ESAs publish joint advice to the European Commission on the review of the securitisation prudential framework

On 12 December 2022, the three European Supervisory Authorities (EBA, EIOPA and ESMA, together the ESAs) published a joint advice (the Advice) (see links below) in response to the European Commission’s (EC) October 2021 call for advice on the review of the securitisation prudential framework. The ESAs made recommendations aimed at improving the consistency and risk sensitivity of the capital framework for banks and recommended that the current liquidity framework for banks and the prudential framework for (re)insurers be maintained in their current forms.

The Advice consists of two parts:

  1. an assessment of the recent performance and appropriateness of the rules on capital and liquidity requirements for banks and
  2. a review of the securitisation framework in Solvency II applicable to (re)insurers.


Advice on the banking sector

The ESAs made the following recommendations with respect to the capital framework for banks:

  • technical fixes aimed at improving the framework's consistency and improve risk sensitivity including:
  1. providing the option to carve fully capitalised tranches out of the calculation of the overall cap for securitisation under Article 268(3) of the Capital Requirements Regulation (CRR)[i] which would make it more risk-sensitive and applicable to a wider range of securitisations
  2. adjusting the treatment of specific credit risk adjustments (SCRAs) for the purpose of calculating the exposure value of securitisation positions retained by originators so that the deduction of SCRAs is extended to other tranches retained by the originator and SCRAs are taken into account in the calculation of the cap as prescribed for non-performing exposures (NPE)[ii] and
  3. adjusting the calculation of "Ka"[iii] under the standard approach (SEC-SA), so that it is calculated on the basis of the capital requirements of the non-defaulted exposures in the pool only, and of "K"[iv] for mixed pools, to reflect the capital requirements used in the formula of exposures in a mixed pool under SEC-SA
  • changes to provide clarity on certain provisions of the current regulatory framework including:
  1. the conditions under which SEC-SA may not be used; the scope of use of the Internal Assessment Approach (IAA), in particular that the IAA cannot replace the mandatory application of SEC-IRBA
  2. the intention behind the hierarchy of the approaches and
  3. the treatment of State guarantees which are transformed from a credit risk mitigation covering the State-guaranteed exposures to a guarantee covering a securitisation position
  • a reduction of the risk weight floor for originators for resilient transactions meeting certain eligibility criteria to support further growth in the significant risk transfer market in a prudent manner by promoting the issuance of resilient securitisations but without jeopardising financial stability
  • amendments to certain provisions relating to both the CRR requirements applicable to securitisations and the requirements applicable to exposures under the credit risk framework of the CRR including the treatment of portfolio guarantees and the calculation of the maturity of the credit protection in case of a call option for the protection buyer.


Advice on the insurance sector

The ESAs view is that the introduction of the simple, transparent and standardised securitisation (STS) regime in 2019 has not had a significant impact on (re)insurers’ investment decisions. The ESAs state that, on the basis of the input received and the analysis performed, the Solvency II framework has not driven (re)insurance activity in EU securitisation and that there is insufficient evidence to conclude that the current capital requirements for spread risk on securitisation positions in Solvency II are not fit for purpose.

The ESAs conclude that, although some changes to the existing calibration method of Solvency II, which would make it coherent with the overall Solvency II framework and more consistent with the CRR securitisation framework, could be feasible, their effectiveness is uncertain and would come at the cost of increased complexity.

As a result of the above findings, the ESAs do not advise changes to the current framework of Solvency II with regards to the prudential treatment of securitisation.


Additional remarks

The ESAs stress that further analysis should be conducted to gain a complete understanding of the relevant factors driving the securitisation market, some of which lie outside the scope of the prudential framework, including the recent monetary policy environment, the role of the due diligence and transparency requirements and the prevailing stigma attached to securitisation. For that purpose, it is recommended that the ESAs conduct further monitoring work on additional data as it becomes available.

