June 2022 Newsletter

1.            Welcome !

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

Read full text (reading time 1 minute).

2.            A time of opportunity, a time of danger

Given the extraordinary and turbulent times and developments in the last months, in this edition of our Newsletter we diverge somewhat from the usual pattern and endeavor to make an analysis of current opportunities and threats that may affect the European securitisation market.

Read full text (reading time 8 minutes).

3.            Market Data

As a regular feature of our Newsletter we will publish some statistics regarding the STS market together with a few thoughts as to what these may mean.

Read full text (reading time 2 minutes).

4.            Improved format of PCS Verification Report

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.Read full text (reading time 2 minutes).

5.            Our people

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.

Read full text (reading time 1 minute).

Welcome !

Welcome to this edition of the STS Newsletter by PCS, keeping stakeholders up to date about market and regulatory developments in the world of STS.
Given the extraordinary and turbulent times and developments in the last months, in this edition of our Newsletter we diverge somewhat from the usual pattern and endeavour to make an analysis of current opportunities and threats that may affect the European securitisation market.
In our regular features, we share updated data on the STS securitisation market. Then we briefly introduce our improved Verification Report. Finally, in the people section we present Ian Bell, CEO of PCS.

As ever, we very much welcome any feedback.

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% 2Joint 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.

Market data

  • As of June 6th, 2022, 49 transactions had been listed on ESMA’s website as STS and 8 transactions listed on the website of the FCA in the UK, for a total of 57 STS transactions year-to-date. 
  • Although these numbers compare badly to the 2021 full year numbers of 175 ESMA notified deals and 21 FCA notified deals, the balance of transactions does tend to fall in the second half.
  • So, 2022’s 49 ESMA transactions compare to 56 on the same date in 2021.  The 8 FCA transactions compare to 11 on the same date.
  • Nevertheless, numbers continue to decline in what should be a worrying trend.  Many, including PCS, have expressed the view that monetary tightening would lead to an increase in “plain vanilla” and hence STS issuance.  The tightening is here but the issuance is not.  This reinforces our argument that a flawed regulatory framework is a key brake on any revival of STS securitisations.
  • With 17 auto STS deals so far this year in the EU versus 12 RMBS deals, the relative decline of mortgage backed securities as the backbone of the STS market shows no sign of reversing itself.
  • So far in 2022, 8 synthetic transactions have been notified STS to ESMA, versus a full year total of 15 in 2021.  We are not sure how much should be read into this as STS only became available half way through 2021 but many synthetic transactions tend to take place towards the end of the year.

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.

Improved format of PCS Verification Report

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.

Our people

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.

Ian Bell

I was trained as a lawyer and joined Clifford Chance as a trainee in 1987 where, in April 1988, my life collided with the nascent European securitisation market in the form of TMC 4, the fourth UK mortgage backed transaction.  Foolishly, rather than run away, I embraced the madness and worked pretty much exclusively in the field of securitisation, first as an associate, then from 1996 as a partner.  I left in 1999 to become European General Counsel at Standard & Poor’s before being asked to move to the “business side” and run the structured finance group in Europe, Africa and Middle East, spanning the GFC.  I was then asked in 2012 to helm PCS.

My personal tastes run to good food and wine, both in the cooking and eating, and then cycling and triathlons to get rid of inevitable consequences.  I read mainly history, science fiction and some physics.

2021 - The STS Year in Review

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

Numbers...

20202021YoY
Public7081-16%
Private18897-48%

More numbers...

20202021YoY
ABCP17275-56%

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.

Asset classes

Public Transactions20202021YoY
RMBS2523stable
Auto2627+42%

Public EU & UK 10-12-2021 YTD

Public EU & UK Full Year 2020

Commentary

The growth story in 2021 from an asset class point of view is the auto sector which went form 26 in 2020 to 37 this year making it, in number of deals, the largest STS asset class.

This was at the expense of RMBS which remained stable (losing just two transactions from 25 to 23). In addition to RMBS’ relative decline this year against the auto sector, one should also note that 2021’s 23 transactions stand against 49 transactions in 2019. This comparison is made starker by the fact that, for a variety of technical reasons, STS transactions in 2019 only began in March of that year. RMBS’ 2021 year on year stability is resting on a historically extremely low base.

Two interesting figures in the auto sector are also worth mentioning.

First, without a real “non-conforming” auto sector, 100 % of EU publicly placed auto transactions were STS. That was only 94 % in Europe as a whole reflecting the possible growth of a near prime/non-conforming auto securitisation market. How this interacts in the coming years with the STS market will be worth keeping an eye on.

Secondly, for the first time, securitisations by non-captives were issued in a larger amount than transactions for lenders connected to manufacturers. Again, whether this only reflects 2021’s low sales numbers for new cars and a temporary growth in the secondhand car market or is indicative of broader changes to auto finance will be interesting to see.

Jurisdictions

2021

10-12-2021 YTD

2020

Full year 2020

Commentary

The jurisdictional story follows broadly the asset class story. This year saw the UK and Germany trading places as the largest STS market. With the growth of the auto sector – closely associated to Germany – and the shrinking of the RMBS STS issuance in the UK (where 11 fewer RMBS STS transactions were closed than last year), Germany emerged as the largest issuing country, going from 12 % of issuance in 2020 to 23 % in 2021. Conversely, the UK went from a 30 % market share in 2020 to half that in 2021 (15 %). Other countries broadly maintained their relative percentages.

Synthetics/on-balance-sheet transactions

Synthetic transactions became eligible for STS on 9th April 2021. Since then, 10 transactions have been notified. As they are private, no information can be gleaned from ESMAs website as to asset classes, jurisdictions or whether they use third-party verification agents. PCS has received a number of mandates for STS synthetic transactions, some of which have been completed and are included in those notified to ESMA.

General Market Commentary

In last year’s end-of-year newsletter we indicated that, in the auto sector at least, by the end of the year, spreads had retraced their path to pre-COVID levels. This was a strong indicator that low 2020 issuance was due to supply constraints and not lack of investor appetite.

By the end of 2021 and not just in the auto sector, many spreads had retraced their path to pre-Great Financial Crisis levels. We saw a couple of German auto transactions print at 10 bps and, in the secondary market, prime Dutch RMBS trade as low as 9 bps (for AAA’s). At one point, in the summer, German autos traded down to 4 bps in the secondary and still are finishing the year at around 5 bps.

Throughout the year, across all jurisdictions and all asset classes, we saw spreads slowly but relentlessly grind down both in the primary and secondary until about a month ago when we saw a minuscule uptick.

So, in 2021 just as in 2020, lack of supply, not demand is the constraining factor in the STS securitisation market.

Predictions

Predicting markets at the best of times is somewhat of a foolish endeavour. Today, with uncertainty over a global pandemic hanging over everything, it is truly quixotic.

That said, last year PCS predicted that the public STS market would grow YoY by 15 % and today we see that it has grown by…. 16 %. So, let us see if we can be lucky twice.

