Although the EU Securitisation Regulation (the Regulation) has been in force since 1 January 2019, the delayed adoption and implementation of the Delegated Regulations and Regulatory Technical Standards and the absence of meaningful regulatory guidance have created challenges for market participants in implementing the requirements.
Based on our experience of advising a range of participants on structuring their transactions, this article considers how market participants have responded to those challenges.
What is a securitisation?
Although there is a carve out for specialised lending (i.e., transactions involving physical assets meeting certain criteria), the broad and unwieldy definition of ‘securitisation’ means that the Regulation captures transactions which do not look or feel like a securitisation in the traditional sense (e.g., certain loan-on-loan transactions). Over the past year, there has been renewed focus on how to apply the definition in practice.
A transaction will be treated as a securitisation under the Regulation where “the credit risk associated with an underlying exposure, or pool of exposures [mortgages, loans, non-performing loans, trade receivables, etc.], is tranched” and has all of the following characteristics:
- Payments in the transaction are dependent on the performance of the exposure or pool of exposures (the so-called ‘dependency test’). Such payments will be treated as dependent if there is a direct correlation between payments made by obligors in relation to the underlying exposure or pool of exposures and payments made to ‘investors’ (including lenders and buy side entities) under the transaction documents. Limited recourse transactions normally fall within scope but transactions that have repayment guarantees or where the investor has recourse to other (non-securitised) assets may not satisfy the dependency test.
- The subordination of tranches determines the distribution of losses during the ongoing life of the transaction (i.e., those entitled to receive payments under the transaction documentation do not rank pari passu).The transaction is not a specialised lending transaction – this applies to certain types of physical asset financing (such as shipping and commodities).
- The Regulation defines a tranche as a “a contractually established segment of credit risk associated with an exposure or pool of exposures, where a position in the segment entails a risk of credit loss greater than or less than a position of the same amount in another segment”.
- Transactions structured as tranches of debt securities with differing levels of subordination (e.g., senior and junior notes) or as senior loans and junior loans (where the repayment of the junior loan is subordinated to payments due to the senior lenders) are normally treated as meeting the ‘subordination test’. Even if there is only a single tranche of funding, the transaction may qualify as a securitisation if there is overcollateralization.
- There has been some debate in the market over whether the financing of a transaction that is structured as a combination of a single tranche of debt and a single slice of equity falls within scope. This is because common equity is not normally a contractually established segment of credit risk (rather, its subordination to debt is a matter of general law or structural subordination). In practice, a careful legal analysis of the specific terms of the transaction documentation (including the waterfall provisions and/or the presence of a proceeds deed (where applicable)) is required to determine whether the contractual provisions have the effect of subordination. The structure of the payment flows up the chain and whether the borrower or sell side entity is newly established may impact the analysis.
- The transaction is not a specialised lending transaction – this applies to certain types of physical asset financing (such as shipping and commodities).
It is possible that some of these issues and uncertainties will be addressed in future regulatory guidance or through the European Securities and Markets Authority’s (ESMA) Q&A process. In the meantime, each transaction should be assessed against the securitisation definition on a case-by-case basis applying a common sense and risk based approach.