Response to consultation on draft RTS on performance-related triggers in STS on-balance -sheet securitisations
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For a mechanism that should be standard to all the transactions, the alternative option (“Trigger 2”) makes the calculations more complicated without providing an additional benefit:
• Based in our estimations, losses transferred in a stressed back loaded scenario applying the Trigger 1 would be equal or higher than when applying the Trigger 2.
• In addition, for transactions with a first loss tranche protected, the Trigger 2 may be triggered in most of the scenarios (even in a base case scenario of losses) due to the nature of the structure and the trigger, without necessarily generating additional transfer of losses. This automatically changes the profile of the transaction to a sequential tranche, increasing the cost of the transaction for the originator.
We will share with you some numerical examples that allow us to demonstrate the conclusions above.
• For a transaction with a first loss tranche protected, there are potential additional losses transferred in stressed back loaded scenarios, but without necessarily having an increase on the cost of the protection (according to our pricing methodology).
• For a transaction with a mezzanine tranche protected, the losses transferred to the investors in stressed back loaded scenarios may not increase. However, depending on other features of the structure as well, there is a possibility that the cost of the protection would increase materially, as per our rating and pricing methodology. That increase in cost may not be justified if there is no real significant benefit under such extreme scenarios with a very low probability of occurring.
Therefore, we would suggest applying the tighter level of the Trigger 1 (@75%) only for the transactions with a first loss tranche protected.
2. No, we do not consider that having the possibility of switching back to non-sequential would be detrimental for the simplicity of the transaction. This would require additional quarterly checks by the protection payer on the trigger values; however, these checks are not very sophisticated and the originator would have to monitor the respective ratios in any case. In addition, if the quality of the portfolio improves and there are no other backward-looking triggers breached, a sequential protection will increase significantly the overall cost of the transaction without necessarily providing additional benefits (eg. additional losses, higher capital relief).
We consider that applying the switch back to non-sequential should not be mandatory for all the transactions, but rather an option that could be agreed between the parties.
• The backward-looking triggers EIF usually applies cannot get “cured” (eg. cumulative defaults or losses)
• When using forward-looking triggers like WAPD or high risk rating buckets, the breach could be cured if the quality of the underlying portfolio improves. This is a mechanism already use by some players in the market.
2. In Article 3 – “Additional backward-looking trigger”, please provide some clarification about when the triggers should be tested. For the purpose of our comments on the RTS we are:
i. testing the Trigger 1 after allocating the losses of the period and before estimating the amortization for each tranche
ii. testing the Trigger 2 based on the ratio at the end of the previous period (Q-1)
3. In Article 3 – “Additional backward-looking trigger”, please provide some clarification on whether the Synthetic Excess Spread should be accounted for estimating the detachment point of the most senior protected tranche and how (eg. 1Y available excess spread).
4. For the avoidance of doubt, in Article 3 – “Additional backward-looking trigger”, please clarify that the detachment point of the most senior protected tranche is estimated in relative terms (percentage) and not in amount (EUR).
Q1. Do you agree with the specification made in Article 2?
Yes, the clarification is pertinent.Q2. Do you agree with the aim of Article 3 with regard to ensuring that the credit enhancement of the senior tranche does not fall below a certain threshold because of the non-sequential amortisation?
This principle is understood and supported but it needs to be taken cautiously. Prorate amortization schemes are designed to preserve the economics of the transaction under the base case. Locking the amount of credit enhancement of the senior too early will make protection buyer to pay extra for their hedge.Q3. Do you agree with the trigger set out in the Article or would you prefer the alternative option in order to meet the aim of this additional backward-looking trigger? Please justify your answer, providing, if possible, evidence of the outcome of both triggers based upon your past experience.
We agree with the trigger proposed in the Article 3 (“Trigger 1”).For a mechanism that should be standard to all the transactions, the alternative option (“Trigger 2”) makes the calculations more complicated without providing an additional benefit:
• Based in our estimations, losses transferred in a stressed back loaded scenario applying the Trigger 1 would be equal or higher than when applying the Trigger 2.
