Welcome !

Welcome to the end-of-year edition of the STS Newsletter by PCS, keeping stakeholders up to date about market and regulatory developments in the world of STS.

As ever, we very much welcome any feedback on this Newsletter.

Market data – Looking back at 2022 – What the numbers tell us about STS

In this section, we will focus on specific numbers in 2022 before going, in section 3., to a broader analysis of what transpired in 2022 in the STS securitisation markets.

Please note that, differently from most year-end commentaries, we have focused on number of deals rather than volume of issuance. The reason for this is not that numbers have a greater explanatory power than volume but rather that they have a different and complementary explanatory power.

Many research firms and other commentators provide the volume numbers and it seemed of limited value to just do the same. By focusing on numbers, PCS hopes to shed not a better light but a different light on the year.

(All numbers are as of 12th December 2022 and so comparisons with 2021 are not exactly on the same basis. PCS only expects very few additional STS deals by year end though..)

The big picture

(Hover over the sections for legends)

Commentary

Europe-wide STS transactions went from 206 to 177 and term true sale transactions went from 125 to 99.

Last year’s comparison showed a misleading steep decline in EU true sale STS deals. This, as we explained at the time, was the result of legacy ABCP transactions achieving STS in 2020 and therefore falling out of the figures in 2021. This year’s decline has however nothing misleading about it. Publicly placed STS true sale transactions decreased (from 79 to 75) in 2022, for reasons we explain below.

Looking at the UK alone adds little to change to this downbeat analysis. UK STS transactions were at 18 for both years.

Asset classes

Public Transactions	2021	2022	YoY
RMBS	23	27	+17%
Auto	37	32	-14%
Consumer	12	13	stable

Commentary

As RMBS shows a slight increase and consumer loan numbers remain almost identical, the victim of the lower number of public European STS transactions is the auto sector. Last year’s asset class story had been the emergence of autos as the dominant product in number, overtaking RMBS, the previous holder of the title. This year saw its percentage of deals drop back, almost back to sharing the top spot with mortgages.

This is consistent with other market data showing that auto issuance (STS and non-STS) in 2022 was €12.5 bn. This is not only a meaningful climb down from 2021’s €16.7 bn issuance but is also the lowest auto public issuance since the GFC¹PCS is grateful to BAML for its non-STS numbers.

As for last year, non-bank/non-captives grew as a percentage of issuance at the expense of captives. The best guess though is that this is not so much a reflection of long-term trends as much as the subdued market for new cars due to supply issues. When (if?) Europe’s industrial supply chain problems are solved, it is reasonable to expect a rebalancing of the auto securitisation mix.

To be clear though, this is a relative decline for autos. RMBS issuance in the EU (STS and non-STS) is also down 21 % in volume. Even CLOs (not an STS product) went from €39 bn in 2021 to €25 bn in 2022. Placed securitisations Europe wide fell from €125 bn to €88 bn.

Jurisdictions

Commentary

Not a lot of evolution in the jurisdictional distribution except for the decrease of Germany relative to the other countries. This though seems to be primarily the jurisdictional mirror image of the decline in auto issuance, long associated with that country.

Synthetics/on-balance-sheet transactions

The number of synthetic/OBS transactions notified to ESMA as STS went from 15 in 2021 to 32 in 2022. The comparison is misleading to some extent since synthetic/OBS securitisations could only be STS as of April of last year. The comparison is therefore of part of a year vs a full year.

However, the incorporation of synthetic/OBS transactions within STS has clearly been a success and PCS anticipates that it will continue to grow as an STS asset class in 2023 and beyond.

Asked what he had found the most challenging part of being a prime minister, Harold Macmillan is reported to have answered: “Events, dear boy, events…” And how 2022 has proved him right.

When PCS looks back at its prediction section in last year’s End of Year Newsletter , there is a certain sense of pride that we had been so extraordinarily prescient. Our predictions were spot on .… or rather would have been if the year had ended on June 1st. Thereafter, not so much.

Any attempt by the writer to escape footballing metaphors in this season is as lost a cause as that of an astronaut escaping the gravitational pull of a black hole beyond its event horizon. So .…

2022 – a game of two halves

The first part of the year, until June, looked good for European securitisation as a whole and especially STS. The withdrawal of central bank liquidity was bringing traditional originators back to the market after long absences, especially in RMBS, including in the UK. The approaching January 2025 deadline for the final implementation of Basel III was also leading originators to eye “full-capital-stack” securitisations to achieve capital relief.

The previous year had been very positive for securitisation as a whole (with issuance of € 125 bn) but not so good for STS in relative terms. This year looked like the year STS would play some catch-up on CLOs and non-STS RMBS (such as BTL and NC loans).

Synthetics were going strong to add to the upbeat outlook.

Then Ukraine was invaded, followed by a panic over energy supplies, followed by an acceleration of inflationary pressures, followed by increasingly dire predictions of central bank rate hikes; the whole wrapped in a deep fog of uncertainty.

As a result, the second half of the year saw something of a collapse in public issuance. It must be noted that this was not a panic, nor was it a dead stop. Deals did get done, albeit with reduced demand, albeit often on a pre-placed basis with a small investor group.

This second half can itself be divided in two. From June to October, the driver of reduced issuance was entirely price volatility. An originator was reluctant to go to market with initial price talk at 60 bp to find that it was having to pay 90 bp on the day of pricing. On the other side of the equation, an investor was reluctant to buy at 60 bp to find that the same paper would be trading at 90 bp at the end of the year, forcing a mark-to-market loss. So both stayed away.

By October, the macro-economic outlook for Europe dimmed and credit concerns began to creep in – especially for less “top end” issuers. These credit concerns fed into investor expectations on price and resulted in deals being postponed or pulled by originators not willing to pay the new spreads.

Miscellaneous observations on 2022

Securitisation is part of fixed income…

Although, in itself, a fairly trivial observation, it is important to see what happened to STS securitisation as part of what happened to securitisation; and what happened to the latter as part of what happened to fixed income generally. The increase in spreads seen in STS securitisations broadly reflect increases seen in the whole fixed income market in 2022 (with somewhat of a timing lag for securitisation both on the increase and the decrease).

…but that is not the whole story

As securitisation volumes dropped in 2022, covered bond issuance hit an all-time high at €210 bn for benchmark issuance and probably about three times that for overall issuance.

For years now, the regulatory community has deflected responsibility for the weakness of the European securitisation market away from an inappropriate regulatory framework to the monetary policy of the central banks. This led them to predict (or strongly imply) that tighter monetary policy would lead to a growth in issuance. This year has proved them partly right. There was growth in issuance. It is just that all of it was in covered bonds. PCS invites regulators and policy makers to draw the correct conclusions from the data and focus on fixing the regulatory framework.

Privatisation: no need to panic

Policy makers have been concerned by the number of deals going to the private STS market as against the public market. First, the numbers for this year indicate that this is not a trend. Last year saw 79 public transactions against 127 private ones. In 2022 so far, 75 public deals compete with only 102 private ones.

But also, PCS has seen a number of deals scheduled for public distribution that were “privatised”. This includes technically public securitisations that were, however, pre-placed with a very small group of investors as well as private transactions with banks. In all cases PCS has dealt with, these “privatisations” reflected concerns of price volatility (see above) and never over the regulatory burden of private versus public disclosure.

The liquidity story

When limiting the types of securitisations eligible for inclusion in regulatory liquidity coverage ratio pools under the CRR and confining them to the lowest category (2b), banking regulators have cited the alleged illiquidity of this product. Similar considerations are adduced under Solvency II to punish STS securitisations held by insurance companies.

However, one key feature of 2022 has been to demonstrate these concerns are misplaced. Secondary trading in 2022 was the highest since the GFC at €60 bn. More anecdotally but powerfully indicative, in the dark week of the UK’s mini-budget meltdown, when the bid for the 30-year gilt vanished, £4 bn of asset-backed paper traded in the secondary market without a hitch.

The myth of the illiquidity of the asset-backed market was further debunked in a paper by Risk Control that PCS urges regulators and policy makers to read, and which may be found here.

With regards to Solvency II, PCS continues to be puzzled by the assertion that the Solvency II calibrations are fit for purpose when the capital requirements for having an illiquid pool of whole mortgages on the balance sheet remains lower than the capital required to purchase a highly liquid AAA rated senior tranche of a securitisation benefiting from substantive credit enhancement of the same pool of mortgages.

Predicting the future has always been somewhat of a quixotic endeavour but today we suspect it is positively delusional.