At a global level, the macro story of 2021 is the potential return of higher, non-transient inflation. For the securitisation market, inflation is usually a good thing. European securitisation is a floating rate market in a broadly fixed rate capital market. If investors become concerned that inflation will drive up rates, floating rate products become more attractive. But we have already seen that the low level of STS public issuance is not driven by low investor appetite but by lack of supply. So, if concern over possible inflation merely raises investor demand even further, this will not necessarily transfer into higher volumes of issuance. Higher investor interest can, of course, lead to tighter spreads making issuing more attractive. But, first, spreads are already so low that it is hard to see how much further they could travel. Secondly, however far they travel, they will still not likely compete with central bank cash.

On the other hand, we continue to see extremely accommodative monetary policy as a key to disincentivizing large bank issuers, particularly the availability of near-free cash provided by central banks. Therefore, the impact of inflation on the STS market will be mediated by central bank action and specifically by whether central banks reduce the flow of cheap liquidity to the banking system.

So, what will the Bank of England and the ECB do? Both find themselves between Charybdis and Scylla (or, if you are more transatlantically minded, a rock and a hard place): on the one hand, the monster of uncontrollable inflation, on the other, the dragon of omicron and a fifth wave. Currently, the Bank of England has leant toward a more hawkish discourse with the ECB seemingly indicating that no meaningful action would be considered until well into 2022. What will that translate into remains, however, obscure.

We suspect therefore that 2022 will see a cautious return of UK bank issuers in RMBS wanting to ensure that if the BoE acts, they will be ready.

We also see a continued but small growth of non-bank lenders across the European space as part of a longer term trend.

In autos, a resumption of economic activity should see a growth of new car sales which could drive some growth in issuance by captives. That, though, is predicated on a strong return to growth and so dependent, once again, on the trajectory of the pandemic.

With the implementation of Basel 3 (in 2023 in the UK – and, apparently, The Netherlands – and 2025 in the rest of the EU), banks have also focused more resolutely on internal capital allocation. So we have seen more bank lending facilities such as warehouses seek STS. This, PCS believes, will continue in 2022.

So, PCS anticipates 2022 being better for the STS market than 2021.

However, with the large macro-drivers likely to remain relatively unchanged – especially in the EU – we do not anticipate any radical transformation. We think growth of 10 % to 15 % in STS issuance is a reasonable expectation.

In addition, we anticipate around 25 to 30 synthetic transactions.

Hurrah for growth …. but is it enough ?

“Pessimism
A philosophy forced upon the convictions of the observer by the disheartening prevalence of the optimist with his scarecrow hope and his unsightly smile.” (Ambrose Bierce)

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.

2022, the year that builds 2023 and beyond

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.

Best Wishes for 2022

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.

October 2021 Newsletter

Welcome !

Welcome to this Special Edition of the STS Newsletter, keeping stakeholders up to date about market and regulatory developments in the world of STS and securitisation.

This Special Edition is dedicated to sustainability rules and securitisation.

As ever, we very much welcome any feedback.

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.

June 2021 Newsletter

Welcome !

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

On May 17th, 2021, the Joint Committee of the European Supervisory Authorities (EBA, ESMA and EIOPA) issued its report on the regulation of European securitisation.

When we announced this publication in our News section we indicated that, subject to a more in-depth analysis, we felt the Report to be a substantial missed opportunity.

In this edition of our Newsletter, we provide the promised deeper analysis.

In our regular features, we share updated data on the STS securitisation market, discuss interpretation issues regarding Article 21.9 and present Rob Leach, Member of our Analytical Team.

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

Market data

  • As of 1st June, 2021 only 56 transactions had been listed on ESMA’s website as STS. To this, one needs to add the 9 transactions listed in the UK for a total of 65 year-to-date. Compare this to the full year number of 300 for 2020. Traditionally, more deals are completed in 2H than 1H. But even accounting for this, STS issuance looks to fall this year. This is worth keeping in mind when reading our piece on the ESAs report.
  • We have not provided a pie chart for the UK STS market for the simple reason that, as of 1st June, 2021 it amounted to 9 transactions. These comprised 5 private transactions and only 4 public (2 auto deals and 2 RMBS). This dearth reflects the almost total withdrawal of the traditional bank and building society RMBS issuer (sole exception being Yorkshire Building society with their Brass deal). For comparison, 2020 full year came in at 23 public STS deals.
  • Comparing the country pie-charts is made difficult by the removal of the UK which is, as ever, the largest issuing jurisdiction in 2020. But no dramatic shift in jurisdictional distribution so far. That said, the very small number of transactions makes statistically meaningful comments hard to come by.

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.

ESAs report on the functioning of the Securitisation Regulation

On May 17th, 2021, the Joint Committee of the European Supervisory Authorities (EBA, ESMA and EIOPA) issued its report on the regulation of European securitisation.

When we announced the publication in our News section we indicated that, subject to a more in-depth analysis, we felt the Report to be a substantial missed opportunity. This is the promised deeper analysis.

Background

The avowed purpose of the regulation was to revive the European securitisation market on a safe and sound basis. Yet, two years in, the European securitisation market continues to decline in volume.

Part of the decline of the market can be attributed to events outside the regulation, notably extremely accommodative monetary policy by the ECB and factors related to COVID-19.

But we also know from countless market participants’ interventions, but also from the work of not one but two independent experts groups set up by governments and the Commission that two key reasons for this failure to revive the European securitisation market are (a) the inadequacy of the capital calibrations for securitisation (in the CRR and Solvency II) and (b) the absence of a level playing field between the treatment of high quality securitisations and equivalent capital market instruments when it comes to regulatory benefits and burdens (including LCR treatment).

It was therefore hoped that this formal, public and very official review by the three regulatory authorities would prove to be the opportunity for them to inform the European Commission of why the regulation was failing its avowed purpose and how this could be reversed.

Executive Summary

  • Although by common consensus at the heart of the regulation’s failure to revive the market, the Report merely mentions the issues of inappropriate capital treatment and uneven playing fields and studiously avoids making any comment or recommendation or even taking any position. This, the Report explains, is due to the narrow mandate provided by the article in the regulation mandating the review. PCS is not convinced that the mandate precluded a constructive commentary and maybe even the suggestion of some policy steps. If the ship’s captain sends you below deck to report of the engines, he is not likely to criticize you for exceeding your mandate if you add to your report that the keel is holed, the ship is taking water and that an immediate starting of the pumps would be a good idea.
  • Even when an issue is identified, the Report often eschews putting forward a remedy. If nothing else, this shyness is likely to lead to yet more delays in implementing remedial steps.
  • We consider this to be a lost opportunity for the ESAs to engage with the real issues that limit the success of an otherwise well drafted piece of legislation: the inappropriateness of the prudential benefits for such a high standard as STS and the desperately unbalanced playing field between securitisation and comparable capital market instruments.
  • On the other hand, where issues are identified and proposals made, the Report is usually sensible and the suggestions constructive even if they often feel peripheral.

