Response to consultation on draft RTS on the determination by originator institutions of the exposure value of SES in securitisations
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We have no specific comments regarding the clarity of the proposed provisions. As discussed in our responses to the following questions, we believe that both the “full model” and the “simplified” approaches are inadequate and can even lead to arbitrage.
On the contrary, in our view, the so-called “alternative approach” is the only one that is adequate both from a prudential standpoint (it adequately reflects prudential risk) and from a cost-effectiveness standpoint (it makes sense, from an economic perspective, to use it in synthetic transactions, instead of thicker junior tranches). It is also simple and would ensure homogeneity across banks and JSTs. Finally and importantly, this “alternative approach” is compatible with the level 1 text.
Clarifications are thus not needed on the currently proposed RTS provisions, which we believe should not be retained in the final version of the RTS. The so-called “alternative approach”, however, should be developed in the final version of the RTS.
The only adequate prudential approach is the one that reflects the actual risk to which an originator is exposed. In the case of UIOLI SES, this risk spans over a one-year period, generally on a (quarterly) rolling basis. Therefore, only a deduction at 1 year (on a rolling-basis) makes sense from a prudential standpoint.
This is the so-called “alternative approach” referred to in the draft RTS, and which we believe should be developed as the only approach in the final RTS.
Hedging the expected loss in the capital structure is not efficient, as investors will consider that those losses will be almost certain. On portfolio with significant EL, such as SME portfolios, the calibration of the retained first loss is problematic in absence of SES mechanism, as expected losses will cumulate over time.
An UIOLI SES mechanism allows that the credit protection focuses on the unexpected loss part of the capital structure through the life of the transaction provided it is well calibrated
It is the case if synthetic excess spread available to cover future losses is defined and reset on each quarterly reporting date with the following constraints:
• Losses in respect of that excess spread can only be within one year following that reporting date
• Losses in respect of that excess spread cannot be above 1y EL defined at the start of the reporting period.
Under those conditions, we believe having an exposure amount based on the maximum losses that can be covered by the excess spread over a rolling window with a one year horizon is appropriate.
This one-year horizon is consistent with the Basel framework that uses an expected loss to a one year horizon. Taking into account future expected loss beyond this horizon would thus create an inconsistency with the overall balance of the framework : banks would have to deduct own funds expected losses that, without securitisation, should not be incorporated in the regulatory framework.
We also believe that it is compatible with CRR Article 248(1)(e). This article requires the EBA to specify the exposure value of elements (i) to (iv) that should be included in the exposure value of SES, ”as applicable”: in the case of UIOLI SES, amounts for “future periods” are not “applicable” and hence should not be deducted at inception. Rather, the nature of SES and the prudential risk to which banks are exposed should be taken into consideration to determine the adequate exposure value of SES. Typically, in the case of a UIOLI SES recalibrated quarterly, the originator is at risk over a one-year horizon, on a quarterly rolling-basis, not over a horizon extending until the maturity of the securitisation transaction. Requiring lifetime deduction of SES contradicts both CRR Article 248(1)(e) and the overall calibration of the Basel framework.
To be noted, regulatory uncertainty surrounding the prudential treatment of SES since the adoption of the Capital Markets Recovery Package has already undermined the use of SES, which is however a very useful tool in a number of transactions. SES is used, for instance, in transactions with the European Investment Fund, to encourage SME lending in the EU. We thus ask for a fairer treatment of SES in the final version of the RTS, based on the so-called “alternative approach”, which, in our view, is compatible with the level-1 text.
Q1. Do respondents find the provisions clear enough or would any additional clarification be needed on any aspect?
We have no specific comments regarding the clarity of the proposed provisions. As discussed in our responses to the following questions, we believe that both the “full model” and the “simplified” approaches are inadequate and can even lead to arbitrage.
On the contrary, in our view, the so-called “alternative approach” is the only one that is adequate both from a prudential standpoint (it adequately reflects prudential risk) and from a cost-effectiveness standpoint (it makes sense, from an economic perspective, to use it in synthetic transactions, instead of thicker junior tranches). It is also simple and would ensure homogeneity across banks and JSTs. Finally and importantly, this “alternative approach” is compatible with the level 1 text.
Clarifications are thus not needed on the currently proposed RTS provisions, which we believe should not be retained in the final version of the RTS. The so-called “alternative approach”, however, should be developed in the final version of the RTS.
Q2. Do you agree with the possibility of choosing between the full and the simplified model approaches in a consistent manner?
We have no specific comments on this possibility since we believe none of the proposed approaches provides for an adequate prudential treatment of SES.Q3. Instead, would you favour that the RTS consider only one method (i.e. the full model approach or the simplified model approach) for the calculation of the exposure value of the synthetic excess spread of the future periods?
Since they are based on lifetime deduction, both approaches are excessively penalizing, making SES economically unviable. The “scalar” proposed in the draft RTS does not solve the issue: the question is not whether the impact of lifetime deduction should be partially mitigated, but what a sensible prudential treatment of SES (either “trapped” or “UIOLI”) could be.The only adequate prudential approach is the one that reflects the actual risk to which an originator is exposed. In the case of UIOLI SES, this risk spans over a one-year period, generally on a (quarterly) rolling basis. Therefore, only a deduction at 1 year (on a rolling-basis) makes sense from a prudential standpoint.