In this section, we try to identify the events and phenomena that are likely to be important in determining the course of the STS market. But if it is prediction you seek, honesty forces us to advise that a quick trip to the local supermarket to purchase a chicken followed by some judicious toying with the bird’s entrails is as likely to yield an accurate result. This is the world we live in. “Events, dear boy, events…”

The fundamentals are still favourable to STS

Central bank policy is likely to continue to reverse the quantitative easing of the last few years. This leaves banks with substantial amounts of TLTRO, TFS and TFSME cash to repay and replace by other types of funding. As we saw above, much of that funding is going to be through covered bonds. But strategically minded banks will be inclined to avoid putting all their funding eggs in the same basket and should seek to issue some securitisations.

The role of non-bank lenders is likely to continue to grow. These players cannot access covered bonds and have credit ratings too low to access non-equity financing at a commercially viable rate.

The final implementation of Basel III deadline of January 2025 will be one year closer in 2023. This will require banks, if they wish to preserve their lending envelopes, to raise meaningful new capital or reduce risk-weighted assets (RWAs). The latter, short of portfolio sales, can only be achieved by securitisations – whether in traditional or synthetic format.

Finally, the price volatility of 2022 has left a decent size overhang of transactions which were originally scheduled for this year. Should volatility abate and spreads land in an acceptable place, those postponed securitisations could result in a strong recovery in early 2023.

But the headwinds are rising

Fears of recession are growing.  A meaningful economic slowdown in Europe could negatively impact securitisation in two ways. 

First, credit concerns could push up spreads to levels that make it impossible or deeply unattractive for issuers to come to market.  In particular, there is the impact of high spreads on the securitisability of pools generated in lower interest rate environments – “underwater pools”.  These can be securitised, of course, but only if the originator takes a “loss on sale” impact to its P&L.

From January to October 2022, spreads rose inexorably for all asset classes in all jurisdictions.  Senior auto paper trading at 4 bp in January was trading at 50 bp in October.  Dutch RMBS that could be purchased at 11 bp in late January would cost you 65 bp by late October. Since then, spreads in the secondary have pulled back a little.  A key question of 2023 will be whether spreads continue to retrace their steps and how far down they will go before stabilising, or indeed if their rising resumes.

Secondly, a recession may slow the generation of new loans.  This will reduce the volume of primary assets capable of being securitised, as well as the need for financing.

Conclusions?

If the lights do not go out over winter in the largest economy in Europe, and Russia does not resort to a nuclear attack, and China does not invade Taiwan to distract from a botched COVID policy and slowing economy, and central banks do not dreadfully overshoot on rate rises tipping the economy into deep recession, and central banks do not fail to tame inflation leading to major industrial unrest and no foolish archaeologists decide to open that tomb covered in mysterious undecipherable markings despite the terrified warnings of the local autochthonous population then ….

We think that we will see a fairly decent first half of 2023 in STS with a quieter second half.  We think overall issuance will be better than 2022 but not dramatically so. We also see synthetic STS issuance continuing at roughly the same pace.

We think the UK will play a bigger role in overall issuance than it has over the last few years.

But then again, you might want to double check against that chicken liver.

The new dispensation

On December 9^th, the Chancellor of the Exchequer unveiled the roadmap to the post-Brexit reform of the regulatory framework for British finance.

Although overshadowed by more headline grabbing subjects such as the future of ring-fencing and bankers’ bonuses, proposals around securitisation were part of the package.

To summarise, since Brexit and during the post-Brexit negotiations, the Treasury kept its powder dry.  Other than promising to devolve large sections of financial regulation from legislative acts, where the European Union had placed them, to regulatory handbooks drafted by the FCA and the PRA, little indication was given about the overall direction of travel.  In particular, it was not clear whether UK rules would stay almost identical to those in the EU in the hope of access to the European market or whether the UK would go it alone.

Maybe it is the result of the new-new-new UK government being run by free-trade, deregulating, “Singapore-on-the-Thames” Brexiteers.  Maybe it is the recognition that, having left the club slamming the door, the club trustees were not going to allow you to still use the clubhouse for free. Either way, the British government has now openly opted for the go-it-alone and make your own rules approach.

However, because the government has also – as promised – devolved most of the technical rulemaking to the FCA and the PRA, it is not clear how deeply the new securitisation rules will differ from the current rules inherited from the EU.  But that will depend primarily on the views of the regulators rather than those of the politicians.

Securitisation proposal

The current proposals for the UK regime unveiled by the Treasury were published in a draft statutory instrument (an application decree/level 2 instrument for our continental readers).

The draft can be found here.

There are quite a few highly technical drafting changes the implications of which are still somewhat unclear.  But here are the highlights.

The definition of “securitisation” remains unchanged.

The STS regime remains in place.   However, the criteria of what makes a securitisation STS have disappeared from the legislative text altogether and are now entirely delegated to the FCA to draft.  Presumably, the FCA will have a consultation to determine what criteria need be met for a securitisation to achieve the STS standard.

Intriguingly enough, with the criteria for STS having disappeared from the draft legislation and, in the absence of a definition of “non-ABCP securitisation” the proposed text appears to leave open the possibility of synthetic securitisations being STS.  This seems now to be in the gift of the FCA although it should be noted that so far the PRA has shown a marked reluctance to assist synthetic securitisations.

The third-party verification and data repositories regimes are kept broadly unchanged.

In line with the free-trade approach of the Treasury, an equivalence regime for STS is set out, with the Treasury deciding which jurisdictions may benefit. 

In a similar vein, the exemption for the special purpose vehicle having to be in the UK is maintained.  The originator and sponsor though need to be UK located.  (However, the concession that allows EU STS to be treated as STS in the UK until December 2024 remains in place.)

Oddly, in our view, the text allows for re-securitisations – which are banned in the EU.  However, any re-securitisation transaction will need to be pre-approved on a deal-by-deal basis.

Retention and disclosure requirements are still in place but the text seems to allow non-UK issuers to sell to UK investors provided they comply with substantially the same standards.  So the total identity of standards required by the EU has been abandoned.

Bear in mind that this is merely a summary of the high points and the document is still a draft.  It could change quite a lot before becoming law.

• Hot off the press, the Joint Committee’s response to the European Commission’s call for advice came out on December 12th. As Christmas presents go, the regulatory Santa must have thought the securitisation community had been very bad in 2022 and only deserved a long, wordy lump of coal this year. For a first blush reaction, you can read our News Item.
• The definition and rules around future green securitisation are still part of active discussions between the European Parliament and the European Council which, together with the European Commission, are currently negotiating the final text of the forthcoming EU Green Bond Standard Regulation.  It is expected that something will be emerging within the next few weeks.
• In 2022, PCS has brought out its European Symposia Series. These one day complimentary events are devoted to the securitisation market in each specific country as well as across Europe, including a look at current trends and possible future developments. The events offer a chance to meet securitisation experts, regulators, originators, arrangers, investors and servicers, discuss market trends and build relationships. In 2022 we have held Symposia in Warsaw, Lisbon, Athens, Helsinki, Brussels and Milan. For our 2023 calendar see Stakeholders Calendar.
• Two studies were published recently by Risk Control.  The first is an analysis of the relative liquidity of Corporate Bonds, Covered Bonds (CB) and Asset Backed Securities (ABS). The main finding is that the relative liquidity of ABS shifted significantly after 2016, becoming superior to that of CB. The paper may be found here.  The second is a detailed study of how the new output floors regime within Basel III will affect bank incentives to securitise loans. The main finding is that securitisation of some asset classes, most notably corporate loans, will be greatly discouraged whereas that of residential mortgages will actually be boosted. This paper may be found here.
• In the Netherlands, DNB came with news about the way they are going to fill in their role as STS supervisor going forward. From November 1^st, 2022, DNB will no longer send an assessment of each deal to the institution that had notified the transaction. Instead, they will start conducting investigations at institutions in order to review the arrangements, processes and mechanisms that have been implemented to comply with the Securitisation Regulation. This resembles the approach of the French AFM (as described in our previous Newsletter).

We would like to take this opportunity to celebrate the ten years of the PCS initiative and thank our readers and other stakeholders for their support through a decade of seeking, with their help, to support the European securitisation market as well as to convey our season's greetings and best wishes for the new year.

So, from London, Paris, Milan, Munich, Poznan, Amsterdam and Banholt, the Outreach Team and the Analytical Team from PCS send you Season’s greetings and wish you a happy, prosperous and, above all, healthy 2023.

Regulatory state of play

Between consultations on regulatory technical standards which are key to the functioning of the market (SES, homogeneity, SRT) and more in-depth reviews of entire segments of the regulatory architecture (Securitisation Regulation review, Call for Advice on the CRR and Solvency II) it seems that there is great potential for progress for the EU stalled market. Yet, is this more light than heat?

In this edition we look in more detail at the European Commission’s report on the Securitisation Regulation and what lessons it may hold.

EC report on the functioning of the Securitisation Regulation

On October 10^th the European Commission released its report on the functioning of the Securitisation Regulation. The Commission was obligated by the regulation itself to produce such a report. (The obligation was in article 46 of the regulation which is why you will see it mentioned by some commentators as the “Article 46 Report”).

