Documents considered by the Committee on 28 October 2015 - European Scrutiny Contents

2 Financial services and a Capital Markets Union

Committee's assessment Politically important
Committee's decisionNot cleared from scrutiny; recommended for debate in European Committee B, together with three related documents; drawn to the attention of the Treasury Committee
Document details(a) Proposal for a Regulation concerning securitisation; (b) Proposal for a Regulation concerning prudential requirements
Legal baseArticle 114(1) TFEU, ordinary legislative procedure, QMV
DepartmentHM Treasury
Document Numbers (a) (37128), 12601/15 + ADDs 1-2, COM(15) 472;

(b) (37143), 12603/15, COM(15) 473

Summary and Committee's conclusions

2.1 The Capital Requirements Directives have, since 2007, introduced a supervisory framework in the EU which reflects the Basel Committee on Banking Supervision's rules on capital measurement and capital standards. The latest legislation, known as CRD IV, in force since July 2013, transposes into EU law the latest global standards on bank capital adequacy. In February the Commission launched a consultation about a proposed Capital Markets Union (CMU) and has now published a Communication about an action plan for building the CMU, which we also consider in this Report.

2.2 As part of the CMU project, the Commission seeks the development of a simple, transparent and standardised (STS) securitisation market in order to support jobs and growth. It proposes a Regulation, which would update the legal framework for securitisations and develop the proposed STS regime. A second proposed Regulation would amend a CRD IV Regulation, by recalibrating the prudential requirements for credit institutions and investment firms either issuing or purchasing securitisations.

2.3 The Government tells us that it strongly welcomes these proposals, although it seems to have reservations about some of the detailed text, concerning possible binding mediation, the final certification and supervision regime and the extent of the need for Delegated Acts.

2.4 We note the Government's welcome for these proposals, albeit with reservations. As the proposals are important in the context of the Commission's action plan for the CMU we recommend that they be debated, with that action plan, in European Committee B. In the debate Members would be able to explore further the Government's reservations. We draw the documents and the debate recommendation to the attention of the Treasury Committee.

Full details of the documents: (a) Proposal for a Regulation laying down common rules on securitisation and creating a European framework for simple, transparent and standardised securitisation and amending Directives 2009/65/EC, 2009/138/EC, 2011/61/EU and Regulations (EC) No. 1060/2009 and (EU) No. 648/2012: (37128), 12601/15 + ADDs 1-2, COM(15) 472; (b) Proposal for a Regulation amending Regulation (EU) No. 575/2013 on prudential requirements for credit institutions and investment firms: (37143), 12603/15, COM(15) 473.


2.5 The Capital Requirements Directives (CRDs) have, since 2007, introduced a supervisory framework in the EU which reflects the Basel Committee on Banking Supervision's Basel II and Basel III rules on capital measurement and capital standards. The latest legislation, known as CRD IV, which comprises a CRD replacing earlier CRDs and a Capital Requirements Regulation (CRR) and which came into force in July 2013, transposes into EU law the latest global standards on bank capital adequacy in Basel III.[ 15]

2.6 In February the Commission published a Green Paper, about building a Capital Markets Union (CMU), to consult on a range of issues relating to improving market-based financing of the EU economy. It said that it would decide on appropriate follow-up measures on the basis of the consultation to put in place the building blocks for such a union by 2019. The Commission called for responses to the 32 questions posed by the Green Paper by 13 May and said that it expected to present an action plan in the summer. In July, having seen the Government's response to those questions, we cleared the document from scrutiny, but drew it and, particularly, the Government's response to the attention of the Treasury Committee.[ 16] We consider elsewhere in this Report a Commission Communication about an action plan for building the CMU.[ 17]

The documents

2.7 As part of the CMU project, the Commission seeks the development of a simple, transparent and standardised (STS) securitisation market in order to support jobs and growth. It argues that a high-quality framework for EU securitisation can integrate EU financial markets, diversify funding and unlock capital, freeing up lending to the wider economy. It presents two proposals. The first proposed Regulation, document (a), would update the legal framework for securitisations and develop the proposed STS regime. The second proposed Regulation, document (b), would amend the CRR, by recalibrating the prudential requirements for credit institutions and investment firms either issuing or purchasing securitisations. (The Commission intends to bring forward a third aligned proposal for a Delegated Act in the near future, which would revise the Solvency II[ 18] prudential treatment for insurers.)