• In addition, for transactions with a first loss tranche protected, the Trigger 2 may be triggered in most of the scenarios (even in a base case scenario of losses) due to the nature of the structure and the trigger, without necessarily generating additional transfer of losses. This automatically changes the profile of the transaction to a sequential tranche, increasing the cost of the transaction for the originator.
We will share with you some numerical examples that allow us to demonstrate the conclusions above.
Q4. Which level of the trigger would you consider more appropriate and why?
Based on the examples presented above, by applying the tighter level of the Trigger 1 @75% instead of @50%, we estimate that:• For a transaction with a first loss tranche protected, there are potential additional losses transferred in stressed back loaded scenarios, but without necessarily having an increase on the cost of the protection (according to our pricing methodology).
• For a transaction with a mezzanine tranche protected, the losses transferred to the investors in stressed back loaded scenarios may not increase. However, depending on other features of the structure as well, there is a possibility that the cost of the protection would increase materially, as per our rating and pricing methodology. That increase in cost may not be justified if there is no real significant benefit under such extreme scenarios with a very low probability of occurring.
Therefore, we would suggest applying the tighter level of the Trigger 1 (@75%) only for the transactions with a first loss tranche protected.
Q5. Do you agree with the specification of the forward-looking trigger in Article 4? In your view, will the possibility of switching back to non-sequential, as set out in paragraph 6, be detrimental for the simplicity of the specific transaction and the objective of standardisation of STS on-balance-sheet securitisations?
1. Yes, we agree with the specifications included in Article 4.2. No, we do not consider that having the possibility of switching back to non-sequential would be detrimental for the simplicity of the transaction. This would require additional quarterly checks by the protection payer on the trigger values; however, these checks are not very sophisticated and the originator would have to monitor the respective ratios in any case. In addition, if the quality of the portfolio improves and there are no other backward-looking triggers breached, a sequential protection will increase significantly the overall cost of the transaction without necessarily providing additional benefits (eg. additional losses, higher capital relief).
We consider that applying the switch back to non-sequential should not be mandatory for all the transactions, but rather an option that could be agreed between the parties.
Q6. According to market practice, is it common that performance-related triggers can change several times the amortisation system of the tranches throughout the life of a synthetic securitisation? If so in your view, please provide concrete examples of triggers, distinguishing between backward-looking and forward-looking triggers.
No, it is not very common. The EIF does not often apply mechanisms that allows the transaction to go back to non-sequential amortisation. On our experience:• The backward-looking triggers EIF usually applies cannot get “cured” (eg. cumulative defaults or losses)
• When using forward-looking triggers like WAPD or high risk rating buckets, the breach could be cured if the quality of the underlying portfolio improves. This is a mechanism already use by some players in the market.
Q7. Do you agree that the information that the originator shall provide under Articles 7 and 26d of the Securitisation Regulation includes the information needed by the investor providing protection to understand and verify the functioning of the performance-related triggers in an STS on-balance-sheet securitisation?
Yes, we agree.Q8. Since as a first step before specifying the triggers above, the EBA reassessed the triggers included in recommendation 2 on Amortization Structure of the EBA 2020 Report on significant risk transfer in securitisation (see Section 5.2), and some elements from them were taken on board in the draft RTS, stakeholders are also invited to comment on the suitability of other triggers included in that recommendation for the purpose of these draft RTS.
No additional commentsQ9. Do you have any other comments on these draft RTS?
1. The RTS should provide a grandfathering for the STS transactions that have been closed and will be closed before the regulation under the document is amended and applicable2. In Article 3 – “Additional backward-looking trigger”, please provide some clarification about when the triggers should be tested. For the purpose of our comments on the RTS we are:
i. testing the Trigger 1 after allocating the losses of the period and before estimating the amortization for each tranche
ii. testing the Trigger 2 based on the ratio at the end of the previous period (Q-1)
3. In Article 3 – “Additional backward-looking trigger”, please provide some clarification on whether the Synthetic Excess Spread should be accounted for estimating the detachment point of the most senior protected tranche and how (eg. 1Y available excess spread).
4. For the avoidance of doubt, in Article 3 – “Additional backward-looking trigger”, please clarify that the detachment point of the most senior protected tranche is estimated in relative terms (percentage) and not in amount (EUR).