Final APS 120 and draft APG 120

Key points

• Regulatory Capital Approach - Confirmed removal of advanced modelling approach. ADIs may use either the external ratings based approach or the standardised approach to calculate regulatory capital requirements – concerns remain as to the impact this will have on securitisation funding to non-banks and smaller ADIs.
• Adjustments to proposed deductions from CET1 - Non-senior securitisation exposures rated above A3 or AA- are no longer required to be deducted from Common Equity Tier 1 Capital (CET1) and may be risk weighted. APRA will allow the use of the standardised approach for non-senior securitisation exposures that are unrated or for which the ADI cannot infer a rating.
• Subordination of Derivatives - Confirmation by APRA that subordination of derivative payments to any ADI counterparty is prohibited, with no distinction between ADIs and originating ADIs.
• Revolving securitisations - Issues remain with the treatment of revolving securitisations which may impede credit card securitisations by ADIs and which for other asset classes require, at a minimum, technical clarification.
• Transition - Transitional arrangements for existing facilities under Attachment D of APS 120 (to termination or renewal) and this would include the ranking of derivative transactions in a securitisation. No transitional relief in respect of capital requirements.

Next steps

• New APS 120 will take effect from 1 January 2018. 
• Written submissions in respect of draft APG 120 due by 20 December 2016.
• Upcoming consultation on revised reporting requirements for securitisation and covered bonds which would also take effect from 1 January 2018.
• No implementation of simple, transparent and comparable (STC) securitisation but APRA has left the door open for incorporation of STC criteria in APS 120 at a later date.

Introduction

The Australian Prudential Regulation Authority (APRA) released the final version of Prudential Standard APS 120 - Securitisation (APS 120) together with a draft Prudential Practice Guide - APG 120 Securitisation (draft APG 120) and APRA's Response to Submissions on draft APS 120 (Response to Submissions).

Although there have been some refinements to the previously released draft APS 120, many of the key changes to draft APS 120 remain in the final version, including the removal of the advanced modelling approach to calculating regulatory capital, as well as APRA's approach to the subordination of derivative payments, date-based calls, funding-only securitisations and shared collateral arrangements.

The following is a summary of the main points of interest that arise from the implementation of APS 120 and draft APG 120 which applies to authorised deposit-taking institutions (ADIs) and all roles undertaken by, or investments of, an ADI in a securitisation.

Regulatory Capital Approach

The final APS 120 confirms the removal of the advanced modelling approach. As of 1 January 2018 ADIs may use either the external ratings based approach or the standardised approach to calculate regulatory capital requirements. There has been a great deal of industry discussion about the impact this change will have on the funding costs and availability for non-banks and smaller ADIs that receive warehouse funding from the larger ADIs that have used an internal assessment approach for their securitisation exposures. It is expected that the removal of the advanced modelling approach will result in existing warehouse securitisations, in particular, being restructured and/or rated and that additional funding costs may be passed onto the underlying originators.

In response to submissions, APRA adjusted its proposed approach to an outright deduction from Common Equity Tier 1 Capital (CET1)  of all non-senior securitisation exposures. In the final APS 120, APRA has helpfully allowed for a more sensitive approach to highly rated, non-senior securitisation exposures. Accordingly, non-senior securitisation exposures externally rated at least A3 (short term) or AA- (long term) are not required to be deducted from CET1 and instead may be risk weighted. As well, APRA will allow the use of the standardised approach to assign a risk weight for non-senior securitisation exposures that are unrated or for which the ADI cannot infer a rating. However APRA has confirmed that resecuritisation exposures will be deducted from CET1.

Under paragraph 62 of APS 120 APRA has also allowed non-originating ADIs (in addition to originating ADIs) to apply a risk weight cap for senior securitisation exposures (although for a non-originating ADI this must be determined under APS 112).

