Response to consultation on draft RTS on the determination by originator institutions of the exposure value of SES in securitisations
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Nevertheless, we would make the following observations/remarks with respect to the provisions contained within the draft:
• It is unclear what is meant by the length of “each period” in the definition of UIOLI and Trapped under point 8? Is it on an annual or quarterly basis, or at the SES reset date?
• We believe the two definitions of synthetic securitisations (e.g., UIOLI and Trapped) should be extended to include SES reset dates. For example, in the definition of UIOLI, there is reference to the lack of availability of SES once it is exhausted until the “expected maturity”. The reality for certain transactions is that SES will reset at every reset date until maturity.
Separately, as outlined in para 3 of Article 2, originator institutions are mandated to notify the competent authority before 15 October regarding what approach it intends to take from 01 January the following year. However, it is unclear how this would operate in the initial year once the RTS is finalised. Would the requirement to calculate the exposure value of SES not apply at all until the 1 January following the first 15 October which occurs after the date on which the RTS enter into force? (For example, if the RTS enter into force in April 2023, the requirement would apply from 1 January 2024 (with the first election notified by 15 October 2023), but if the RTS enter into force in November 2023, they would not apply until 1 January 2025 (with the first election notified by 15 October 2024)?
Linked to this, we would also question the rationale for originator institutions to be subject to an “independent review on a yearly basis” as laid down in para 4 of Article 2. In our view, we don’t believe this is necessary for originators who use the Simplified Model Approach.
As a suggestion, we also believe it would make more sense to use different scalars for an FIRB underlying pool that would likely have a higher EL than Retail IRB transactions for example. In addition, it is unclear if the example transactions have any first loss features. The SCRA offset would be less for these type transactions.
We also believe that the existing market practice as laid down via ECB guidance 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. As well as this, it was our understanding during the Level 1 process that the drafting of Art 248 (1) does not pre-determine the actual exposure value and the contribution of each of the four constituents to such exposure value and rather provides full flexibility to the EBA regarding the exposure value estimation, which could, for that matter, allow the EBA to embed the existing ECB supervisory practice within the RTS. Put another way, the drafting of Art 248 (1), and in particular, the inclusion of “as applicable” provides the EBA with sufficient flexibility with setting the exposure value in a proportionate manner.
Taking into consideration the existing supervisory practice and the economics of securitisation transactions, we believe the prudential risk to which banks are exposed should be the main focus of the RTS when determining 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.
The result of current draft RTS is that there will be a double counting of reserves. Because the SES is used to cover the expected loss, it is already covered by provisions. The capital requirement will be on top of that. This new requirement will also apply to all synthetic securitisations, regardless of whether or not they qualify as STS.
To illustrate this point, please find attached a worked-up example on a typical transaction with corporate underlying exposures.
Current capital treatment (based on example)
In each reporting quarter, the amount of unutilised SES in respect of the current annual period is deducted from the Group’s CET1 capital as a securitisation deduction, akin to the “rolling-window” approach as described in the CP. This is added to the first loss deduction and the total deduction is offset by specific credit risk adjustments (SCRAs).
Note, originators that have opted to risk weight the first loss at 1250% and not deduct the exposure value from CET1 will be able to use all of the SCRAs to offset all the SES deduction.
Proposed capital treatment: impact a typical transaction with corporate underlying exposures
Features of the underlying portfolio:
• Total RONA 2,000,000,000
• Total EL 50,000,000
• EL % 2.50%
• Provisions 2.50%
Structure of the transaction:
• First loss 2% (retained and deducted by originator)
• SES 0.5%
The table contained in uploaded pdf document shows the impact of the proposed calculation on the originator’s capital position (see excel sheet for more details).
SES First loss SCRAs Amount deducted from CET1 (post offsetting SCRAs) CET 1 benefit of transaction Impact
Rolling window approach (Current approach)
10,000,000 40,000,000 50,000,000 - 0.57%
Full model approach
40,314,600 40,000,000 50,000,000 30,314,600 0.50% -0.07%
Simple model approach
30,931,573 40,000,000 50,000,000 20,931,573 0.52% -0.05%
In this scenario, the originator goes from having no deduction to capital under the current approach to potentially having up to €30m deducted from capital in the full model approach.