Some General Points

First, we were heartened to read the full support for the revitalisation of the European securitisation market displayed in the report’s introduction and the reiteration by the Commission of the benefits such revitalisation would bring to the real economy. PCS hopes this vocal support will be met by equally strong practical legislative and regulatory steps but some recent public pronouncements and proposals from supervisory authorities make us wary that each oratorical step forward could well be met by a practical step backwards.

Secondly, reading between the lines, it seems that a driving force behind the report was the avoidance of any recommendation requiring an amendment to the regulation itself rather than to delegated acts: in the lingo of Brussels, any changes to the level 1 text. PCS is not unaware of the political calculations that may lie behind this position. But it is an unfortunate self-limitation particularly when looking at disclosure for private transaction – as to which more below.

Finally, for those who pay attention to these things, the report does not deal with the burning topics of the CRR capital requirements for banks investing in securitisations, the liquidity coverage ratio (LCR) eligibility criteria or the Solvency II capital requirements for insurance investors. As these key rules appear in other regulations than the Securitisation Regulation, the Commission not unreasonably deemed them “out of scope” of this report. These issues, of course, are the subject of a Call for Advice issued by the Commission to the Joint-Committee of the ESA’s which was supposed to be produced by September 1st and should emerge any day.

What the report does deal with are the following topic:

• Risk retention
• Investor due diligence
• Private vs public transactions and disclosure
• STS equivalence regimes for non-EU transactions
• Green securitisations and the EU “Green Bond Standard”
• Third party verification agents in STS
• Using limited licensed banks instead of SPVs
• Non-EU issuer obligations for sales to EU investors (the “jurisdiction issues”)

Risk retention

Here the Commission decided all was working as it should and no changes need be made to the rules. This seems sensible.

Investor due diligence

The Commission acknowledged the view of many, both on the sell and buy sides, that the mandated disclosures in the ESMA templates were disproportionate. It also noted what we have repeated many times: even if the disclosure requirements for securitisation can be defended on their own merits, there are no equivalent or even remotely as onerous requirements on similar instruments. This uneven playing field encourages regulatory arbitrage and is a major headwind to any revitalisation of the market.

Unfortunately, the Commission did not address the issue of the uneven playing field. It did provide a small silver lining by requesting ESMA to revisit the templates with a view to slimming them down. This is certainly better than nothing but, we feel, side-steps the crucial problem of the discriminatory treatment of securitisation compared to other instruments.

Private vs public transactions

The Commission addressed the fear that a rise in private securitisation transactions was occurring as a result of issuers trying to avoid the disclosure requirements of public deals. Based on our own experience, we are fairly certain this is not the case. The report wisely concluded that there was not enough evidence to decide either way.

On the use of the same templates for private and public transactions, the Commission is asking ESMA to devise a dedicated private transaction template. The twist though is that the Commission seems to accept that such template is not required by or for investors. It wants one for supervisory authorities.

Our own view, communicated to policy makers, is that the dilemma of not allowing, on the one hand, capital market deals to “hide in the private shadows”, to use a somewhat overdramatic expression, but without, on the other hand, burdening bank lenders with unnecessary data requirements is to redraw the public/private line away from where it is now (on the use of a prospectus). It seems more prudentially logical to distinguish between (a) capital market instruments and (b) traditional relationship banking facilities.

The advantage of this approach is that traditional banking facilities (including ABCP and warehouse facilities), together with the banks’ due diligence processes, are already regulated by banking supervisors. Such deals should not require any obligatory disclosure since banks’ existing due diligence should be sufficient. Public deals defined as capital market instruments with non-bank investors (or bank treasury investors) would require the extensive disclosure templates produced by ESMA. Sadly, this would require an amendment to the level 1 text which the Commission does not appear willing to contemplate.

If ESMA is going to draw up new templates based on the needs of supervisors, we urge the supervisors to provide ESMA with a realistic list of the data they will genuinely use in their supervision rather than a laundry list of all the data they may wish to use in an ideal world.

STS equivalence

A number of market participants wished the Commission to grant an equivalence regime so that issuance from non-EU originators meeting local requirements could be treated as STS when held by EU investors. The Commission pointed out, rightly in our view, that outside the UK no jurisdiction had anything close to the EU STS regime and so equivalence was not relevant.

As for the UK, the Commission skirts the question which, let us be honest, is one of high politics rather than technical standards.

Green securitisation

The Commission endorsed the position of both the EBA and the ECB (as well as that of PCS and the majority of market participants) that there should be no special regime for green securitisations and that these should be governed by the general principles laid out in the European Green Bond Standard – namely that an instrument is green if the money raised is used for green purposes.

Third party verification agents

The Commission decided all was working well and no changes were required. We agree.

Limited licensed banks

Someone suggested that the Commission look into the idea of using limited licensed banks instead of SPV’s to issue all securitisations. The Commission concluded – as did pretty much everyone else – that this was a terrible idea.

The jurisdictional scope

This is likely to be the most controversial part of the report.

From the moment it passed, the regulation has contained an ambiguity as to whether non-EU securitisations were required to conform to the mandatory provisions imposed on EU securitisations – specifically the retention requirements, the disclosure requirements and the obligation not to cherry pick assets. In other words, was the Securitisation Regulation extra-territorial or did it only apply to EU deals.

This ambiguity was made worse when the Joint-Committee of the ESAs took a hard line on interpretation arguing not only for extra-territoriality but for imposing on non-EU deals not only EU obligations but the requirement of EU located liable party e.g. EU based retention holders.

The report pulls back from the Joint-Committee’s more extreme view that the law requires EU based entities to be involved in all non-EU securitisations sold to EU investors. However, it does endorse a wide extra-territorial approach. For the Commission, any non-EU securitisation sold to EU investors does need fully to comply with all the Securitisation Regulation requirements.

Since EU supervisors cannot control non-EU parties, the Commission also throws the obligations to ensure that non-EU transactions meet the EU standards on EU investors. EU investors, of course, are subject to sanctions by EU supervisors.

In theory, a non-EU issuer who wants to sell to the EU could choose to meet all the retention, disclosure and no-cherry picking requirements of the Securitisation Regulation. This is not therefore a legal prohibition on EU investors buying non-EU deals.

In practice, unless the European bid is a large part of the investor bid for any deal, it is hard to see why an issuer would meet all of its national rules (e.g. Reg A B in the US) and all the European rules. This interpretation may well be the death-knell of European investors capacity to purchase non-European securitisations, at least directly.

PCS’ own mandate is to focus on European securitisations, so we do not have an official position on this subject. We do have much sympathy for the Commission’s position. Yet, we do wonder if there would not be a less extreme approach that would allow EU investors to purchase non-European deals that substantially meet all the Securitisation Regulation’s requirements.

Other stuff

The report was also bad news for non-EU Alternative Investment Fund Managers (AIFM) who had hoped not to have to comply across the board with EU rules if they were small or if they only marketed a few funds in the EU. The answer, as far as the Commission is concerned, is if you are an AIFM marketing a single fund in the EU, whatever your size, you will have to comply with all the Securitisation Regulation obligations on institutional investors.

Also, the report looked at the supervisory framework – grounded primarily in the national competent authorities – and found no cause to change the current system. Considering the Commission’s reluctance to amend the level 1 text, this is unsurprising.

The report does note the risk of divergence in a system based on national authorities. This echoes concerns voiced by the ESAs and may well be the harbinger of greater attention and cooperation across European national regulators.

Conclusions

On the whole, this is not a bad report although it does miss opportunities for change – especially around private transaction disclosure.

It also clearly lobs the ball into ESMA’s court on some key issues around disclosure. We hope that ESMA will be bold when dealing with these matters and take the opportunity substantially to improve the situation in line with the Commission’s strong support for measures that support the market.

Also, as we have said in our news item when this report came out, much of the key battles still need to be fought around the CRR, LCR and Solvency II amendments.

In this respect, we would like to quote the last paragraph of the report in full:
“The Commission remains fully committed to the aim of creating the framework for a thriving and stable EU securitisation market. Such a market is an indispensable building block of a genuine Capital Markets Union and might become even more important for tackling the challenges of financing economic activity in the significantly more difficult market environment that seems to be evolving at the moment. The Commission will therefore continue to closely monitor the securitisation market and intervene, if and when deemed appropriate, to fully reap the benefits of a thriving securitisation market for the EU.”

We could not have put it better ourselves.

Remember, as always, that PCS’ data is by deal rather than, as many research houses do, by volume.  This is not that this is a better way of presenting the data but it is a different way of presenting the data which, hopefully, reveals additional information.

