SCI CRT Awards Issue Oct 19

CRT News
Esdaile concludes: “Looking beyond the synthetic securitisation market,
a portfolio-based approach to providing credit risk transfer would
also be beneficial for those companies providing credit who are not (yet)
financial institutions, such as Paypal and Square.”
Richard Budden
STS synthetics framework unveiled
| 25 September
The EBA has published its long-awaited discussion paper on its proposals
for an STS framework for synthetic securitisation (SCI 20 September). The
discussion paper aims to enhance transparency and further standardise
risk transfer trades – although, for the moment, STS synthetic securitisations
won’t benefit from preferential capital treatment via a reduction in
senior tranche risk weights.
According to Christian Moor, principal policy officer at the EBA: “The
discussion paper was created from scratch, although we incorporated features
from the discussion paper on significant risk transfer and our 2015
paper on synthetic securitisations. It aims to further standardise the market
– including its structural features – and enhance transparency.”
Indeed, as part of the effort to enhance transparency, the EBA carried
out a data exercise with the International Association of Credit Portfolio
Managers (IACPM). Data supplied by the association’s 22 member
banks constituted the main source of the performance data that are presented
in paper. IACPM data were supplemented by rating agency data
and supervisory data on significant risk transfer transactions.
The paper uses lifetime default rates to show how synthetic securitisations
have performed better than traditional securitisations for all asset
classes. Demonstrating the strong performance of risk transfer transactions
was the most important hurdle from the EBA’s perspective.
The idea of a discussion paper on STS synthetic securitisations was
considered highly improbable over a year ago, but several factors have
forced a paradigm shift on this issue. Moor explains: “STS came into
force this year and supervisors had the chance to look at the first STS
deals and they got comfortable with the label, but they realised that they
had no data on synthetics. So supervisors saw this as an opportunity to
standardise the market and help facilitate significant risk transfer, due to
concerns over excess spread and other issues.”
Nevertheless, the discussion paper doesn’t currently envisage any
preferential treatment for STS synthetic securitisations. Moor notes:
“At this stage, it was too early to opine on that. The STS market has just
started this year, so more evidence is needed to see if it works.”
He continues: “Our work has provided more clarity on transaction
performance, although defaults usually happen somewhere between
three to five years and the data collected is limited. The CRT market, on
the other hand, has picked up over the last two years.”
Moor notes that Basel also doesn’t have a framework for this and
supervisors have found it difficult to come up with recommendations that
deviate from it. “However, the data shows that synthetic securitisations
perform well – which is one of the arguments to consider for a preferential
capital treatment. We are waiting for industry feedback on the topic.”
The discussion paper’s most salient features concern provisions over
counterparty credit risk, early termination, synthetic excess spread and
credit events.
The counterparty credit risk provisions are in line with Article 270 of
the CRR, which states that STS synthetic securitisations should reference
SME loans and be carried out with an SSA or cash collateralised
with private investors. However, the discussion paper attempts to balance
the risk between the investor and the originator, since if the collateral is
deposited with the originating bank it can be lost under a bankruptcy scenario.
Consequently, the paper notes that the collateral should be deposited
in an account of a third-party credit institution or held in a trust.
Typically, under a bankruptcy scenario, contract clauses allow investors
to terminate the protection, since that scenario exposes them to a
bank’s deteriorating servicing standards. However, from a supervisory
perspective, the capital that was previously released after the completion
of a capital relief trade and the achievement of SRT hasn’t been replaced
following the termination of the protection. Hence, the discussion paper
specifies that the protection cannot be terminated when the originator
goes bankrupt.
The paper also prohibits the use of synthetic excess spread, since it’s
a “complex structural feature”. According to the paper, the complexity
arises with respect to the quantum of committed excess spread, its calculation
and allocation mechanism.
However, from an issuer perspective, synthetic excess spread should
not hinder significant risk transfer. Banks have noted in the past that
excess spread is not a balance sheet item, given that it is future income and
therefore there is no need to hold capital against it, as per CRR requirements.
Consequently, if there is no impact on the capital position of the
bank, then using it to absorb losses should not hinder SRT (SCI 1 March).
Finally, the document states that credit events have to incorporate
restructuring events. Moor states: “For a synthetic framework, you need
a balance between investor and originator risk and, in this case, a restructuring
event would give the originator room to cover any losses.”
Looking ahead, Moor concludes: “We won’t see an STS synthetic
securitisation until 2021. But in the meantime, the paper should help educate
supervisors on the risk transfer benefits of synthetics, while facilitating
the SRT assessment of transactions and help banks comply if we end
up with a regulation in two years’ time.”
The consultation ends on 25 November and a public hearing will take
place at the EBA’s premises in Paris on 9 October. Beginning in December,
the authority will be assessing market feedback and deliver a report with its
recommendations to the European Commission by June next year.
Stelios Papadopoulos
32 SCI Capital Relief Trades Awards | October 2019 www.structuredcreditinvestor.com