The new EU framework for securitisation transactions and their capital treatment - what you need to know

As part of the Capital Markets Union action plan announced in September 2015, the European Commission (the "Commission") proposed an overhaul of the rules applicable to securitisation transactions in Europe. The proposals were set out in two draft Regulations: the first providing for a uniform set of rules applying to the securitisation market in the EU, (the "Securitisation Regulation"), and the second amending the prudential securitisation framework for banks and investment firms in the Capital Requirements Regulation ("CRR") (the "CRR Amending Regulation"). 

These two Regulations were published in the Official Journal of the European Union on 28 December 2017 and will come into force on 17 January 2018. They will apply, subject to transitional provisions, from 1 January 2019.

Part I - The new rules governing securitisation transactions

The final Securitisation Regulation sets out the new rules on risk retention, due diligence and transparency for securitisation transactions.  In addition, the Regulation sets out the new criteria and framework for "simple, transparent and standardised" ("STS") securitisation transactions. STS securitisation transactions will receive preferential capital treatment and benefit from other regulatory advantages such as a proposed exemption from clearing and a proposed relaxation of margining rules for derivatives entered by a securitisation special purpose entity ("SSPE").

Highlights

• Retention level remains at 5% - for now
• The retention obligation now falls directly on originators, original lenders and sponsors in addition to the existing due diligence obligation on investors
• "Limb (b)" originators (i.e. who acquire assets from third parties) are subject to requirements to ensure they have real substance
• EU securitisation market remains open to issuance by non-EU entities, but non-
  EU originated transactions are ineligible for STS treatment
• Re-securitisation is almost completely banned, even if there is only one securitisation exposure in the pool 
• Stringent new penalties for originators and sponsors who fail to meet retention requirements

There are, however, some other changes to the current rules on risk retention which have been in place since January 2011. Until now, the CRR has required banks and investment firms investing in securitisations to ensure that the originator, original lender or sponsor of the transaction discloses that the level of risk it is holding in the transaction is at least 5%, and the method by which that risk will be held. There has not been a direct obligation on regulated originators or the sponsor of the deal to hold the retention, although they have been incentivised to do so in order to meet the demands of investors. 

Under the Securitisation Regulation, the retention requirement now comprises an indirect obligation (i.e. as currently) on all "institutional investors" to ensure retention requirements are met before they invest in a securitisation position, and a direct obligation on the originator, sponsor or original lender to hold at least 5% of the economic risk in the transaction. The permitted methods by which an eligible retention holder can hold the economic risk have not changed from those allowed by the existing CRR. "Institutional investors" will now include a broader group of regulated financial entities, including alternative investment fund managers marketing funds in the EU, insurers, occupational pension schemes, UCITS fund managers and internally managed UCITS, as well as banks and investment firms. This brings regulated investors all into line with respect to their regulatory obligations when investing in securitisations, rather than each of the financial sectors having similar but different rules. 

The rules on which entities are eligible to be the retention holder have also been adapted to make clear that a "sponsor" of a securitisation (such as a bank that establishes and manages a securitisation transaction without itself originating the assets) can be a third-country bank as well as a credit institution authorised in the EU under the Capital Requirements Directive ("CRD").

Furthermore, the rules have prohibited the use of vehicles which technically meet the legal definition of an "originator" but are established for the sole purpose of purchasing assets and securitising them. This so-called "sole purpose test" reflects concerns raised by the EBA back in April 2016 about the use of limb (b) of the definition of "originator" in CRR, which allows an entity to constitute an originator if it purchases existing assets for its own account and then securitises them. It was possible to establish an originator SSPE with third-party equity investors solely for the purpose of creating an entity that meets the legal definition under limb (b) by buying existing exposures and securitising them within a very short timeframe (sometimes on the same day). The Commission has followed the EBA's lead and has clamped down on certain limb (b) originator structures which, in its view, do not meet the spirit of the risk retention rules. Under the Securitisation Regulation and draft retention RTS, originators will now need to show that they are entities of substance, and that they are assuming real credit risk of the exposures for their own account in order to satisfy the "originator" definition. 