In the ten years since our founding, PCS has continually strived to improve the ways in which it helps the market. As part of that mission, PCS started a series of symposia across Europe aimed at investors, issuers, regulators and other market participants.  In each symposium we combine a Europe wide view with a local focus

Each complementary event covers fundamental principles as well as the most recent market and regulatory developments. It explores the benefits of securitisation as a crucial mechanism for financial institutions in obtaining funding but also in achieving capital relief. We have been honoured by the participation of experienced voices from the buy side, sell side, legal but also supervisory authorities.

PCS has already held symposia in Warsaw, Lisbon, Athens, Helsinki and Milan which attracted over 350 attendees.

For the upcoming symposia in Brussels, Dublin, Amsterdam, Madrid, London, Paris and Frankfurt see Stakeholders Calendar.

PCS has a new website.  In addition to the traditional sections on verified transactions, the new site has added troves of new resources for anyone looking for information on securitisations.  From the curious novice to the hard core practitioner looking for some highly technical information, the PCS website should be your first stop.  Up-to-date market information, regulatory texts, webinars and presentations on key topics, all and more is there.

PCS is a compact organisation with a total staff of 15.

In each newsletter we will introduce one of them so that people get to know us. This time, Max Bronzwaer, Member of the Board of PCS UK and PCS EU and member of the Outreach Team.

For any questions or comments on this STS Newsletter you can contact the PCS staff.

Ian Bell	CEO	[email protected]
Mark Lewis	Head of the Analytical Team	[email protected]
Martina Spaeth	Member of the Analytical Team	[email protected]
Rob Leach	Member of the Analytical Team	[email protected]
Fazel Ahmed	Member of the Analytical Team	[email protected]
Daniele Vella	Member of the Analytical Team	[email protected]
Rob Koning	Issuer Liaison	[email protected]
Harry Noutsos	Issuer Liaison	[email protected]
Ashley Hofmann	Director Market Outreach	[email protected].org
Max Bronzwaer	Member of the Board of PCS UK and PCS EU and member of the Outreach Team	[email protected]

A time of opportunity, a time of danger

A war in Europe with no plausible endgame, the specter of a global food shortage or worse, the reality of inflation yet the threat of recession, a China that hangs in pandemic and economic limbo waiting to see which way the government will turn not just for the short term but also for the longer horizon and an accelerating and obvious climatic deterioration: uncertainty is not new to the world but often the range of outcomes is fairly constrained (the Dotcom crash of 2001) or the direction of change broadly understood (the oil crisis of 1973 – downward - the fall of the Berlin Wall – upward). Today, the citizens of the world seem to hold their breath as its policy makers, despite the firm speeches and confident messaging, appear tentative if not downright lost.
Before these truly global challenges, the travails of the European securitisation industry may seem below trivial. But we do not mention these challenges to generate despondency. First, we believe that the revitalisation of European securitisation could be an important component to a positive outcome for a number of these challenges. For example, even if we do not hold much hope that the success of Dutch RMBS will have an impact on the course of “Xi Jinping Thought”, it can play a key role in inflecting the course of climatic degradation. Secondly, and this is the main argument of this article, as with so much around us, European securitisation finds itself in a state of great uncertainty, with future outcomes that range from the best to the worse. And which comes to pass depends on the cumulative decisions to be made by policy makers in the coming months. The regulation of securitisation and finance generally does not operate in a self-contained technocratic bubble. Uncertainties at the macro-political level (including in central bank decision making) trickle down to what can appear to be remote reaches. In the coming months, a number of seemingly disconnected technical and oftentimes abstruse decisions (green bond definitions and capital requirements, disclosure templates and revisions to the insurance industry regulatory architecture) will play a major role in determining the fate of securitisation in Europe.
These are listed below but without going into details. The details are fairly well known and we have covered them in articles and newsletters before. The aim of going over them once more is to draw attention to their number and their interconnectivity. It is easy to see each one as a separate highly technical matter best suited to a technocratic solution. In reality, they should be approached with a full understanding of their collective capacity to shape the European securitisation market and send it towards gentle oblivion or towards playing a decisive role in funding both Europe’s growth and its transition to a sustainable economy.
With an understanding of the cumulative and inter-connected impact of these decisions we hope to encourage the securitisation community to mobilise in a coordinated way to push for the finalisation of the reforms started by the Securitisation Regulation in 2017. ¹See for example, “Securitisation: the Indispensable Reform” (Eurofi- page 58) This will require that we act together and not focus narrowly on the one or two issues that concern specifically our institutions. Even if you are not active in residential mortgage lending, the issue of green templates for RMBS should concern you. Without a viable ecological niche for securitisation in the green capital market eco-system, all securitisations will struggle. Workable templates for RMBS are part of making that niche viable.
On the policy making side, we hope to encourage concerted and centralised action at the level of the European Commission, of individual member states acting through the European Council or individually and of the European Parliament to push forward these issues as a package. We hope that these are seen as part of a global solution rather than a fragmented series of decisions to be looked at by different institutions or different departments separated by more-or-less watertight bulkheads. This is not to dismiss the institutionally necessary separate roles of the various actors. The EBA must provide the technical advice on bank capital requirements and the co-legislators must decide level 1 norms. Our plea is for this process to be integrated and coordinated across the various initiatives.
So, what are these decisions in the coming months that require a singular will and coordination?

CRR Calibration

The Commission has asked the Joint-Committee of the ESA to report back by September 2022 on a series of possible changes to the current regime. The EBA will be asked its views on the appropriateness of the calibration of the capital requirements for prudentially regulated bank holding securitisations.
PCS, together with the securitisation community, has long argued that the current calibrations simply do not reflect the data and, especially for STS securitisations, the structural qualities generated by the standard. In particular, the removal by the STS criteria of the totality or quasi-totality of the agency risks that underpin the infamous p factor should be properly reflected in the rules.

LCR eligibility

This is also part of the Commission’s request for advice.  This is an issue the importance of which is often underplayed.  The current rules for when a security is eligible to be included in a bank’s liquidity coverage pools do not reflect, once more, the data for their liquidity.  Since this was first determined in 2014, yet more data has confirmed the original analysis.  PCS has been told by a number of banks that whether a capital instrument can be included in the LCR pool (and with what haircut) is often a key determinant of the investment decision.

At a recent EBA roundtable, the banking regulators though expressed a great reluctance to engage with this particular point and the community will need to be both very focused and convincing if any progress is to be achieved.

Solvency II capital requirements

Again, this is part of the Commission’s call for advice. This time the ball is in EIOPA’s court. Currently, as with capital requirements for bank investors but even more egregiously so, the capital requirements for an insurance company holding a securitisation are often way in excess of its actual risk. The reasons for this are technical but result, by way of illustration, in the capital required by an insurance company to purchase a pool of whole loan residential mortgages with all the embedded risk being lower than the capital cost of holding the AAA tranche of the same pool in securitised format. The latter being securities that saw no loss whatsoever in Europe throughout the depth of the crisis and stresses experienced since 2008.
The reform of Solvency II is the Cinderella of this tale. Probably the most impactful change that could be made to the securitisation regime, it is the one that attracts the least interest and attention. Why? Because insurance companies no longer invest in securitisations – courtesy of the current regime. Insurance company holding in securitisations were down to 2.5% of their total book and holding of high-quality STS securitisations to a derisory 0.05% ²“Joint Committee Report on the Implementation and Functioning of the Securitisation Regulation” (page 43). So securitisation is not seen as “an issue” for most insurance companies preferring to expend their political capital on problems that are on their balance sheets rather than on those that could be, in a better world. This leads EIOPA to downgrade securitisation reform on its list of interest.
Yet fixing Solvency II and introducing a more rational capital requirement framework for insurance undertakings is probably the most meaningful of the calibration reforms.

Excess Spread RTS

The EBA is to publish its draft excess spread regulatory technical standard. A sensible approach to this most technical of issues is a key to allowing banks to extend the use of synthetic/on-balance-sheet securitisation for capital management.
With the finalisation of Basel 3 approaching, including some version of the output floor, the capacity of the European banking sector to finance growth in the economy and the green transition will be sorely challenged by capital requirements. Providing a safe but efficient capital management toolbox is crucial for a continent where 75 % - 80 % of all financing still comes from banks. ³This is in marked contrast with the US that can take a more sanguine view of capital requirements when (a) only 25 % of finance comes from the banking sector and (b) not all that banking sector is subject to Basel 3 The stakes are high.

Homogeneity and trigger RTS

Less crucial than the previous RTS, the EBA must also publish RTS’ on the definition of homogeneity in synthetic/on-balance-sheet STS transactions and define certain permissible triggers.
This is an opportunity, which we are confident the EBA will seize, safely to optimise the capacity of those securitisations to allow efficient capital management.

Synthetic/on-balance-sheet STS securitisation guidelines

Maybe not the most high-profile expected regulatory publication, the EBA will be drafting guidelines to interpret the STS criteria for synthetic/on-balance-sheet securitisations. Experience from the true sale guidelines, a broadly sensible and reasonable set of rules, shows that a workable approach to the detailed definition of STS should not be neglected by the securitisation community. EBA guidelines have the capacity to empower or disable whole market segments.