We now turn to the Report in more detail.

Investor due diligence

  • The ESAs suggest that further guidance should be produced by the regulators themselves on what is adequate and proportionate due diligence especially around the work expected of investors on the loan level data.
  • This proposal is sensible on its face but one that causes PCS deep concern in practice. First, a natural tendency of regulatory authorities that seek consensus is to gravitate toward the maximum burden. If two regulators cannot agree on how much work an investor should do, they can agree that the largest amount will satisfy both. More due diligence would not, in principle, be something PCS would be concerned about were it not for the devastating impact on the securitisation market of the unlevel playing field with other capital market instruments. When the burden on investors in securitisation is already an order of magnitude greater than investors in other types of equally risky or often riskier assets (e.g. covered bonds or corporate bonds) additional obligations can only push securitisation further underwater. Therefore, we beseech the regulatory authorities to start fixing the level playing field before adding any additional burdens on one of the players lest they find that, by the time the field is levelled, one of the players has already been permanently removed from the game.

Retention

  • The Commission is invited in the Report to solve the continuing ambiguity over the applicability of the EU retention rules to non-EU or partially EU deals, using as a solution the ESAs own suggestions as set out in their earlier opinion. Although PCS is aware that the ESAs suggestion was seen as problematic by some in the market, we consider it to be in line with the spirit of the European rules.
  • The Commission is also invited finally to publish the long delayed regulatory technical standard on retention to give some certainty to market participants.

Data disclosure

  • Although the Report acknowledges that many participants in the market have drawn attention to the complexity and huge quantity of data that is required to be produced for securitisations, the only suggestion is that regulators should get together to coordinate better their supervision of this data.
  • PCS is a strong proponent of transparency but was disappointed that, in a Report covering the securitisation regulation, the ESAs did not raise the issue of the immense imbalance in disclosure requirements between securitisations and all other secured capital market instruments (notably covered bonds). We feel that one cannot assess the impact of a piece of sectoral legislation as if it existed in a vacuum, with no reference to any other sectoral legislations covering proximate market segments. Capital markets are an ecosystem and to understand the role and impact of any of the system’s components one must look at its role in relation to other components. We do not feel that doing so goes beyond the Report’s mandate.

Private transactions

  • Acknowledging that the current definition of “private securitisations” (anything that does not need a prospectus) is probably far too wide and forces a heavy burden on transactions that need not bear it, the Report invites the Commission to revisit it – but without any real guidance as to how it might want to do so, but a warning that it might be difficult.
  • Extensive public disclosure for the benefit of investors in public transactions is certainly a positive aspect of the current regulation. But it is much less clear whether the extension of those disclosure requirements to certain types of private transactions really serves the overall purpose of the regulation or, on the contrary, is an unnecessary burden resulting from over inclusive drafting.
  • PCS supports a reduction of the types of securitisations covered by the extensive disclosure requirements to those where such disclosure really serves the overall purposes of the regulation.

STS regime generally

  • The Report provides much interesting, if dispiriting at times, data on STS securitisations.
  • One of the most devastating datum is that securitisation only makes up 2.3% of insurance companies’ investments and that, of those 2.3%, only 2% are STS. So, STS makes up less than 0.05% of insurance companies’ investments. No surprise then that an improvement of the Solvency II calibration for STS was not high on the list of insurance companies’ “asks” in the recent review of Solvency II. At the same time, without such re-calibration, insurance companies will continue to shun STS securitisations – not because of risk or stigma but simply because the current calibrations are way out of line with the real risk profile. This is why PCS would strongly urge the Commission not to conclude from the fact that better calibrations of STS securitisation were not on the list of improvements of Solvency II suggested by the insurance industry that such better calibrations are not a vital part of making EU financial regulation fit for the purpose of funding European economic growth.
  • Another interesting data point is that the capital treatment of STS securitisations is by far and away the benefit most valued by market participants. When one considers that the next two most valued benefits (broader investor base and better pricing) are most likely connected to the capital benefits, it is clear the central element of assessing STS and its role and future lies in capital calibration.
  • The Report also mentions that comparative prudential treatments of securitisations with other capital market instruments (including disclosure burdens and costs, investor due diligence requirements and capital requirements) are essential to understand the potential of STS to revive securitisation in Europe.
  • Having drawn attention to all those facts and admittedly suggesting that maybe something could be done, the Report then, unfortunately, studiously refuses to take any position on what that could be

STS criteria

  • The Report notes that certain securitisations are not capable of obtaining STS: managed CLOs and CMBS but, correctly in PCS’ view, points out that this is by design – not a bug but a feature.
  • The Report acknowledges that some market participants have complained of the stringency of some criteria but point out that the STS criteria are meant to define a high standard and so should not be diluted. Here PCS, although broadly in agreement, would point out that, with the benefit of having seen many criteria play out in real transactions, a few tweaks would be sensible.
  • The Report spends quite some time on why there are no ABCP programs that are STS compliant, identifying the criteria that make it unreasonable for most sponsors to turn an existing conduit into an STS conduit. But having suggested that some changes could be considered, the Report muses that, since there are no practical benefits whatsoever in the existing legislation for any market participant in a conduit being STS, maybe a change in criteria would not really make any difference. We agree.

Supervision

  • Carefully reading the Report, one may discern the most diplomatic of attempts tentatively to raise the issue of why the regulation of a pan-European standard was not entrusted to pan-European regulators but to national authorities with an invitation to explore some form of reflection on the possibilities of some regulatory centralisation. The ESAs are treading carefully here.

Third party verification agents

  • We must thank respondents to the survey who reported that TPVs were “an additional source of guidance and control to interpret the STS requirements which is valued by investors and less experienced securitizing parties”
  • The ESAs saw benefit in our work but wished that TPVs were more transparent in their interpretations of STS criteria and had more frequent interactions with national competent authorities. PCS sees no issue with both those requests and will explore how best to act upon them.

Conclusions

On a second reading of the Report, nothing has changed our initial sense that this is a lost opportunity for the ESAs to engage with the real issues that limit the success of an otherwise well drafted piece of legislation: the inappropriateness of the prudential benefits for such a high standard as STS and the desperately unbalanced playing field between securitisation and comparable capital market instruments. By not doing so, the Report did, unfortunately, not provide the rounded analysis of the functioning of the Securitisation Regulation within its ecological niche in the capital markets we think was called for.

STS criteria highlighted : Article 21(9)

Article 21(9) is one of the STS criteria that regularly has triggered debate about interpretation.

The Joint Committee of ESA’s has recently published Q&A’s that may be very useful to market participants.

One of the questions relates to Article 21(9) of the Securitisation Regulation and the answer implies that issuers may need to make adjustments to their disclosure.