If the originator has opted to risk weight the first loss at 1250% and not deduct the exposure value from CET1, then regardless of approach, the amount deducted from CET1 will be zero as the SCRAs fully offset all the SES deduction in all scenarios.
There is a real concern that using the lifetime approach to SES will result in future deals, under the new proposals, being uneconomical and thus reducing the effectiveness of synthetic securitisations as risk management tool for managing on-balance sheet exposures. Such a result would seem to be contrary to the rationale of including on-balance sheet synthetic securitisations as STS eligible.
Proposal
• Retain the existing ECB treatment which is the 1-year horizon for capitalising SES and to avoid double counting of reserves, which is also the current standard market practice.
In our opinion, the Level 1 text does not explicitly state that future periods need to be deducted at inception and over a period beyond the current 1year rolling basis. At the same time, we believe that Art 248 provides sufficient flexibility to the EBA to continue to use the ECBs existing supervisory practice.
(For further information please see the accompanying excel sheet provided).
Additionally, we would also underline that the approach put forward in the draft RTS seems contradictory to the initial policy objective of extending the STS label to on-balance sheet securitisations, which was to incentivise the use of the mechanism to support continued lending by originator institutions by freeing up regulatory capital. Our concern however is that if the existing approach is agreed then we could see less transaction activity due to the underlying economics which would be impacted by the regulatory framework. Separately, we disagree with the assertion that originator institutions somehow use synthetics for regulatory arbitrage. In our view, this is not supported by empirical evidence, while if there are concerns about such arbitrage, we would expect these to be addressed by the SSM in the SRT assessment.
As outlined under Article 2 of Regulation (EU) 2021/558, the application date of Art 248 of CRR is set for April 2022, yet no guidance is referenced within the draft RTS on when these new rules should apply to existing and future transactions apart from the fact that the RTS will enter into force 20 days following publication in the EU Official Journal.
Given the draft RTS differs significantly from that of the existing market practice, and will be applicable to existing transactions, our members believe it is crucial that some form of grandfathering or deferred application date is included within the final RTS. Having to alter existing transactions is operationally challenging and complex, particularly considering they were executed under the expectation that they were fully in accordance with the supervisory guidance provided by the ECB at the time. Altering deals after their execution could result in many becoming uneconomical, impacting the capital position of the originators in question. We therefore think it is only reasonable that some form of grandfathering or sufficient phase-in timeframe is included in the final draft RTS. We are fully aware of the resource constraints the EBA is under, and the complexity involved in delivering on this mandate, but we would underline that the original Level 1 text stipulated that the EBA submit its draft RTS to the European Commission by 10 October 2021.
While it was outlined that the Level 1 text may not provide for grandfathering, we would suggest an delayed entry into force of the final RTS until at least [6 or 9] months after publication in the EU Official Journal.
Separately, we would note that this delay has led to regulatory uncertainty surrounding the prudential treatment of SES since the adoption of the Capital Markets Recovery Package and in our view, it has undermined the use of SES, which is 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?
Overall, we believe that most of the provisions as outlined in the draft RTS are clear, however, we believe that both the “full model” and the “simplified” approaches are inadequate from an economic perspective. On the contrary, in our view, the so-called “alternative approach” is the only one that is suitable 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 NCAs. Finally, and importantly, this “alternative approach” is compatible with the level 1 text.Nevertheless, we would make the following observations/remarks with respect to the provisions contained within the draft:
• It is unclear what is meant by the length of “each period” in the definition of UIOLI and Trapped under point 8? Is it on an annual or quarterly basis, or at the SES reset date?
• We believe the two definitions of synthetic securitisations (e.g., UIOLI and Trapped) should be extended to include SES reset dates. For example, in the definition of UIOLI, there is reference to the lack of availability of SES once it is exhausted until the “expected maturity”. The reality for certain transactions is that SES will reset at every reset date until maturity.