Green securitisation definition

We commended the recent report of the EBA⁴“EBA publishes an excellent report on “Green Securitisation” on green securitisation and especially its conclusion that securitisation did not require its own sustainability regime. Securitisations are capital market instruments and should therefore participate of the general regime for green bonds.
For securitisation, the key issue here is whether a green securitisation is a securitisation of green assets or a securitisation where the proceeds of the issuance are used to fund the transition. The EBA, the ECB, trade associations such as AFME and we at PCS are firmly of the view that securitisations should be treated as any other financing and be defined as green by the use of their proceeds. This is not just a pro-securitisation point. It is a pro-sustainability point. This approach maximises the financing of Europe’s green plan.
But technical issues in the drafting of the EU Green Bond Standard regulation have put in doubt this approach and we encourage the co-legislators to introduce the necessary amendments to remedy this problem.

General disclosure rules

In addition to the specific disclosure rules for green securitisations, as part of the review of the securitisation regime being conducted by the Commission an examination of the appropriateness of the current disclosure regime may be on the cards.
Although PCS is strongly in favour of a very robust disclosure regime, it cannot be denied that some of the current rules generate substantial amounts of data that, to all intents and purposes, are examined by absolutely no-one: not investors, not researchers and not regulators. The value of extensive disclosure in certain types of private deals that flow from traditional banking relationships is also highly questionable. Finally, the imbalance between securitisation disclosure requirements and the disclosure requirements attaching to other asset-based financings remains as egregious as it is inexplicable. Such unlevel playing fields generally bear a high risk of creating dangerous regulatory arbitrages and in the case of securitisation we believe they have indeed already done so.

A revision of the disclosure requirements would be very welcome.

The United Kingdom

All the above has focused on a constellation of decisions to be made by and within the European Union. But the UK market is bouncing along the bottom in terms of issuance.
Almost every single one of the changes described above has its UK mirror. In addition, the UK does not have a synthetic/on-balance-sheet STS regime at all which is not only unfair on UK banks but will likely constrain their capacity to fund future growth.
We therefore urge both the UK authorities and the UK securitisation community to move decisively in the direction of an improved and more rational securitisation regime along the same lines as those mentioned in the context of the European Union.

Conclusion

Through a myriad steps, Europe has the opportunity to bring about its declared aim to revitalise a safe securitisation market .… or bury it. To make it succeed, the highest policy making bodies must approach all these steps with a unity of purpose and intent. They should not see them as individual disparate steps amenable to separate technical solutions but as the components of a whole that need to work together for the common purpose.
The benefits of a strong securitisation market have been analysed at length and are pretty universally and publicly recognised. Now, once again, European securitisation stands at cross-roads. Yet, differently from 2013/2014 when all knew that the market would either survive or die through regulatory change, today, when the choice is maybe no longer survival but relevance, the importance of the moment may be less well understood.
Will securitisation dwindle into a small niche market or become the force it needs to be to fund the European economy and green transition?
That is what the decisions that will be made in the next few months will determine.

Remember, as always, that PCS’ data is by deal rather than, as many research houses do, by volume.  This is not that this is a better way of presenting the data but it is a different way of presenting the data which, hopefully, reveals additional information.

PCS strives to continually improve the readability and usability of its Verification Report.

As it has over the years, based on feedback and input from the investor community, PCS has introduced an improved format for the STS Verification Report.

The most important changes to the report are the merging of certain criteria points, to create a shorter and more streamlined checklist, improved visuals and the addition of some navigation buttons. 

The number of criteria points has been reduced from 103 to 85, significantly shortening the checklist. While the number of individual points in the checklist has been reduced, there has been no change in PCS’s methodology or criteria in verifying STS compliance.  The shortening of the checklist results instead from merging several of the previously separate but closely-related criteria points.

The checklist has also been updated with a cleaner visual format and colour template, designed to enhance its readability.  Additionally, navigation buttons have been added to aid in moving between various sections of the checklist.

We have also updated the checklists for our CRR and LCR Assessments with a cleaner visual format and colour template, to enhance readability and to align the visual format and colour template between the various PCS checklists.

See here for an example of the new format of the PCS Verification Report.

PCS is a compact organisation with a total staff of 14.

In each newsletter we will introduce one of them so that people get to know us. This time, Ian Bell, CEO of PCS.

Welcome !

Welcome to the end-of-year edition of the STS Newsletter by PCS, keeping stakeholders up to date about market and regulatory developments in the world of STS. In this edition we do not follow the usual pattern of our Newsletter but will instead look back at the year 2021, assess the current state of play and look towards 2022.

As with 2020, the year 2021 was a year of COVID-19 and the pandemic weighed, directly and indirectly, on all aspects of our lives.

STS securitisation was no exception, if only indirectly through the effects of yet another massive injection of pandemic related “helicopter money” from Frankfurt and Threadneedle Street.

As ever, we very much welcome any feedback on this Newsletter.

Market data – Looking back at 2021 – What the numbers tell us about STS

There can be no doubt that 2021 was a strange year with the unexpected lengthening of the COVID crisis and its increasingly erratic twists and turns as well as its puzzling, sometimes contradictory, but always difficult to read impact on the economy. In some senses, it was a good year for STS, in others, less so. We develop our broader analysis of the meaning of 2021 for the securitisation market as a whole in our later segment (“Hurrah for growth .… but is it enough ?”). Here, we focus on specific STS numbers. We also look at our predictions for 2022.

Please note that, differently from most year-end commentaries, we have focused on number of deals rather than volume of issuance. The reason for this is not that numbers have a greater explanatory power than volume but rather that they have a different and complementary explanatory power. Many research firms and other commentators provide the volume numbers and it seemed of limited value to just do the same. By focusing on numbers, PCS hopes to shed not a better light but a different light on the year.

(All numbers are as of 10th December 2021 and so comparisons with 2020 are not exactly on the same basis. PCS only expects 4 to 5 additional STS deals by year end though. Also, 2020 EU numbers still contain UK transactions, so EU 2020 to 2021 comparisons need to factor in the departure of the UK. This is why we also give Europe wide – including the UK – figures to compare.)

The big picture

Numbers

Commentary

This headline decrease is highly misleading as it is entirely driven by the “mechanical” decrease in ABCP transactions being notified. We analyse this phenomenon below and would advise our readers simply to ignore this number. More importantly, the number of notified public deals went up from 70 to 81.

Unchanged from previous years, originators issuing in all asset classes that can achieve STS in a straightforward manner universally continue to do so when publicly placing paper in the markets. Last year, we had indicated that the only exception was “Buy-to-let” RMBS. Although this remains broadly true, 2021 saw three RMBS BTL transactions achieve STS, indicating that even this hold-out might be migrating to the STS camp.

As in 2020, 100 % of STS securitisations publicly placed with investors in 2021 elected to be verified by a third-party verification agent.

In addition to the traditional “true-sale” securitisations, as of April 2021 “synthetic” securitisations (also known as “on-balance-sheet” securitisations) have been able to achieve STS status in the EU (but not the UK). As of mid-December, 10 synthetic transactions had been listed with ESMA as STS.

Below the surface

Commentary

The 16 % increase in publicly placed STS is welcome but must be understood in the context of a nearly 50 % increase (by volume) in European securitisation as a whole.

This year saw both a continuation and an acceleration of the trends that PCS identified in December 2020 (2020 – The STS Year in Review – Prime Collateralised Securities (pcsmarket.org)).

These trends include the continued ebbing of plain vanilla securisations originated by large banking institutions. We have long identified as the primary driver of bank STS volumes the competition presented by the various ultra-low rates lending windows made available by the ECB and the Bank of England. Anticipating the closure or narrowing of those windows, market participants – including PCS – were wrongfooted by the unexpected pandemic and central banks’ response. In the UK, whilst the TFS closed, the new TFSME was introduced and pumped almost £ 90 bn of liquidity into the banking system. In the EU also, the PELTRO took over from TLTRO 3.

So, behind the 16 % increase in public deals, 2021 saw the continuing substitution of traditional bank originators by new non-bank market participants. This was particularly noticeable in the UK where none of the large master-trusts issued at all and only three traditional building societies came to market.

The decrease both in absolute and relative terms of the number of private transactions should put paid to the concern expressed by some public bodies. There was suspicion aired in some quarters that the increase in private transactions was taking place at the detriment of public deals; in other words that transactions that would normally have been public were being executed in the private market possibly to avoid disclosure requirements. PCS already published on that matter last year, noting this was a misperception. No deals were migrating to the private sphere and the large number of private ABCP transactions reflected two facets specific to that segment of the market. In our 2020 end of year newsletter, we had explained that (a) multiple versions of the same deal appeared on the ESMA list thus making these transactions appear more numerous than they were and (b) almost all those deals were long-standing transactions rather than new financings, in other words “stock” rather than “flow”.