Proposals during the legislative process had indicated that the ability to issue into the EU securitisation market would be limited to EU entities, but, except with respect to STS transactions, that requirement has been removed and the market remains open to third-country originators and original lenders as well as expanding to allow third-country sponsors. 

Article 6 of the Securitisation Regulation requires the European Banking Authority (the "EBA") to draft regulatory technical standards ("RTS") detailing further the requirements for modalities and measurement of risk retention, the prohibition on hedging and selling the retained interest, the criteria for retention on a consolidated basis, and the exemption from retention for transactions on a clear, transparent and accessible index. On 15 December 2017, the EBA published a draft of those RTS (the "draft retention RTS") for consultation. The draft retention RTS will, when they come into force, partially replace the currently applicable RTS on risk retention, disclosure and due diligence, although they deal only with retention and initial disclosure of retention, as due diligence and ongoing disclosure will be dealt with in separate RTS.

The draft retention RTS largely preserve the existing approaches to the retention modalities and conditions, but do provide some further clarification. In particular:

• It is confirmed that the retention requirement can be met on a contingent basis through letters of credit, guarantees or other forms of credit support.
• Originators can transfer to an SSPE exposures with a higher risk profile than those they do not securitise, provided that this is clearly disclosed to investors. This removes uncertainty about the legitimacy of securitising impaired assets and non-performing exposures.
• Where the retaining entity is unable to continue acting as a retainer due to the transfer of a holding in the retainer or for legal reasons beyond its control, the retainer can be changed to another entity which is eligible to act as retainer at the time of the transfer.
• An entity will be treated as having been established for the sole purpose of originating assets (and will therefore not be eligible as an originator) unless the following apply:
  
  it has a business strategy and the capacity to meet payment obligations consistent with a broader business enterprise, involving material support from capital, assets, fees or other income available to the entity other than from the securitised exposures or the retained interest;
  
  it has been established and operates for purposes consistent with a broader business enterprise; and
  
  it has sufficient decision makers with the required experience to enable it to pursue its established business strategy, as well as an adequate corporate governance structure.

An originator must disclose to investors how it meets this last requirement in the offer document or prospectus.

The draft retention RTS are subject to a consultation period which ends on 15 March 2018. It seems likely therefore that they will be finalised prior to the 1 January 2019 application date of the Securitisation Regulation, so that there may be no need to rely on the transitional provisions described below which allow reliance on the existing RTS for matters relating to risk retention until the date the new draft RTS apply.

Re-securitisation

The Securitisation Regulation includes an almost total ban on re-securitisation, which is defined as a securitisation in which any one of the underlying exposures is a securitisation position. Until now, re-securitisation has been possible but positions in those transactions have attracted substantially higher capital charges than securitisation positions. The breadth of the definition has been the source of considerable lobbying effort to persuade the Commission to clarify that the re-tranching of a single tranche of a securitisation transaction should not be treated as re-securitisation. There had been previous helpful commentary from Basel to the effect that a position would not amount to a re-securitisation if the cash-flows could be replicated by an exposure to the hypothetical securitisation of a pool of assets which contains no securitisation exposures. However, this Basel commentary appears not to have been influential with the European institutions in their consideration of the Commission proposals.

There are limited exceptions to the ban on re-securitisation, where it is done in order to facilitate a winding-up of an institution, its continuance as a going concern, or in order to preserve the position of investors where the underlying is non-performing. In each of these cases, however, the prior approval of the relevant competent authority will be required.

STS criteria

This briefing is not intended to deal in detail with the STS framework as it has been the subject of significant lobbying effort. However the text box sets out the principal criteria that a transaction must meet in order to be treated as an STS securitisation. Note that this is not an exhaustive list.