This is the so-called “alternative approach” referred to in the draft RTS, and which we believe should be developed as the only approach in the final RTS.
Q4. Do you agree with the specifications of the asset model made in Article 3?
As explained above, we do not believe that either the “full model” or the “simplified” approach provides for an adequate prudential treatment of SES. We thus do not have specific comments on this question.Q5. Do you agree with the specifications for the determination of the relevant losses made in Article 5?
As explained above, we do not believe that either the “full model” or the “simplified” approach provides for an adequate prudential treatment of SES. We thus do not have specific comments on this question.Q6. Do you agree with the calculation of the exposure value of synthetic excess spread for future periods made in Article 6?
As explained above, we do not believe that either the “full model” or the “simplified” approach provides for an adequate prudential treatment of SES. We thus do not have specific comments on this question.Q7. Shall the average of the scenarios be made in a different way for UIOLI and trapped mechanisms (e.g. back-loaded and evenly-loaded only for UIOLI mechanisms, and front-loaded and evenly-loaded for trapped mechanisms)?
As explained above, we do not believe that either the “full model” or the “simplified” approach provides for an adequate prudential treatment of SES. We thus do not have specific comments on this question.Q8. Do you agree with the specification of the simplified model approach made in Article 7?
As explained above, we do not believe that either the “full model” or the “simplified” approach provides for an adequate prudential treatment of SES. We thus do not have specific comments on this question.Q9. Do you consider that the formula can be further simplified (e.g. by using the maturity of the credit protection multiplied by a conservative scalar instead of WAL)?
As explained above, we do not believe that either the “full model” or the “simplified” approach provides for an adequate prudential treatment of SES. We thus do not have specific comments on this question.Q10. Do you agree with the scalar assigned for UIOLI mechanisms? If not, please provide empirical evidence that justifies a different scalar based on the different loss absorbing capacity of UIOLI vs trapped mechanisms.
As explained above, we do not believe that either the “full model” or the “simplified” approach provides for an adequate prudential treatment of SES. We thus do not have specific comments on this question.Would you favour that approach? If so, how do you think that this rolling-window approach for calculating UIOLI SES will affect the efficiency and viability of synthetic transactions in comparison with the current supervisory practices? Please justify your response with specific illustrative examples or data.
In our opinion, the so-called “alternative approach” is the one that makes sense both from a prudential standpoint and from a cost-effectiveness standpoint.Hedging the expected loss in the capital structure is not efficient, as investors will consider that those losses will be almost certain. On portfolio with significant EL, such as SME portfolios, the calibration of the retained first loss is problematic in absence of SES mechanism, as expected losses will cumulate over time.
An UIOLI SES mechanism allows that the credit protection focuses on the unexpected loss part of the capital structure through the life of the transaction provided it is well calibrated
It is the case if synthetic excess spread available to cover future losses is defined and reset on each quarterly reporting date with the following constraints:
• Losses in respect of that excess spread can only be within one year following that reporting date
• Losses in respect of that excess spread cannot be above 1y EL defined at the start of the reporting period.
Under those conditions, we believe having an exposure amount based on the maximum losses that can be covered by the excess spread over a rolling window with a one year horizon is appropriate.
This one-year horizon is consistent with the Basel framework that uses an expected loss to a one year horizon. Taking into account future expected loss beyond this horizon would thus create an inconsistency with the overall balance of the framework : banks would have to deduct own funds expected losses that, without securitisation, should not be incorporated in the regulatory framework.
We also believe that it is compatible with CRR Article 248(1)(e). This article requires the EBA to specify the exposure value of elements (i) to (iv) that should be included in the exposure value of SES, ”as applicable”: in the case of UIOLI SES, amounts for “future periods” are not “applicable” and hence should not be deducted at inception. Rather, the nature of SES and the prudential risk to which banks are exposed should be taken into consideration to determine the adequate exposure value of SES. Typically, in the case of a UIOLI SES recalibrated quarterly, the originator is at risk over a one-year horizon, on a quarterly rolling-basis, not over a horizon extending until the maturity of the securitisation transaction. Requiring lifetime deduction of SES contradicts both CRR Article 248(1)(e) and the overall calibration of the Basel framework.
Q12. Do you agree with the treatment of the ex-post SES of future periods in the RTS? If not, please provide rationale and data supporting your views
As explained above, treatment of ex-post SES in future periods, beyond a one-year horizon is not consistent with the Basel framework that uses an expected loss on a one-year horizon, and not beyond. Including in the exposure value Ex-post SES for future periods would assume that future incomes beyond one year impacted by the losses are also recognized on the current income statement of the institutions (and thus, in the institution’s own funds) which is obviously not the case.Q13.Do you have any other comments on these draft RTS?
As highlighted in our previous responses, both “full model” and “simplified” approaches developed in the draft RTS under consultation would make SES uneconomic. In other terms, originators would not have any economic rationale to use SES and would instead place larger junior tranches.To be noted, regulatory uncertainty surrounding the prudential treatment of SES since the adoption of the Capital Markets Recovery Package has already undermined the use of SES, which is however a very useful tool in a number of transactions. SES is used, for instance, in transactions with the European Investment Fund, to encourage SME lending in the EU. We thus ask for a fairer treatment of SES in the final version of the RTS, based on the so-called “alternative approach”, which, in our view, is compatible with the level-1 text.