Q2. Do you agree with the possibility of choosing between the full and the simplified model approaches in a consistent manner?
Overall, we do not believe that either the full model or simplified approaches are appropriate for originators and believe that if such were to be adopted, they would impact negatively the vast majority of securitisations using SES.Separately, as outlined in para 3 of Article 2, originator institutions are mandated to notify the competent authority before 15 October regarding what approach it intends to take from 01 January the following year. However, it is unclear how this would operate in the initial year once the RTS is finalised. Would the requirement to calculate the exposure value of SES not apply at all until the 1 January following the first 15 October which occurs after the date on which the RTS enter into force? (For example, if the RTS enter into force in April 2023, the requirement would apply from 1 January 2024 (with the first election notified by 15 October 2023), but if the RTS enter into force in November 2023, they would not apply until 1 January 2025 (with the first election notified by 15 October 2024)?
Linked to this, we would also question the rationale for originator institutions to be subject to an “independent review on a yearly basis” as laid down in para 4 of Article 2. In our view, we don’t believe this is necessary for originators who use the Simplified Model Approach.
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?
No, in our view we do not believe that either the full model or simplified approaches are appropriate for originators and believe that if such were to be adopted, they would impact negatively the vast majority of securitisations using SES.Q4. Do you agree with the specifications of the asset model made in Article 3?
No, in our view we do not believe that either the full model or simplified approaches are appropriate for originators and believe that if such were to be adopted, they would impact negatively the vast majority of securitisations using SES.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 in Q3, 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 questionQ10. 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.
In our view, the 0.8 scalar for the UIOLI mechanism is too high and unless addressed will result in result in a disproportionate impact on such transactions. We would add that the calculation of the scaler has been based on empirical evidence of 15 transactions which are EIF/EIB deals. In our view it would be more appropriate to calculate the scalar based of a sub-set of industry transactions, or at the very least be lowered to 0.4 as referenced in the draft RTS.As a suggestion, we also believe it would make more sense to use different scalars for an FIRB underlying pool that would likely have a higher EL than Retail IRB transactions for example. In addition, it is unclear if the example transactions have any first loss features. The SCRA offset would be less for these type transactions.
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.We also believe that the existing market practice as laid down via ECB guidance 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. As well as this, it was our understanding during the Level 1 process that the drafting of Art 248 (1) does not pre-determine the actual exposure value and the contribution of each of the four constituents to such exposure value and rather provides full flexibility to the EBA regarding the exposure value estimation, which could, for that matter, allow the EBA to embed the existing ECB supervisory practice within the RTS. Put another way, the drafting of Art 248 (1), and in particular, the inclusion of “as applicable” provides the EBA with sufficient flexibility with setting the exposure value in a proportionate manner.
Taking into consideration the existing supervisory practice and the economics of securitisation transactions, we believe the prudential risk to which banks are exposed should be the main focus of the RTS when determining 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.
The result of current draft RTS is that there will be a double counting of reserves. Because the SES is used to cover the expected loss, it is already covered by provisions. The capital requirement will be on top of that. This new requirement will also apply to all synthetic securitisations, regardless of whether or not they qualify as STS.
To illustrate this point, please find attached a worked-up example on a typical transaction with corporate underlying exposures.
Current capital treatment (based on example)
In each reporting quarter, the amount of unutilised SES in respect of the current annual period is deducted from the Group’s CET1 capital as a securitisation deduction, akin to the “rolling-window” approach as described in the CP. This is added to the first loss deduction and the total deduction is offset by specific credit risk adjustments (SCRAs).
Note, originators that have opted to risk weight the first loss at 1250% and not deduct the exposure value from CET1 will be able to use all of the SCRAs to offset all the SES deduction.
Proposed capital treatment: impact a typical transaction with corporate underlying exposures
Features of the underlying portfolio:
• Total RONA 2,000,000,000
• Total EL 50,000,000
• EL % 2.50%
• Provisions 2.50%
Structure of the transaction:
• First loss 2% (retained and deducted by originator)
• SES 0.5%
The table contained in uploaded pdf document shows the impact of the proposed calculation on the originator’s capital position (see excel sheet for more details).