In addition, the advice confirms that ESMA has commenced the revision process of the disclosure templates for securitisation transactions and will assess, as a part of this, whether greater proportionality can be introduced into the templates.


Our verdict: a missed opportunity

The current prudential treatment of securitisation is viewed by many stakeholders as excessively conservative and as a practical impediment to the development of the securitisation market (and the EU's broader commitment to Capital Markets Union). Whilst it was hoped that the ESAs' review of the framework would result in recommendations for significant change, the Advice falls short in that regard.  In particular, banking sector stakeholders will likely be disappointed that the ESAs have rejected the opinion of respondents that securitisations should be categorised as high liquidity assets in the liquidity framework. (Re)insurance sector stakeholders will also likely be frustrated by the lack of to the prudential treatment of securitisation under the Solvency II framework. The sector's response to EIOPAs public consultation on the framework had highlighted the framework's capital and due diligence requirements as obstacles for (re)insurers investing in securitisations and a broader hindrance to the revival of the securitisation market. The Advice will be viewed as a missed opportunity to such stakeholders.

The EC, in its report on the functioning of the Securitisation Regulation, indicated that it would assess the need for adjustments to the prudential framework once the ESAs advice was received. The EC has not to date commented on the Advice and it remains to be seen whether the EC will action the ESAs' recommendations.


Links to ESA advices:

 

For further information in relation to this topic, please contact Peter Walker, Partner, Jack Sheehy, Partner, Sinéad O'Connor, Partner, Ciarán Rogers, Partner, Sarah Murray, Senior Associate, Elizabeth White, Knowledge Lawyer or any member of ALG's Capital Markets Debt team.


Date published: 20 December 2022

 

[i] Article 268(3) currently provides that that maximum capital requirement for the securitisation position an originator or sponsor holds shall be calculated by multiplying the capital requirements of the underlying exposures had they not been securitised (or, in the case of mixed pools, the exposure-weighted average of the capital requirements of the internal ratings-based approach (SEC-IRBA) and standard approach (SEC-SA) portions of the underlying exposure) by the largest proportion of interest that the institution holds in the relevant tranches ("V"). V shall be equal to: (i) for an institution that has one or more securitisation positions in a single tranche, the ratio of the nominal amount of the securitisation positions that the institution holds in that given tranche to the nominal amount of the tranche and (ii) for an institution that has securitisation positions in different tranches, the maximum proportion of interest across tranches.

 

[ii] As a result of the legislative change made to the CRR by Regulation (EU) 2021/558 in 2021, when calculating the maximum capital requirement for a NPE securitisation, expected losses associated with exposures underlying a qualifying traditional NPE securitisation shall be included after deduction of the non-refundable purchase price discount and, where applicable, any additional specific credit risk adjustment.

 

[iii] Under the SEC-SA, the risk-weighted exposure amount for a position in a securitisation is calculated by multiplying the exposure value of the position, as calculated in accordance with Article 248, by the applicable risk weight in accordance with the formula specified in Article 261(1) of the CRR (the Risk Weight Calculation). The Risk Weight Calculation, parameter "Ka" is calculated in accordance with Article 261(2) which incorporates"Ksa". Ksa is “the capital charge of the underlying pool as defined in Article 255 and Article 255(6) of the CRR refers to Chapter 2 for the "Ksa" calculation, which shall be obtained by “multiplying the risk-weighted exposure amounts that would be calculated under Chapter 2 in respect of the underlying exposures as if they had not been securitised by 8 % divided by the value of the underlying exposures”. This means that defaulted assets, which are captured in the calculation of "W" for the purposes of "Ka", are also captured in the calculation of "Ksa". The ESAs therefore recommend clarifying that "Ksa" should be calculated on the basis of the capital requirements of the non-defaulted exposures in the pool to avoid double counting.

 

[iv] The ESA's recommend to amend Article 259(7) of the CRR by replacing "Ksa" with "Ka" as the latter reflects the capital requirements to be used in the formula for exposures in a mixed pool under the SEC-SA.