New incentives for the European securitisation market proposed by the ESA’s
Mitigation for derivatives in STS securitisations
Following the consultation papers back in May 2018, on 12 December 2018, the European Supervisory Authorities (ESAs) published two joint drafts of regulatory technical standards (RTSs) regarding the clearing obligation and risk mitigation techniques for OTC derivatives not cleared by central counterparties (CCPs).
The reason for the standards is the new European Securitisation Regulation in which art. 42 specifies the amendment of art. 4 and art. 11 of the European Market Infrastructure Regulation, EMIR, (Regulation (EU) no. 648/2012). The purpose of the new standards is to modify the clearing obligation and risk mitigation techniques for OTC derivative contracts not centrally cleared with regard to simple, transparent and standardised securitisations – referred to as STSs below (see White Paper 81). The goal is to ensure that derivatives associated to covered bonds have a level playing field with derivatives associated to securitisations, in order to prevent any distortion or arbitrage between the use of securitisations and covered bonds and guarantee proper implementation of the European Market Infrastructure Regulation.
The amendments to the EMIR clearing obligation stem from art. 42 of the Securitisation Regulation because two further paragraphs have been added to art. 4 of EMIR. The new paragraph 5 of art. 4 EMIR (Rev.), specifies that covered bonds and STS securitisations within the meaning of the Securitisation Regulation are to be exempted from the clearing obligation as long as certain conditions are met. These are as follows:
- In the case of securitisation special purpose entities (SSPEs), the SSPE only issues securitisations that meet the STS requirements of the Securitisation Regulation.
- The OTC derivative is only used to hedge interest rate or currency mismatches regarding the covered bond or securitisation.
- The agreements made under the covered bond or securitisation must satisfactorily mitigate counterparty credit risk with respect to OTC derivative contracts.
The new version of art. 4, paragraph 6 of EMIR requires the ESAs to create drafts of regulatory technical standards (RTSs). These are to detail the criteria for establishing which agreements on covered bonds or securitisation adequately mitigate counterparty risk to guarantee that the clearing exception is applied coherently and regulatory arbitrage is prevented.
Therefore, based on the existing regulations for covered bonds (see Delegated Regulations (EU) 2015/2205 and (EU) 2016/1178), the draft of the RTS on the clearing obligation in the final report specifies the exact criteria for deciding which agreements on covered bonds (art. 1 of the RTS) and which securitisation agreements (art. 2 of the RTS) adequately mitigate the counterparty risk with respect to the clearing obligation.
Furthermore, art. 3 and 4 do specify curtailments in the (EU) 2015/2205 and (EU) 2016/1178 Delegated Regulations regarding the clearing obligation for covered bonds in order to remove duplication between the amended EMIR and the supplementary Delegated Regulations.
Furthermore, article 42 of the Securitisation Regulation introduces a second mandate. The purpose of the article is to amend the (EU) 2016/2251 Delegated Regulation on risk mitigation techniques for OTC derivative contracts not cleared by a central counterparty as specified in article 11, paragraph 15 of EMIR. The RTS draft changes the existing RTS by extending the current treatment of covered bonds to include STS securitisations. The (EU) 2016/2251 Delegated Regulation is to have article 30a added to it, which will now specify the rules for risk mitigation techniques for OTC derivative contracts not centrally cleared and where these contracts have been concluded by an SSPE in conjunction with a securitisation. Following the existing rules on covered bonds as specified in article 30 of the (EU) 2016/2251 Delegated Regulation, in the case of OTC derivatives concluded by an SSPE in conjunction with an STS securitisation and which meet the conditions of article 4, paragraph 5 of EMIR, counterparties can now also stipulate in their risk management processes that (a) variation margins are not posted by the securitisation special purpose entity, but that it is collected from its counterparty in cash and are returned to the counterparty when due and (b) no initial margins are posted or collected.
However, this is only permitted if the following conditions are met:
- The OTC derivative’s counterparty ranks at least pari passu with the holders of the most senior securitised tranche. This condition only applies if the OTC derivative’s counterparty is neither the defaulting party nor the affected party.
- The securitisation special purpose entity is subject to a level of credit enhancement of the most senior securitised tranche of at least 2% of the outstanding notes.
- The netting set does not include any OTC derivative contracts unrelated to the securitisation.
The RTSs were presented to the European Commission for final integration into European law. Once submitted, the European Commission has three months to decide whether it will incorporate the drafts into European law.