STS securitisations must have certain structural features, including, by way of summary, the following:

• the originator, sponsor and SSPE must all be in the European Union;
• the assets must be transferred unencumbered to the SSPE via true sale or assignment (including an equitable assignment provided that perfection of the transfer must be effected on certain events affecting the seller);
• there must be no active portfolio management of the assets other than substitution for breach of representations and warranties;
• the exposures are a single homogenous asset type with regard to cash-flows, credit risk etc. and must be full recourse to the debtor and any guarantor;
• the exposures do not include transferable securities other than corporate bonds not listed on a trading venue;
• there are no self-certified mortgages in the pool;
• the borrower's creditworthiness meets the requirements of the Consumer Credit Directive or the Mortgage Credit Directive, as appropriate;
• no exposures are in default, at least one payment has been made under the exposures and no exposures to debtors or guarantors to whom certain credit impairment characteristics apply should be included; and
• payments in the transaction do not depend predominantly on the sale of underlying assets (allowing for roll-overs and re-financings of assets).
  
  

STS securitisations must also include the following standardised terms, by way of summary:

• the risk-retention requirement must be met;
• the transaction must not include any derivatives other than rates and currency hedges;
• reference rates used to determine interest payments are standard market rates and must not reference complex formulae or derivatives;
• there must be no significant cash trapping in the vehicle after enforcement or acceleration beyond what is required for payment of investors except in exceptional circumstances to avoid deterioration in credit quality of the assets;
• principal receipts must be applied to pay noteholders by way of sequential amortisation or must switch to sequential amortisation on the occurrence of certain asset-credit-quality triggers;
• revolving securitisations must include provision for early amortisation on occurrence of various triggers for falls in asset quality or value below certain triggers;
• the transaction documents must set out the contractual responsibilities of the servicer and trustee and include provision for replacement servicer and swap provider, liquidity provider and account bank on default;
• the transaction documents must clearly set out the remedies and actions relating to events which affect asset performance (e.g. debt forgiveness and restructuring) as well as the priorities of payments, trigger events etc.; and
• the transaction documentation should include clear provision for resolution of conflict between classes of noteholder, clearly defined voting rights and the responsibilities of the trustee.
  
  

STS securitisations must also meet additional transparency requirements over and above those that apply to all securitisations. These include:

• provision to potential investors with data on static and dynamic historical performance over at least the last five years of substantially similar exposures to those being securitised, together with the sources of the data and the basis on which the exposures are similar;
• verification by an external independent party of a sample of the underlying exposures prior to issuance to ensure disclosure of accurate information;
• the originator or sponsor must provide liability cash-flow model to potential investors before pricing, and must make it available after pricing on an  ongoing basis to investors and potential investors on request;
• where the assets are residential loans or auto loans, the originator or sponsor must make available information on the environmental performance of the assets; and
• other information on underlying exposures required by the Regulation must be made available in the case of STS transactions prior to pricing, and transaction documents, any prospectus and the STS notification must be made available before pricing at least in draft form and in final form within 15 days of closing.
  
  

For completeness, note that there are separate STS requirements for asset-backed commercial paper ("ABCP") transactions, although those are beyond the scope of this briefing. 

Transparency

The Securitisation Regulation lays down a comprehensive list of transparency requirements even for securitisations which do not meet the STS criteria. Without recreating the detailed list here, the Regulation requires that quarterly investor reports and underlying transaction documents must be made available to newly established "securitisation repositories" registered with the European Securities and Markets Authority ("ESMA"). There is, however, an exemption for private placements for which no prospectus is produced. In that case, the information must be provided to holders of securitisation positions, competent authorities and on request, to potential investors, but need not be made by way of the securitisation repository. The information on the underlying exposures and the investor reports must be made available on standard templates to be developed by ESMA within a year of the Regulation coming into force. As these provisions overlap significantly with the somewhat dysfunctional Article 8b of the Credit Rating Agencies Regulation (Regulation (EC) 1060/2009), the latter provision is repealed by the Securitisation Regulation. 