There is an issue with the definition of "senior securitisation exposure" under APS 120 and commentary on that definition in paragraph 10 of draft APG 120. Draft APG 120 provides an example whereby when there are several tranches in a securitisation above the first loss piece and such tranches share the same rating, only the most senior tranche in the cash flow waterfall would be treated as senior (unless the only difference among them is maturity). It is not clear why differences in coupon, for example, should impact the seniority of these tranches. As well, there is commentary in the APS 120 definition of "senior securitisation exposure" that if a senior tranche is partially hedged only the most senior hedged portion would be treated as senior for regulatory capital purposes. It is not clear why hedging alone should result in this treatment, particularly where in the case of currency hedging, any currency risk is subordinated typically.

Subordination of Derivative Payments

One of the biggest issues remaining in APS 120 is the new prohibition on the subordination of derivative payments in a securitisation.  The restriction in paragraph 6 of Attachment D applies to any ADI (not just an originating ADI) and would prohibit both the standard flip clause (where the ADI is the defaulting party or the sole affected party) and the subordination of uncollected break costs.

The Response to Submissions and para 106 of APG 120 states that this restriction has remained in APS 120 because such subordination could be a means of support for the securitisation by the ADI. It is hard to see how the subordination of payments to an ADI in a default scenario in particular would comprise support.

This new prohibition on the subordination of derivative payments is likely to lead to higher replacement triggers applying to ADIs from a ratings perspective. In the context of fixed rate receivables, additional reserves and/or limits on fixed rate receivables in a portfolio are also a possibility from a ratings perspective.

If a ratings consequence is higher replacement triggers applying to an ADI derivative counterparty, this will ironically increase the likelihood of ADI triggered termination events under derivatives where an ADI is unable to find an appropriately rated replacement.

The higher replacement triggers and risk of not being able to find a replacement counterparty (given the strength of current ADI ratings relative to other financial institutions) may also lead to higher derivative costs in securitisation transactions and less appetite for entering into derivative transactions.

It is expected that the industry will seek further clarification from APRA on this point, including whether APRA intended these provisions to apply to originating ADIs only (as briefly suggested by APRA at the Australian Securitisation Forum conference).

Regulatory Capital Relief Transactions

An originating ADI may exclude the underlying exposures in a securitisation in the calculation of its regulatory capital for credit risk under APS 112 or APS 113 if it satisfies the requirements of Attachment A of APS 120.

Attachment A of APS 120 sets out the operational requirements for regulatory capital relief, including the following key points:

• 20% cap on non-senior securities and any tranche of non-senior securities held by the originating ADI.
• Securities issued by the SPV must fund exposures in the pool up to the longest contractual maturity date.
• Limited rights to repurchase exposures in the pool (10% clean up call, further advances, remedies for breach of asset representations within 120 days).

Warehouse securitisations are eligible for capital relief provided the criteria in Attachment A is satisfied, including funding extending to the longest contractual maturity date of the underlying exposures in accordance with paragraph 9 of Attachment A. Draft APG 120 contemplates that warehouses with availability periods may qualify for capital relief where there are limited terms renegotiated at extension (i.e. funding rates at market pricing). The restriction in APG 120 on changes to other terms in the warehouse seems overly inflexible as there are many terms which could be changed without such changes comprising implicit support and it may be that industry raises this with APRA for further clarification. 

Funding-only Securitisations

An originating ADI may treat a securitisation as funding-only if it satisfies the requirements of Attachment B of APS 120. In that case, an originating ADI must continue to include the underlying exposures in the securitised pool in the calculation of its regulatory capital for credit risk under APS 112 or APS 113.

Attachment B of APS 120 sets out the operational requirements for funding-only securitisations. As previously noted when draft APS 120 was released, the inclusion of date-based calls 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.

In respect of date-based calls, APS 120 confirms that:

• the date-based call must relate to senior securities only.
• the call date is set at the time securities are issued.
• non-senior securities must share pro rata loss allocation and must not differ in maturity.
• the call is at the full discretion of the originating ADI and is not structured to avoid allocating losses or otherwise structured to provide credit enhancement.
• the purchase is conducted on an arm's length basis and on market terms and conditions.

