Securitisation Derivatives and the Margin Exemption
On 4 May 2018, the Joint Committee of the European Supervisory Authorities (ESAs) published a consultation paper on the draft regulatory technical standards (the Draft RTS) amending Delegated Regulation (EU) 2016/2251 on risk-mitigation techniques for OTC derivative contracts not cleared by a CCP (the Margin Rules)9 in the context of simple, transparent and standardised securitisations (STS Securitisations) (the Consultation)10.
The Draft RTS purports to align and ensure the consistency of the treatment of derivatives entered into by covered bond entities in connection with covered bond issuances, or by a securitisation special purpose entity (SSPE) in connection with an STS Securitisation.
Article 42(2) of the Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 (the STS Regulation)11 amended Article 4 of Regulation No 648/2012 of the European Parliament and of the Council (EMIR) by adding paragraph (5), which excludes both STS Securitisations and covered bond issuers from the EMIR clearing obligation, subject to specific requirements. In particular, the scope of the new paragraph (5) states that:
"Paragraph 1 of this Article shall not apply with respect to OTC derivative contracts that are concluded by covered bond entities in connection with a covered bond, or by a securitisation special purpose entity in connection with a securitisation, within the meaning of Regulation (EU) 2017/2402 of the European Parliament and of the Council provided that (…)"
ESAs have to develop draft RTSs to determine the level and type of collateral required with respect to OTC derivative contracts entered into by SSPEs and covered bond entities in connection with STS Securitisations and covered bonds respectively, taking into account any impediments faced in exchanging collateral with respect to existing collateral arrangements under the covered bond or securitisation issuances.
Main Proposed Changes
Largely the amendments proposed in the Consultation are aimed to align the regulatory treatment of STS Securitisations and covered bond issuances by extending the existing exemption applicable to covered bonds issuers and cover pools to STS Securitisations. Under Article 30 of the Margin Rules, covered bond issuers and cover pools are exempted from posting any initial margin (IM) and variation margin (VM). This special treatment has been justified due to the legal impediments that covered bond issuers or cover pools may encounter when providing collateral. Please see for further details our Delta Report.
However, no equivalent exemption exists currently under EMIR for securitisations. The Consultation considers that SSPEs have similar collateral arrangements to those of the covered bond issuances, which would justify a similar exemption arrangement, although fewer requirements would be needed.
Article 30a of the Draft RTS establishes that:
- With respect to OTC derivatives contracts that are concluded by a securitization special purpose entity in connection with a securitization within the meaning of Regulation (EU) 2017/2402 and meeting the conditions of Article 4(5) of this Regulation (EU) 648/2012, by way of derogation from Article 2(2), where the conditions set out in paragraph 2 of this Article are met, counterparties may provide in their risk management procedures the following:
- that variation margin is not posted by the securitisation special purpose entity but that it is collected from its counterparty in cash and returned to its counterparty when due
- that initial margin is not posted or collected
Article 30a of the Draft RTS sets out the following conditions that must apply in order to benefit from the exemption:
- the counterparty to the OTC derivative concluded with the SSPE ranks at least pari passu with the holders of the most senior securitisation note. This condition applies only where the counterparty to the OTC derivative contract is neither the defaulting nor the affected party
- the establishment of a level of credit enhancement of the most senior securitisation note of at least 2 per cent of the outstanding notes on an ongoing basis and
- the netting set does not include OTC derivative contracts unrelated to the STS Securitisation
In principle it is understood that the requirement set out in Article 30(2)(d) of the Margin Rules that the relevant OTC derivative contract is used only to hedge interest rate or currency mismatches will not need to be included since it is already covered in EMIR itself.
The benefit of this exemption is limited to OTC derivative contracts that rank at least pari passu with the most senior class of notes under an STS securitisation so this will limit the practical benefit of the exemption in the context of STS securitisations. This may result that hedging arrangements in respect of subordinated classes of notes may be subject to VM and IM obligations.
Another limitation that will have a practical impact is that the Draft RTS is very clear that this exemption will only apply for OTC derivative contracts entered into in respect of STS securitisations thus leaving outside this regime any non-STS securitisations. It is very unlikely that this will change since Article 42 of the Securitisation Regulation has a very strict scope of application (please see above).
In any case, the above is relevant now that it has been confirmed that the European Commission's 2016 Regulatory Fitness and Performance (the EMIR Review) will not amend the definition of "financial counterparty" (FC) to include SSPEs, who will typically be "non-financial counterparties" (NFC) Therefore, VM and IM requirements would only apply where the SSPE has exceeded the relevant thresholds, thus becoming an NFC+.
The Draft RTS will be submitted to the European Commission for endorsement by 18 July 2018. This will be followed by scrutiny by the European Parliament and the Council, before being published in the Official Journal of the European Union.
Subject to the above limitations, the Draft RTS should be welcome by both the derivative and the securitisation market. However, as explained above, the exclusions of non-STS securitisations will limit the practical impact of this exemption.
The proposed changes are made with the same purpose of those under the ongoing EMIR Review, which aim to reduce unnecessary burdens for NFCs. This is also in line with the recent position clarifying that SSPEs will not be included within the definition of FCs as was anticipated. For more details on the EMIR Review, please see the Delta Report.
THE DELTA REPORT
9 Available at: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R2251&from=EN
10 Available at: https://www.eba.europa.eu/news-press/calendar?p_p_id=8&_8_struts_action=%2Fcalendar%2Fview_event&_8_eventId=2205968
11 Available at: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32017R2402&from=EN
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