2.8 Securitisation involves pooling various types of contractual debt such as residential mortgages, commercial mortgages, loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling their related cash flows to third party investors as securities. The first proposed Regulation would define securitisation as:

    "a transaction or scheme, whereby the credit risk associated with an exposure or pool of exposures is tranched, having both of the following characteristics:

    ·  (a) payments in the transaction or scheme are dependent upon the performance of the exposures or pool of exposures;

    ·  (b) the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme."

2.9 The second proposed Regulation would base its use of securitisation on that definition.

2.10 The proposals seek to realign incentives in the securitisation market. More complex securitisations, with riskier structures, would be made less attractive relative to products that meet requirements of simplicity and transparency. The prudential rules would then be recalibrated, reflecting the ability of investors to make more informed investment decisions and better price risk. The Commission says that its proposed regime:

    "does not mean that the securitisation position is free of risks, nor does it indicate anything about the credit quality underlying the securitisation. Instead, it should be understood to indicate that a prudent and diligent investor will be able to analyse the risks involved in the securitisation."

2.11 The proposed Regulation about common rules on securitisation and an STS framework, document (a), would apply to institutional investors becoming exposed to securitisation and to originators, original lenders, sponsors and securitisation special purpose entities (SSPE). In relation to consolidating and updating EU rules on securitisation, this proposal would:

·  include definitions to ensure consistent application across financial sectors, which largely follow those agreed under the CRR;

·  update some where necessary in order to meet the needs of the market, such as the definition of SSPE providing a more practical definition of likely special purpose vehicles;

·  define institutional investors within scope as insurance and reinsurance undertakings (as in Solvency II), institutions for occupational retirement provision (IORPs), alternative investment fund managers (AIFM), undertakings for collective investments in transferable securities (UCITS) management companies, internally managed UCITS and credit institutions and investment firms as designated by the CRR;

·  take the framework for investor due diligence from the AIFM Directive, which would broadly form the benchmark standard for all institutional investors in order to ensure consistency and a level playing field;

·  maintain the 5% risk retention rule, making the entity responsible for a securitisation retain (on an ongoing basis) a minimum 5% stake across all tranches, to ensure 'skin-in-the-game' throughout the life of the deal;

·  update the framework with the intention of resolving concerns around a potential loophole, which has seen certain entities able to circumvent the 5% rule;

·  seek to reverse the burden of responsibility — under CRR it is the investor who holds the liability for ensuring the risk retention rules are met, now it would apply to the party retaining the risk;

·  establish transparency rules covering all types of securitisations across all sectors — the Commission seeks a proportionate regime that allows investors to accurately analyse securitisations and not solely rely on third parties, with measures including regular updates on underlying exposures, developed prospectuses and other legal documentation, investor reports and notification of 'significant events' (including major changes to risk profile, or breaches of obligations);

·  task the European Securities and Markets Authority (ESMA) with developing Regulatory Technical Standards (RTS) which would prepare and update templates for disclosure, with an issuer being obliged to upload the information to a website;

·  update and harmonise rules on administrative and criminal sanctions, in a way consistent with the existing acquis, in order to have consistency across the supervision regime;

·  seek to resolve issues relating to arbitrage and to establish cooperation regimes, given the cross-jurisdictional nature of the EU securitisation market, including a way for competent authorities to work with the joint committee of the European Supervisory Authorities (ESAs) to develop best practice and information exchanges; and

·  envisage, as part of this effort, a last-resort role for ESMA binding mediation if there were intractable conflicts.

