Response to consultation on the draft RTS on homogeneity of underlying exposures in securitisation

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Question 1: Do you agree with the focus of the RTS, general approach and underlying assumptions on which the RTS are based? Does the proposed approach provide sufficient clarity and certainty on the interpretation and application of the criterion of homogeneity?

The IDSA believes the suggested RTS provides a structured framework to help determine homogeneity. We believe that the EBA is correct to state that “given the broad scope of the asset categories, belonging to one such asset category does not render the underlying exposures sufficiently homogeneous. Additional criteria, largely in line with the current market practice, should therefore be applied, in the form of risk factors, the application of which would result in further differentiation of exposures within the respective asset category.”

From a portfolio concentration and diversity perspective, we have a concern with the main approach chosen to determine the homogeneity of the collateral pool and believe that there are strong arguments to proceed with the hybrid version. We agree that the use of similar underwriting standards, methods and criterion in conjunction with uniform servicing procedures should provide the base for determining homogeneity. Combining this with a non-exhaustive list of asset categories ensures a further degree of common and shared risk profiles. The main approach also includes using a pre-defined list of risk factors to further classify the underlying assets. While this is likely to produce an extremely homogeneous pool of assets, it also has the danger of producing a very concentrated pool of homogeneous assets which will reduce the level of diversity within the pool and could well increase the overall riskiness of the pool as it becomes too concentrated in a similar type of asset.

Question 2: Do you agree with the assessment of the homogeneity of underlying exposures based on criteria specified under (a) to (d)? Should other criteria be added or should any of the criteria be disregarded?

The IDSA believes that risk factor (d) could potentially cause a degree of undue concentration risk and reduce diversity within the pool. The IDSA believes that it is worth considering an alternative option to determine the homogeneity in the pool. Under an alternative proposal, “the homogeneity would be defined by means of compliance with a set of detailed criteria, capturing a wide spectrum of potential sources of heterogeneity of the underlying exposures linked to their various cash flow, contractual, credit risk, prepayment and other characteristics (including, for example, with respect to the currency, maturity, or minimum credit quality).”

The EBA states that this approach would be inconsistent with the treatment of other classes such as covered bonds where the assessment of the assets is performed at the level of the asset category (i.e. it is a common market practice that the cover pool assets are composed of one primary asset class, such as, for example, residential loans). However, this does not seem to take account of the fact that under these proposals there is the additional requirement to take account of “similar underwriting standards” and “uniform servicing practices” as elements of the homogeneity test.

Question 3: Are there any impediments or practical implications of the criteria as defined? Are there any important and severe unintended consequences of the application of the criteria?

The RTS states that homogeneity for the purposes of STS securitisation should not provide incentives that would prevent the originator from structuring a diversified portfolio, nor should it lead to excessive concentration in the portfolios, for example to exposures to obligors in a specific geographical area, or to a specific type of obligors. We believe that the use of too many criterion and categories may result in a less diverse portfolio.

The pool of underlying exposures should only contain exposures of one asset category which share similar characteristics with respect to the type of obligor, the credit facility, the collateral, the repayment characteristics or other factors, because such similarities enable the investor to assess the pool of underlying exposures on the basis of common methodologies and parameters.

The RTS lists among its risk factors repayment/amortisation, industrial sector, jurisdiction and, governing law. The draft standards outline an example of a homogeneous pool that has been differentiated based on relevant risk factors. In this example, it states that “The pool of underlying exposures would thus only contain exposures of non-income producing residential mortgages secured by residential property located in one specific jurisdiction (and could not be mixed with exposures of income-producing loans secured by residential property in that of other jurisdictions).” It states that this should result in a pool of exposures that have similar risk profiles and cash flow characteristics, enabling the investor to assess the underlying risks on the basis of common methodologies and parameters.

