Brexit And The UK Regulation Of Term Securitizations

Brexit And The UK Regulation Of Term Securitizations – What Could Possibly Go Wrong? Presented by: Marke Raines Date: 7 February 2022 UK Securitization Regulation 101 - Rated EU term securitization suffered no defaults during the GFC - There has been a sustained EU regulatory assault on securitization under the guise of protecting investors since 2009 - Placed EU term securitization issuance in 2020 was still only 17% of 2006 issuance - Regulatory barriers continue to preclude the recovery of the EU securitization market - The Bank of England and HM Treasury have both stated that securitization is important to fund the UK economy - Upon Brexit, Parliament adopted the entire EU approach to securitization - HM Treasury, having been apprised of all of the relevant evidence on term securitization performance and the effect of the current regulatory regime, announced in December 2021 that it is, broadly, "continuing to support" the current regulatory approach Term Securitization Is Old (And New)  1769 - first Silesian transaction linking small, unmarketable loans with a broader capital market  1970 - the first US mortgage-backed securities  1985 - first issuance of bonds backed by UK mortgages originated by Bank America Really Basic UK Term Securitization - 80 debt/100 financial collateral = AAA credits - £100m financial collateral -> £100m financial collateral -> £80m AAA secured bonds Term Securitization Usually Results In The More Efficient Use Of Capital 1. The originator, for example, a mortgage lender, typically retains an exposure to the first loss on the securitized assets and an interest in the profit generated by the securitized assets (being the excess of income on the securitized assets over the transaction and funding costs of the securitization) 2. Assuming the originator applies the sale proceeds of the securitized assets to write more business (usually the case), the originator's book of financial assets increases but supported by the same shareholder capital Then Investor Confidence Went... - In the summer of 2007, prompted by fears about the US sub-prime market (see The Big Short), global investor appetite for structured bonds evaporated - The London interbank market froze in August 2007 - European securitization placed issuance dropped by nearly 95%, to @€25bn in 2009 - The GFC... Stellar Performance Of European Term Securitization During The GFC  rated European ABS and RMBS: no defaults. -Securitization can be a sturdy ally for investors', Financial Times, 15 August 2017.  Losses generally confined to CMBS transactions and some lower tranches of certain ABS and CMBS deals -Ibid.  Cumulative default rate for all European structured finance notes rated by S&P including CDOS of ABS, CMBS and corporate securitizations) was at mid-2014 1.58% of original balance -'Seven Years On, the Cumulative Default Rate for European Structured Finance Is Only 1.6%', Ratings Direct, Standard & Poor's Ratings Services, 26 August 2014, 2.  In 2014, the European Banking Authority compared the performance of top-rated European RMBS and ABS with top ratings assigned to corporate issuers, including financial institutions and insurance undertakings: 'Despite being relatively low during the 2006-2009 time period, the default rate of corporate ratings appears to be substantially higher than the default rate of EU RMBS and ABS products, the latter being close to zero.' -'EBA Report on Qualifying Securitization-Response to the Commission's call for advice of January 2014 on long-term financing, 13. Securitization Was Encouraged By EU Member States - And Grew  From 1988, special legislation was enacted in France, Spain, Portugal, Greece and Italy, Germany, the UK and other EU Member States to facilitate securitization  The European securitization market grew rapidly  In 2006, €477.6 billion of bonds backed by European assets were issued and placed Term Securitization Usually Results In The More Efficient Use Of Capital  The originator, for example, a mortgage lender, typically retains an exposure to the first loss on the securitized assets and an interest in the profit generated by the securitized assets (being the excess of income on the securitized assets over the transaction and funding costs of the securitization)  Assuming the originator applies the sale proceeds of the securitized assets to write more business (usually the case), the originator's book of financial assets increases but supported by the same shareholder capital Zero EU Regulation Of Securitization Prior To Or During The GFC - No EU regulation of securitization prior to July 2009 - The only EU rules relevant to securitization were: 1. Recognition of risk transfer by originator credit institutions; 2. Risk weighting of ABS and of undrawn liquidity facilities; and 3. Securitization-specific prospectus requirements EU Regulation Of Securitization Following The GFC 1. Highly detailed and prescriptive 2. Continually revisited, amended and expanded 3. A staggering volume of regulation (our in-house excel overview and guide runs to more than 3mb) 4. Eu regulation of securitization cannot be summarized in five hours, much less in a few slides 5. But a few main heads of EU regulation can be identified... Risk Retention 1. Meant to align interests of originator/sponsor/original lender and investors 2. 5% to be retained by originator, sponsor or original lender -Reg (EU) 2017/2402 (securitization regulation) art 6(1), as amended 3. 13 years after first introduced by directive 2009 111/EC, detailed risk retention requirements are still being amended and supplemented -EBA consults on technical standards on risk retention requirements under the securitization regulation, European banking authority, 30 June 2021 Disclosure 1. Extensive 'transparency' requirements for originators, sponsors and SPV issuers -Reg (EU) 2017/2402 (Securitization Regulation) Art 7 2. Detailed information on assets and structure to be made available to investors, to 'competent authorities' and, upon request, to potential investors - and, for public deals, to securitization repositories -Reg (EU) 2017/2402 (Securitization Regulation) Art 7 3. Technical standards regarding information and details of a securitization, including format and templates, only came into force on 23 September 2020 -Commission Delegated Regulation (EU)2020/1224 and ion Delegated Regulation (EU)2020/1225 Due Diligence By Institutional Investors  Investor must vet credit granting criteria, risk retention, underlying exposures and all structural features that can 'materially impact' performance -Reg (EU) 2017/2402 (Securitization Regulation) Art 5(3)  Establish written procedures to monitor the securitization position and the underlying exposures on continuing basis -Reg (EU) 2017/2402 (Securitization Regulation) Art 5(4)  Be able to demonstrate to competent authorities a detailed a comprehensive and thorough understanding of securitization position and underlying exposure -Reg (EU) 2017/2402 (Securitization Regulation) Art 5(4)