European Commission Revises and Adopts Regulatory Technical Standards on Risk Retention

The European Commission has adopted and published final draft Regulatory Technical Standards (RTS) specifying requirements for originators, sponsors and original lenders in relation to risk retention under the EU Securitisation Regulation.

The standards incorporate limited changes to draft standards the European Banking Authority (EBA) published in April 2022. Some of the principal differences are:

1. Clarification of the expertise requirement: The Securitisation Regulation prohibits an entity which has been established or operates for the sole purpose of securitising exposures from holding the risk retention as an originator (the "sole purpose test"). Article 2 of the draft RTS specifies the factors to consider when determining whether an entity satisfies the sole purpose test.

   The draft standards published by the EBA included a requirement that an originator's "responsible decision-makers" have the necessary experience to enable the entity to pursue its business strategy. The draft RTS adopted by the European Commission instead places that requirement on members of the management body of the originator.

   This change emphasises the importance EU regulators place on originators being capable of performing their origination activities independently and making all relevant decisions “in-house."

2. Detailed factors for random selection of securitised exposures: The EBA draft standards specified that the retainer should weigh quantitative and qualitative factors to ensure random selection to retain a material net economic interest as described in Article 6(3)(c) of the Securitisation Regulation (i.e., by retention of randomly selected exposures equivalent to not less than 5% of the nominal value of the securitised exposures).

   The draft RTS adopted by the European Commission includes a comprehensive list of factors to consider when selecting exposures to meet this risk retention requirement, including vintage of origination, maturity date, loan to value ratio, outstanding loan balance and geographical location, among other factors.

3. Enhanced information access for investors: The draft RTS adopted by the European Commission specifies that investors must have access to all information necessary to confirm that the criteria applicable to retention in the form of a first loss tranche has been satisfied. This is a change from the EBA's draft standards, which required the disclosure of "appropriate information" and, as such, could have potentially expanded the scope of information requested by investors. In practice, however, investors are not expected to require any additional information because securitisation documentation typically already requires the provision of information considered sufficient for this purpose.
4. Clarification of retention on a consolidated basis, permitted hedging and fees charged by retainers: The draft RTS adopted by the European Commission provides additional clarity regarding the application of the retention requirements on a consolidated basis, permitted hedging activities and the requirement that certain fees charged by retainers be taken into account in measuring the level of retention. The changes are not generally substantive. They confirm, among other things, that:
   • certain financial institutions must remain supervised entities to hold the retention on a consolidated basis (i.e., if a particular entity is no longer subject to consolidated supervision, the remaining entities within the consolidated group must ensure that at least one of them continues to fulfil the retention requirements);
   • the retainer may hedge the retained net economic interest where the hedge is not against the credit risk of either the retained securitisation positions or the retained exposures; and
   • any fees paid to the retainer should be set on an arm's length basis and, in the absence of comparable transactions in the relevant market, should take into account valuation metrics which reflect the service being provided and the type of securitisation.The European Commission also deleted a provision permitting such fees to be contingent on the performance of the securitised assets.
5. Securitisation of own issued debt instruments: The draft RTS adopted by the European Commission introduces an article addressing the fulfilment of the risk retention requirement in securitisations of own-issued debt instruments, recognising the unique characteristics of such securitisations. The draft RTS provides that an entity which securitises its own issued debt instruments, including covered bonds, will be considered to have fulfilled the retention requirements under the Securitisation Regulation so long as the underlying assets in the securitisation consist solely of those own-issued debt instruments.

Regulators in the UK plan to develop separate technical standards on risk retention in line with the UK's own securitisation regulations. The extent of divergence between the UK standards and the EU's final draft RTS remains to be seen.

The Council of the European Union and the European Parliament will review the European Commission’s draft. Further changes are possible but not expected. Once approved, the RTS will come into force 20 days after its publication in the Official Journal of the European Union, expected later this year.