The Committee answer vis-a-vis Article 21(9) indicated that “Information regarding servicing procedures should be found in a publicly available document especially where this documentation explains how the servicing of delinquent and defaulted exposures are taken care of, so as to further facilitate investors’ due diligence regarding compliance with Article 21(9) of the SECR”.

PCS views this response as clear indication that the required information referred to in 21(9) should be contained in the documents that are provided to investors. Where previously some transactions contained statements that the Article 21(9) information was contained in policies and procedures or servicing manuals to which the investors had no access, it appears clear now that the specific servicing/remediation/recovery details need to be included in the transactions documentation provided to investors. Such information could also be included in attachments to available documents (e.g., the servicing agreement) or contained in a summary within the Prospectus or other transaction documents

5. Our people

PCS is a compact organisation with a total staff of 12.

In each newsletter we will introduce one of them so that people get to know us. This time, Rob Leach, Member of the Analytical Team.

Rob Leach

I originally was trained as a credit analyst at a large commercial bank in the US and eventually became a real estate lender in the bank’s Philadelphia office. I later moved into securitization when I joined a rating agency in New York. Shortly thereafter, I moved to the London office, where I eventually came to manage the team of analysts in London responsible for CMBS ratings. In more recent years, I served in a control/risk management role responsible for quality review activities across several structured finance sectors. In 2019, I moved to PCS, coinciding with the implementation of the STS regulation and PCS’s STS activities as a Third Party Verification Agent.

When not working, I enjoy a variety of activities, since a while now including mask-wearing, social distancing and waiting for home delivery. In line with the current social trends, I’ve fully adopted the work-from-home lifestyle, enjoying the blurring of lines between work life and that other part of life formerly known as the not-at-work life. I live with two rabbits and am an adherent of “slow gardening.”

February 2021 Newsletter

Welcome !

Welcome to this 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, in our regular features, we share updated data on the STS securitisation market and present Rob Koning, a member of our Outreach Team.

In addition to those regular features, we have an update about the state of play regarding the upcoming new regulation on synthetic STS transactions.

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

Market data

In this edition, we have not included the usual pie charts for STS transactions ytd, as these currently stand at 9 and 3 notifications to ESMA and the FCA respectively. These small numbers would make for pie charts with little added value. In our next Newsletter we will provide charts again.

  • With only 9 transactions notified to ESMA so far, of which 5 ABCP and 4 term transactions, few, if any, meaningful conclusions can be drawn. With 6 private transactions to 3 public ones, there is little sign of a reversal of private transactions’ domination of the STS space but again, early days.
  • The transactions notified to the FCA comprised of 2 ABCP trade receivables transactions and 1 private consumer loan deal.
  • 9 ESMA notifications seems a slow start. Even if one adds back the 3 UK transactions to reach 12, this compares weakly with the 29 transactions notified to ESMA by the same time last year. But early 2020 saw a stunning start to the year leading to high hopes for the year’s volume dashed by COVID and lock-down. As we predicted in our December 2020 Newsletter, the first half of 2021 is likely to be very similar in number of STS transactions to the second half of 2020. Nothing in these numbers (and the numbers of announced STS transactions) indicates that this prediction needs revision.

As they had promised, ESMA sifted the UK transactions from their list. Although they still appear in the ESMA list, they are marked “cancelled”. ESMA also provided a separate spreadsheet setting out all the cancelled UK transactions which can be found on the relevant page of their website. So anyone wanting to check whether a given UK securitisation is still STS can look it up on this list. (Hint: it will not be).

STS and Synthetic Securitisation – state of play

The last time we broached the subject of the proposed synthetic STS legislation was in our mid-December end-of-year Newsletter.

We were still awaiting with some trepidation the publication of the final political compromise between the European Parliament and the Member States. This occurred on December 16th, almost immediately after the publication of our Newsletter.

That final compromise brought both some relief and some disappointment. The relief was that most of the difficult issues around which some potentially damaging proposals had been floated ended up in (mostly) the right place. The disappointment came from the timetable. Whereas we and many market participants had expressed the hope that STS for synthetics would be able to come into force in the first quarter of 2021, the calendar slipped, although not dramatically. Also, considering the generous grandfathering provisions of the draft law, this slippage may have only limited consequences.

Timetable

Despite, arguably optimistic, predictions of an entry into force of the new STS regulation by the middle of the first quarter, it now seems likely that the law will only be on the books around May/June of 2021.

As you can see, the current forecast is for the law to be voted by the European Parliament in March (with the 8th March Plenary Session the current favorite for the vote). Of course, a potentially heavy COVID driven agenda could result in delays either for the Parliamentary or the Member States’ vote.

The diagram also refers to the EBA RTS drafts, of which more below.

Non-STS Content

  • Amends rules relating to non-performing loan securitisation, including a new definition of NPL securitisation and new – and more sensible – rules around retention for NPL securitisations.
  • Amends and reinforces the restrictions on where securitisation special purpose vehicles may be located (in all cases and not just for STS). Whereas the original regulation prohibited SPVs from some tax havens, the new rules will tie the prohibition to two published lists relating to money laundering and tax. This is more than a matter of details, as our Australian friends pointed out when they noticed their country was on one of the prohibited lists.
  • Requires the EBA to explore by 1st November 2021 how new rules around sustainability could be crafted for securitisation. Market stakeholders should most definitely watch this space.

STS Content

The final legislative text does not fundamentally change the approach to the new synthetic STS category.

Complexity

The first point that we would like to stress is that the new synthetic STS criteria are not simple. PCS has now replicated its STS true sale checklist for the new synthetic criteria, breaking down the complex legislative language into the smallest binary, yes/no, questions that have to be answered to confirm a synthetic transactions’ STS status.

For the existing true sale STS rules, this stands at 103 separate criteria, all of which must be met. For the new synthetic STS rules, that number stands at 145 to 160!

Pressure points resolution

During the political negotiations four issues had arisen around which a number of proposals had been floated, which – had they been included in the final text – would have severely (and potentially terminally) affected the possibility for any originator/protection buyer to issue a synthetic STS securitisation. Mostly, these were positively resolved in the final agreement.

  1. Early termination/non-sequential amortisation: despite contrary proposals, these will be allowed.
  2. Time calls: again, after suggestions these may be prohibited, they will be allowed. As a compromise though, the originator/protection buyer needs to explain to his prudential regulator why the exercise of a time call is not due to asset deterioration. In other words, why the bank is not terminating its credit insurance just as it is needed.
  3. Collateral: If a securitisation is “funded” (i.e. cash collateral is provided by the investor/protection seller) and that cash is left with the originator/protection buyer, then that originator/protection buyer needs to meet minimum rating requirements. Proposals had been bandied around that would have been exceptionally punitive for southern European banks whose ratings are capped by low sovereign ratings. A compromise though was reached allowing lower rated banks to hold the collateral if they receive permission from their prudential regulator.
  4. Synthetic Excess Spread: Proposals had been discussed to ban the use of synthetic excess spread (SES) in STS transactions. The final text pulls away from such draconian measures and does allow SES subject to sensible limits reflecting the EBA’s approach. The SES needs to be a fixed percentage capped at the one year “expected loss” for the pool. (A number that has a precise definition in the Capital Requirements Regulation (CRR)). Caution though: as a trade-off for allowing SES, the rules will now require that a yet to be determined amount of additional capital be allocated under the CRR to the SES amount. We discuss this below in the CRR section.