In paragraph 20 of draft APG 120 APRA notes that only a single-tranche of non-senior securities is permitted in a funding-only securitisation with a date-based call option (however APRA notes that more than one class of non-senior securities in a funding-only securitisation is permissible if there is no date-based call option; APRA allows this to facilitate transition to a capital relief securitisation should this be possible in the future).

Draft APG 120 also confirms that a step-up margin in respect of uncalled securities is permissible where the originating ADI does not exercise a date-based call provided the originating ADI does not fund the step-up margin (including through a basis swap).

Funding-only securitisation of revolving credit facilities

In the securitisation of "revolving credit facilities" section of Attachment B of APS 120, the restriction on adding new exposures to a pool or funding further draws within that pool following an amortisation event (whether scheduled or an early amortisation in response to some sort of trigger) remains.

In its Response to Submissions, APRA notes that it expects the funding of further draws on exposures in the pool to be funded outside of the securitisation in order to avoid the originating ADI's interests being subordinated to those of investors who have not provided further funding. This will present challenges in the context of credit card revolving securitisations which will need to be overcome with structuring solutions.

Under paragraph 9 of Attachment B scheduled or early amortisation also must not further subordinate the originating ADI's subordinated interest, subordinate the originating ADI's seller interest to those of the investors or in other ways increase the originating ADI's exposure to losses associated with the underlying exposures.

There are general restrictions (not just in the context of revolving credit facility securitisations) in paragraph 21 of APS 120 on the originating ADI altering the underlying exposures in a pool such that the pool's credit quality is improved, as well as on increasing a retained first loss position or providing additional credit enhancement after the inception of a transaction. These restrictions should be clarified in the context of master trust type revolving securitisations (whether of revolving credit facilities or otherwise) where pool exposures will fluctuate and credit quality may change. In terms of such master trust type revolving securitisations, it would appear that the subordination provided by an originating ADI can be set at inception but that if, for example, a rating agency changed its credit enhancement requirements, an originating ADI would not be able to increase subordination (e.g. as a percentage of the funded pool) post-inception and therefore the programme could be at risk of downgrade. In the context of paragraph 45 of draft APG 120, originating ADIs may also need to structure the transactions so that the level of subordination as a proportion to funding does not drop below the inception level.

The definition of "seller interest" which is used in the Attachment B "securitisation of revolving credit facilities" provisions requires a technical clarification in that not only the investor interest needs to be deducted, but also the ADI's subordinated interest.

With the deletion of the definition of "revolving securitisation" in draft APS 120 the focus of the revolving provisions in Attachment B is on the underlying exposure being revolving, rather than the securitisation itself being revolving. This is good from the perspective of not cutting across the treatment of warehouse securitisations in the standard but also results in the 20% holding cap exclusion (discussed below) applying to the seller interest in a securitisation of revolving credit facilities only. The definition of "securitisation of revolving credit facilities" is restrictive and applies as soon as one or more exposures is a revolving credit facility which will need to be taken into account in structuring securitisations, particularly as securitisations of revolving credit facilities are not eligible for capital relief under paragraph 35 of APS 120.

Draft APG 120 has introduced a proposed guide cap of 20% on the holding of senior securities by an originating ADI, with, in the case of  "securitisation of revolving credit facilities",  the 20% cap applying to the ADI's senior investor interest rather than its seller interest. This qualification may be fine in the context of the revolving credit facilities provisions on the basis that the ADI is expected to primarily hold the seller interest and the subordinated interest but as this reference is limited to the securitisation of revolving credit facilities, it would not appear to extend to a revolving securitisation of receivables (e.g. mortgage loans) which are not themselves revolving credit facilities, which may be an issue in the context of, for example, a mortgage loan revolving master trust programme.

