The European Banking Authority (the EBA) recently published a consultation paper with proposed amendments to the regulatory technical standards (RTS) on the homogeneity of the underlying exposures in securitisation, following amendments to the EU Securitisation Regulation which allow on–balance sheet synthetic securitisations to be designated as simple, transparent and standardised (STS).
The EU Securitisation Regulation (Regulation (EU) 2017/2402, as amended) includes a framework for securitisations to be designated as STS. At the outset, this applied to asset-backed commercial paper (ABCP) and non-ABCP securitisations, but not to synthetic securitisations, which were to be considered at a later date.
A securitisation which meets the relevant STS criteria (and in some cases, other criteria) can benefit from preferential regulatory treatment, including lower regulatory capital charges with respect to the related exposures for bank investors under the Capital Requirements Regulation and for insurance and reinsurance undertakings under Solvency II, and eligibility for certain exposures in specified asset classes as Level 2B high quality liquid assets under the liquidity coverage ratio (LCR) for banks.
One of the criteria for a securitisation to be considered STS is that the pool of underlying exposures should be homogeneous in terms of asset type, taking into account the specific characteristics relating to the cash flows of the asset type, including the contractual, credit risk, and prepayment characteristics. The pool of underlying exposures is required to contain only one asset type. The EBA was required to prepare draft RTS setting out which underlying exposures shall be deemed to be homogeneous for the purpose of this requirement, and those RTS were finalised and came into force as Commission Delegated Regulation (EU) 2019/1851 (the Homogeneity RTS) in November 2019.
As part of the EU Capital Markets Recovery Package, various amendments were made to the EU Securitisation Regulation and these came into force in April 2021 (the EU Securitisation Regulation Amendments). The EU Securitisation Regulation Amendments included the introduction of an STS framework for on–balance sheet synthetic securitisations. This includes a similar homogeneity requirement, and the EBA was required to develop draft RTS in relation to that requirement.
The Homogeneity RTS provide that underlying exposures shall be deemed to be homogeneous where four conditions are met:
(a) They correspond to one of the following asset types:
(i) Residential loans secured by residential property or guaranteed by an eligible protection provider qualifying for credit quality step 2 or above
(ii) Commercial loans secured by one or more mortgages on commercial property
(iii) Credit facilities provided to individuals for personal, family or household consumption purposes
(iv) Credit facilities, including loans and leases, provided to any type of enterprise or corporation
(v) Auto loans and leases
(vi) Credit card receivables
(vii) Trade receivables
(viii) Other underlying exposures that are considered by the originator or sponsor to constitute a distinct asset type on the basis of internal methodologies and parameters
(b) They are underwritten in accordance with standards that apply similar approaches for assessing associated credit risk.
(c) They are serviced in accordance with similar procedures for monitoring, collecting and administering cash receivables.
(d) One or more of the specified homogeneity factors are applied in accordance with Article 2 of the Homogeneity RTS.
Article 2 of the Homogeneity RTS sets out homogeneity factors for the assets referred to in paragraphs (a)(i), (ii), (iv), (v), (vi) and (viii) above. Credit facilities provided to individuals for personal, family or household consumption purposes and trade receivables were determined to be sufficiently homogeneous provided that similar underwriting standards and servicing procedures are applied, so no homogeneity factors were specified for those asset classes.
On 28 July 2022, the EBA published the consultation paper, setting out proposed amendments to the Homogeneity RTS, with the intention of ensuring consistency between the requirements for non-ABCP, ABCP, and on–balance sheet synthetic securitisations by including them in a single regulation. The amendments would bring on–balance sheet synthetic securitisations within the scope of the Homogeneity RTS, and would also make further adjustments which are intended to reflect current market practice when assessing certain exposures and which would apply to non-ABCP and ABCP securitisations as well.
The EBA notes that, for certain exposures to enterprises, originators apply the underwriting standards for exposures to individuals rather than those for exposures to small and medium-sized enterprises (SMEs). As a result, the EBA considers that it is necessary to specify which asset type applies in this situation, given that one of the requirements for the underlying pool of exposures to be deemed homogeneous is that it must contain a single asset type. Consequently, the asset type referred to in paragraph 1(a)(iii) above is proposed to be amended to include credit facilities provided to enterprises where the originator applies the same credit risk assessment approach as for individuals not covered under the other specified asset classes.
In addition, the EBA notes that underwriting standards for exposures to large corporates are usually different from those applied to exposures to other corporates and SMEs. Consequently, it proposes to amend the homogeneity factors relating to credit facilities provided to enterprises or corporations to specify two separate types of obligor: (1) enterprises and corporates except for large corporates and (2) large corporates. “Large corporates” would have the meaning defined in the “CRR III” proposal which sets out certain draft amendments to the EU Capital Requirements Regulation.
The EBA also proposes to amend the homogeneity factors relating to auto loans and leases and credit card receivables, which would result in five separate types of obligor: (1) individuals and enterprises where the originator applies the same credit risk assessment approach as for individuals, (2) other enterprises and corporates other than large corporates, (3) large corporates, (4) public sector entities, and (5) financial institutions ((4) and (5) are unchanged).
Grandfathering provisions are included so that any ABCP and non-ABCP securitisations which are designated as STS before the amendments to the Homogeneity RTS take effect may continue to apply the original requirements for the life of those transactions. In the case of on–balance sheet synthetic securitisations which are designated as STS before the amendments to the Homogeneity RTS come into force, the proposal is that the amended Homogeneity RTS would apply one year after it enters into force.
It is important to note that the proposed changes will not apply in the United Kingdom, where there is now a separate securitisation regime.
Following the end of the Brexit transition period on 31 December 2020, the EU Securitisation Regulation was adopted as part of UK law, in the form that applied at that time, and was then amended by way of UK regulations to ensure that it would operate effectively in the United Kingdom (as so amended, the UK Securitisation Regulation). The EU Securitisation Regulation Amendments were made after that date and therefore do not apply to the UK Securitisation Regulation, and similarly the proposed amendments to the Homogeneity RTS will not apply to the version of the Homogeneity RTS which applies in the United Kingdom.
HM Treasury does not currently intend to amend the UK STS framework to include synthetic securitisations. However, the recognition of EU STS in the United Kingdom is proposed to be extended for a further two years, and in due course an STS equivalence regime may be put in place in the United Kingdom. For more details please see our LawFlash, United Kingdom Expected to Extend Temporary Recognition of EU STS Securitisations.
The consultation paper invites comments with respect to the proposals, in particular on various specific questions. Comments are required to be submitted by 28 October 2022.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact the author,Merryn Craske, or any of the following Morgan Lewis lawyers:
Chicago
Patrick J. Lampe
Philip W. Russell
Jeffrey D. Weinstein
London
Merryn Craske
Julian Goodman
Richard Hanson
Theresa Kradjian
New York
Reed D. Auerbach
Steven H. Becker
Harlyn Bohensky
Matthew P. Joseph
Keith L. Krasney
Steve Levitan
Edmond Seferi
Washington, DC
Asa J. Herald
Cory E. Barry
Jeffrey R. Johnson
Mark R. Riccardi
Paul R. St. Lawrence
Charles A. Sweet
Alex Velinsky