Some have lauded the Capital Markets Union securitisation reforms as a source of EU growth. Others are less optimistic
It is a truth held to be self-evident that the EU needs more developed and deeper debt capital markets to achieve higher levels of economic growth. The Capital Markets Union (CMU), of which the securitisation regulation is a high-profile component, is intended to help achieve this aim.
Leaving aside prudential matters which will be dealt with in sector specific regulation, the securitisation regulation pulls together in one place the EU’s post-crisis securitisation reforms. This is one of the regulation’s greatest virtues. However, that virtue is diluted by each EU jurisdiction being required to appoint its own sectoral regulators as competent authorities to implement and enforce the new rules. Investors will be subject to regulation, in their home jurisdiction, by their sectoral regulators. Originators, sponsors and issuers will be subject to separate regulation in theirs’ (although it’s not yet clear how regulators will be chosen for currently unregulated originators). This creates the potential for EU securitisation being covered by a patchwork of competing and possibly overlapping regulators, both within and between jurisdictions. The extraterritorial reach of each jurisdiction’s regulations also remains to be seen.
The introduction of positive requirements for originators, original lenders, sponsors and issuers could bring the substance of the EU framework nearer to the approach taken by the US. Unfortunately, overenthusiasm to ensure no free-riding has resulted in double counting, with investors being required to verify the compliance by those parties with such obligations. Investors will be responsible for verifying detailed transaction structuring and documentation requirements, which are supposed to be the responsibility of the issuer. This suggests that decision-making processes around investments in securitisations will not be quick. Investors are going to have to ensure they have sufficiently documented (and observed) processes put in place to ensure compliance with all the requirements imposed not only on the investor, but also many of those imposed on the issuer. It is perhaps too early to say that the securitisation regulation amounts to a charter for lawyers and advisers, who will scrutinise securitisation documentation on behalf of pension funds and report back on compliance with the various regulatory requirements. But it does not seem an altogether unlikely outcome.
One of the CMU’s stated aims is to reduce Europe’s supposed over-reliance on banks as a source of debt capital. However, the securitisation regulation further tilts the playing field in favour of bank originators. For instance, the requirement to verify that an originator or original lender has sound underwriting criteria and processes applies only to securitisations where the originator or original lender is not a bank or investment bank. This will both increase the due diligence burden on institutional investors looking to invest in non-bank originated securitisations, as well as the operational burden on non-bank originators. Similarly, asset-backed commercial paper (ABCP) programmes cannot benefit from the simple, transparent and standardised (STS)category if its sponsor is not a bank. Europe will not, at this rate, be reducing its reliance on bank financing any time soon.
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If you hated bailing out banks, how would you feel about bailing out securitisations? |
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The securitisation regulation introduces a new pseudo prospectus requirement for privately placed securitisations. Such a summary might be shorter and more direct than a Prospectus Directive-compliant prospectus. However it would still be a relatively detailed document, and its preparation would incur significant costs. There is also the question of whether such a pseudo prospectus is necessary in a transaction where the investors have access to all underlying documents and information. While it could provide a useful road map, it is not clear what happens if that transaction summary is inadvertently inconsistent with the final transaction. Can the investor rely on misleading prospectus liability when it should have spotted the inconsistencies in reviewing the transaction documents? Or does prospectus liability attach to the transaction summary? Either way, the summary is likely to increases costs for privately placed securitisations, but does not obviously confer a corresponding benefit on investors.
The very large amount of information originators, sponsors and issuers are required to provide to regulators also raises the spectre of moral hazard. Painful as the global financial crisis has been, some reflection as to whether the covered bond model is appropriate for all (or indeed any) financial markets is warranted. Think of it this way: if you hated bailing out banks, how would you feel about bailing out securitisations? Given the very large amount of information that originators, sponsors and issuers are now obliged to supply to their regulators, the question of ‘to what end?’ must be one that occurs to both investors and issuers.
The securitisation regulation creates a new category of STS securitisation. In fact it creates two such categories; one for non-ABCP securitisations and the other for ABCP securitisations. The intent is for the two to be broadly similar, but recognise the structural differences between the two types of securitisation. The requirements include that the underlying exposures be homogenous in type, performing, to borrowers with good credit, and be full recourse to the borrowers. The securitisation is to be clearly documented and self-liquidating, with any interest rate or currency mismatches be hedged and the portfolio not actively managed. There are also requirements, novel in Europe, for the provision of static and dynamic pool data and cash flow models. For ABCP there are restrictions on the maturity mismatches (underlying assets can’t have a maturity of more than two years) and requirements for sponsor liquidity support. While it may be clarified during the implementation phase, it is not entirely clear that any issuer will be able to comply with the hedging requirements; while clearing has been disapplied, it is not clear that collateralisation has. That no securitisation could ever fall into the STS category can’t be ruled out. The intent is that STS securitisations should receive favourable regulatory capital and liquidity bucket treatments.
Some may expect the securitisation regulation to hit its target. But it creates no compelling incentive to investors or originators to originate or invest in securitisations. The European securitisation market may yet provide growth for Europe, but it will be despite this regulation, not because of it.
By David Shearer, partner at Norton Rose Fulbright in London