Overall, therefore, the most threatening pressure points appear to have been resolved in a satisfactory manner. A cloud though still hangs over those synthetic transactions which need to use SES and we will await the EBA’s proposals with some trepidation.

CRR

In addition to amendments to the STS Regulation, amendments are being made to the Capital Requirements Regulation to allow lower capital allocations to the senior tranches of synthetic securitisations achieving STS. (For a fuller discussion of why this is important, we invite you to read our article “Synthetic STS – Quo Vadis?” in our December Newsletter.

Article 270

The agreed legislative draft effectively replaces the current Article 270. This article was an exception to the principle that synthetic securitisations could not benefit from the lower capital requirements allowed to true sale STS securitisations. This exception was limited however to certain SME backed transactions.

The new rules would allow any synthetic transaction that met the STS criteria (subject to our note below) to get the benefit of these lower capital requirements. In other words, Article 270 is now extended to all asset classes (save for NPLs).

Additional requirements

A word of warning though. In the existing CRR rules for true sale STS securitisation it is not sufficient that a transaction be STS to benefit from the lower capital requirements. Additional criteria above and beyond STS also need to be met. These criteria when added to the other STS criteria are sometimes referred to, by market participants, as STS+. (Incidentally, they are also the subject matter of PCS’ CRR Assessment which is often sought in addition to PCS’ STS Verification.)This requirement for additional criteria is maintained for synthetics seeking lower capital requirements under the proposed new rules. STS+ will remain relevant. (Helpfully, PCS intends to offer its CRR Assessment for synthetic transactions).

Synthetic Excess Spread

As mentioned above, the political compromise around SES requires the EBA to provide a draft regulatory technical standard (RTS) which will define an amount of capital that a bank using SES in a synthetic securitisation will need to allocate against that SES.

Setting aside the puzzling notion that a bank needs to set aside capital for a non-balance sheet revenue stream rather than an asset, it is unclear at this stage how this additional capital will be calculated. Depending on the outcome of the EBA’s work, it could well be that few, if any, synthetic securitisations using SES could be profitably issued. This therefore casts a shadow over securitisations intending to use SES and we look forward to the EBA providing some swift guidance as to their thinking.

Grandfathering

The good news is that grandfathering under the proposed legislation is easy.

Existing synthetic securitisations

All that is required for a synthetic securitisation issued prior to the entry into force of the new law to become STS is for that transaction to meet the STS requirement at the time of notification to ESMA.

The likelihood of the current draft not being voted or being amended by the Parliament in plenary is extremely small. Therefore, it should be possible for banks to structure and issue synthetic securitisation right now with a fairly high expectations that these will be able to benefit from lower capital requirements by the second half of the year. No need to wait.

Existing Article 270 securitisations

To avoid existing Article 270 SME securitisations legitimately issued since January 2019 losing the benefit of the lower capital requirements because of the addition of new criteria for synthetic STS, the proposed law sensibly grants automatic grandfathering to all those transactions. They will continue to remain eligible notwithstanding that they do not necessarily meet all the new criteria.

PCS’s role

Third-party verification agents

The new synthetic STS proposals retain the role of independent, regulated third party verification agents on the same basis as for true sale STS securitisations.

PCS has already stated that it will perform this role for this new market sector once the law has passed.

Grandfathering

Because, as we have seen, it is possible for banks immediately to structure and issue synthetic securitisations with a high level of confidence that these will attract the lower capital requirements for senior tranches by year-end, PCS is also immediately able to provide a two-stage verification service. In the first stage, PCS will provide, at or before closing, a preliminary checklist covering all the proposed synthetic STS criteria (and, if requested, the STS+ additional criteria). In the second stage, which will fall after the entry into force of the law, PCS will complete its verification and issue its final checklist.

For more details, please visit our website page.

Brexit reminder

The new law, quite obviously, only applies to EU member states. Currently, PCS is not aware of any legislative proposal in the United Kingdom that would introduce a similar regime. Therefore, none of this applies to UK securitisations.

Improved format PCS Verification Report

PCS regularly askes stakeholders what changes and improvements they would like to see in our reporting format. Following the latest request for feedback, PCS has implemented an improved reporting format. The new format of our STS Verification Checklist can be viewed at this page.

5. Our people

PCS is a compact organisation with a total staff of 12.

In each Newsletter we will introduce one of them so that people get to know us. This time, Rob Koning, Issuer Liaison in the Outreach Team.

Rob Leach

After a start in banking as relationship manager at Amro Bank, later merged into ABN AMRO, I switched in 1994 to the relatively new and unknown securitisation product. After a few years of struggling to survive for my department, the growth of the securitisation business gained traction in the late 90’s and so did my business line. Until 2008 I have been running the global ABCP business of the bank, first based in Chicago and later in Amsterdam. In 2008, the securitisation activities of ABN AMRO were acquired by RBS and I continued my work in the securitisation industry as an independent consultant.

After a period at Rabobank, I was invited in 2012 to become the first Director of the Dutch Securitisation Association and in 2018 I also joined PCS as liaison for originators, arrangers and issuers.

I am married and father of 5 and grandfather of 6 and live in the place I was born, Amsterdam, in an apartment near the river Amstel. In my spare time, I like hiking and biking in my hometown and the surrounding countryside.

2020 - The STS Year in Review

Welcome !

Welcome to this special 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 2020, assess the current state of play and look towards 2021.

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

Market data – Looking back at 2020 – What the numbers tell us about STS

Introduction

There can be no doubt that 2020 was the year of COVID-19 and the pandemic weighed, directly and indirectly, on all aspects of our lives. STS securitisation was no exception. We look at STS numbers generally and by asset-class and jurisdiction and attempt to draw out the big picture and emerging trends. We also look at our predictions for 2021.

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. But by focusing on numbers PCS hopes to shed not a better light but a different light on 2020. An example of this difference in perspective would be Dutch RMBS, where the volume decreases were driven by the (temporary?) withdrawal from the market of the largest issuers by volume. However, when one looks at the numbers, one sees an increase in smaller transactions by smaller platform players. That is the type of development that can be missed if one solely looks at the volumes. Also, a small number of very large transactions can distort the picture. A week ago, for example, ING issued a € 14bn retained RMBS out of its Spanish branch. This alone will add massively to the 2020 issuance.

(All numbers are as of 6th December 2020 and so comparisons with 2019 are not exactly on the same basis. PCS only expects 4 to 5 additional STS deals by year end though).

The big picture

Numbers

Numbers...