Securitisation repositories

The Regulation sets out detailed requirements for registration of securitisation repositories to which information must be provided where the transaction is public. Details of the information to be provided by the originator or sponsor to the trade repository are to be set out in the RTS. 

A securitisation repository must apply to be registered with ESMA and must meet requirements for operational reliability, safeguarding of information and confidentiality. The requirements are similar to those for registration as a trade repository for derivatives contracts under EMIR, and this Regulation provides for an extension of registration for trade repositories that wish to provide services as a securitisation repository. ESMA will have powers to require securitisation repositories to provide information, to carry out on-site inspections, and to impose penalties for failure to comply with the requirements for registration as a securitisation repository, similar to those it has in respect of trade repositories.

Securitisation repositories will be required to provide direct and immediate access to the European Supervisory Authoirities ("ESAs"), the ESRB, the European Central Bank and the European System of Central Banks, resolution authorities, national supervisors and investors and potential investors. Details of the information to be provided by the trade repository to each of the entities mentioned in this paragraph is to be set out in the RTS. 

Self-certified mortgages

Self-certified mortgages may only be included in the asset pool of non-STS transactions if those mortgages were originated prior to the coming into force of the Mortgage Credit Directive. Self-certified mortgages are banned from STS transactions altogether.

This position is something of a reprieve for the market which had had concerns about the legality of legacy mortgage securitisations following the entry into force of this Regulation. Self-certified mortgage loans have been effectively prohibited since the Mortgage Credit Directive came into force, as the lender is required to conduct a full affordability assessment prior to origination.

Synthetic securitisation

The Regulation will not, when it comes into force, allow any synthetic securitisation to qualify as an STS securitisation. However, the EBA will be required to publish a report and submit it to the Commission, who is then required to report to the Parliament and the Council of the European Union (the "Council") on the establishment of an STS framework for synthetic securitisations. Only balance-sheet synthetic transactions (i.e. transactions in which the originator holds the assets on its balance sheet and transfers risk through the use of credit derivatives or guarantees) will be considered, as the Regulation specifically rules out the application of the STS framework to synthetic transactions aimed at arbitrage activity.

Derivatives clearing and margining

Under EMIR, certain classes of counterparty to OTC derivative contracts are required to clear their OTC derivative transactions through a central counterparty. As SSPEs are currently treated as "non-financial counterparties" ("NFCs") under EMIR, they are only required to clear derivative contracts which fall into a class required to be cleared if the notional amount of derivative contracts entered by that NFC and other NFCs within its group is below the applicable "clearing threshold". The clearing threshold is currently set at EUR3 billion for interest rate or currency contracts. Hedging transactions are generally excluded from counting toward the EUR3 billion threshold.

Transactions which are not subject to the clearing obligation are generally subject to mandatory margining, unless the counterparty to the contract is an NFC under the clearing thresholds. As SSPEs are currently NFCs, and their derivatives can usually be treated as hedging transactions, they are able relatively easily to avoid falling within the mandatory margining regime. If they were to be required to margin their transactions, compliance would be difficult as there is usually no spare cash in the transaction to post to the swap provider by way of margin. If margin were required, a liquidity or other similar facility would be needed, creating additional risk as well as cost in the transaction.

The Securitisation Regulation would amend EMIR with the effect that SSPEs issuing solely STS transactions would be exempt from the obligation to clear their interest rate and currency hedges provided there is adequate mitigation of counterparty credit risk. The requirements for "adequate mitigation of counterparty credit risk" are to be set out in RTS to be made under EMIR. "Adequate mitigation of counterparty credit risk" could at first glance appear to require that SSPEs would have to exchange margin for un-cleared derivatives in order to provide appropriate risk mitigation. However, the Securitisation Regulation also provides that the ESAs should draft new RTS setting out which arrangements for SSPEs (and covered bond transactions) will be treated as adequate. Those RTS will presumably be published as part of the wider Commission legislative proposals for the EMIR review under Article 85 of EMIR, which are now being considered by the Parliament and the Council (the "EMIR Review").