2.12 The second aim of the proposed Regulation, document (a), is to develop an appropriate set of criteria for STS securitisations and a supervisory regime to facilitate the market and compliance. The Commission sets out a framework of criteria for securitisations to meet STS requirements for term securitisation, primarily asset backed securitisation (ABS), and shorter-term asset backed commercial paper (ABCP). The simplicity criteria for term STS would be:

·  involvement of an SSPE that would ensure any sale or assignment would be enforceable against the seller in case of insolvency and that there would be no severe clawback provisions in the event of insolvency;

·  underlying exposures would not be encumbered;

·  discretionary active portfolio management of exposures would not be allowed;

·  underlying exposures would be homogenous, contractually binding and preclude transferable securities (shares, bonds or rights);

·  no securitisation of existing securitisations;

·  exposures should be originated in the ordinary course of the originator/lender's business, who should have experience of originating exposures of that kind, assessments of borrower creditworthiness should meet the rules from the Mortgage Credit Directive and Consumer Credit Directive, and underwriting standards should meet at least the same level as for non-securitised loans;

·  underlying exposures should not include exposures in default or to credit-impaired debtors or guarantors;

·  debtors or guarantors should have made at least one payment prior to the transfer of exposures; and

·  repayments should not depend on the sale of assets (although that would not preclude refinancing of underlying loads, for example re-mortgaging).

2.13 The standardisation criteria for term STS would be:

·  the risk retention requirements should be met;

·  derivatives should not be included unless they were for the purpose of hedging currency and interest rate risk — those particular risks should also be mitigated (and actions to do so disclosed);

·  interest payments should be based on generally used market interest rates;

·  in the absence of a revolving period (where only interest repayments were made), cash should not be trapped in an SSPE and should be passed to investors as per positions, and there should be no provisions requiring automatic liquidation of underlying exposures at market value;

·  where there is a revolving period, documentation should allow for early amortisation events or triggers to end the revolving period, such as a fall in the credit quality of the exposures below a contractually agreed level;

·  transaction documentation should specify various matters, such as the obligations, duties and responsibilities of the servicer and its management team, processes to ensure insolvency of the servicer would not jeopardises ongoing servicing, provisions for the replacement of derivative counterparties, liquidity providers and the account banks in the event of their defaulting or becoming insolvent;

·  transaction documentation should also clearly set out asset performance remedies (such as debt restructuring or payment holidays), including payment priorities and potential trigger events; and

·  provisions should be set out to facilitate conflicts between classes of investors, including the role of trustees and voting rights.

2.14 The transparency criteria for term STS would be:

·  prospective investors should be provided access to data on default and loss performance on substantially similar exposures for a minimum of the previous five years;

·  there should be independent external verification of a sample of underlying exposures prior to issuance, with a confidence level of accuracy needing to meet 95%;

·  liability cash flow models should be provided to prospective investors and then to the final investor on an ongoing basis; and

·  the originator, sponsor and SSPE to be jointly responsible for meeting these and the wider securitisation transparency and disclosure requirements.

2.15 ABCP are short-term securitisations, backed by loans that themselves tend to have shorter maturity, such as car-loans or trade receivables. They are conduit programmes, requiring sponsors to hold financial assets from one or more asset sellers. The Commission proposes an STS regime for all transactions within an ABCP programme to meet most term STS criteria, with a number re-written to reflect the specific product needs. These revisions include:

·  rules that exposures should have weighted average life less than two years and residual maturity less than three years;

·  loans secured by existing mortgage exposures should not be included;

·  for each transaction the role of the sponsor should be set out by the contract; and

·  the sponsor should perform its own due diligence to verify the seller's underwriting standards, servicing capabilities and collection processes would meet requirements set out in the CRR.

2.16 At the ABCP programme level, a number of rules would be added on top of term STS. These would include:

·  a requirement that credit enhancement should not create a second layer of tranching;

·  the sponsor should be a credit institution supervised under CRD IV, supporting all positions at the transaction level, covering risks and any other costs;

·  there could be no clauses, such as call options, that would have an effect on final maturity; and

·  it would be the joint responsibility of the originator, sponsor and SSPE to comply and make the disclosures required in relation to securitisations generally.

