EU Securitization Regulation 2017/2402 main amendments in response to COVID-19 financial crisis (2024)

Regulation 2021/557 (the “Regulation”)¹ recently amendedRegulation (EU) 2017/2402 (the ‘’original SecuritizationRegulation”)² to help recovery from the COVID-19 Crisis.

As the severe economic shock caused by the COVID-19pandemic and related expectational measures have afar-reaching impact on the world economy, the targetedchanges to the original Regulation are intended to ensure thesecuritization framework provides for an additional tool tofoster economic recovery in the aftermath of the COVID-19crisis.

The main elements of the Regulation impacting thesecuritization market are as follows:

“Non-performing Exposures” (NPE)

The COVID-19 crisis risks increasing the number of non-performing exposures (NPEs), and increases the needfor institutions to manage and deal with their NPEs. Newrequirements will apply to NPE securitizations:

• Definition of NPE securitization: Securitizations backed by a pool of exposures meeting art. 47a(3) of Regulation (EU) No 575/2013.³ The value of these NPE makes up at least 90% of the pool’s value at the time of origination (art. 2 of the original Securitization Regulation).
• Risk retention: The risks associated with the assets backing NPE securitizations are economically distinct from those of securitizations of performing assets. NPEs are securitized at a discount on their nominal or outstanding value reflecting the market’s assessment of future cash flows and asset recovery. In NPE securitizations originators seek to offload the defaulted assets from their balance sheets. It is important that the risk-retention requirement aligns the interests of originators, sponsors and original lenders of the securitization with those of investors.
  • At a minimum originator, sponsor or original lender should retain, on an ongoing basis, at least 5% of the net value of the securitized exposures qualified as NPE as per art 47(3) of the Regulation 575/2013. The discounted value of the exposures transferred to the Securitization entity is to be considered as basis of calculation.
  • There is a possibility for the independent servicer to take on the risk retention slice because it has substantive interest in the workout of the assets and value recovery.
• Credit rating: The credit-granting criteria applied on performing exposures are not applicable to NPE at the time the originator purchased them from a 3rd party. Sound standards shall apply in the selection and pricing of the exposures during onboarding in order to make a sensible, well-informed investment decision.

Synthetic securitizations (STS On-balance sheet)

A new set of requirements are introduced specific to Syntheticsecuritizations which can be used as one way of moving awaythe risk from systemically important parts of the financialsystem by means of credit protection agreement:

Synthetic securitizations on-balance sheet should comply withSTS criteria (art. 26b to 26 e):

• Transfer of credit risk should relate to exposures originated or purchased by EU regulated institutions within its core lending business activity and held on its balance sheet
• Credit risk should not be hedged more than once by obtaining credit protection in addition to the protection already provided by the synthetic securitization
• Credit protection should only depend of the outstanding size and credit risk of the protected tranche
• Non-contingent premiums or other arrangements as up-front premium payments, rebate mechanism or overly complex premium are prohibited
• Early termination of the credit protection by the originator is limited to well defined circ*mstances that could not be anticipated at inception and need to involve changes in legislation or taxation events with negative impact on credit risk or economics)
• Ensure full disclosure of the use of synthetic excess spread and the definition of strict criteria to guarantee an effective transfer of risk
• Only high-quality credit protection arrangements should be eligible. For unfunded credit protection, only providers with 0% risk weight recognition are eligible and in case of funded one, eligible collaterals should be high quality collateral which may be assigned as 0% risk weight. Cash collateral should be held at 3rd party credit institutions or on deposit with the protection buyer
• Reference obligations on which credit protection is purchased should be clearly identified at all times via a reference register and kept up to date
• Ensure a transparent and sound documented payment process for the determination of actual losses in the reference portfolio, for that purpose, a third-party verification agent should be appointed to enhance legal certainty in the transaction for all parties involved and the occurrence of disputes and litigations in relation to loss allocation process and ensure the accuracy of certain aspects of the credit protection when a credit event has been triggered

Sustainable securitization framework

The Regulation lays down a stepping-stone towards thedevelopment of specific sustainable securitization framework.A report to this shall be published by 1 November 2021, forthe purpose of integrating sustainability-related transparencyrequirements into this Regulation.

The report shall include an assessment of the introduction ofsustainability factors, the implementation of proportionatedisclosure and due diligence requirements, the content,methodologies and presentation of information in relationto environmental, social and governance-related adverseimpacts.

These standards are required to “mirror or draw upon theregulatory technical standards” drawn up for the SustainabilityFinancial Disclosure Regulation.4

Investments in securitization entities in non-cooperative jurisdictions:

Article 4 of the Regulation provides that securitization specialpurpose entities (SSPEs) should not be established in (i) thirdcountries that are listed on the EU list of non-cooperativejurisdictions for tax purposes and updates thereto or (ii)in the list of high-risk third countries which have strategicdeficiencies in their regimes on anti-money laundering andcounter terrorist financing.

The same article provides for a new reporting obligationfor EU investors which invest in an SSPE established after 9April 2021 that is located in a jurisdiction that is engaged inharmful tax practices (as listed in Annex II, which recaps thestate of play of the cooperation with the EU with respect tocommitments taken by cooperative jurisdictions to implementtax good governance principles). Such EU investor shallnotify the investment in securities issued by that SSPE to thecompetent tax authorities of the Member State in which theinvestor is resident for tax purposes. This information may beused to assess whether the investor derives a tax benefit.

Annex II currently lists the following jurisdictions ascooperative jurisdictions that have committed to implementtax good governance principles: Australia, Barbados,Botswana, Eswatini, Jamaica, Jordan, Maldives, Thailand andTurkey.

What does it mean for you?

Valuation

Calibration of the Capital requirements calculation byconsidering the net value approach instead of the nominalvalue of NPEs to avoid disproportionate capital charges andhigher funding and transaction costs.

Use of the Net value when determining losses allocationapproach (attachment point and detachment point) whensetting up capital requirements.

Caps for NPE securitizations using the full net basis approach,i.e., the Exposure value and Expected losses should be netof Non-refundable purchase price discount (NRPPD) whencalculating the Caps to better capture the characteristics ofNPEs.

Ensure that the NRPPD is adequately sized to cover allunderlying assets and to address the risk of incorrect valuationof the NPEs.

Reporting to the tax authorities

Luxembourg investors investing in a SPPE established, after 9April 2021, in a jurisdiction listed in Annex II, e.g., Australia,are required to notify their investments in that SSPE to theLuxembourg tax authorities. No formal process is currentlyforeseen for such notification.

Sustainability

In the case of a securitization where the underlying exposuresare residential loans or auto loans or leases, the originator andsponsor shall publish the available information related to theenvironmental performance of the assets financed by suchresidential loans or auto loans or leases as required by art.22(4) of the original Securitization Regulation.

Originators may, from 1 June 2021, decide to publish theavailable information related to the principal adverse impactsof the assets financed by the underlying exposures onsustainability factors

Further, by 1 January 2022, based on the report ofCommission the above requirements may be extendedto securitizations where the underlying exposures arenot residential loans or auto loans or leases, with a viewto mainstreaming environmental, social and governancedisclosure.

How EY can help?

We can offer our services in following areas:

• Portfolio Assets valuation services, ranging from assistance with valuation reviews to full scope valuation opinions. We typically intervene across the lifecycle of the securitization instrument, from acquisition to financial reporting.
• Financial modelling services (e.g., cash flow modelling forecasts)
• Financial due diligence to assist in the portfolio acquisition process
• Analysis and support on the Tax compliance/notification obligations