Reading between the lines, it seems likely that securitisation vehicles might be given similar treatment to that given to covered bonds in the current delegated act on risk mitigation techniques for non-cleared OTC derivatives made under Article 11 of EMIR (the "Margin Rules"). If that were the case, the vehicle itself would not be required to post margin, but would be required to collect margin from the swap counterparty provided the transaction meets certain structural requirements, including that the swap counterparty is a secured creditor and ranks at least pari passu with the noteholders in the waterfall.

There is no relaxation of mandatory clearing of derivative transactions for SSPEs issuing non-STS securitisation positions. If SSPEs remain categorised as NFCs, this should not cause undue difficulty, as they can continue to discount hedging transactions from the notional amount of OTC derivatives in assessing whether they meet the clearing threshold. 

However, the EMIR Review includes a proposed change to the categorisation of SSPEs, which would mean that following the EMIR Review coming into force, SSPEs would be categorised as FCs. The proposals also apply the clearing thresholds to FCs rather than (as currently) just to NFCs, so a new category of FC+ will be created. SSPEs who are FC+ would, unless issuing solely STS positions, be required to clear their transactions. In applying the clearing thresholds, FCs will not be able to discount hedging transactions such as interest rate and currency swaps.

Any potential categorisation as an FC+ creates several difficulties for non-STS securitisations. With regard to clearing at least, a securitisation swap may not be sufficiently standard to fall within a class of derivative which is subject to the clearing obligation. However, all this means is that the SSPE would then be required to exchange margin with the swap provider instead. If no clear exemption is provided for non-STS securitisations, this would be problematic for the reasons given above. 

There has been some indication from the Council that the EMIR Review proposal could be amended to allow SSPEs to remain NFCs. However, it will be some time before the proposal is finalised and until then it is not clear whether SSPEs issuing non-STS securitisation positions may be required to find funding for additional cash-flows in the transaction to meet margin calls.

Transitional provisions

The new rules apply only to securitisations the securities of which are issued, or the initial securitisation positions of which were created, on or after 1 January 2019. Until that date:

• The current CRR rules on investor due diligence in Part Five of CRR apply to transactions either issued on or after 1 January 2011 or before 1 January 2011 but which add or substitute exposures after 31 December 2014.
• Regulated entities must continue to apply the existing risk retention requirements and due diligence requirements under CRR and the Delegated Regulation on risk retention, Solvency II, or the Alternative Investment Fund Managers Directive (as applicable to the investor) for securitisations issued prior to 1 January 2019, in the form the relevant rule applies on 31 December 2018.
• Until the new RTS on risk retention are published, originators, sponsors and original lenders must apply the current risk retention RTS made under CRR to the new direct obligation to hold the retained risk under Article 6 of the Securitisation Regulation.
• Until new RTS are published on the disclosure requirements, originators and sponsors must continue to make available the information required by the RTS made under Article 8(b) of the Credit Rating Agencies Regulation.

Retail sales

The Regulation includes a suitability requirement for sales of securitisation positions to retail customers and a limit of 10% of the client's investment portfolio where the total portfolio is less than EUR500,000.

Penalties

The Regulation includes significant penalties for breach including penalties on the originator, original lender or sponsor for failure to comply with the retention requirement. Until now, the sanction for regulated originators or sponsors has not been clear – and it has been possible to issue securitisations in which the originator, original lender or sponsor does not retain the relevant economic risk but the in-scope regulated investor accepts the additional capital charges. Whilst this meant, largely, that the investor would in practice require the originator or sponsor to retain the required economic risk, the inclusion of the direct retention requirement and significant penalties for breach (including fines of up to 10% of turnover, and bans on members of the management body of an originator or sponsor from exercising management functions) shifts the compliance burden to the regulated originator, original lender or sponsor directly.

