The Securitisation Regulation: key points for US investment managers

​The EU’s Securitisation Regulation becomes effective from 01 January 2019. The Regulation replaces securitisation provisions in, among other things, the Alternative Investment Fund Managers Directive (AIFMD). Importantly, some US investment managers will now find themselves subject to the Regulation’s due diligence and risk retention requirements.

What is the Securitisation Regulation and when does it come into effect?

The EU’s Securitisation Regulation was published in the Official Journal of the EU on 28 December 2017 and becomes effective from 01 January 2019.

The Securitisation Regulation is part of the European Commission’s on-going work to build an efficient capital markets union (CMU) in the EU. It repeals and replaces securitisation provisions in sector-specific legislation, including the Alternative Investment Fund Managers Directive (AIFMD) and introduces rules for issuing simple, transparent and standardised (STS) transactions. The Securitisation Regulation imposes due diligence and risk retention requirements on "institutional investors", the definition of which includes managers of alternative investment funds (AIFs), including hedge funds.

For a detailed review of the provisions of the Regulation, see our elexica article, “European Securitisation Regulation”.

For a summary of the Regulation’s key points for EU AIFMs, see our elexica article, "The Securitisation Regulation: key points for EU AIFMs".

Why this might affect you

The way in which the term “institutional investor” is defined in the Securitisation Regulation means that certain categories of investment managers (including US managers), which have until now been outside the scope of the existing AIFMD securitisation rules, will have to comply with the Securitisation Regulation.

The definition appears to expand the Securitisation Regulation’s scope beyond the existing AIFMD and Level 2 Delegated Regulation in three ways:

  • the new rules apply to non-EU investment managers which manage and/or market AIFs into the EU - previously, only managers authorised under AIFMD were in scope and, for the time being at least, only EU managers can become authorised
  • the rules also seem now to extend to sub-threshold managers (ie as far as open-ended funds are concerned, those managing AIFs with an aggregate AuM of under €100m) which have not opted into the full AIFMD, and
  • the strict wording of the Securitisation Regulation appears to impose a requirement that, if an investment manager manages and/or markets a single AIF into the EU, the new rules would apply as well in respect of the AIFs it manages and/or markets outside the EU.

We assume that the extension referred to in the third bullet was unintended (and it is hard to see how, in practice, the rules could be enforced against US or other non-EU investment managers in respect of AIFs which are neither managed nor marketed in the EU). There is, however, no guidance as yet on this point, for example, in the form of Q&As from the European Securities and Markets Authority (ESMA). While we anticipate - and certainly hope - that the new rules will eventually apply to US investment managers only in respect of the AIFs they manage and/or market within the EU, we will be following this point closely and updating clients as soon as the position is clearer.

What does it mean in practical terms?

The Securitisation Regulation sets out obligations for investment managers in two key areas, namely (a) due diligence and (b) risk retention. Looking at each in turn:

Due diligence

As an institutional investor, an investment manager will have to carry out due diligence in connection with a securitisation position. This includes the following obligations (note that this list is non-exhaustive):

Prior to holding a securitisation position, the investment manager must:

  • verify that the originator or original lender:
    • has disclosed the risk retention to the investment manager
    • retains a material net economic interest on an ongoing basis
    • grants all the credits which give rise to the underlying exposures on the basis of sound and well-defined criteria and clearly established processes for approving, amending, renewing and financing those credits
    • has effective systems in place to apply those criteria and processes
  • carry out a due diligence assessment which enables the investment manager to assess the risks involved and which considers at least:
    • the risk characteristics of the individual securitisation position and underlying exposures
    • all the structural features of the securitisation which could materially impact the securitisation position’s performance
    • that, where a securitisation has been notified as STS, the transaction complies with the criteria set out in the Regulation. (In carrying out this review, an investment manager can place “appropriate” reliance on the STS notification and the information disclosed to it by the originator, sponsor or securitisation special purpose entity, so long as the investment manager does not do so either “solely or mechanistically”.)

During the lifetime of the transaction, an investment manager holding a securitisation position must also (among other things):

  • establish appropriate written procedures proportionate to the risk profile of the securitisation position in order to monitor the performance of the securitisation position and of the underlying exposures
  • perform regular stress tests on the cash flows and collateral values supporting the underlying exposures or (where relevant) on the solvency and liquidity of the sponsor
  • report to the investment manager’s management body so that
    • the management body is aware of the material risks arising from the securitisation position, and
    • those risks are adequately managed
  • be able to demonstrate to its regulatory authority, if requested, that
    • the investment manager has a comprehensive understanding of the securitisation position and its underlying exposures, and
    • it has implemented written policies and procedures for the risk management of the securitisation position.

Institutional investors will have to perform due diligence on non-EU entities acting as sponsor, original lender or originator to ensure that they meet risk retention requirements which are broadly equivalent to those imposed on EU entities.

Risk retention

The risk retention requirement remains at 5% under the Securitisation Regulation.

Under the current AIFMD Level 2 Delegated Regulation, the onus for ensuring that a securitisation transaction satisfies this requirement falls on the investment manager - the investment manager can only assume exposure on behalf of an AIF it manages where the originator, sponsor or original lender has explicitly disclosed to the investment manager that it retains a material net economic interest of at least 5%.

Under the Securitisation Regulation, however, this will be supplemented by a "direct" requirement whereby originators, sponsors and original lenders will have an obligation to retain a 5% net economic interest - these entities will have to agree between them which will act as the retention holder (in the absence of agreement, this will be the originator).

Grandfathering provisions

The Securitisation Regulation will apply in respect of:

  • securities relating to securitisation transactions issued on or after 01 January 2019, and
  • securitisation transactions issued prior to 01 January 2019 where new securities are issued on or after 01 January 2019.

Securities issued in respect of securitisation transactions before 01 January 2019 can use the STS designation provided (a) that ESMA is notified of such an election and (b) the criteria set out in the Securitisation Regulation are met.

The European Banking Authority and ESMA have both published consultations on Level 2 measures under the Regulation - these closed in March 2018 and final draft advice will be sent to the European Commission later in the year.

Until the new Level 2 measures are in place, existing provisions on risk retention and disclosure requirements will continue to apply.

The due diligence requirements set out in the AIFMD Delegated Regulation will continue to apply in respect of securitisations where the securities were issued:

  • between 01 January 2011 and 01 January 2019, or
  • before 01 January 2011 where new underlying exposures have been added or substituted since 31 December 2014

in each case, even where an institutional investor acquires the securities after 01 January 2019.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.