Regulations & Current Topics
Regulation has a profound impact on CRS. As a relatively young asset class, CRS is still in development and regulation continues to shape the market both directly and indirectly. There is a great variety of regulations that affect the economic efficiency and structuring of CRS, with significant differences across jurisdictions. This is due to the nature of CRS: a type of securitisation, which allows banks to achieve capital relief on a portfolio of credit exposures. As such, it has multiple touchpoints with regulation.
Firstly, regulation governs CRS directly, as a type of securitisation also known as ‘balance sheet synthetic securitisation’ (“BSSS”). For example, the European Securitisation Regulation includes minimum standards and requirements for the main parties involved in a securitisation transaction, such as the originating bank and the investor. It also created a framework for “Simple, Transparent and Standardised” (“STS”) securitisation which enables transactions that meet these additional STS criteria to benefit from lower capital requirements. Since April 2021, CRS transactions are eligible to become “STS”. We strongly support this development, as we have been advocating this since 2015, and elaborate on this below.
Secondly, CRS is also a way of credit risk mitigation, thereby allowing banks to achieve capital relief. Capital relief is a key rationale for banks to enter into CRS. Banking regulation, such as the Capital Requirements Regulation (“CRR”), determines the extent to which a bank can gain capital relief and under which conditions. Within the European Union, capital relief is only granted if a bank achieves “Significant Risk Transfer” (“SRT”), in other words when a bank can show that the transaction indeed achieves credit risk mitigation to a significant extent.
In addition, banking regulations stipulate the capital requirements for the underlying credit exposures. The Basel III and its finalisation, also known as ‘Basel IV’, is the most recent comprehensive regulation affecting capital requirements for banks’ credit exposures, as well as overall capital requirements for the bank. Banking regulation and supervision also govern whether banks are allowed to use internal models for determining capital requirements for its credit exposures, and whether these are appropriately calibrated. Sophisticated and well-calibrated internal models are hugely important for investors in CRS, as these typically allow for a more accurate estimation of potential losses that a given portfolio could experience during the life of the CRS transaction.
Finally, the structuring of a CRS transaction and the activities of banks are impacted by many other regulations, such as accounting and tax regulation. These generally have a far broader scope, however, they may have a noticeable impact on CRS transactions nonetheless.
As a pension fund asset manager, by our nature we have an investment horizon that stretches decades rather than years or months. Therefore, the long-term viability and sustainability of the CRS market is of the utmost importance to us. We strongly believe that this objective is only achievable if a balance is found between the long-term interests of banks, investors and the regulator.
Because of this conviction, we have since many years become a vocal advocate for harmonisation of practices, appropriate standards for healthy transactions and transparency. We do this through active dialogue with regulators, banks and investors, as any rule or standard will need to meet the objectives of all three. We further contribute to roundtables and consultations and publish our opinions where we believe this adds value.
We hope that by helping to shape standards in this young and promising market, we can continue to create sustainable partnerships in which risk is genuinely shared between the bank and investors.
Current topics – STS for synthetic CRS
In April 2021, the framework for ‘Simple, Transparent and Standardised’ (“STS”) securitisations, became applicable to balance sheet synthetic securitisation (“BSSS”), which is the technical legal term for CRS. This followed after reports from the European Commission (“EC”) and the European Banking Authority which were supportive of this change.
As an adamant supporter of healthy transaction structures, we strongly encourage this development and are keen to continue contributing to improvement of the STS criteria for CRS transactions. We believe key features of any healthy and sustainable investment class are that it is relatively easy to understand and manage, which is closely aligned with the objectives of STS. In our view, the CRS transactions that we have invested in to date already broadly follow the spirit of STS.
To qualify for the STS qualification, CRS transactions need to adhere to a variety of criteria, each of which falls under one the three main pillars of the label. For ‘Simple’, this includes, among others, a homogeneity requirement for the underlying asset pool: only one type of exposure, for example corporate loans, is allowed. Under ‘Transparent’, the risk sharing bank has to share data on historical default and loss performance and independent verification of the eligibility for (a sample of) the underlying exposures is required. An example of the requirements under ‘Standardised’ is a minimum risk retention by risk sharing bank (please find more information and our view on risk alignment here). Finally, several specific criteria for CRS transactions are included, such as which credit events should be included at a minimum.
The current STS standards allow for cash proceeds of STS compliant synthetic securitisations to be held on deposit by the risk sharing bank, albeit under conditions. We believe strongly that these cash proceeds should always be collateralised in order to mitigate bank counterparty credit risk. More details on collateralisation of investment notional can be found here.