We therefore anticipated that 2021 would see fewer ABCP transactions than 2020 and that 2022 would show a very marked diminution in numbers as the old stock had been converted to STS and ongoing notifications would attach primarily to the much smaller flow of new transactions. That said, we had not anticipated that the numbers of STS ABCP transactions would drop quite as swiftly as they did in 2021. As a proportion of overall European STS transactions, ABCP transactions accounted for only 42 % in 2021 compared to 66 % a year earlier.

ABCP transactions accounted for only 42 % in 2021 compared to 66 % a year earlier.

We, at PCS, are usually optimists although we believe of the realist school. But, noting around us the sound of popping corks and congratulatory hurrahs, we felt moved to sound a possibly jarring note of caution.

Yes, Europe saw its largest placed yearly market since the GFC

Yes, 2021 saw more than 50 % growth over last year.

Yes, new issuers came to market.

And yet, yet ….

Some numbers

Counting securitisations has always been more of an art than a science, dependent on fluid nomenclature, differing data bases and uncertain categorisations. For this analysis, we have used numbers from a single reputable house to keep things consistent. But if your chosen numbers do not exactly align with those here, do not panic. Neither of us is right or wrong, just counting in a slightly different way. But, aside from the exact numbers, the broad thrust from all the research houses as well as our own data, is consistent.

Placed securitisation in Europe (including the UK) in 2021 will stand at around € 124 bn. This compares to € 80 bn in 2020 and € 95 bn in 2019. This is a growth of 56 % over last year (admittedly a miserable vintage) and 31 % over two years ago.

RMBS grew 27 % over last year. Auto issuance grew less but still grew from € 16.7 bn to € 19 bn (13 %).

CMBS went from € 2.4 bn to a spectacular € 7.2 bn – a tripling in a single year. (+ 200 %) – and CDO’s nearly doubled to € 43 bn.

And, notwithstanding this sudden increase in volume, spreads not only returned in many asset classes to pre-COVID levels but in some cases to pre-GFC levels (see our Market Data section).

This growth had been predicted by no-one – including PCS.

What is there not to like?

The diminution of ambition

PCS was set up in 2012 to assist in supporting a return to a deep, liquid, simple and safe securitisation market that would play a key role in the European financial architecture. A market that would allow European banks to manage pro-actively their capital in a Basel III environment as well as be a major source of funding. A market that would provide European investors and particularly insurance companies and pension funds a deep pool of AAA/AA assets with a fair return allowing them to move away from sovereign debt without sliding too far down the credit curve.

When such a market was discussed, comparisons with the United States were common and this renascent European market was supposed to be the foundation of a new Capital Market Union within the EU (then containing the UK) reversing the continent’s dependance on the banking sector for 75 % of all financings (compared to 25 % in the US).

It is with this ambition that policy makers and market participants discussed regulatory changes and legislative initiatives. It is for this ambition that the STS regime and the Securitisation Regulation was passed.

To see how this compares to the US, we invite you to read our article (“The indispensable reform”).

The market the securitisation community once aimed at involved annual issuance volumes in Europe of around € 400 bn – € 500 bn. PCS has calculated that the smallest market volumes consistent with securitisation playing a meaningful role is € 265 bn per annum.

When the Securitisation Regulation was passed, the European Commission suggested it would result in € 100 bn of additional issuance. Many criticized it at the time for “low-balling” its ambitions. Today, after a banner year and three years after the entry into force of that regulation we have achieved € 30 bn of additional issuance over 2019.

This year was a good year for European securitisation. But it is a year that still leaves European issuance € 70 bn below the Commission’s low target, € 150 bn below the minimum necessary for securitisation to play a meaningful role and € 275 bn to € 375 bn below the level at which securitisation plays the same role in Europe as it does in the US.

And we still see no sign of new investors, particularly from the insurance and pension fund areas.

We believe that it is fine to celebrate the achievements of 2021 but let us not become so used to securitisation bumping along the bottom that we lose sight of how much still needs to be done and how far we are from where both the private and public sectors have said we need to be.

Is it the right kind of growth?

The securitisation market discussed above and anticipated by policy makers was a deep market the backbone of which was plain vanilla, simple and transparent issuance in the traditional asset classes at fairly low spreads for risk averse investors with a range of more complex and exotic products with higher spread for sophisticated investors.

To reach € 124 bn, the market grew in 2021 by € 44 bn. This involved a € 7 bn decrease in corporate securitisations. So those areas that grew, grew by € 51 bn.

Of that growth:

• € 12 bn was “buy-to-let” mortgage RMBS
• € 21 bn was CLO/CDOs
• € 4.8 bn was CMBS

Those three categories accounted for around € 38 bn of the € 51 bn growth (75 %).

Broadly, ABS accounted for the rest.

In RMBS, prime RMBS accounted for € 9.3 bn of the issuance. This is a decrease from 2020.

Non-prime and BTL RMBS accounted for € 26.2 bn. In other words, the plain vanilla classic product of STS in 2021 accounted for a quarter of its own asset class and 7.5 % of overall securitisation issuance.

In 2021, for the first time ever, CLO’s/CDO’s – a sophisticated managed product that cannot achieve STS status – became the largest asset class and not by a small margin.

We are not suggesting that CLO’s/CDO’s, CMBS or BTL RMBS are not legitimate asset classes or solid securitisation products. But they are not simple and, in the case of the first two, have idiosyncratic risks that make them more difficult to analyse. This was extensively discussed in PCS’ 2013 white paper and the EBA’s original report out of which STS grew and explains their exclusion from the STS standard.

What is clear, is that they cannot be the core of a growing simple market such as envisaged by policy makers or as needed by Europe.

So, as much as we can celebrate their growth and the contribution to the overall growth of securitisation in Europe, this is not a growth that appears to be taking Europe (including the UK) in the direction that we had collectively set for ourselves.

The calendar for 2022, when it comes to securitisation, may appear very light. This section will go through the key changes that will impact the market and we will see that few, if any, will or are likely to be finalized next year. From today’s vantage point, 2023 looks like the year in which many of these key changes will land.

But if the events calendar looks light, the worksheet for 2022 is very heavy indeed. This is because the discussions, arguments, data gathering and conversations that will shape the outcome of those events will be taking place next year. For example, PCS has argued passionately that securitisation must find a workable and equitable place within a sustainable finance regime. Next year will see the debates in the European Parliament around the EU Green Bond Standard legislation as well as around the EBA report on a possible sustainable securitisation framework. Those with an interest in securitisation will have to make their case in 2022 if we hope to land a fair outcome in 2023

Looking at some of the issues that will be shaped by 2022 debates and will in turn shape the future of European securitisation (both in the EU and the UK), we highlight the following.

Calibration issues

From before the passage in 2017 of the Securitisation Regulation, many stakeholders in the securitisation market, including PCS, have argued that the capital requirements for banks and insurance companies holding STS securitsations was neither reflective of the real risk of those instruments nor fair or accurate when compared to the requirements for other capital market products. Rectifying those incorrect calibrations will require modifications to the Capital Requirements Regulation (the CRR) and Solvency II respectively – and, since the beginning of this year, their onshored versions in the UK.

In addition, many have pointed out that the limitations on the inclusion of STS securitisations in banks’ liquidity coverage ratio pools (LCR pools) are inconsistent with their liquidity performance.

Improving capital requirements for bank investors under the CRR, for insurance investors under Solvency II and eligibility for inclusion in LCR pools, both in the EU and the UK, are what we refer to as the “calibration issues”.

The Commission decided finally to move forward with a re-examination of the calibration issues. Last October it tasked the Joint-Committee of the ESAs to provide their views with the possibility of amending the laws. The Joint-Committee though has until September 2022 to report. This means that, in the best-case scenario, no draft legislation should be expected from the Commission until well into 2023. But if we wish to see a positive outcome, stakeholders will need to make their voice heard in 2022.

Whether a similar re-examination can be expected in the UK looks fairly unlikely at this stage, following the publication yesterday of HM Treasury’s report on the review of the securitisation regime (see our news item). On the calibration issues, as well as on the possible inclusion of synthetic securitisations in the STS regime, the newly published report makes for very dispiriting reading even if the door is not quite entirely closed and locked shut.

Green Securitisation

In the EU, two strands that will define the possibility of green securitisations and whether it can find a place within a new sustainable finance environment will interweave in 2022 in ways that are not entirely clear.

