Divergence in securitisation regimes: a taste of things to come?

Changes to the EU securitisation framework aimed at supporting recovery from the economic shock caused by the COVID-19 pandemic came into effect on 9 April 2021. Legislative changes to Regulation (EU) 2017/2402 (Securitisation Regulation), together with consequential amendments to Regulation (EU) 575/2013 (Capital Requirements Regulation), made under the Capital Markets Recovery Package aim to make it easier for capital markets to support the economic recovery.

Two main areas of the changes focus on:

• removing regulatory obstacles to the securitisation of non-performing exposures (NPEs); and
• extending the simple, transparent and standardised (STS) securitisation framework to synthetic securitisations.

Securitisation of NPEs

Since the beginning of the COVID-19 pandemic, European Union and Member State authorities have put in place substantial measures in order to support undertakings throughout the EU in light of the economic strain caused by the crisis. Despite the economic impact of COVID-19, a comparison of available figures[1]for quarterly bankruptcy declarations of businesses across the EU in 2020 (as against the equivalent from 2019) shows a marked decrease in bankruptcy declarations:

Bankruptcy declarations of businesses

% change compared with the same quarter of the previous year

The reduced number of bankruptcy declarations has likely been influenced, at least in part, by the economic support packages implemented at EU and Member State level. Nonetheless, the pandemic has increased the need for financial institutions to be able to manage and deal with their NPEs. Accordingly, recognising that securitisations can play an instrumental role in reducing NPEs in financial institutions' balance sheets, the amendments to the Securitisation Regulation introduce certain new definitions to, and tailor certain provisions in, the Regulation to remove obstacles to securitisation of NPEs, including:

• the insertion of a definition of "NPE Securitisation" being a securitisation backed by a pool of non-performing exposures the nominal value of which makes up not less than 90 % of the entire pool’s nominal value at the time of origination and at any later time where assets are added to or removed from the underlying pool due to replenishment, restructuring or any other relevant reason;
• the amendment of Article 6 (Risk retention) in relation to NPE Securitisations by the insertion of new provisions for calculating the size of retention. For NPE Securitisations, the retention of a material net economic interest pursuant to Article 6 is to be calculated by reference to net value (i.e. the discounted value of the NPE when securitised) rather than nominal value. This reflects that the risk for investors is not based on the nominal value of the NPEs but rather the discounted value at which the exposures are securitised; and
• provisions enabling the servicer to act as the risk retaining entity in NPE Securitisations (rather than the originator, sponsor or original lender) which reflects that the servicer of the assets may have a greater interest than other stakeholders in the debt workout for the assets and in value recovery in these securitisations.

Extension of STS securitisation framework to synthetic securitisations

In synthetic securitisations the securitised exposures remain in the ownership, and on the balance sheet, of the originator and tranching or credit risk transfer is achieved with the use of credit derivatives or guarantees. Synthetic securitisations are an important credit risk management device for financial institutions as they allow them to transfer the credit risk of typically sizeable corporate loans to investors.

The amendments to the Securitisation Regulation extend the STS securitisation framework to certain synthetic securitisations (having previously been limited to off-balance sheet / "true sale" securitisations) by the insertion of a new section that allows synthetic securitisations to be treated as STS on-balance-sheet securitisations if they meet certain criteria. This allows qualifying synthetic securitisations to benefit from the more favourable capital treatment and will free up financial institutions' capital for further lending.

The requirements are broadly consistent with the criteria for "true sale" STS securitisations; however, certain further requirements have been included to cater for the differences between synthetic securitisations and true sale securitisations. These include requirements concerning the credit protection agreement, credit protection payments, the verifications required to be provided by third-party verification agents of the accuracy of the credit protection and associated matters and the use of synthetic excess spread.

The beginning of EU / UK divergence

The Brexit on-shoring process saw the seeds of divergence sown as a number of significant changes to the Securitisation Regulation were made resulting in a UK securitisation regime which is characterised by an additional degree of flexibility not seen in its EU counterpart.

Due to EU legislative process timing issues, the amendments to the Securitisation Regulation outlined above were not on-shored into UK law. They mark a further divergence between the EU and UK securitisation regimes, and arguably an unexpected one given that the UK economy and financial services market have similarly been impacted by the Covid pandemic. Whether or not the UK will follow suit remains to be seen but we can expect the UK to keep a keen eye on the effectiveness of the EU regime changes.

What next for the UK securitisation regime?

The UK government is actively consolidating its approach to securitisations post Brexit and is viewing the UK's position with an international lens. It has made clear in its live consultation on the reform of taxation of securitisation companies that it is seeking to ensure treatment of securitisations not only keeps pace with the evolving nature of the capital markets, but also 'contributes to maintaining the UK’s position as a leading financial services centre'. Similarly, under the Financial Services Act 2021 there is a statutory obligation on the PRA, when making UK capital requirements rules, to consider their effect on the relative standing of the UK as a place for internationally active credit institutions and investment firms to be based or carry on activities.

More generally, the UK government sees the UK's departure from the EU as an important opportunity to review the UK's framework arrangements to ensure its approach to financial services regulation is right for the UK and seeks to create a framework which commands confidence internationally. The Financial Services Future Regulatory Framework Review which we wrote about here seeks to create a regulatory environment which is conducive to a stable, innovative and internationally competitive UK financial services sector.

The flexibility seen in the on-shoring of the Securitisation Regulation might well be viewed as a taster for a future trend in UK financial services regulation. We will have a better idea of whether or not further flexibility, and divergence from the EU regime based on UK actions, can be expected when HM Treasury reviews and reports on the UK Securitisation Regulation later this year.

In the meantime, market participants need to be aware of the practical impact of differences between the EU and UK securitisation regimes, particularly in securitisations with a cross-border element, and closely monitor developments for future changes.

How can Brodies help?

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To discuss the issues raised in this post or for further information on our Securitisation practice please contact Marion MacInnes or another member of Brodies' Securitisation and Structured Finance Team.

[1]Source: Eurostat (https://ec.europa.eu/eurostat/statistics-explained/index.php?title=File:Bankruptcy_declarations_of_businesses_%25_change_2020_Q4_compared_with_the_same_quarter_of_the_previous_year.png)