2.17 The proposed Regulation would also provide that:

·  issuing entities (the originator, sponsor and SSPE jointly) would self-certify compliance with STS and would notify their competent authority and ESMA of this, which they would publish on their websites — only then could a transaction take place;

·  ESMA should develop RTS, including templates, which would specify the information that issuers would need to provide to show compliance with STS;

·  investors be able to rely on issuer self-certification, rather than introducing additional STS due diligence requirements for investors;

·  supervision would be fulfilled by competent authorities in accordance with relevant sectoral legislation for credit institutions, investment firms and institutional investors; and

·  there would be efforts to ensure that any breaches would lead to a reputational impact, requiring that, where possible, such breaches would be notified publically.

2.18 The Commission's proposed revisions to CRR in the second proposed Regulation, document (b), are intended as the mechanism by which STS would be made yet more attractive. It argues that the STS regime would allow participants to better understand and price risk, and therefore should have more proportionate and favourable prudential treatment. The proposed Regulation would bring the EU rules for securitisation into line with the latest Basel Committee work on securitisation.[ 19] This would revise the approaches by which financial institutions and regulators calculate the Risk Weighted Assets (RWAs) for securitisation exposures, and would implement a new hierarchy of those approaches. The recalibration for STS securitisations closely follows a recent European Banking Authority (EBA) report on qualifying securitisations. Under all of the approaches, RWAs for STS securitisations would see all tranches of a transaction generating lower capital charges in line with the EBA report. In addition, the floor would be lowered for senior positions in STS securitisations from 15% to 10%.

2.19 Other measures in the proposed Regulation include:

·  a revision to the 'look-through' approach to securitisation, which sets maximum risk weights at the level of the average risk weight of underlying exposures — institutions with knowledge of the composition of the underlying exposures could assign this weighting to the senior securitisation position;

·  development of a maximum cap on risk-weighted exposure for institutions which use the internal ratings based approach, setting the limit at the same level had the exposures not been securitised — with the treatment being allowed to extend to sponsors, because risks would actually be reduced by securitisation;

·  a number of special treatments in CRR would be removed;

·  re-securitisations would be subject to a higher risk weight floor (100%);

·  securitisation of SME loans could receive STS-type treatment where they were backed (or counter-guaranteed) by public guarantees — synthetic securitisations would otherwise be unable to receive STS treatment;

·  a Commission intention to amend the Liquidity Coverage Ratio delegated act to reflect STS once the final prudential treatment is agreed; and

·  an amendment to empower the Commission to update CRR in order to reflect developments at the international level on qualifying securitisations.

2.20 The two proposed Regulations are accompanied by an impact assessment and an executive summary of the impact assessment. The impact assessment first looks to define and analyse the problem which needs to be addressed, sets out the general legislative objectives that have to be met when considering solutions, outlines the policy options, and then analyses costs and benefits and the prospective impacts (included impacts on smaller enterprises).

The Government's view

2.21 In her Explanatory Memorandum of 13 October 2015 the Economic Secretary to the Treasury (Harriett Baldwin), saying that the Government strongly welcomes this Commission policy initiative, published alongside the CMU Action Plan,[ 20] comments first that:

·  these measures highlight the positive role that CMU can play in developing more proportionate, effective and risk-sensitive regulatory frameworks; and

·  the plan for securitisation, and other efforts like it which seek to diversify funding sources, will be a boost to jobs, growth and investment across the EU.

