. The proposal is that this review process be reserved for more complex transactions that diverge from market standards. This proposal, if adopted should be welcomed by market participants, as it would likely make SRT transactions faster, cheaper and easier to implement.

Capital treatment

In relation to capital treatment , the proposals are designed to bring capital treatment more in alignment with their risk profile – specifically to reduce RW (risk weight) floors, review LGD (Loss Given Default) input floors and to encourage further development of the NPE securitisation market in Europe. For Solvency II, the approach suggested is to allow for similar treatment to that provided for equally rated corporate and covered bonds. If this treatment were to be adopted by the Commission, it would bring to an end a long running argument about the seemingly preferential capital treatment afforded to covered and corporate bonds despite poorer performance and (in some cases) higher default rates than similarly rated asset backed securities.

SME finance

Interestingly , the key area of focus for SME finance in the Report is the unavailability of data and what there is only accessible in a fragmented and inconsistent way. The proposal therefore centres on mandating ESMA to set up "ESAP", or a European Single Access Point, for company data. This data should be free to use and not licensed or hindered in any way. There are a number of other areas that might have been reviewed, not least the overall treatment of trade receivables/ABCP issuance/ reporting , but these are not addressed per se in the Report.

Cash -v- Synthetic Securitisation

The HLF takes the view that synthetic transactions should be permitted STS designation and that there should be no differentiation in terms of capital/regulatory treatment between the two types of deal. In making this recommendation, it prominently references, and by implication endorses the recent EBA paper which sets out a framework/ blueprint for synthetic STS categorisation.

Liquidity coverage ratio (LCR) 

As may be evident from the title of this issue, the HLF is seeking to remove another anomaly that has been seen to stunt the development of the securitisation market – the inequality of treatment under the LCR as between rated covered and corporate bonds on the one hand and highly rated asset backed securities on the other. This is another issue that has been debated extensively by market practitioners and would a) bring some alignment into the LCR and b) perhaps stimulate the bank investor side of the market hitherto unwilling to hold asset backed securities that do not currently qualify for useful assessment under the LCR.

Securitisation Regulation

Finally, and of some importance to close followers of the development of the market, the HLF makes a number of pertinent suggestions relating to the Securitisation Regulation: 

• It recommends laying to rest the confusion surrounding Article 5.1(e) of the Securitisation Regulation – where there is an EU investor, but a non – EU "originator", the HLF recommends that such an investor be allowed to determine whether it has received sufficient information to meet the due diligence requirements proportionate the risk profile of the intended investment. This particular issue has attracted a lot of comment and criticism in equal measure and ESMA was reticent to express a view. It is to be hoped that the Commission will implement this change/clarification as this will introduce a measure of certainty into a key area of the market.
• Further, tucked away in the end credits, is the recommendation also that the Commission facilitate the securitisation of legacy and NPE portfolios and allow for the development of an active market by explicitly permitting the re-underwriting of such assets where and entity acquires them with a view to securitisation.
• The HLF also seeks to make requirements for due diligence and disclosure relating to private securitisations proportionate and to allow for greater use of ND (no data available) fields in reporting templates. Some commentators are likely to think that this is still not enough to ease the reporting issue for private deals and that "opt out " protocols should be permitted – the HLF presumably felt that a toned down request might have more chance of getting through the Commission process.

All of these matters have been raised on a number of occasions by finance and legal parties in relation to real world practical issues facing structuring securitisation transactions in a compliant manner – the acceptance by the Commission of these fixes would remove a number of technical barriers and assist in greater clarity and certainty, not least in relation to legal analysis/ opinion coverage.

It remains to be seen what the reaction of the Commission to the Report will be. It is of course important to note that the proposals relating to the development of the securitisation market are a small part of the overall vision to promote the European CMU, but even if only some of the recommendations are adopted, it is likely that this could re-energise a securitisation market that has to date found that the Securitisation Regulation has not necessarily delivered on its initial promise. 

How can we help?

In this briefing we have covered some of key issues in relation to the CMU and its impact on the European securitisation market. The Ashurst securitisation team is available to discuss any of the points raised in this briefing and how it may impact your business.

1.  REGULATION (EU) 2017/2402 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 12 December 2017 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012.