Foreign ADIs

APS 120 continues to apply to a limited degree only to foreign ADIs with paragraph 3 of APS 120 setting out the limited separation and disclosure, risk management and self-assessment requirements to be complied with by foreign ADIs.

Transitional provisions

The following transitional provisions apply under APS 120 (however in all cases exposures to a securitisation are subject to the new capital requirements under APS 120 from 1 January 2018):

• For service and facility agreements complying with the current APS 120 (January 2015) and in existence prior to 1 January 2018, the ADI may treat such agreements as complying with the new requirements under Attachment D until the earlier of the termination of the agreement or the first date on which the agreement may be renewed or cancelled.
• For regulatory capital transactions complying with the current APS 120 and in existence prior to 1 January 2018, an originating ADI may continue to exclude the underlying pool of exposures in its regulatory capital calculations until the first date on which a clean-up call may be exercised. If there is no clean-up call in the securitisation, the originating ADI may apply to APRA for alternate transitional arrangements.

Other points

Other technical points to note under APS 120 and draft APG 120 are:

• The definition of "securitisation" remains tied to a concept of two or more tranches or classes of creditors with a focus on different levels of credit risk and non-senior securitisation tranches absorbing losses ahead of the senior tranche. The language in the previous version of APS 120 regarding a warehouse being a securitisation even if it does not have a least two tranches of creditors or securities has been removed.
• The definitions of "originating ADI" and "managing ADI" are largely unchanged and APRA acknowledges that it has intentionally gone broader than the Basel III securitisation framework on the basis that a managing ADI has a close association with the securitisation it is managing which would be known to the marketplace and so originating ADI restrictions applying to the managing ADI, including in the context of implicit support, are appropriate.
• There is a new clarification in the definition of "resecuritisation exposure" that an exposure resulting from retranching of a securitisation exposure is not a "resecuritisation exposure" if the ADI is able to demonstrate that the cash flows to and from the ADI replicate in all circumstances an exposure to a securitisation of a pool of assets that contains no securitisation exposures.  As noted above, under Attachment C of APS 120 resecuritisation exposures are to be deducted from CET1.
• APRA reconfirmed its long-standing approach of not allowing loans subject to trust-back arrangements (where shared collateral has been assigned to the SPV) a risk weighting of less than 100 per cent unless a formal second mortgage is in place (as set out in paragraph 67 of APS 120).
• Synthetic securitisations remain ineligible for capital relief and an originating ADI must, under paragraph 38 of APS 120 include the underlying exposures in the pool in the calculation of regulatory capital. There is discussion on what a synthetic securitisation is under paragraph 51 of draft APG 120 which is worth noting.
• Consistent with current APS 120, Attachment D of the new APS 120 provides that the repayment of draws on liquidity or funding facilities must never be subordinated to any investor interests in a securitisation and must not be subject to deferral or waiver.
• An ADI that undertakes a self-securitisation must comply with APS 120 from the point it uses the securities as collateral under a repo with the Reserve Bank of Australia (prior to that point the self-securitisation does not exist for purposes of APS 120).
• Under paragraph 78 of APS 120, prior to entering into a funding arrangement involving an ADI providing another party an interest in that ADI's assets, the ADI must notify APRA of the proposed arrangement unless that arrangement falls within the identified exceptions (securitisations and synthetic securitisations under APS 120, covered bonds, securities lending, repurchase agreements over marketable securities and collateral for OTC or centrally-cleared derivative transactions). In requiring prior notice, APRA is concerned about a party being provided with recourse to an ADI's assets in preference to the depositor protection and priority claim provisions of the Banking Act 1959. 
• Paragraph 22 of draft APG 120 provides that to address APRA's concerns regarding cherry picking in the use of ratings, where a securitisation is rated by more than one rating agency, in order for a tranche to be treated as rated for regulatory capital purposes, each agency must rate that tranche (it is not acceptable to have only one of two agencies rating a particular tranche and such a tranche would effectively be treated as unrated).