2.22 The Minister tells us that;

·  industry interlocutors have said that the EU securitisation market is dying because of a loss of market confidence and an increased regulatory impact, which has seen issuance falling year on year since 2008;

·  they say that urgent action is required in order to revitalise the market;

·  action, that if pursued effectively, will bridge the gap between bank balance sheets and capital markets, bringing improved access to finance, helping diversify risk across the entire financial services sector and playing an important role in SME lending; and

·  estimates indicate that there is an opportunity to bring in additional funding into the EU economy of between €100 billion (£72.75 billion), the Commission's estimate, and $300 billion (£195.44 billion), the estimate of the Association for Financial Markets in Europe.[ 21]

2.23 The Minister says that:

·  the global financial crisis taught policy makers, regulators and industry many lessons, an important one being the need for all parties involved to have access to the necessary information;

·  it is for that reason the Government supports the Commission's approach to STS criteria, focusing on standards of simplicity, transparency and disclosure in order to allow participants to correctly price risk;

·  an alternative approach built restrictively around credit quality would potentially prevent transactions ever failing, but it would not do anything to grow the market and improve access to finance;

·  EU securitisations across the investment grades performed very safely during and following the crisis, generating near-zero losses;

·  following the development of the proposed STS regime, it would therefore be appropriate to calibrate the prudential treatment of securitisation in a more risk-sensitive fashion; and

·  the Government will seek an outcome that addresses financial stability concerns, but also provides the necessary incentives to encourage STS securitisation, and to discourage riskier structures that may be less transparent and unduly complex.

2.24 The Minister then turns to a number of points of detail, saying that:

·  noting the plan for self-certification, the Government believes such a regime can work if participants have confidence in the STS criteria, in their ability to meet and maintain their obligations under it and in the role of competent authorities;

·  examples of potentially damaging uncertainty include issuers having to guess whether or not they meet vague criteria or investors fearing that extensive supervisory involvement might bring down STS post-transaction (and thereby worsening capital treatment);

·  the Commission's inclusion of a limited, last-resort, role for binding mediation, reflects the cross-jurisdictional nature of the regime;

·  in the Government's view binding mediation is not necessary, as the final regime should be sufficiently certain, and allowing of contractual remedies, in a way that ensures competent authorities need not come into conflict over any differences in approach;

·  the final certification and supervision regime must be practicable and learn the lessons of the financial crisis, particularly the impact caused by the credit rating agencies, as it is in no one's interest to develop a regime that leads to market failure and even creates systemic risks;

·  the Government welcomes the inclusion of a separate regime for ABCP, as conduit programmes provide a key alternative to bank funding for EU SMEs and also aid broader corporate financing;

·  in a number of areas the proposals would direct the ESAs to develop RTS, and provide the Commission powers to adopt them;

·  the Government will seek to include as much detail as possible in the proposals, but acknowledges the desire from industry to receive further technical advice from the ESAs where appropriate; and

·  it also acknowledges the need for a vehicle to update STS prudential rules following further work at the international level and in the first instance will seek to ensure consistency with CRR.

2.25 The Minister tells us that:

·  there are no direct financial implications of the Commission proposals for the UK;

·  the Commission indicates that the ESAs will need to hire temporary agents in order to deliver the necessary RTS at a total cost of €1.733 million (£1.280 million) in appropriations in Heading 1 of the Multiannual Financial Framework; and

·  the costs have been estimated for staff expenditure in conformity with the cost classification in the ESA draft budget for 2015.

2.26 Finally the Minister tells us that the Luxembourg Presidency has expressed a desire to reach an initial Council agreement on the proposals before the end of the year. She comments that this is an ambitious timeline that will require swift progress if it is to be achieved.

Previous Committee Reports


15   See Back

16   (36667), 6408/15 + ADD 1: see Thirty-seventh Report HC 219-xxxvi (2014-15), chapter 17 (18 March 2015) and First Report HC 342-i (2015-16), chapter 74 (21 July 2015). Back

17   (37134), 12263/15: see chapter 3 of this Report. Back

18   Solvency II is the EU legislative regime governing insurance and reinsurance undertakings. Back

19 Back

20   Op cit. Back

21   AFME Paper 2013 "The Economic Benefits of High Quality Securitisation to the EU Economy". Back

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Prepared 6 November 2015