20192020TotalYoY
ESMA listed STS transaction14327341690%

Commentary

  • With over 400 STS transactions registered, despite fears expressed in 2018, the STS standard is achievable for most “traditional” types of securitisation.
  • Originators issuing in all asset classes that can achieve STS in a straightforward manner have universally elected to do so when publicly placing paper in the markets. The only exception remains “Buy-to-let” RMBS – almost entirely a UK and now Dutch product – where STS is not sought. This is usually attributed to the fact that BTL-RMBS is not eligible for the Liquidity Cover Ratio (LCR) pools of bank investors. With that exception, all publicly placed STS eligible securitisation is STS.
  • Securitisations which are issued to be used as collateral with central banks (“retained transactions”) may or may not seek the STS. This is because neither the ECB nor the Bank of England have STS as a requirement in their collateral rules.
  • 100% of STS securitisations publicly placed with investors in 2020 elected to be verified by a third-party verification agent (“TPVA”). A number of retained transactions also elected to do so.
  • Over 95% of all publicly notified STS securitisations in 2020 (including retained transactions) elected to be verified by a TPVA.

Below the surface

Numbers...

20192020YoY
Public10481-22%
Private39192392%

Commentary

  • The five-fold increase in private transactions hides a 22% fall in the number of public transactions notified to ESMA as STS. This, though, is not an STS phenomenon but reflects a general decrease in securitisation issuance from € 90 bn in 2019 to € 75 bn in 2020.
  • The decline reflects, in our opinion, the impact of COVID on the securitisation market generally. This impact was two-fold. First, but maybe less important, a slow down in retail borrowing at the onset of the crisis meant warehouse facilities filled up more slowly and funding requirements overall looked less substantial. Secondly, and in PCS’ view more impactful, central bank monetary policy drowned the banks in free liquidity. In these circumstances, fairly expensive securitisations find it difficult to compete with free cash for the heart of bank treasuries.
  • Monetary policy will explain why the largest reduction in issuance yoy is from the traditional banking world, leaving as anchor issuers in the STS space (i) banks that have a long-term strategic focus on and commitment to securitisation despite the short term cost impact; (ii) financial institutions such as auto-captives that have placed securitisation at the heart of their business model and (iii) new challenger platforms that have also done the same. This does not mean there has been no STS issuance from more traditional banks, but it decreased substantially in 2020.
  • After a blow-out at the beginning of the crisis, secondary market spreads started to tighten almost immediately and steadily in all jurisdictions and asset classes to return by mid-September to pre-COVID levels pretty much everywhere. Since then in some asset-classes, such as German auto’s, spreads have come inside of their pre-COVID levels. This is the clearest indication that the issues with STS issuance volumes were supply and not demand driven.
  • Of the 192 private STS securitisations notified to ESMA, 174 were ABCP transactions. This number needs to be understood though and two points must be borne in mind. First, the STS Regulation requires that each conduit wishing to obtain STS status for a transaction must notify ESMA separately. So, if an originator has a transaction funded by 5 conduits, even though this is a single ABCP securitisation transaction, it will have to be notified 5 times to ESMA. Since ESMA does not publish any information on ABCP STS notifications, it is impossible to determine how many actual securitisation transactions are reflected in that 174 number. Secondly, differently from term transactions, ABCP transactions usually go on for many years with annual or bi-annual amendments reflecting changing circumstances. What we saw in 2020 were conduit sponsors using the opportunity of these amendments to make their ABCP transactions STS. Therefore, these 174 ABCP transactions do not represent new deals or new funding. The vast majority are transactions that have been existent for sometimes decades but are converting to the STS standard this year. Also, the small number of ABCP transactions last year reflected the fact that conduit sponsors had been granted a one year grace period before having to apply the new capital requirements to their conduit liquidity facilities. This meant that STS benefits only started for sponsors on 1st January 2020 rather than 1st January 2019 when they kicked in for everyone else.

Asset classes & Jurisdictions

Public Transactions20192020YoY
RMBS5028-44%
Auto4431-30%
UK4223-45%
Dutch167-56%
German1812-33%

Commentary

The sample of figures above confirms the overall picture. In both the UK and the Netherlands, a large part of the issuance is usually from traditional banks and most often in RMBS. In 2020, one of the two largest Dutch issuers (Obvion) stayed away from the markets post-COVID and the other (Aegon) stayed away in 2020 altogether. (Also, some smaller regular issuers like Argenta and EDML were missing in the public market.) Similarly, in the UK there was almost no post-COVID issuance from traditional bank and building society RMBS issuers. In Germany though, where auto-captives play a larger role and have built their business models around securitisation, declines were more modest. In the Netherlands though, the volume decline is more stark than the numbers since the large deals from traditional banks have been replaced in part by smaller deals from new platform entrants such as MeDirect.

Predictions

Predicting markets at the best of times is somewhat of a foolish endeavour. Today, with uncertainty over a global pandemic hanging over everything, it is truly quixotic. Yet, predictions are a traditional part of the holiday season, like Christmas trees, presents and over-eating. So here we go …

PCS continues to believe that the most important driver of subdued issuance remains the competition from central bank free money. Without any special knowledge, we assume that the current consensus view that the vaccines will be rolled out to a sufficient level to put restrictions on economic activity behind us by April/May is correct. However, central bank – and particularly the ECB still bearing the scars of its premature tightening in 2011 – are exceedingly unlikely to change monetary policy before well into 2022. A research house we recently spoke to, believed that no central bank tightening will occur until 2024.

So, based on our conversations with market participants and our own transaction pipeline, we see current ongoing volumes of issuance remaining steady for the first half of 2021. Once economic activity returns post-vaccine an acceleration of lending to consumers will, on the one hand, fill up warehouse facilities faster and, on the other hand, lead traditional lenders to want to dip their toes back in the water. But the free central bank money will still cast its baneful influence on issuance volumes. So, we expect some growth in the second half of 2021 but nothing spectacular.

One aspect that could add to issuance though is the growing interest by banks in deconsolidating securitisations. These are securitisations that allow the originator to free regulatory capital under the Capital Requirements Regulation. After their almost complete disappearance in the last two decades, such transactions are starting to re-appear with the looming threat of Basel III. Free money from central banks does nothing for your capital requirements and so this type of STS transaction should not suffer from it.

Taking capital relief deals and greater funding needs in 2H21 together, PCS expects the STS term market to grow a little over 2020, by about 15%.

The trajectory of ABCP STS notifications is harder to ascertain, since, as we have indicated above, most of these new STS notifications are not new deals and so the decision to amend them to STS or not involves more complex and also more private considerations over which it is harder to obtain visibility. PCS suspects that ABCP notifications might run at roughly the same rate as in 2020 before dipping in 2022 when all the existing low hanging fruit have been picked and STS ABCP will have come mostly from new transactions.

None of this takes any account of any possible STS synthetic market, as to which, we invite you to read our synthetics article below.

Synthetic STS – Quo Vadis ?

