The road to simple and transparent securitisation

Alex Campbell, partner, and Gonzalo Fernandez, consultant, in the structured finance and debt capital markets group at FieldFisher, consider the recent BCBS-IOSCO consultation on simple, transparent and comparable securitisations structures.

Original news

The Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) have set out criteria for identifying, and to assist the financial industry’s development of, simple, transparent and comparable securitisations structures in a new consultation. The criteria also aim to help parties involved in a securitisation transaction evaluate the risks of a particular securitisation as part of their due diligence on securitisations. Those wishing to comment on the criteria should do so by 13 February 2015.

A number of major international financial institutions have broadly welcomed the criteria for identifying simple, transparent and comparable securitisations put forward in a consultation by the BCBS and IOSCO.

What is the background to this consultation?

The volume of term securitisation issuance declined significantly following the onset of the financial crisis in 2007. While issuance levels have begun to rally in some jurisdictions and asset classes recently, activity generally remains below that of pre-crisis levels. The BCBS-IOSCO consultative document dated 11 December 2014 (the CD) identifies two principal reasons for the slower market:

  • a lack of investor confidence in securitisation as an asset class following losses in mortgage-backed and collateralized debt obligation transactions during the credit crisis, and
  • the difficulties investors face when trying to assess the credit and other risks of securitisations, particularly with more complicated transactions, such as resecuritisations

The CD sets out the results of extensive market research, undertaken by a BCBS-IOSCO taskforce established to identify the factors that may be hindering the development of sustainable securitisation markets and to help encourage the development of simple, transparent and comparable securitisations. Fourteen criteria for simple, transparent and comparable securitisations have been identified across three risk types, which are asset risk, structural risk and fiduciary/servicer risk. Each of the criteria is mapped onto one or more of the overriding aims of simplicity, transparency and comparability. The purpose of the criteria is to assist investors with their due diligence on securitisations and their ability to evaluate relevant risks more easily.

Numerous market participants have provided written comments on the CD, which was closed for consultation on 13 February 2015. We have not taken the comments of the market participants into account in the answers to the questions below.

What are the concerns and risks in the securitisation process?

The principal concern for investors in securitisation transactions is the quality of the underlying assets backing the issued securities. The securitisations that performed worst in the financial crisis were those that relied heavily on unproven diversification benefits from pooling diverse, structured, low quality and sometimes illiquid assets together. It is no surprise, therefore, that the first six criteria focus on asset risk. The other risks identified are structural risk and fiduciary/servicer risk.

What has BCBS-IOSCO identified as the key areas where reform would assist in increasing transparency?

According to the survey, investors found that they had insufficient information on the underlying credit risks to be able to perform a reasonable assessment of securitisation. Performance data on the underlying assets, particularly in the case of new portfolios or asset classes, were often not available to investors. The main aim of the reform is to help transaction parties—including originators, investors and other parties with a fiduciary responsibility—to evaluate the risks of the particular securitisation that they are reviewing. The criteria identified in the CD are designed to improve the clarity and transparency of transactions. We note three criteria:

  • assets underlying the securitisation should be credit claims or receivables that are homogenous with respect to their asset type, jurisdiction legal system and currency
  • information provided to investors should be set out in a clear and effective manner and provided within a reasonably sufficient period of time prior to issuance for investors to make informed investment decisions, and
  • the contractual obligations, duties and responsibilities of all key parties to the securitisation should be defined clearly in the transaction documents

The ‘alignment of interest’ criteria is particularly interesting, as it says that in order to align the interests of those responsible for the underwriting of the credit claims or receivables with those of investors, the originator or sponsor of the credit claims or receivables should retain a material net economic exposure and demonstrate a financial incentive in the performance of these assets following their securitisation. This criteria is designed not only to assist with increasing transparency, but also with increasing the integrity of securitisations. The criteria requires the originator or sponsor to keep ‘skin in the game’ as a way of reassuring investors that they are happy to retain some economic exposure to the securities that they are selling.

How would each of the criteria, if adopted, affect securitisation structures?

We envisage that the criteria, if adopted, will encourage the market to develop transactions that follow a standardised approach and which will be easier for investors to undertake more effective risk analysis on. Investor confidence in securitisation as an asset class will grow once it begins to lose its reputation for being too complex or opaque for comfort.

The criteria should also help ensure that parties appointed as fiduciaries and servicers have the requisite skill and experience to undertake such roles on transactions effectively, particularly in work-out of loss mitigation situations. This should help facilitate the orderly restructuring of transactions in the event that it becomes necessary due to unforeseen circumstances.

Should lawyers consider changing the way they practice/draft/structure in light of the consultation?

Lawyers should already be drafting legal documents for transactions that are clear, simple and easy to follow for the end user. However, we think that the criteria should further encourage the development of market-standard documentation which is familiar to investors and which should not radically vary in substance from transaction to transaction.

Could the push for transparency have any unintended consequences?

One of the asset risk criteria states that the performance of a simple, transparent and comparable securitisation should not rely upon the initial and ongoing selection of assets through active management on a discretionary basis of the securitisation’s underlying portfolio. In order to meet the principle of true sale, the transfer of underlying credit claims or receivables should not be effected through credit default swaps, derivatives or guarantees, but by a legal assignment of the claims or the receivables from the seller to the securitisation. The criteria therefore maintain that a simple, transparent and comparable securitisation should be structured as a true sale rather than synthetic securitisation.

While synthetic securitisations are typically more complex than true sale securitisations, we are of the view that they can be structured and documented in a way that is simple, transparent and comparable with other transactions. By discouraging the use of the synthetic securitisation structure, the criteria may inadvertently stifle innovation at the very time that the market should be striving to develop the next generation of securitisation product.

Interviewed by Duncan Wood.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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