The additional capital charges remain for banks and investment firms within the scope of CRR who fail to conduct the requisite due diligence to ensure that the originator, sponsor or original lender has disclosed its commitment to retain the required risk. While the Securitisation Regulation does not provide additional sanctions for other regulated investors, the CRR Amending Regulation discussed below preserves the imposition of additional risk weights in cases of negligence or omission by the institution. The EBA is required to draft further implementing technical standards ("ITS") to ensure uniform supervisory practice across Member States in applying these additional risk weights.

In all other cases of infringement, the Securitisation Regulation allows Member States to set out its own rules for the imposition of sanctions, including criminal sanctions.

Regulatory technical standards

The Securitisation Regulation provides for various RTS to be drafted by the ESAs to provide further detail in certain areas. We have discussed the RTS in relation to risk retention, published on 15 December 2017, above. On the same day, the EBA published a draft of the RTS to be made under Article 20 of the Securitisation Regulation detailing the criteria by which asset pools will be deemed to be homogenous, for the purpose of the STS classification (the "Homogeneity RTS"). The Homogeneity RTS apply criteria based on asset category, uniform underwriting and servicing of assets, as well as similar risk profile and cash-flow characteristics, with the aim of facilitating decisions as to which assets can be mixed within a pool, while enabling investors to conduct uniform due diligence. The draft Homogeneity RTS are also open for consultation until 15 March 2018.

Otherwise, the ESAs are required to publish, within six months of the coming into force of the Securitisation Regulation, technical standards on a variety of issues including the data that must be provided to the securitisation repositories, the nature of the notification requirement for STS transactions, the authorisation requirements for third parties issuing STS certification, and the requirements for adequate mitigation of counterparty credit risk for uncleared derivatives entered by an SSPE. 

Within a year of the Regulation coming into force, RTS are due to be published on the ongoing disclosure requirements for originators and sponsors. The ongoing disclosure requirements are currently included in the existing RTS made under Part Five of CRR, but have been carved out of the new draft retention RTS and are to be dealt with separately. Also within a year of the Regulation's in-force date, the ESAs are required to publish RTS on what will be considered to be a legitimate purpose for re-securitisation. The Commission is also required to update the current ITS under CRR governing the additional capital charges applicable to investors who fail to comply with their due diligence requirements, including ensuring that the originator, sponsor or original lender complies with its retention requirement. 

Part II - The new securitisation capital framework

The CRR Amending Regulation replaces the existing securitisation capital framework in Chapter 5 of Title II, Part Three of CRR in its entirety, with effect from 1 January 2019.

The new approaches used reflect the securitisation framework published by the Basel Committee on Banking Supervision ("BCBS") in December 2014, and amended in July 2016. The July 2016 BCBS amendments built into the 2014 BCBS securitisation framework a more favourable capital treatment for "STC" securitisation positions. "STC" securitisations are securitisations that BCBS identifies as simple, transparent and comparable, and are similar in concept to those which meet the STS criteria, although the criteria themselves differ.

The CRR Amending Regulation is otherwise fairly faithful to the BCBS securitisation framework, and the main features are set out below.

New hierarchy of approaches

The CRR Amending Regulation applies to banks and investment firms who are required to calculate capital charges on securitisation positions, whether as originator, sponsor, or investor, and also in the role of transaction parties who assume credit risk on securitised exposures (such as certain liquidity facility and credit support or swap providers). It does not apply to other regulated entities.

The changes to CRR apply a brand new hierarchy of approaches to be applied by firms in calculating their capital requirements for securitisation positions. The old standardised and internal ratings-based ("IRB") approaches will be removed, as will the supervisory formula. The current rules on the Internal Assessment Approach for ABCP transactions remain (subject to some amendment), but ABCP transactions are beyond the scope of this note.