Background

In the STS Regulation passed in 2017, European legislators explicitly closed the door to STS synthetic securitisations. Yet, they also signaled that if the door was closed, it was not locked and instructed the European Commission to bring to the Parliament a project for incorporating such securitisations into the STS regime. Following a report commissioned by them from the EBA and published in May of this year, the Commission prepared some draft legislation which was presented to the European Parliament and European Council for expedited treatment. As this Newsletter is published, the draft legislation that would allow synthetic securitisations to become STS is being negotiated between the Commission, the Parliament and the Council and there is a decent chance that a political agreement could be reached before year end. In turn this would see synthetics become eligible for STS status already in Q1.

What is at stake ?

Upcoming reforms in the calculations for mandatory regulatory capital for banks (Basel III and additional European elements) and the impact of the leverage ratio is likely to put great pressure on European financial institutions to raise substantial new capital in, what were even before COVID-19, difficult conditions.

Therefore, tools that allow banks to manage their capital requirements by legitimately removing risk from their balance sheet have become a key element of the future of banking in Europe. Synthetic securitisations are one such tool.

But they suffer from a problem resulting from the anomalous and often logically inconsistent regulatory treatment of securitisations. A bank has a pool of assets. Those assets require capital to be allocated against them. To reduce that capital, the bank will “insure”, via a synthetic securitisation, some of the risk of that pool. This transferred risk may well be the risk for which 100% of the regulatory capital is required. But, after transferring some of the risk, the senior part of the risk that is not transferred is now treated as a securitisation AND the same risk in securitised form is treated much more severely than in its raw state. The result is that the capital usually required by that senior part of the risk AFTER all the real risk has been insured is often no less (and in some cases even greater) than the capital required before the bank removed that risk.

Allowing synthetic securitisations to be STS is a way to mitigate this absurdity. It will do this by allowing senior risk in retained synthetic STS form to attract the lower STS capital required by the CRR.

Will it work ?

Although the Commission could have done this by creating a new synthetic standard with benefits similar to those that exist for true sale securitisations for investors, they chose to follow the EBA’s lead and limit any benefits solely to the originator holding the senior tranche for capital reasons. In other words, the proposed law can only benefit banks seeking to manage their capital requirements.

PCS sees two problems with this approach. First, it is a missed opportunity to create a new investor standard that could have been the seed of a new class of tradeable securities. This would have improved the prospects of the European Capital Markets Union (“CMU”). Policy makers focused more on fixing the mistakes of the past than on building the future.

Secondly, although policy makers opted to limit the scope of the legislation solely to originators holding the senior piece, they then added provisions which, in fact, go against the interests of the same originators and make it more difficult to execute this type of securitisations. This would have made sense if they were creating an investor standard but they chose not to do this. A good example of this are the discussions around cash collateral and how it should be taken away from the originator in yet to be settled circumstances. In this, the proposed law seems to be working at cross-purposes.

Another potential problem is the issue of synthetic excess spread, where sensible EBA proposals appear to have become somewhat of a political football and where we cannot exclude a fairly bad result.

Will we have synthetic STS securitisations in 2021?

It seems probable that some political deal will be struck this year or early next year. This would, in theory, see STS synthetics become available early in 2021. A question mark though will be how the synthetic excess spread and cash collateral debates end up. In particular, and especially for the former, it is possible that the can will be kicked down the road by devolving the final decision to an EBA drafted regulatory technical standard. Depending on when that standard is passed and the level of uncertainty as to where the EBA will come out, it is possible that some or many banks will postpone doing STS transactions. This is hard to predict though. The delay in the passing of the “homogeneity” RTS for true sale securitisations did not thwart issuance in early 2019. But that was also because the market had a fair sense of where the EBA would come out on the issue.

What about STS synthetics in the UK and Brexit ?

PCS did a lengthy piece on this which can be found here.

Summary: there will be no synthetic STS securisations in the UK unless the UK government passes legislation to that effect. The chances of this are fairly small at this juncture.

Brexit and STS

Barring extraordinary developments – which in 2020 can never be entirely discounted – the UK will truly exit the European Union on 31st December 2020, at midnight Brussels time.

So where has the tortuous exit process, at times pure slapstick comedy, at times horrifying road to Golgotha, left securitisation and STS in particular?

First, one must recognize that whatever final deal is struck over fish and chocolate, for the finance industry, Brexit was always going to be a “hard Brexit”. Many clear-eyed observers have long considered that the UK’s request to protect the City of London by covering broad swathes of the financial industry with “equivalence regimes” was not so much optimistic as what American sports aficionados call a “Hail Mary”. For reasons unconnected to Brexit, EU policy makers have, over the last few years, become very wary of “equivalences” in financial regulation. For them to grant extensive equivalences to the City of London would have required them to overcome that skepticism. Such a reversal, in turn, would have called on an immense amount of political goodwill. The type of political goodwill that the UK government, seemingly wedded to triumphalist declarations, not so much squandered as drenched in kerosene and set alight.

Securitisation was no different. Despite some concessions from the UK, the STS regime will basically suffer a total fracture running down the Channel.

This article summarises the position of STS securitisation in the new year. For those wanting to delve deeper in the arcana, we also provide the links to the relevant texts – in red highlights.

Legislative background

On the UK side, the legislative rules that regulate Brexit are set out in a UK Act of Parliament: the European Union (Withdrawal Agreement) Act 2020. Under this act, Her Majesty’s Government can pass statutory instruments to regulate diverse parts of the UK legislative landscape in the implementation of Brexit. Such an instrument was passed to amend the EU securitisation regulation: the Securitisation (Amendment) (EU Exit) Regulations 2019. This is our key document and will be referred to as the “UK REG”.

The UK Securitisation Regulation: what it does and does not do

General purpose

The main purpose of the UK REG is to onshore the STS Regulation. In other words, the UK REG makes all the logically necessary changes to jurisdictional clauses.

So, “EU” in the STS Regulation is replaced by “UK”, “ESMA” by “FCA”, “EBA” by either “FCA” or “PRA”, references to specific EU legislation by their new UK replacements and so on.

What is unchanged?

  1. The STS criteria – these remain exactly the same for both term transactions and ABCP
  2. The role of Data Repositories
  3. The role of Third-Party Verification Agents
  4. The notification requirements for STS (but to a new FCA website)
  5. The disclosure requirements for UK issuers (but not non-UK ones)
  6. The ban on re-securitisations
  7. The risk retention requirements

What is changed?