While the IDSA can see the merit in this proposal we believe that the use of the risk factors may have three unintended negative consequences:

1. Concentration risks/less diverse
2. Pools not reflective of the business models of the originators
3. Challenges in drafting the key risk sections in the prospectus

By applying so many restrictions through the risk factors, the collateral pools will, by design, be less diverse and more concentrated which may actually contribute to a riskier pool than a more diverse one. The pool will be subject not only to similar asset types but also similar lending products in the one jurisdiction. Different lending products will have different characteristics, which may well have different performances at different stages of the economic cycle. Diversity is a positive attribute and in general, leads to lower levels of risk. By overly restricting the degree of diversity, there is a real concern that more concentrated portfolios may be subject to event risk and have a more volatile performance than more diversified portfolios.

Limiting the collateral pools by the proposed risk factors may, in many instances, result in a collateral pool that is not reflective of the actual business transacted by the originator.

Many originators originated many different products under one set of credit and risk management policies and underwriting standards. Many originators, due to their limited scale may not have a sufficiently large homogeneous portfolio, as defined by the risk characteristics, to achieve the economies of scale to facilitate a cost-effective securitisation and thus preclude them from participating in the market. Indeed, as the Capital Markets Union in Europe develops further, it is expected that there will be significantly more cross-border lending in the real economy. As originators expand their footprint outside their home market they too will be constrained as they will not be able to issue cross-border STS securitisations and may also suffer from a scale problem.

The IDSA also has a concern with the impact of using risk factors in determining the homogeneity of a pool and then having to include such risk factors in a prospectus where the number of key risks that can be discussed are limited. The ranking of the risk factors, which is already considered challenging, is likely to become more difficult.

The concept of allowing adverse selection in the transfer of assets to the SSPE outlined in the draft Regulatory Technical Standards specifying the requirements for originators, sponsors and original lenders relating to risk retention allows adverse selection as long as this is “is clearly and conspicuously communicated in writing to the competent authorities, investors and potential investors prior to the investment being made.” Adopting similar language in relation to disclosure of these risks would also allow flexibility in selecting assets to be transferred to the SSPE. The full disclosure would help transparency and ensure that the risks are highlighted.

Overall, we believe that the adoption of a hybrid proposal would contribute to a better functioning market

Question 4: Do you agree that when considering the relevance of the risk factors, the asset category, type of securitisation (non-ABPC or ABCP), and specific characteristics of the pool of exposures, should be taken into account? Should other elements be considered as important determinants of the relevance of the individual risk factors?

See 3 Above.

Question 5: Do you agree that the same set of criteria should be applied to non-ABCP and ABCP securitisation? Or do you instead consider that additional differentiation should be made between criteria applicable to non-ABCP and ABCP securitisation, and if so, which criteria?

NA

Question 6: Do you agree with providing a list of asset categories in the RTS? Do you agree with the asset categories listed? Should other asset categories be included or some categories be merged? For example, should separate asset categories of project finance, object finance, commodities finance, leasing receivables, dealer floor plan finance, corporate trade receivables, retail trade receivables, credit facilities to SMEs and credit facilities to corporates, be included? Please substantiate your reasoning.

ESMA in its Consultation on its Draft technical standards on disclosure requirements, operational standards, and access conditions under the Securitisation Regulation has considered the possibility of developing additional underlying exposure templates for other categories of underlying exposures found in non-ABCP securitisations.

Based on this analysis, ESMA identified three possible categories: CDOs, Whole Business Securitisations and Rare (across the EU) and idiosyncratic underlying exposure types: this category includes healthcare receivables, funds recovered from electricity tariff deficits, student loan payments, dealer floorplan receivables, and any other underlying exposure type not covered in the above-mentioned categories and templates.

Following a mandate received from the European Commission, the EBA has also developed a set of draft standardised reporting templates for NPL exposures.

It would appear logical that the asset categories used by the EBA and the templates developed by ESMA should be comparable.

Question 7: Do you agree with the definitions of the asset categories provided? For example, do you consider that the asset category of credit facilities to SMEs and corporates should be further specified and for the SMEs should refer to the definition provided in the Commission Recommendation 2003/361/EC, or should other reference be used (for example to Art. 501 of the CRR)? Please substantiate your reasoning.

