The Netherlands: STS framework for synthetic securitisations

Key takeaways

• In July 2020, the European Commission published the STS Proposal and in connection therewith the CRR Proposal.
• The STS Proposal introduces a specific framework for simple, transparent and standardised synthetic on-balance-sheet securitisations (“Synthetic STS Framework“).
• The compromise texts of the STS Proposal and the CRR Proposal were agreed on 14 December 2020 and approved by the ECON Committee of the European Parliament on 14 January 2021.
• A plenary debate of the European Parliament was scheduled for 10 March 2021.
• Once adopted by the Council and European Parliament, the final text of the Synthetic STS Framework will be published in the Official Journal of the EU and the Synthetic STS Framework will enter into force on the 20^th day following that publication.

In depth

Strong traditional securitisation market in the Netherlands

During the mid-1990s, the Dutch securitisation market began to develop with the issuance of residential mortgage-backed securities. As the traditional securitisation market grew and became more sophisticated, the types of financial assets being securitised broadened. Traditional securitisations and other types of structured finance transactions have become increasingly important for Dutch banks and corporates as part of their funding strategies.

Less known in the Netherlands are synthetic securitisations, which are securitisation transactions structured to allow credit institutions to manage their regulatory capital requirements. As a result of the introduction of a specific framework for simple, transparent and standardised synthetic on-balance-sheet securitisations, market participants expect a significant increase in synthetic securitisations in 2021.

Traditional securitisations versus synthetic securitisations

Securitisations (both traditional and synthetic) are used by originators to transfer the credit risk linked to a portfolio of the originator’s assets to a third party. The essence of traditionally structured securitisation transactions is that the originator transfers ownership in the underlying assets that are being securitised to a bankruptcy remote special purpose entity (SPE). The SPE in turn finances the acquisition of the underlying assets by issuing notes to investors.

In a synthetic securitisation, there is no such transfer, better known as “true sale”, of the underlying assets. Instead, the (legal) ownership of the underlying assets remains with the originator and the originator contractually transfers the economic risk associated with the ownership of the assets to a third party. Such contractual arrangement may take the form of a participation, credit default swap, guarantee or credit-linked note. A synthetic securitisation relies on the recognition that, upon meeting certain criteria, originators may derecognize certain underlying assets from their balance sheet for regulatory capital requirements.

Funded and unfunded synthetic securitisations

Transactions involving a credit derivative can be either funded or unfunded. In funded synthetic securitisations, the SPE will enter into a credit protection agreement with the originator to hedge a tranche of risk. Under such credit protection agreement, the SPE commits to pay the losses of the originator upon the occurrence of a credit event (e.g., payment defaults or insolvency of the originator’s debtors). In return, the originator will pay a credit protection premium to the SPE. In order to be able to cover such potential losses, the SPE will issue credit-linked notes (CLNs) to noteholders. The proceeds of the issuance of the CLNs will be deposited in an account as collateral, which will be used to pay the originator in case of a credit event.

In an unfunded synthetic securitisation, the originator will not enter into a credit protection agreement with an SPE and no upfront payment will be deposited as collateral. Instead, the originator will directly enter into a credit protection agreement with a protection buyer (e.g., central governments, central banks, multilateral development banks, insurers or international organisations). Unfunded transactions, therefore, could entail counterparty credit risk for originators because there is no upfront payment or collateral available.

Simple, transparent and standardised (STS) framework for synthetic securitisations

On 1 January 2019, Regulation (EU) 2017/2402 (“Securitisation Regulation“) came into effect with the intention of providing a general framework for securitisation across the EU. Under the Securitisation Regulation, synthetic securitisations were initially excluded from the STS framework and therefore from a more favorable regulatory capital treatment. Synthetic securitisations could not be classified as an STS securitisation and, as a result, could not benefit from the more favorable capital treatment, as one of the STS requirements is a “true sale” of the underlying assets or an assignment or transfer with the same legal effect.

In July 2020, the European Commission published a proposal to amend the Securitisation Regulation (“STS Proposal“) and in connection therewith a proposal to amend Regulation (EU) No 575/2013 (“CRR Proposal“). The STS Proposal introduces a specific framework for simple, transparent and standardised synthetic on-balance-sheet securitisations (“Synthetic STS Framework“) while the CRR Proposal extends the more favorable regulatory capital treatment of STS securitisation exposures to synthetic securitisation exposures meeting all the relevant criteria set out in the Synthetic STS Framework . The rationale for the STS Proposal and the CRR Proposal is to help in the recovery from COVID-19 by making it easier for banks to use securitisations to transfer some of the risk of loans made to SMEs to investors, so that they can continue to lend to SMEs.

To cater for the Synthetic STS Framework a new Section 2a “Requirements for simple, transparent and standardised on-balance-sheet securitisations” has been inserted. This section has been drafted to be consistent with the STS requirements for traditional securitisations. However, because of the differences between traditional and synthetic securitisations, Section 2a also introduces new requirements with respect to, among others, the credit protection agreement and a third-party verification agent that must be appointed to carry out a factual review of the correctness and accuracy of certain aspects of the credit protection when a credit event has been triggered, and the use of synthetic excess spread. Furthermore, when the collateral provided is in the form of cash, it should be held either with a third-party credit institution or on deposit with the protection buyer, subject in both cases to a minimum credit quality standing.

Legislative process

On 10 November 2020, the Committee on Economic and Monetary Affairs (“ECON Committee“) of the European Parliament adopted two reports, one for the STS Proposal and one for the CRR Proposal. The ECON Committee’s subsequent decisions of 11 November 2020 to enter into interinstitutional negotiations were confirmed by plenary on 13 November 2020 and have been held in the months following. Following these interinstitutional negotiations, the compromise texts of the STS Proposal and the CRR Proposal were agreed on 14 December 2020 and approved by the ECON Committee of the European Parliament on 14 January 2021. A plenary debate of the European Parliament was scheduled for 10 March 2021.

Once (formally) adopted by both European bodies (i.e., the Council and European Parliament), the final text of the Synthetic STS Framework will be published in the Official Journal of the EU and the Synthetic STS Framework will enter into force on the 20^th day following that publication.

Conclusion

The EU has determined that securitisation can soften the negative economic impact of the pandemic and assist in the recovery from this impact. The STS Proposal and the CRR Proposal are intended to preserve the ability of banks to continue lending to companies, especially small and medium-sized companies, by updating the current securitisation regulatory framework. Within the sophisticated Dutch securitisation market, some Dutch credit institutions have already been exploring synthetic securitisations. As a result of the introduction of the Synthetic STS framework, we expect many more to follow this path.