Council of EU holds firm to salvage STS securitisations

The Council of the European Union has blocked attempts by members of the European Parliament (MEPs) to double the current 5% risk retention rate for originators of securitisation deals in a trialogue agreement, which participants believe will save the market from a heavy blow. Other potentially onerous requirements have also been eased, Risk.net has learned.

“Ultimately, we are currently applying a 5% risk retention, so there is no change, but it does mean it is not going to get worse for asset-backed securities [ABS],” says Erik Parker, a London-based ABS strategist at Nomura.

In September 2015, the European Commission (EC) presented a proposal to establish a high-quality label for securitisations – known as simple, transparent and standardised (STS) securitisation – which would qualify them for lower bank and insurance capital requirements.

The proposal had entered the trialogue stage of the legislative process, where the EC, Parliament and Council negotiate a final draft proposal. The Parliament had controversially introduced a requirement to increase the risk retention for all securitisations (not just STS) from 5% to 10%, depending on the methodology used to retain the risk. The Council apparently rejected this change, leading to seven rounds of fraught negotiations.

Late on May 30, the Parliament and Council agreed a final draft proposal that maintains risk retention requirements at 5%, according to a statement from the Council. The full details of the agreement have not yet been published. Market participants are welcoming the return to the EC’s original drafting on retention.

“The key point is that after extensive discussions and proposals on new risk retention rules, we finally have a deal. We understand an agreement was found to maintain the 5% for all modalities with provisions for supervisors to monitor build-up of excessive risks on the market and to be ready to step up with warnings or recommendations,” says Anna Bak, a manager at the Association for Financial Markets in Europe (Afme).

Market participants had argued against increasing the risk retention requirement on the grounds that it would further harm the EU’s securitisation market by making deals uneconomic for the issuers.

“Parliament was initially asking for up to 20% – some asking for up to 25% – risk retention. The final agreement reached is effectively for the status quo. So it shouldn’t lead to a sudden surge in issuance, but equally, it removes a significant piece of uncertainty that could have had negative consequences for the ABS market if risk retention had changed to be higher,” says Parker of Nomura.

Positive outcomes

The alteration in the risk retention requirement is not the only positive news to emerge from the agreement. Two other alarming provisions around public reporting and penalties for incorrectly certifying a deal as STS have also been amended.

“We had heard that private deal data does not need to be published, [which] is also very important, and that there was a negligence and omission standard included in the STS regime – that will be welcome and is absolutely essential,” says an industry source close to the negotiations.

The Parliament introduced a controversial provision for originators, sponsors and securitisation special-purpose vehicles (SSPVs) to reveal to all investors the other investors in the securitisation and the ultimate beneficial owners. This was to be disclosed in a quarterly investor report, which would also reveal the size of each investment fund’s holding and the tranche of the securitisation held.

No one in their right mind is going to be prepared to issue STS certification as there are 55 rules and those are subject to interpretation

Ian Bell, Prime Collateralised Securities Secretariat

The threat to participants, especially dealers and fund managers, from revealing their positions is that market competitors could then target and acquire their end-clients. Two sources tell Risk.net they have been informed this provision was removed early on in the trialogue process.

One source also claims sanctions have been eased for wrongly certifying a securitisation as STS, provided the certification process was rigorous.

In the original EC draft proposal for STS securitisations, it stated that if a securitisation is labelled STS, but is found not to comply with the criteria, participants could face fines of up to 10% of annual turnover. The Council and the Parliament tightened the wording around this provision to state that penalties only apply to originators and sponsors, but it still posed a significant legal risk if they were to wrongly certify securitisations as STS.

“If you had certified a transaction as STS as an issuer and it was determined by the regulator that it wasn’t, then you are potentially open to a sanction of 10% worldwide turnover. No one in their right mind is going to be prepared to issue STS certification as there are 55 rules and those are subject to interpretation. Even if you certified something in good faith, a regulator could turn around and say they disagreed with your interpretation of one of the laws and then, in theory, you could be fined,” says Ian Bell, head of the Prime Collateralised Securities (PCS) Secretariat, an industry initiative to certify high-quality securitisations.

A source tells Risk.net that in a meeting prior to the final agreement reached yesterday, a new negligence and omissions standard had been introduced to the STS framework. According to the source, legal liability will remain on the originators and sponsors. But to impose maximum fines, regulators will have to prove the certifier was negligent.

In practice, this means certifiers will receive the heaviest fines only if the regulator proves they were either deliberately labelling non-compliant securitisations as STS or were inadequately assessing the securitisation against the STS rules.

Easing fears

“Our fear was that the additional legal criteria required to get that STS label, and the potential penalties you are then, as issuers, exposing yourself to, would have made issuers more reluctant to go for the STS label. So if the potential penalties have been watered down that should reduce the negative consequences of going for an STS label, which should ultimately mean more STS issuance,” says Parker of Nomura.

According to a spokesperson for the Council, the regime will consist of both sanctions and remedial measures, with technical discussions on the exact arrangements continuing on the basis of the general trialogue agreement.

In a public statement, the Council also stated they will allow originators to use authorised third-party certifiers. Bell of PCS says this will help originators with the legal risk involved with certifying STS securitisations as it demonstrates the originator was not knowingly acting against the law or being reckless with their certification.

“If a third party does it and the regulator challenges them, they can say, ‘We weren’t negligent because we used a third party and that third party has a licence. How can we have been negligent?’” says Bell.