STS securitisations will qualify for favourable capital treatment only if they meet additional requirements on top of those set out in the Securitisation Regulation. These include a cap of 2% on pool exposure to a single obligor or connected clients (unless the exposures are leases with an obligation for an eligible third party to purchase them for a pre-determined price), and the exposures are below certain risk-weight caps under the Standardised Approach in Part 2 of CRR, as well as a loan-to-value cap of 100% at securitisation. Second-ranking residential or commercial mortgages can only be included if the prior ranking security is also included in the pool.

The CRR Amending Regulation replaces the current CRR securitisation framework with a single hierarchy of approaches as follows: 

SEC-IRBA

The "SEC-IRBA" approach must be used by all institutions where:

• There is sufficient information to calculate the capital charge on the underlying pool (known as "K_IRB").
• The position is backed by a pool of exposures which is an "IRB pool" - i.e. of a type for which the institution has permission to use the IRB approach in Part 3 of CRR (the "IRB Approach") and is able to calculate risk weighted exposure amounts for all of those exposures under the IRB Approach - or a mixed pool, provided in the case of a mixed pool the institution can calculate K_IRB for at least 95% of the underlying exposure amount.
• The competent authority has not prohibited the institution from using the SEC-IRBA under new powers it has to do so on a case-by-case basis where the securitisation has highly complex or risky features.

The risk-weighted exposure amount for a securitisation position under the SEC-IRBA is calculated based on inputs including K_IRB, the attachment and detachment points of the tranche, the effective number of exposures in the pool, and the weighted average loss-given-default for the pool. The model also uses a supervisory "parameter" which operates as a capital surcharge based on the granularity of the pool, the seniority of the tranche, and the tranche maturity (the latter calculated on the basis of either a weighted average of the contractual payments to be made for that tranche, or a factor of legal final maturity). This capital surcharge is intended to cover the additional structural risk considered by BCBS to be inherent in securitisation structures.

The resulting capital requirement per unit of securitisation exposure (known as "K_SSFA(K_IRB)") is used to determine the risk weight that should be applied to tranches above those which absorb losses up to the amount of capital which would have been required for the unsecuritised pool (the "pool capital requirement"). This is done by multiplying the K_SSFA(K_IRB) for the exposure by 12.5 (as the basic capital requirement for the position is 8% of the risk-weighted exposure amount).

For tranches which absorb losses up to the pool capital requirement, the risk weight will be 1250% - equivalent to a one-for-one capital charge once multiplied by the basic 8% capital requirement. The new rules do not allow for the institution to deduct from capital instead of applying the 1250% risk weight, and this may result in a greater overall negative K_SSFA(K_IRB) effect on own funds for the institution, depending on the institution's existing capital ratio. 

For tranches wholly above the pool capital requirement, a risk weight of 12.5 x K_SSFA(K_IRB) will apply. If the tranche straddles the level of the pool capital requirement, a weighted average blend of the two measures is used. 

Finally, risk weights under the SEC-IRBA are subject to a floor of 15% unless they constitute STS securitisation positions.

Where the position is an STS securitisation position, the risk weight floor is 10%, and the capital "surcharge" can be effectively halved provided it does not fall below a set floor. 

SEC-SA

Where the SEC-IRBA cannot be used, the institution must instead use the "SEC-SA", based on the pool capital requirement calculated under the standardised approach for credit risk (known as "K_SA") with inputs for the attachment and detachment points of the tranche and the ratio of exposure in default to the whole pool. The capital surcharge for the SEC-SA is also higher than the capital surcharge for the SEC-IRBA. As with the SEC-IRBA, the risk weight floor is 15%.

The resulting capital requirement per unit of securitisation exposure (known as "K_SSFA(K_A)") is used to determine the risk weight that should be applied to tranches above those which absorb losses up to the pool capital requirement. Similarly to the SEC-IRBA, tranches up to the pool capital requirement will attract a 1250% risk weight, and those above will attract a risk weight of 12.5 x K_SSFA(K_A), with a weighted average risk weight being used for tranches which straddle the level of the pool capital requirement. If the delinquency status of 5% or less of the exposures in the pool is unknown, the SEC-SA can still be used but a standard adjustment will be made to the pool capital requirement. If the delinquency status of more than 5% of the exposures in the pool is unknown, the risk weight of the securitisation position will be 1250%.