SES First loss SCRAs Amount deducted from CET1 (post offsetting SCRAs) CET 1 benefit of transaction Impact
Rolling window approach (Current approach)
10,000,000 40,000,000 50,000,000 - 0.57%
Full model approach
40,314,600 40,000,000 50,000,000 30,314,600 0.50% -0.07%
Simple model approach
30,931,573 40,000,000 50,000,000 20,931,573 0.52% -0.05%
In this scenario, the originator goes from having no deduction to capital under the current approach to potentially having up to €30m deducted from capital in the full model approach.
If the originator has opted to risk weight the first loss at 1250% and not deduct the exposure value from CET1, then regardless of approach, the amount deducted from CET1 will be zero as the SCRAs fully offset all the SES deduction in all scenarios.
There is a real concern that using the lifetime approach to SES will result in future deals, under the new proposals, being uneconomical and thus reducing the effectiveness of synthetic securitisations as risk management tool for managing on-balance sheet exposures. Such a result would seem to be contrary to the rationale of including on-balance sheet synthetic securitisations as STS eligible.
Proposal
• Retain the existing ECB treatment which is the 1-year horizon for capitalising SES and to avoid double counting of reserves, which is also the current standard market practice.
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 outlined in response to Q11, we have reservations regarding the proposed approach to the treatment of SES as laid down in the draft RTS, which if implemented, will make a number of existing and future transactions uneconomical.In our opinion, the Level 1 text does not explicitly state that future periods need to be deducted at inception and over a period beyond the current 1year rolling basis. At the same time, we believe that Art 248 provides sufficient flexibility to the EBA to continue to use the ECBs existing supervisory practice.
(For further information please see the accompanying excel sheet provided).
Additionally, we would also underline that the approach put forward in the draft RTS seems contradictory to the initial policy objective of extending the STS label to on-balance sheet securitisations, which was to incentivise the use of the mechanism to support continued lending by originator institutions by freeing up regulatory capital. Our concern however is that if the existing approach is agreed then we could see less transaction activity due to the underlying economics which would be impacted by the regulatory framework. Separately, we disagree with the assertion that originator institutions somehow use synthetics for regulatory arbitrage. In our view, this is not supported by empirical evidence, while if there are concerns about such arbitrage, we would expect these to be addressed by the SSM in the SRT assessment.
Q13.Do you have any other comments on these draft RTS?
One area which we believe should be addressed within the final draft RTS is around the grandfathering/phase-in of the RTS, unless no material changes are made from the current ECB supervisory practice.As outlined under Article 2 of Regulation (EU) 2021/558, the application date of Art 248 of CRR is set for April 2022, yet no guidance is referenced within the draft RTS on when these new rules should apply to existing and future transactions apart from the fact that the RTS will enter into force 20 days following publication in the EU Official Journal.
Given the draft RTS differs significantly from that of the existing market practice, and will be applicable to existing transactions, our members believe it is crucial that some form of grandfathering or deferred application date is included within the final RTS. Having to alter existing transactions is operationally challenging and complex, particularly considering they were executed under the expectation that they were fully in accordance with the supervisory guidance provided by the ECB at the time. Altering deals after their execution could result in many becoming uneconomical, impacting the capital position of the originators in question. We therefore think it is only reasonable that some form of grandfathering or sufficient phase-in timeframe is included in the final draft RTS. We are fully aware of the resource constraints the EBA is under, and the complexity involved in delivering on this mandate, but we would underline that the original Level 1 text stipulated that the EBA submit its draft RTS to the European Commission by 10 October 2021.
While it was outlined that the Level 1 text may not provide for grandfathering, we would suggest an delayed entry into force of the final RTS until at least [6 or 9] months after publication in the EU Official Journal.
Separately, we would note that this delay has led to regulatory uncertainty surrounding the prudential treatment of SES since the adoption of the Capital Markets Recovery Package and in our view, it has undermined the use of SES, which is 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.
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