On Friday 24th July, the European Commission took the first legislative steps to complete the reform of securitisation rules begun with the passage of the STS Regulation in 2017.
As has been commented on by a number of stakeholders from both the public and the private sector (including PCS whose commentary may be found here), the STS Regulation has been a technical success but a strategic disappointment as it has failed to raise the volume of securitisation issuance. This is widely attributed to the absence of a number of additional steps that would be required for the reform fully to fulfil its potential. On Friday, following on a constructive EBA report on synthetic securitisation, the European Commission published two legislative proposals amending the STS Regulation and the CRR Regulation. These deal with both synthetic securitisations and non-performing loan or "NPL" securitisations.
The first proposal (to be found here) seeks, on the one hand, to create a new category of STS synthetic securitisations and, on the other hand, to amend the retention requirements for NPL securitisations. In the first instance, the Commission follows the EBA's lead in defining STS synthetic securitisations including the allowance of some utilisation of excess spread. In the second, the Commission proposal sensibly would allow the 5% retention to be calculated on the discounted value of the pool of NPLs rather than their nominal value and for this retention to be held by the managers.
The second proposal (to be found here) would effectively extend the benefits of lower capital requirements to the senior tranche of STS synthetic securitisations and makes some amendments to the capital treatment of NPL securitisations.
Some important items to note:
The STS synthetic proposal contains "grandfathering" provisions provided the new rules are met. This means that, although this is only the first step on the road, market participants should start to take these proposals extremely seriously with immediate effect.
By proposing improved capital requirements for STS synthetic securitisation, the Commission has answered the question posed in the EBA paper. This is sensible as the absence of such improvements could not be justified by any logical argument or historical data. The EBA not taking sides on this issue had been one of the disappointments of their otherwise excellent paper.
By limiting capital improvements on STS synthetics to the senior tranche of on-balance sheet transactions, the Commission clearly situates these proposals not so much in the framework of building out a capital markets union as within a broad move to allow banks additional legitimate tools to manage the coming Basel capital requirements. This is very much in line with PCS' own recommendations.
A synthetic STS category and improvements to the approach to NPL securitisation were only two of a suite of proposals made by market participants and the two high level experts' groups which reported on, amongst other topics, European securitisation. For those concerned though that these are the only two proposals currently published, the European Commission has explicitly acknowledged in these papers that they are aware that additional changes to prudential rules for STS securitisations are required. This is consistent with other reports that the Commission will seek to address these further improvements soon - probably after the August break.
Now that these proposals are out, they will have to be examined by the European Parliament and the European Council of Ministers and, if amendments are tabled, the proposals will need to go through the trilogue process of reconciliation. It is therefore quite unlikely that these two texts will be on the statute books before the United Kingdom's transition period comes to an end on 31st December 2020. Therefore, an important question is whether the British government has any plans to follow suit.