Again, the risk-weight floor under the SEC-SA is 15%, except for STS securitisations, for which the floor is 10%, and the capital surcharge can be halved.

SEC-ERBA

Where:

• the SEC-SA would result in a risk weight higher than 25% for STS securitisation positions; or
• the SEC-SA would result in a risk weight higher than 25% or the SEC-ERBA would result in a risk weight higher than 75% for a non-STS securitisation position;
• for securitisations backed by auto-loans auto leases or equipment leases,

the institution must use the SEC-ERBA instead of the SEC-SA.

The SEC-ERBA is the most similar in approach to both the current standardised approach and IRB Approach in CRR, in that standard risk weightings of between 15% and 1250% are ascribed to securitisation positions by rating, seniority and maturity (one or five years or a linear interpolation), with an adjustment for thickness of the tranche. Senior tranches (i.e. the most senior apart from claims such as senior swap payments) have lower standard risk weights than non-senior tranches of the same rating. However the impact of 1250% risk weights to sub-investment grade positions (as in the current Basel framework as implemented in CRR) is lessened - the 1250% risk weight applies only to senior positions with a (long-term) rating of below CCC-, or non-senior positions with a rating of CCC+ and below. 

Again, there is an overall floor of 15% on the applicable risk weight for non-senior tranches, and the risk weight for a non-senior tranche cannot be lower than that of a hypothetical (equivalent in rating and maturity) senior tranche in the same securitisation.

Inferred ratings may be used for unrated positions which are pari passu with an externally rated position, or where the reference position is immediately subordinate to the unrated position. Such an inferred rating can be used provided the reference position does not benefit from additional guarantees or credit enhancement and is equal to or longer in maturity than the unrated position.

Re-securitisation

To the extent that investing in re-securitisation positions remains possible (i.e. in very limited circumstances), firms must apply the SEC-SA but using the securitisation framework for the calculation of the pool capital requirement rather than the credit risk framework, and a higher capital surcharge is used. The risk weight floor will be 100%, and there is no maximum capital requirement.

Caps on capital charges

The proposals also allow an originator or sponsor using the SEC-IRBA, SEC-SA or SEC-ERBA plus an investor using the SEC-IRBA to apply a cap to the capital charge for a securitisation exposure equal to the capital requirement that would apply to the underlying exposures under the standardised or IRB approaches for credit risk in CRR had they not been securitised. A weighted average capital requirement will apply in the case of a mixed pool. 

Where the institution has one or more securitisation positions in a single tranche, the portion of the tranche held by the institution is applied to the resulting cap to determine the capital requirement for the securitisation position, and if the institution holds positions in different tranches, the maximum proportion of interest across tranches is applied.

"Look-through" treatment

A "look-through" approach is also included, which applies to senior securitisation positions. For these exposures, a bank can apply a risk weight equal to the weighted-average risk weight applicable to the underlying exposures. The look-through will now apply whether or not the position is rated, but only applies to senior positions. This is a change from the position under the current CRR which allows a look-through only for unrated tranches and uses a concentration ratio to scale up the capital charge if the securitisation position is not in the most senior tranche.

Comment

When the BCBS published its revised securitisation framework on which the CRR Amending Regulation is based, it stated that the revised approaches would be more stringent than under the existing securitisation framework (currently reflected in CRR). 

The securitisation industry has been of the view that these resulting capital charges are in fact too high when compared with actual defaults across different asset classes, and do not provide sufficient recognition of structural features which limit risk. Furthermore, the capital surcharge used in the SEC-IRBA and SEC-SA results in the capital charge across the capital structure post-securitisation being invariably higher than the capital charge on the portfolio prior to securitisation. The concept of the overall capital neutrality of securitisation has therefore been removed in favour of an approach which models for additional risk due to the securitisation structure.