First, the EU Commission has placed draft legislation on the EU Green Bond Standard (EU GBS) before the Council and Parliament. It is difficult to gauge when this draft legislation will be voted on as the urgency of dealing with climate change in the EU is balanced by the controversial nature of many topics which slows down legislative action. But even if the EU GBS were to be passed in 2022, it is unlikely to be fully functional until technical standards are published. So, the impact of this legislation will hit most likely in 2023. But 2022 will be the year when key decisions will need to be taken about what green securitisation will look like – decisions which will determine whether securitisation can play an important role in financing the transition to a sustainable economy or whether it is sidelined by too restrictive a definition or too onerous a set of requirements compared to other instruments.

Secondly, the EBA is meant to report back to the Commission on their views as to what a sustainable securitisation framework would look like. The fact that the EU GBS and the EBA report are part of two separate processes with non-synchronised calendars is something about which PCS has expressed concern. It raises the specter of a green securitisation regime that is not part of the normal green bond regime but is somehow bespoke. Such a separate regime with different rules, different disclosure burdens, different due diligence requirements would likely lead to green investors turning away from securitisation as a green funding tool if it required a totally different approach and set of compliance rules. A key goal of stakeholders in the securitisation market in 2022, including PCS, is to ensure that the sustainability regime for securitisation is properly incorporated in the overall capital market regime in a sensible way.

After the recent delay from 2022 to 2023 to the full implementation of the Sustainable Finance Disclosure Regulation (SFDR) which also applies to asset managers purchasing securitisations, 2022 will also be the year in which the securitisation industry (issuers and investors) has to work out what disclosure must and can be made to satisfy legal requirements. This promises to be complex work (hence the, in retrospect, inevitable delay).

In the UK, there is currently no public proposal for a UK GBS and no UK taxonomy on which it could be grounded. However, the UK Treasury has indicated that it hopes to have a taxonomy published by the end of 2022. Also, although SFDR does not apply to the UK, a similar disclosure regime has been announced for 2022.

SRT and final Basel III implementation

As of 2023 in the UK (and, it would appear, by request of the DNB, in The Netherlands) and as of 2025 in the rest of the EU, banks will be subject to the full Basel III requirements. These will include the output floors which are likely to raise capital requirements on most banks, in some cases quite considerably.

At the same time, one of the key features of securitisations is its capacity to remove risk from banks’ balance-sheets by transferring assets to a securitisation (whether via a “true-sale” or a synthetic transaction). So, securitisation can ease the burden imposed by additional capital requirements by reducing the risk against which that capital is required. To do so, the securitisation must meet the standards set out by regulators for “significant risk transfer” (SRT)

Basel III’s final implementation is proving highly controversial in Europe and 2022 is shaping up to be a year of many difficult public arguments over numerous technical aspects of the output floors.

Output floors are not a “securitisation issue”. Yet, the interaction between the SRT rules that are supposed to be finalized in 2022 and the technical workings of the output floors will have a potentially enormous impact on the feasibility and value of many “true sale” and synthetic securitisations.

This is not the place to take our readers through the complex issues raised by these proposals, but there is no doubt in PCS’ mind that unless the securitisation community chooses to be part of this debate in 2022, the impacts on our markets will be overlooked and by 2023 a set of decisions may have been taken with deeply negative impacts on parts or all of the securitisation markets.

Monetary Policy

Another key development in 2022 will be the actions of central banks. If inflation fears lead to a reduction in cheap bank liquidity provided by central banks, then securitisation is likely to return and possibly quite strongly.

This is, of course, more in the nature of a watching brief as neither the ECB nor the Bank of England are likely to factor securitisation issuance as a key element of decision making around monetary policy. But in 2022, and for the first time in many years, the direction of travel for central bank policy, torn between inflationary risks and COVID economic recovery needs, is genuinely uncertain.

Again, the result of discussions in 2022, albeit not on securitisation per se, will likely have a major impact on the market in 2023 and beyond.

In conclusion, although nothing very dramatic is scheduled to occur in 2022, this will be both a very busy and important year for the market. When it comes to policy making, it is likely to be the busiest and most important year since 2017 when the final amendments to the Securitisation Regulation were being negotiated.

In this Newsletter, we want to take the opportunity to thank our readers and other stakeholders for the co-operation in 2021 and convey our best wishes for the new year.

So, from London, Paris, Milan, Munich, Poznan, Amsterdam and Banholt, the Outreach Team and Analytical Team from PCS send you Season’s greetings and wish you a happy, prosperous and, above all, healthy 2022.

Securitisation and sustainability

Introduction

A few days from the start in Glasgow of COP 26, the focus on sustainability across Europe has never been as strong. But, beyond the political wrangling and the lofty declarations we are accustomed to, Europe has moved into the phase where actual laws and rules are starting to roll off the production line. In July alone, the European Commission adopted the proposed Carbon Border Adjustment Mechanism (CBAM) and the European Green Bond Standard whilst the European Union passed the EU Climate Law turning the 2019 EU Green Plan into a legally binding obligation on all member states.

At the same time, global capital market investors have raised substantial sums specifically for sustainable investments. In the first quarter of 2021 alone inflows into European “sustainable” funds totaled €120 billion according to Morningstar. Last year, over 700 sustainable funds were set up globally. All indications are that this trend is accelerating.

All this is welcome for anyone who cares for the future of our planet and the living organisms that depend on it, including homo sapiens. Time is extremely short and the time for lofty declarations probably passed a while ago already.

Between the sustainability requirements of global investors and the legal framework falling into place it is increasingly clear that if European securitisation cannot find, practically and legally, a niche within the green capital market ecosystem, it faces a bleak future.

Therefore, PCS thought it useful to issue this Special Edition of the STS Newsletter to canvass the rules relating to sustainability that will directly or indirectly affect securitisations. One should not believe that this is just an issue coming towards us fast. Some of these provisions are already in force.

To ensure that our industry can find its niche we collectively will need to pay close attention to what is being discussed not just around securitisation regulations specifically but around the full spectrum of capital markets and financial regulation.

This Newsletter is divided into sections:

1. The background – what is Europe committed to achieve?
2. The backbone – what are the two key overarching rules for sustainable finance?
3. The disclosure rules – what disclosure rules applicable to finance generally, do impact securitisation?
4. The securitisation rules – what existing and proposed securitisation green rules will affect the market?
5. The battlegrounds – what are the issues that have already emerged as key discussion points in the coming legislative process?

THE BACKGROUND – the Green Plan

To understand detailed regulatory provisions, it is always useful to go back to the underlying reason for their introduction. What were the legislators and regulators trying to achieve?

All European legislation on sustainability is designed to allow the continent to achieve the European Green Plan. This ambitious program was adopted in 2019. In July 2021, the Green Plan was turned into a law (the EU Climate Law) thus transforming it from a statement of ambition to a legally binding obligation on European Member States.

The Green Plan contains two commitments:

• To reduce emissions by 2030 to 55% of their 1990 levels
• To achieve net zero carbon emissions by 2050

The UK has declared a yet more ambitious set of targets:

• To reduce emissions by 2030 to 32% of their 1990 levels
• To reduce emissions by 2035 to 22% of their 1990 levels
• To achieve net zero carbon emissions by 2050

As with the EU, the UK’s commitments are legally binding through the Climate Change Act, originally passed in 2008 but regularly updated with new targets.

THE BACKBONE – the two EU laws that frame EU sustainable finance regulation

The Taxonomy

The Taxonomy Regulation came into force in July 2020.

Its purpose is to define what activities will be deemed by the European Union to be “sustainable” when passing rules (e.g. what is a “green bond” or what can banks count as “green assets” when they are required to report to regulators and the public).

The Taxonomy Regulation is very short and basically defines six types of activities as compliant with the EU’s sustainability principles. It then leaves the details to delegated legislation to be drafted by the European Commission.

That delegated legislation is not short.

The first piece of delegated legislation is the Taxonomy Delegated Act issued in July 2021. It deals with only two of the six categories and runs to 512 pages!

It does not even deal with all the activities in the two categories as two of them, nuclear and gas, generated so much controversy that they were left to a later delegated act. If you read in the press about political fracas around those energy sources, it was about this delegated act.

The UK government, for its part, announced that it would also create a green taxonomy by the end of 2022. To assist, a new advisory group was created in June of this year: the Green Technical Advisory Group (or, for those worried by a possible drying up of acronyms in this area, the “GTAG”).

The EU Green Bond Standard

The European Union Green Bond Standard (or “EU GBS”) is a piece of draft legislation adopted by the European Commission in July 2021. It is now placed before the European Parliament and the European Council for discussion and amendment and will likely become law sometime in 2022.

It defines a voluntary green standard for capital market instruments. Securitisations are explicitly mentioned as instruments that may achieve the standard. How though is not settled – see our paragraph below on the battlegrounds.

The current proposal is that EU Green Bonds are bonds whose proceeds finance activities compliant with the Taxonomy Regulation and whose sustainable credentials are certified by independent and regulated third parties. Note that non-EU bonds are allowed to qualify for the EU GBS.

