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On October 10, 2022, the European Commission (the “Commission”) published its long awaited report on the functioning of Regulation (EU) 2017/2402 (the “EU Securitisation Regulation”). The report reflects the Commission’s assessment of various matters relating to the EU Securitisation Regulation, including, most notably, its interpretation of the jurisdictional scope of the Article 7 transparency requirements and the status of third country Alternative Investment Fund Managers (AIFMs) managing or marketing alternative investment funds (AIFs) in the EU. The report is not binding on national competent authorities, who have primary responsibility for regulating EU institutional investors, but we would expect regulators to follow the Commission's interpretation.
As further described below, the position adopted by the Commission would effectively preclude EU institutional investors from investing in “third country” securitisations (securitisations where the originator, sponsor and securitisation special purpose entity (SSPE) are all non-EU entities, including US securitisations) unless they receive the disclosures required under Article 7 of the EU Securitisation Regulation (the "Transparency Requirements"), which includes investor reports and asset level information provided using the EU disclosure templates.
The Commission’s report does not impact the UK Securitisation Regulation or its interpretation.
Application of Transparency Requirements to third country securitisations
By way of background, Article 5 of the EU Securitisation Regulation sets forth various due diligence obligations with which an EU institutional investor must comply prior to investing in a securitisation. These include verification that the credit granting, risk retention and transparency requirements under the EU Securitisation Regulation have been satisfied. Article 5 differentiates between EU-based and third country sponsors, originators and original lenders in relation to the credit granting and risk retention requirements, but the due diligence requirements with respect to transparency do not specify their geographical scope. US deals that are intended to be eligible for purchase by EU institutional investors typically provide for credit granting and risk retention in accordance with the EU Securitisation Regulation, but frequently take a different approach to the Transparency Requirements. Following publication of the report, this market practice is very likely to change.
Article 5(1)(e) of the EU Securitisation Regulation requires EU institutional investors to verify that “where applicable” the information required by Article 7 has been made available by the originator, sponsor or SSPE. Since the EU Securitisation Regulation came into force in 2019, there has been extensive discussion as to the meaning of “where applicable” and the correct legal interpretation of this provision. US market participants have generally taken the view that full Article 7 compliant reporting does not have to be provided to EU institutional investors if the originator, sponsor and SSPE are all non-EU entities. Consequently, the scope and format of disclosure in US deals has generally not been adjusted to comply with the Transparency Requirements since the EU Securitisation Regulation came into force in 2019. In addition, a significant proportion of US deals expressly disclaim any obligation to provide Article 7 compliant information to investors.
The report states that the Commission does not interpret Article 5(1)(e) as differentiating the scope of information that must be disclosed to investors based on whether a securitisation is issued by EU or third country entities. This means that EU institutional investors must, in order to satisfy their due diligence obligations, verify that all information mandated by Article 7 is provided to them regardless of whether they are investing in an EU, UK, US or other non-EU securitisation.
As a result, US deals will need to comply with all of the Transparency Requirements (in addition to the risk retention and credit granting requirements of the EU Securitisation Regulation) in order to enable EU institutional investors to purchase US securitisation positions. This will involve preparation of pre-pricing disclosures, quarterly investor and asset-level reports (each using prescribed ESMA templates, which vary depending upon the nature of the underlying assets in a securitisation) and reporting of significant events.
The Commission acknowledges in the report that its interpretation of Article 5(1)(e) will de facto exclude EU institutional investors from investing in third country securitisations that do not comply with the Transparency Requirements. The report does not specify whether or not such investors should be required to sell their positions in non-compliant deals, although we would not expect regulators to take such a position.
Review of ESMA templates
As a solution, the Commission has proposed that the technical standards setting out the Transparency Requirements be reviewed and has noted that this may enable third country securitisations to comply with such requirements more easily, thereby reducing the competitive disadvantage to EU institutional investors. In light of this, the Commission has asked the European Securities and Markets Authority (ESMA) to (i) review the reporting templates in order to address technical difficulties in providing certain information, remove unnecessary fields and align them more closely with investors’ needs, (ii) consider whether loan level information is “useful and proportionate” to investors’ needs for all types of securitisations and (iii) develop a dedicated template for private securitisations (securitisations that are not required to produce a prospectus under the EU Prospectus Regulation 2017/1129) in order to simplify the relevant transparency requirements. However, the report does not specify a deadline for any of these items and this proposed solution may take some time to materialise.
No changes were proposed in the report regarding risk retention, but the Commission has suggested that the European Banking Authority continue to monitor the use of risk retention, particularly the rationale for using the different methods available under Article 6 of the Securitisation Regulation.
Diligence requirements for third country alternative investment fund managers
The report also clarifies that third country “alternative investment fund managers” (AIFMs) that are managing or marketing Alternative Investment Funds (AIFs) in the EU constitute institutional investors for purposes of the EU Securitisation Regulation and must comply with the applicable due diligence requirements when they invest in securitisation positions. The report notes that this requirement applies only to the AIFs marketed or managed in the EU by such AIFMs.
Additional matters covered in the report
The report also addresses certain other matters in respect of which market participants have awaited clarification, including (i) a determination that no third country equivalence regime will be introduced for transactions that under the EU Securitisation Regulation constitute “simple, transparent and standardised” (STS) securitisations (and may therefore be eligible for preferential capital treatment); and (ii) acceptance by the Commission of the European Banking Authority proposal to include a sustainable securitisation framework within broader EU Green Bond standards rather than developing a separate framework or a separate sustainability label for securitisations.
Application to UK institutional investors
It should be noted that the Commission’s interpretation of the EU Securitisation Regulation does not apply to the UK Securitisation Regulation. Whether or not the UK takes a similar approach remains to be seen, although market participants have long expected some divergence between the two sets of regulations.
Please contact one of the listed authors of this article or your regular Orrick contact if you have any questions regarding the application of the EU Securitisation Regulation.