  1. Disclosure obligations for third country originators
    • The UK REG makes explicit that non-UK originators and sponsors do not have to comply with the Article 7 disclosure requirements in exact detail. This is ambiguous in the existing EU STS Regulation and the European Commission has never clarified whether non-EU originators and sponsor had to comply with Article 7 or not (despite many requests for such clarification).
    • This change is made by the UK REG amending Article 5 requiring investors to ensure that Article 7 disclosure is complied with and replacing it, in the case of third countries (including, of course, EU countries), with the unambiguous obligation to ensure only that substantially similar disclosure is achieved.
  2. Non-UK SSPEs for STS
    • Whereas, to obtain STS status, the EU STS Regulation requires that the originator, sponsor and SSPE be in the EU, the UK REG removes any territoriality requirement on the SSPE.
    • Therefore, for UK STS, the SSPE can now be located anywhere in the world. But, for UK STS, the originator and sponsors now must be in the UK and no longer, as before, anywhere in the European Union.
  3. Grandfathering and transition of EU STS in the UK
    • The new UK regime provides that all EU securitisations notified as STS to ESMA before a date falling two years from the end of the transition period (i.e. 31st December 2020) will still be considered STS in the hands of UK investors. This is both a grandfathering of EU STS transactions issued on or before 31st December 2020 and a set of transitional provisions for EU STS transactions issued and notified after the new year but on or before 31st December 2022.
    • To be clear though, this does not cover UK STS transactions issued before the end of the year and notified to ESMA. This is because, to benefit from these grandfathering provisions, a transaction must continue to be on the ESMA website list. On 1st January, UK transactions will be removed from that list – as to which see below.
    • What about rules and guidelines?
      • Under the Withdrawal Act, all legislative rules in force at midnight Central European Time on 31st December 2020, will be part of the laws of the United Kingdom unless specifically changed by the UK at a later date.
      • Regulatory Technical Standards passed before that date (such as the homogeneity RTS) will therefore remain legally binding on UK originators structuring STS transactions.
      • Rules and guidelines that are not legally enforceable – are not “legislative” in nature – will cease to have any force in the UK. These would include the EBA guidelines under the STS Regulation.
      • However, to avoid chaos, the Bank of England and the PRA have issued a joint statement stating that they expect all regulated firms to continue to apply EU rules and guidelines unless specifically overruled or irrelevant post-Brexit.
      • Based on that statement, the EBA guidelines on STS interpretation (which, under the STS Regulation are not legally binding even within the EU) should continue to be deferred to when interpreting criteria unless and until overruled by the FCA.

So what does this mean in practice?

  • UK transactions and ESMA
    • As of 31st December 2020, UK originators/sponsors will have to notify ESMA that their securitisations no longer meet the STS requirements – specifically as they do not meet the Article 18 requirements for an EU originator or sponsor. This notification is an obligation under Article 27.4 of the STS Regulation, not a suggestion.
    • That said, based on our reading of the statement of the Joint Committee of the ESAs, whether UK originators or sponsor do notify ESMA or not will make no meaningful difference since the statement indicates that ESMA intends to remove all UK transactions on 1st January 2021 anyway. From that moment, EU based investors will no longer be allowed to treat these transactions as STS and will have to apply to them the higher capital requirements mandated by the CRR (for banks) or Solvency II (for insurers) for non-STS deals. EU banks holding such transactions in their LCR pools will have to remove them. There are no grandfathering or transitional provisions for EU investors.
  • Existing UK transactions and the FCA
    • UK investors cannot treat a UK transaction as STS from 11.00 pm (London time) on 31st December 2020 unless that transaction appears on the new FCA website. The FCA, helpfully, set up that website on November 23rd so that UK originators and sponsors may start to pre-populate it before the end of the year.
    • Please note, that the obligation to notify the FCA via the FCA website appears to be that of the originators and sponsors. There will not be an automatic transfer from ESMA to the FCA. We understand that the FCA has reached out to all UK STS originators to inform them of the new rules,
    • Information on the FCA process, how to upload to the FCA website, called Connect, the templates and other information can be found on the relevant page of the FCA’s website.
  • Existing EU transactions and the FCA
    • As we have seen, all EU transactions notified to ESMA before 31st January 2022 can still be treated as STS in the hands of UK investors. To be clear, this means historical transactions notified before the end of the Brexit transition period and future transaction notified between January 1st, 2021 and December 31st, 2022.
    • So long as these transactions have not been removed from the ESMA list, they will continue to be treated as STS in the UK for their whole life, not just till December 2022.
  • Third-Party Verification Agents (TPVA)
    • As the FCA ceases to be an EU national competent authority on 1st January 2021, no TPVA authorised only by the FCA can verify an EU STS securitisation from that date.
    • PCS EU, being authorised in France by the AMF, will continue though to be able to provide verification to all EU STS transactions.
    • Also, since PCS UK was authorised throughout the EU before that date, all transactions verified by PCS UK prior to 1st January 2021 will remain validly verified under EU law. (This is no different than if PCS had decided to wind itself up or had lost its authorisation at some point. Neither of these occurrences would affect past valid verifications).
    • Only TPVAs authorised by the FCA will be allowed to provide verifications as defined in UK law for UK STS transactions as of 1st January 2021.
    • As re-notification to the FCA of transactions that have already been notified to ESMA are not “new notifications” dated as of the re-notification date, but transcriptions or refiling of existing notifications following Brexit, no new PCS verification is required upon the notification of existing transactions to the FCA.
  • Data Repositories
    • Currently no Data Repositories are authorised anywhere in Europe and so originators and sponsors can post information in accordance with the transitional rules provided for in the STS Regulation. These allow data to be made available on any website meeting certain basic requirements.
    • From 1st January 2021, this situation will continue until at least one Data Repository is authorised. But this requirement is now doubled and separated on each side of the Channel.
    • So UK originators whose transactions are listed as STS on the FCA website, can continue to post data as they currently do until a UK Data Repository is authorised by the FCA. The authorisation of an EU Data Repository by the ESMA will have no impact on this obligation. In other words, UK originators with UK STS transactions can continue, until the authorisation of a UK Data Repository, to post in the current manner even after the authorisation of an EU Data Repository. (They can also choose to post with that authorised EU Data Repository if they wish, but for UK purposes, that entity will not be a “Data Repository” but only a website that meets the basic requirements of the law.)
    • Exactly the same applies to EU originators who can continue to post as they currently do until an EU Data Repository is authorised and are equally unaffected by the authorisation of a UK Data Repository.
  • Cross-Channel Risk Retention
    • A possible source of complexity exists to current transactions where there is a cross-channel risk retention. This would be the case when an originator sought the benefit of the existing rules allowing risk retention on a group basis but where the retention holder was in the UK for an EU STS transaction or in the EU for a UK STS transaction. Such cross-channel risk retention structures would not seem to survive Brexit.

5. PCS – people in numbers

In this Newsletter, we will not highlight one of the members of the PCS team as usual but mention some things you probably did not know about the Outreach and Analytical team at PCS :

  • number of members in the teams: 8
  • number of nationalities represented: 6
  • last job before PCS: rating agency (2), investment banking (3), general banking (2) law firm (1)
  • average shoe size: 42 (EU)
  • average years working in securitisation: 25 years
  • average height: 1.83 m
  • average number of languages spoken by each team member: 2.9.

October 2020 Newsletter

July 2020 Newsletter