The EU’s Securitisation Regulation becomes effective from 01 January 2019. We assess the impact the Regulation has on UCITS, UCITS management companies and delegate investment managers.
What is the Securitisation Regulation and when does it come into effect?
The new Securitisation Regulation (Regulation EU 2017/2402) (the Securitisation Regulation) came into force on 17 January 2018 and will apply 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 the existing patchwork of sector-specific legislation governing European securitisations and replaces them with new rules governing the use of simple, transparent and standardised (STS) securitisations. The Securitisation Regulation also imposes due diligence and risk retention requirements on "institutional investors", the definition of which is broad and includes UCITS management companies and internally or “self-managed” UCITS. For ease of reference, we will refer to both UCITS management companies and self-managed UCITS in this briefing as “UCITS management companies”.
For a detailed review of the provisions of the Securitisation Regulation, see our elexica article, “European Securitisation Regulation”.
For an assessment of how the Securitisation Regulation impacts EU AIFMs, see our elexica article, “The Securitisation Regulation: key points for EU AIFMs”.
For a summary of the Securitisation Regulation’s key points for US investment managers, see our elexica article, "The Securitisation Regulation: key points for US investment managers".
Why this might affect you
The way in which the term “institutional investor” is defined in the Securitisation Regulation means that UCITS management companies will, for the first time, have to comply with rules applicable to securitisation positions they hold in their UCITS funds.
The definition, set out in Article 2(12) of the Securitisation Regulation, includes the following:
“(e) an undertaking for the collective investment in transferable securities (UCITS) management company, as defined in point (b) of Article 2(1) of Directive 2009/65/EC;
(f) an internally managed UCITS, which is an investment company authorised in accordance with Directive 2009/65/EC and which has not been designated a management company authorised under that Directive for its management."
Where the UCITS management company delegates to a third party its investment management functions, including the power to expose the UCITS to securitisations, it may wish to include provisions to ensure that the delegate is contractually on the hook for compliance with the Regulation. Note that under Article 5(5) of the Securitisation Regulation, where such delegation is to another ‘institutional investor’, Member States are required to ensure that any regulatory sanctions for breach can be imposed directly on the institutional investor delegate rather than the appointing UCITS management company.
What does it mean in practical terms?
As an institutional investor, a UCITS management company will have to carry out due diligence in connection with any securitisation position. This includes the following obligations (note that this list is non-exhaustive):
Prior to holding a securitisation position, the UCITS management company must:
- verify that the originator or original lender:
- has disclosed the risk retention at the required level (5%) to the UCITS management company (this might be in the prospectus or offering memorandum of the securitisation issue)
- retains a material net economic interest at the required level (5%) 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, and
- has effective systems in place to apply those criteria and processes.
- carry out a due diligence assessment which enables the UCITS management company 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, and
- that, where a securitisation has been notified as STS, the transaction complies with the criteria set out in the Securitisation Regulation. (In carrying out this review, a UCITS management company 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 UCITS management company does not do so either solely or mechanistically.)
During the lifetime of the transaction, a UCITS management company 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 UCITS’ 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 UCITS management company 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.
UCITS management companies 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.
The Securitisation Regulation amends the UCITS Directive (Directive 2009/65/EC) by inserting new Article 50a pursuant to which UCITS management companies will be required to take “corrective action” on securities that do not fulfil the Securitisation Regulation requirements. In the FCA Consultation Paper 18/22, the proposed COLL 5.2.37 implements Article 50a of the UCITS Directive as follows:
“Where an authorised fund manager is exposed to a securitisation that does not meet the requirements provided for in the Securitisations Regulation, it must, in the best interests of the investors in the relevant UCITS scheme, act and take corrective action, if appropriate.”
Although the consultation on CP 18/22 is still open until 01 October 2018, it is not envisaged that any changes to the wording will be made. In practice therefore, once adopted into COLL, UK authorised funds will, after 01 January 2019, need to start a dialogue with the entity acting as sponsor, original lender or originator to request remediation on all non-compliant securitisations, which may ultimately lead to the need to divest.
UCITS management companies will be required to comply with the Securitisation Regulation 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 that (a) ESMA is notified of such an election, and (b) the criteria set out in the Securitisation Regulation are met.
What should you be doing?
UCITS management companies should now be undertaking the following steps:
- auditing their existing portfolios to determine which securitisation positions, if any, might be impacted by the Securitisation Regulation
- establishing all necessary processes and procedures required to ensure compliance with the Securitisation Regulation post 01 January 2019
- where possible, leveraging off existing procedures established under AIFMD and updating such processes as required, and
- revisiting delegation arrangements, where applicable, to reflect the new requirements.
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.