Do not get too complacent about the word “voluntary”. Although the EU is unlikely to ban an issuer from describing their bonds as “green” or “sustainable” unless they meet this standard, rather than some other standard (e.g. ICMA or CBI) it is likely that the EU GBS will be used in all legislative and regulatory rules dealing with sustainability and the capital markets. It is also likely to underpin the actions of important public sector market actors such as central banks and multi-lateral financing entities.

It is therefore vitally important to ensure that the EU GBS allows securitisation fully to play a role in the financing of Europe’s transition to a sustainable economy. That battle is far from won – see “battlegrounds”.
It is not clear at this stage whether the UK will opt to pass similar legislation defining green capital market instruments.

THE DISCLOSURE RULES – the rules that indirectly affect securitisations

A number of rules of general application, some already in force, will have an indirect but powerful impact on the securitisation market. These rules require various capital market participants to disclose how green are their activities.

SFDR – the Sustainable Finance Disclosure Regulation

The SFDR came into force in March 2021. It imposes mandatory disclosures on “manufacturers of financial products” and financial advisers.

This is not the place to go into the multiple levels of disclosure required by the regulation. The key point is that “manufacturers of financial products” covers pretty much all asset managers and those asset managers are mandatorily required to disclose the sustainability standards of their funds. This applies even to funds that do not claim to be green.

Not only is the disclosure mandatory, but the level and format of the disclosure will be made mandatory through a delegated act. A draft of the delegated act issued by the Joint Committee of the ESAs already exists.

The disclosure requirements do not kick in until June 2022 but – like accountancy periods – this looks back. PCS knows of a number of European funds already asking originators to provide the information required to fulfill their SFDR obligations come next year.

As SFDR came into force in 2021, it was not binding on post-Brexit UK. The UK chose not to apply the SFDR opting instead, in line with its apparent new policy, to leave this type of matter to the regulatory authorities rather than to legislative acts.

In June 2021, the FCA published a consultation paper on new climate-related disclosure requirements for asset managers, life insurers and pension providers, with a phased-in approach starting 1 January 2022 for the largest firms.

Although the content and timing will be different, the set-up in the UK is not likely to be fundamentally different to that in the EU.

NFRD – Non-Financial Reporting Directive

In 2013, the EU passed two directives: the Accounting Directive and the Non-Financial Reporting Directive. The aim was to standardise company reports across the union.

In 2020, the Taxonomy Regulation (remember that one) required the European Commission to amend the NFRD to add sustainability information to the non-financial disclosure required of large and listed companies. In July 2021, the Commission did just that.

The NFRD applies to both banks and insurance companies. It imposes companywide disclosures. But to compile and publish the necessary sustainability information, those banks and insurance companies will need to put in place internal reporting processes to capture the relevant data, for example from investments made by the bank or insurer.

Today, the bank bid represents around 30% of primary securitisation issuance.

Article 449a of the CRR

Supplementing the NFRD obligations of banks, article 449a of the Capital Requirement Regulation (CRR) is a Pillar 3 requirement.

The article will require all large, listed EU banks, as of June 2022 to provide the following:

• quantitative disclosure of ESG risk
• qualitative disclosure of ESG risk
• quantitative disclosure of physical climate risk
• the bank’s ESG policies, KPIs and GAR

The EBA is tasked with defining exactly what those disclosures will need to contain. It consulted on the matter in March of this year and launched a survey in September.

Note the last three letter acronym in the list – GAR – as this will become very important.

Green Asset Ratio – GAR

A new bank metric has now been endorsed by the EBA for both Article 449a and for NFRD disclosure: the Green Asset Ratio or GAR.

As its name indicates, the GAR will be a percentage of “green” assets in a bank’s total assets.

Why should the securitisation community care about these disclosure rules?

There are two reasons these disclosure rules matter for securitisations.

First, bank treasuries and asset managers together form most of any publicly placed securitisation’s investor base. As these disclosures are or will be mandatory, both banks and asset managers will set up internal compliance procedures to gather and process the sustainability data relating to their investments so that they may summarise them for their regulatory filings. If this information is not provided to potential investors by the originator (directly or through some third party), these investors will have to do their own digging to be able to meet the internal compliance information requirements. That is likely to be very unattractive. Therefore, selling a securitisation without attendant sustainability information is likely to become challenging.

Second, all this disclosure – so far – is designed to put moral pressure on investors. It is assumed that no asset manager will wish to report that their funds have a negative impact on the planet. Most banks will probably compete to show the highest GAR amongst their peers. If a securitisation cannot report at least no negative green impact, it will be that much less attractive to most reporting investors. We saw a similar effect in relation to the Liquidity Coverage Ratio rules: securitisations that could not qualify for LCR pools could still be purchased by bank treasuries but de facto lost all or most of the bank bid.

THE SECURITISATION RULES – the green rules that directly affect securitisation

Currently, the only green rule specific to securitisation, is the requirement for STS securitisations backed by auto or mortgage assets to report available information on environmental performance (article 22.4 of the Securitisation Regulation).

A helpful EBA interpretation of “available” has ensured that originators only had to report information that was centrally available rather than conduct expensive and time-consuming research of their securitised pools.

In the April 2021 amendment to the Securitisation Regulation – which opened STS status to synthetic securitisations and made the rules on NPL securitisations more sensible – the EBA was also required to produce a report on the way this information was presented. The report was due in July 2021 but has yet to be published.

More important, in the same regulation (article 45.a), the EBA was also mandated to produce a report on how sustainability disclosure should be made in the context of securitisations generally. This report is due by November 2021 but likely to be delayed.

This second report on general green disclosure contains potential dangers for the securitisation market:

• excessive requirements: if the requirements are unreasonable and would, for most originators, necessitate exorbitant costs in time or money, it will effectively close the possibility of their participation in the securitisation market.
• more unlevel playing fields: the fact that the EBA has been requested to produce a report on securitisation alone rather than on any bond claiming to meet the EU GBS means that there is a real possibility that securitisation issuers will be required by law to produce different and considerably more onerous information than issuers of any other EU GBS capital market instrument. This would intensify the legal discrimination against securitisations versus other instruments of similar risks and characteristics and be diametrically opposed to the EU’s oft stated goal to promote a safe European securitisation market.
• indirect pre-empting of the EU GBS debate: As we will see in “Battlegrounds” below, there is a debate on exactly what a green securitisation looks like. It would not be helpful if the conclusion of this debate were pre-empted by the EBA selecting disclosures that are only compatible with a certain approach to green securitisation (e.g. green assets only)

Finally, and obviously, although the EU GBS debate is not a securitisation debate, the final standard will cover and therefore directly impact securitisations.

THE BATTLEGROUNDS – the emerging issues for securitisation

Green assets versus green proceeds

The first issue to have emerged as a point of contention is whether a green securitisation must be a securitisation of “taxonomy compliant assets” or whether it can be a securitisation where the proceeds are used for lending to green projects.

On the one hand, the draft EU GBS legislation is clear: a green bond is a bond whose proceeds go to fund sustainable, taxonomy compliant activities. A green bond is one that finances the transition to a sustainable economy. Therefore, it follows logically that if the cash raised by a securitisation is used to transition the European economy to a sustainable state, like for any other capital market instrument, that securitisation qualifies as a green bond under the EU GBS.

Some voices have been raised in the market and regulatory communities to suggest that only securitisations of green assets should count as green securitisations. This approach has a superficial intuitive attractiveness, but in our view is wrong both as a matter of logic and green principles.

• Logic: If a company issues a five-year corporate bond to fund a six-year project to build an off-shore wind farm, the investors accept that they will be paid interest and principal on this bond from that company’s brown income. But a wind farm is funded and there is zero doubt that this bond meets the EU GBS. If the same company securitises the brown assets that otherwise would generate the cash to pay the corporate bond and so funds the same wind farm with a securitisation, it makes no sense to deny that securitisation green status. The same wind farm is built with the same money and in both cases the investors get paid by the same cash generated by the same brown assets. The only difference is the balance sheet on which those assets can be found.
• Green Principles: The climate emergency worsens every year and the amount of per annum funding required to achieve the green plans increases as nations and unions fall behind. It is essential that any safe and legitimate financial channel able to contribute to the green transition be fully mobilized. There are reasons – which PCS will go into in a longer paper we intend to publish soon – to believe that certain types of green projects and transformations may not obtain finance (or will obtain less finance) without securitisation. To impede the securitisation channel from funding the green transition on a logically weak formalistic argument runs counter to the overwhelming need to green our economies fast.

Conclusion

The legislative and regulatory debate around capital markets, green finance and sustainability in both the EU and the UK is proceeding very fast and has many moving parts. Although we believe that objectively, securitisation has an important positive role to play in the greening our economies, it will only be able to do so if it can find a niche in the green finance ecosystem. To do this, the final regulatory framework must be holistic, fair and workable.