Market participants have said that they now feel comfortable using the simple, transparent, standardised (STS) regime for securitisation considering that it has been in place for over a year. In spite of outstanding concerns, some are keen for synthetic securitisations to be introduced into the regime.
Sources suggest the market is overwhelmingly in favour of an STS framework for balance sheet synthetics, and generally expect this to be adopted. The big question is whether corresponding regulatory benefits will be given, said Linklaters counsel Leanne Banfield.
“From what we understand, there remains a scepticism in some parts of the EU, such as Parliament, towards synthetic securitisations,” said David Saunders, executive director, private debt mobilisation, notes & structuring at Santander.
Synthetic securitisations do not currently benefit from the STS regime other than a limited exception for certain senior tranches of SME exposures where the credit risk is transferred to a governmental entity, or an institutional investor is providing cash collateral, continued Banfield. "This could change. We are awaiting the EBA’s decision on whether the regime should be extended to balance sheet synthetic securitisations following its public consultation in autumn 2019."
KEY TAKEAWAYS
- There is debate among the securitisation industry about the introduction of an STS regime for synthetic securitisations;
- Market participants are concerned that synthetic securitisations are distrusted by policy makers in the EU;
- The industry is now comfortable using the STS process, in spite of the timescale and no clarity on disclosure templates.
There are many benefits to synthetic securitisations: they are often more efficient and come with a similar risk profile to true sales, despite their sometimes-questionable reputation.
But before the regime is rolled out to other areas of the market, policymakers and legislators need more information on the product.
Saunders added that there is a misconception that synthetics are more complicated than cash/traditional structures. “Cash structures actually require more documentation, and you need to get a legal true sale opinion. There also remains some stigma from 2008, with people still linking balance sheet synthetics with arbitrage synthetics. The market has moved on from the crisis, and the focus is now almost entirely on balance sheet synthetics only.”
A European head of private debt mobilisation added: “People tend to tar balance sheet synthetics with the same brush as the cowboy products that existed before the crisis. However, these two products are chalk and cheese. I think the EBA has gone a long way to understand the difference and distinguished these from more dangerous products, creating a best practice standard from which synthetics can be measured.”
He added that in light of Covid-19, one regulator has said that it could be beneficial for securitisation products in highlighting the value of these transactions if we see banks protected from defaults.
Ultimately, the EBA’s decision will come down to whether it would be an effective product for the market, which Macfarlanes partner, Richard Fletcher, remains sceptical about. “Investor-side clients say they don’t need STS synthetic securitisations.”
He feels the STS regime isn’t suitable for synthetics because they’re typically a more private product – and the label requires transparency.
“It could also create a cliff-edge effect,” said Fletcher. “If you give someone a badge of being STS, others will be treated as less good, which is potentially a more acute issue in the synthetics world given its size.”
What has STS achieved so far?
The STS regime was intended to increase transparency in the securitisation market and create one of the highest standards for asset-backed securities globally, but some are sceptical as to whether it has achieved that.
“It hasn’t moved the needle on market size,” said Ian Bell, chief executive at STS verifier PCS Market. “The hope that it would bring back the market remains unfulfilled.”
Bell added that the STS standard hasn’t been followed through with the commensurate benefits. “This is the highest standard of securitisation in the world, backed by the highest standard of disclosure,” he said. “A much tougher standard has been introduced, but the benefits on offer from a capital point of view fail to reflect this.”
STS securitisations can benefit from preferential capital treatment under the Capital Requirements Regulation – but it’s not a guarantee. What is more enticing for those using the label is an emerging market standard, which will spur investor interest. The goal of the STS label is to distinguish simple and transparent products from those that are more complicated – allowing investors to understand and weigh up the risk of investing in a securitised product.
“Pretty much every securitisation that can be STS has been STS, so far,” said Bell.
“2019 was a transitional year and a starting point, as it took some time to get the market started,” said Michael Osswald, managing director at STS Verification International.
For instance, third party verifiers were only granted authorisation by the regulators in March 2019, despite the regulation being effective from January 2019. “Since then, the market has developed rather nicely, with STS being the rule rather than the exception. I think that it has been a success and created more transparency in the private and public market,” he added.
According to European Securities and Markets Authority (Esma) data, 238 STS securitisations have been issued since the first in 2019. In addition, no STS securitisations have been cancelled. This is in spite of the disclosure templates technically not being in force.
“From an issuer’s point of view, we first approached this with concern about making a mistake. How would we ensure we could provide all the representations and warranties?” added the head of private debt mobilisation. “It took a lot of work for the first one, but since has worked out quite smoothly.”
Fletcher added that while public markets have gotten comfortable with STS, private markets are not seeing as much as of uptick. “This is either because deals they’re doing aren’t going to be eligible as they’re not a conforming asset class, or because the investor doesn’t need it to be STS because of the pricing versus capital benefit,” he said.
In Bell’s view, the criteria involved has been a challenge. “The fact it has over 100 criterion makes it fiddly and nuanced. It isn’t difficult, but it is time-consuming and requires knowledge and attention,” he said.
He continued that one particular issue is the definition of a credit-impaired borrower, found in article 26 of the regulation. It reads: ‘underlying exposures should not include exposures in default or exposures to obligors or guarantors that, to the best of the originator’s or original lender’s knowledge, are in specified situations of credit-impairedness’. This includes obligors who have gone insolvent.
“This is more of a data problem than people trying to push the envelope,” said Bell, adding that firms do not typically capture this information.
“Though market participants have generally gotten used to structuring these securitisations, the reporting obligations and transparency requirements have been a challenge,” said Cuatrecasas partner Jaime de la Torre.
In August 2018, Esma published its final report on securitisation regulatory technical standards (RTS) which included draft reporting templates. However, at the end of 2019, the regulator published a Q&A about revised draft reporting templates. As of today, this remains subject to review by the European Commission and has not yet been adopted into regulation.
“The market has been living with the rules but without the guidance,” said Fletcher.
This was echoed by Linklaters partner Andrew Vickery. “Overall, adapting to the new Securitisation Regulation has been relatively smooth. The most contentious aspect in practice has probably been reporting, but even there, the delay in the adoption of the new templates has given everyone more time to prepare for their use.”
The head of private debt mobilisation added that the verification agent process has been welcomed in particular, in spite of the initial opposition to verification agents from regulators. “We made the argument that although the company is responsible, it is beneficial to have an independent auditor as this also gives investors more comfort.”