NA

Question 8: Do you agree with the approach to determination of the homogeneity based on the risk factors, and the distinction between the concept of risk factors to be considered for each asset category, and relevant risk factors to be applied for a particular pool of underlying exposures, as proposed? Are there any impediments or practical implications of the risk factors as defined? Are there any important and severe unintended consequences of the application of the risk factors?

See 3 Above.

Question 9: Do you agree with the distribution of the risk factors that need to be considered for each asset category, as proposed? What other risk factors should be included for consideration for which asset category?

See 3 Above.

Question 10: Do you agree with the definition of the risk factor related to the governing law, which refers to the governing law for the contractual arrangements with respect to the origination and transfer to SSPE of the underlying exposures, and with respect to the realisation and enforcement of the credit claims? Do you consider the risk factor of the governing law should be further specified, or further limited (e.g. to the realisation and enforcement of the financial collateral arrangements securing the repayment of the credit claims)?

See 3 Above.

Question 11: Do you consider prepayment characteristics as a relevant risk factor for determining the homogeneity? If yes, based on which concrete aspect of the prepayment characteristics of the underlying exposures should the distinction be made, and for which asset categories this risk factor should be considered and should be most relevant?

See 3 Above.

Question 12: Do you consider seniority on the liquidation of the property or collateral a relevant risk factor for determining the homogeneity? If yes, do you consider the distinction between the credit claims with higher ranking liens on the property or collateral, and credit claims with no higher ranking liens on a different property or different collateral, as appropriate for the purpose of determination of homogeneity?

See 3 Above.

Question 13: Do you agree with the approach to determining the homogeneity for the underlying exposures that all do not fall under any of the asset categories specified in the Article 3?

See 3 Above.

Question 14: Do you believe that materiality thresholds should be introduced with respect to the risk factors i.e. that it should be possible to consider as homogeneous also those pools which, while fully compliant with requirements under Article 1 (a), (b) and (c), are composed to a significant percentage (e.g. min 95% of the nominal value of the underlying exposures at origination), by underlying exposures which share the relevant risk factors (e.g. by 95% of general residential mortgages with properties located in one jurisdiction and 5% of income producing residential mortgages located in that and other jurisdictions)? Please provide the reasoning for possible introduction of such materiality thresholds.

NA

Question 15: Alternatively, do you see merit in introducing synergies with IRB modelling, enabling the IRB banks to rely on risk management factors validated for modelling purposes, when assessing the similarity of the underwriting standards, or assessing relevant risk factors? Please provide the reasoning and examples for possible introduction of such synergies.

NA

Question 16: Which option from the two (the existing proposal as described in this consultation paper, and the alternative option as described in this box) is considered more appropriate and provides more clarity and certainty on the determination of homogeneity? Please substantiate your reasoning.

See 3 Above.

Question 17: Please provide an assessment of the impact of the two proposed options, on your existing securitisation practices and if possible, provide examples of impact on existing transactions.

NA

Question 18: Alternatively, do you believe that a hybrid option, combining the existing proposal and the alternative proposal, would be most appropriate? The hybrid option could envisage that all the risk factors would need to be taken into account in the underwriting, and for those risk factors that are not taken into account in the underwriting, (i) either adequate justification would need to be provided that it is not required for the purpose of the homogeneity, (ii) or if the justification cannot be provided, the risk factor would still need to be taken into account when determining the exposures in the pool (on the top of the requirements related to underwriting, servicing, and asset category). Or, should other hybrid option be envisaged? Please substantiate your reasoning.

See 3 Above.

Question 19: What are the advantages, disadvantages and unintended consequences of this alternative option, in particular compared to the existing proposal?

NA

Question 20: Are there any impediments or practical implications of this alternative option as defined? Are there any important and severe unintended consequences of the application of this option?

NA

Name of organisation

Irish Debt Securities Association (IDSA)