Risk retention requirements

The current minimum risk retention level (MRRL) requirement to hold 5 per cent of the net economic interest in the securitisation is unchanged. The MRRL must be held for the life of the securitisation transaction.

The form in which the MRRL must be held (i.e., the vertical slice, revolving assets slice, random selection slice, first loss tranche slice or first loss exposure slice) is unchanged by the Regulation.

Originators, sponsors and original lenders (together, the risk retention holders (RRHs)) will be under a new positive obligation to retain the MRRL in securitisation transactions. This will mean that the risk retention requirements will apply to RRHs regardless of whether the investors are based inside or outside the EU.

The default position, assuming a lack of agreement to the contrary, is that the originator is required to retain the MRRL. The Regulation allows the RRHs to agree to collectively hold the MRRL on a pro rata basis if the RRHs are the same type (i.e., either all originators or all original lenders or all sponsors).

Originator test

The definition of ‘originator’ has been tightened under the Regulation so that “an entity shall not be considered to be an originator [for the purposes of the risk retention requirements] where the entity has been established or operates for the sole purpose of securitising exposures”. Originators will need to demonstrate that they have a “broader business enterprise”.

The draft Securitisation RTS explains that factors that should be taken into account in determining whether an entity has a broader business enterprise include:

• demonstrating the capacity to meet payment obligations consistent with a broader business enterprise (involving material support from capital, assets, fees or other income available to the entity, disregarding any securitisation assets and income); and
• having responsible decision makers with the required experience to enable the entity to pursue the established business strategy and an adequate corporate governance arrangement.

The difference between an originator and an original lender is that an originator can securitise loans that it purchases from third parties as well as loans that it makes.

Due diligence

The existing due diligence requirement for EU institutional investors to ensure that the minimum risk retention requirements are satisfied prior to investing in securitisations is unchanged.

In summary, this means that EU institutional investors will need to have arrangements in place to verify that:

• the RRHs are complying with the risk retention requirements;
• the originator, sponsor and securitisation special purpose entities (SSPEs) have complied with the transparency requirements in the Regulation; and
• the originator or original lender (if they are not credit institutions or investment firms) follow sound and well-defined criteria, and have established processes for approving, amending, renewing and financing credits that form the underlying exposures of the securitisation.

Transparency

Originators, sponsors and SSPEs will be required to provide investors, regulators and, upon request, potential investors with certain information on the transaction and the underlying exposures (on a quarterly basis) as well as with the essential documentation used in the transaction and the final offering document, prospectus or
transaction summary. The disclosure requirements are extensive.

In certain instances, this information must be disclosed via a registered securitisation repository or, if no registered securitisation repository exists, via a website that meets specified requirements as to data control and security.

The precise application of the transparency requirements will depend on whether the securitisation is public or private.

Simple, transparent and standardised securitisations

The Regulation provides that certain securitisation transactions can be treated as STS transactions if they satisfy specific eligibility criteria. It is important to note that investing in an STS securitisation may afford certain investors more favourable regulatory capital treatment.

The specific eligibility criteria for STS transactions include:

• the originator, sponsor and SSPE in an STS securitisation transaction must be established in the EU;
• only true sales are eligible for inclusion (and so synthetic securitisations are excluded);
• the transaction must be backed by pools of exposures that are homogeneous in asset type, and must not include transferable securities (other than certain types of corporate bonds);
• clear specification requirements must be met for the relevant transaction documentation and obligation to provide a precise liability cash flow model to potential investors; and
• transactions must not include actively managed assets.

Originators and sponsors will be required to jointly notify the European Securities and Markets Authority (ESMA) that a securitisation meets the STS requirements. The notification, which must include an explanation of how the STS criteria are satisfied, will be published by the ESMA on its website.

Sanctions for breaches

Currently, the penalty for noncompliance is a punitive capital charge against investors’ balance sheets.

Under the Regulation, originators, original lenders, SSPEs and sponsors may potentially be subject to a broad range of administrative (or even criminal) sanctions.

In the UK, the Financial Conduct Authority (FCA) will be given certain supervisory, disciplinary and investigatory powers over persons who are subject to the regulation (irrespective of whether they are authorised and regulated by the FCA), including the power to impose a fine, censure certain individuals, issue a public rebuke, apply for an injunction or restitution orders, require restitution or impose temporary prohibitions on individuals holding management functions.

Client Alert 2018-240