European Commission proposals pave way for better regulation of NPL and synthetic securitisations

Following the High Level Forum ("HLF") report to the European Commission ("EC"), see previous Ashurst briefing here, and as part of the wider package of measures relating to capital markets union, on 24 July 2020, the EC announced via a press release, a legislative proposal to address two of the issues raised as critical by the HLF, namely permitting synthetic securitisations to qualify for STS treatment and amending the approach to the securitisation of non–performing exposures ("NPEs").

The two proposals are set out by way of suggested amendments to the two primary regulations – the Capital Requirements Regulation¹ ("CRR") and the Securitisation Regulation². The reason for tabling the amendments is expressly noted as being to help the recovery from the COVID-19 pandemic and is stated to be part of the broader response by the EC to facilitate economic recovery post the COVID–19 pandemic, against the backdrop of an EC economic forecast pointing to a very deep recession. Since there is a clear desire to encourage banks to continue to (and to be able to) lend to corporates in the aftermath of the crisis, the EC recognises the need to upgrade any tools allowing banks to lend to the real economy.

The EC accepts in the two proposals that the existing European framework relating to the legal and regulatory treatment of securitisation transactions does not cater for on balance sheet synthetic securitisation and that the treatment of NPE securitisation is not currently "fit for purpose". Accordingly, in two draft legislative measures, the EC sets out targeted amendments to remedy/alleviate these particular areas.

The proposals are based upon the two reports by the European Banking Authority ("EBA") setting out concerns with the current framework with reference to synthetic securitisation and the regulatory treatment of NPE securitisations. In both cases, the EC agrees with the EBA reports and the analysis, with respect to synthetic structures, that it is possible to set appropriate standards for synthetic transactions and that there appears to be no evidence to suggest that synthetic securitisation structures necessarily lead to higher losses than traditional ones. In relation to NPE securitisation, the EC appreciates that the usual rules relating to the risk retention requirement in Article 6 of the Securitisation Regulation are difficult to comply with for NPE structures and so proposes that this requirement could be fulfilled by the special servicer in such a transaction. In addition, real values, as opposed to nominal ones, may be used for the loss/retention calculation. Finally, and as highlighted by the HLF report, there is a clarification to the approach to verification and due diligence in relation to credit-granting standards, acknowledging that the current terms of Article 9 of the Securitisation Regulation are problematic for NPE deals.

The text of the two draft amendment regulations is fairly detailed but, in essence, the amendments to the Securitisation Regulation set out relevant new definitions for "non-performing exposure securitisation", as well as amendments to Article 6 (to allow the servicer to act as the risk retainer and lower values to be used for the 5 per cent calculation) and Article 9 (to disapply the specific credit standards where the exposures are NPEs).

For synthetic securitisations, the text is more extensive – new definitions relevant to credit protection are introduced and a whole new Article, "26a to 26e" is to be inserted, containing the requirements for "simple, transparent and standardised on balance sheet securitisations". There are detailed new provisions relating to simplicity, standardisation and transparency in Articles 26b, 26c and 26d and requirements concerning the credit protection arrangements in Article 26e.

The amendments to the CRR mirror the suggested approach to the amendments in the Securitisation Regulation, namely introducing a flat risk weight position for the senior tranche of NPE securitisations, and for other tranches modifying the general framework by applying a floor of 100 per cent to the risk weight and preventing the use of IRB foundation parameters. In relation to synthetic transactions, the application of the relevant STS risk weights set out in the current CRR (Articles 260, 262 or 264) will be extended to include senior positions in "STS on-balance-sheet securitisations" complying with the new rules (see above).

The reaction of the EC to the issues raised by the EBA, the HLF and other market commentators is to be welcomed. It is also relevant to note that the proposal documents contain an endorsement of the market and a stated desire by the EC to allow the market to flourish and expand as a tool to allow banks to manage their balance sheets, and to be able to free up capital to lend to corporates in the coming months, where the economic position is likely to be adversely impacted by the COVID-19 crisis. 

The proposals will now be laid before the European Parliament and, assuming they are adopted, will bind all Member States, which of course begs the question as to what the reaction of the UK will be and whether similar amendments will be brought into line with these measures, which may in turn depend on how long it takes until the formal publication in the Official Journal, with Brexit only a few months away.

How can we help?

The Ashurst securitisation team is available to discuss any of the points raised above in relation to suggested amendments to the CRR and the Securitisation Regulation and how it may impact your business or any other securitisation related queries.

1 Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions
2 Regulation (EU) 2017 / 2402 laying down a general framework for securitisation and creating a specific framework for simple , transparent and standardised securitisation