Response to draft Guidelines on the STS criteria for ABCP securitisation
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A possible solution would be to include a “sunset provision” and for the existing seller to make a full disclosure. A sunset provision, in relation to the original origination could come into effect after a reasonable period of time, such as 36 months, and be contingent on a positive credit performance of the underlying loans. Credit issues related to the original quality of underwriting of the loan should become apparent within a 36-months of the loan drawdown.
This provision makes sense for a short and limited period where assets are being ramped-up and there is a desire to ensure a homogeneity of the pool. However, underwriting criteria evolve with the market over time and such a strict application of fixed eligibility criteria at the exposure level could prevent the addition of assets to the pool substitution, repurchase and replenishment reasons. Traditionally the addition of new assets to a collateral pool, for these reasons, have been governed by the maintenance of certain collateral pool level criteria, for example, a cap on the maximum weighted average LTV rate, a maximum exposure size or a maximum maturity profile. Changing the criteria from exposure level to pool level would be in keeping with market practice.
However, the conditions attached to the use of traditional interest rate and foreign exchange rate derivatives is significantly more onerous than those for non-derivative based mitigants. For derivatives “the appropriateness of the mitigation of interest rate and currency risks through the life of the transaction must be demonstrated through quantitative information including the fraction of notional amounts that are hedged, as well as a concise sensitivity analysis that illustrates the effectiveness of the hedge under extreme but plausible scenarios”. However, for risk mitigation not carried out through derivatives, there is no requirement to provide quantitative information and sensitivity analysis. But there is a requirement that these measures should be fully funded and available at all times. From an information disclosure and transparency perspective, it would be appropriate for similar quantitative information and sensitivity analysis to be carried out and disclosed to facilitate investors, in particular, to fully understand the risks and the mechanisms used to mitigate these risks.
Indeed, there is an additional issue in relation to the proposed definition of a “complex formulae” which is determined by meeting the definition of an exotic instrument by the Global Association of Risk Professionals (GARP). It defines a financial asset or instrument as one with features making it more complex than simpler, plain vanilla, products. But this is a definition by exception and relies on the concept of a plain vanilla product, which is not defined! It is likely that the formula used in setting bank SVR’s would be defined as complex formulas!
The more restrictive approach adopted by the guidelines relative to the STS Regulation means that deals back by loans linked to bank SVR rates would be precluded these deals from achieving an STS certification, which would seem contrary to the aims of the STS Regulation.
Any barrier to entry in the provision of the model should be precluded and access should be free of charge to all potential investors.
Q5. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
There is a concern with regard to a situation where an original lender is no longer in existence and the subsequent buyer of the portfolio may not be in a position to provide the relevant representations and warranties. This could exclude a portfolio of assets from being securitised and attaining the STS designation.A possible solution would be to include a “sunset provision” and for the existing seller to make a full disclosure. A sunset provision, in relation to the original origination could come into effect after a reasonable period of time, such as 36 months, and be contingent on a positive credit performance of the underlying loans. Credit issues related to the original quality of underwriting of the loan should become apparent within a 36-months of the loan drawdown.
Q6. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
There is some concern with regard to guidelines in relation to “the eligibility criteria to be applied to exposures transferred to the SSPE after the closing as part of substitution, repurchase, replenishment and ramp-up periods in accordance with paragraph 18, should be no less strict than the eligibility criteria applied to the initial underlying exposures. Eligibility criteria to be applied to such exposures should be specified in the transaction documentation. This criterion refers to eligibility criteria applied at exposure level.” The concern here is that the eligibility criteria could refer to the original underwriting criteria as the guidelines state “this criterion refers to eligibility criteria applied at exposure level.” This would imply that the original underwriting would continue to apply to new assets added to the collateral pool after closing, under the conditions outlined above.This provision makes sense for a short and limited period where assets are being ramped-up and there is a desire to ensure a homogeneity of the pool. However, underwriting criteria evolve with the market over time and such a strict application of fixed eligibility criteria at the exposure level could prevent the addition of assets to the pool substitution, repurchase and replenishment reasons. Traditionally the addition of new assets to a collateral pool, for these reasons, have been governed by the maintenance of certain collateral pool level criteria, for example, a cap on the maximum weighted average LTV rate, a maximum exposure size or a maximum maturity profile. Changing the criteria from exposure level to pool level would be in keeping with market practice.
Q7. Do you agree with the techniques of portfolio management that are allowed and disallowed, under the criterion of the active portfolio management? Should other techniques be included or excluded?
See 6 Above.Q13. Do you agree with the interpretation of the predominant dependence with reference to 30% of total initial exposure value of securitisation positions? Should different percentage be set dependent on different asset category securitised?
The use of the phrase “material damages” is open to interpretation and could result in some parties taking contrary vires on the same credit exposure. A tighter definition would ensure consistency in the interpretation of this element.Q14. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
We agree with this interpretation.Q15. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
We agree with this interpretation.Q16. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
We agree with this interpretation.Q17. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
We agree with this interpretation.Q19. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
The stipulation that interest rate and currency risks need not be perfectly hedged to be considered “appropriately mitigated” but can be mitigated through the use of reserve funds or other measures with the mitigation considered from an economic rather than accounting point of view.However, the conditions attached to the use of traditional interest rate and foreign exchange rate derivatives is significantly more onerous than those for non-derivative based mitigants. For derivatives “the appropriateness of the mitigation of interest rate and currency risks through the life of the transaction must be demonstrated through quantitative information including the fraction of notional amounts that are hedged, as well as a concise sensitivity analysis that illustrates the effectiveness of the hedge under extreme but plausible scenarios”. However, for risk mitigation not carried out through derivatives, there is no requirement to provide quantitative information and sensitivity analysis. But there is a requirement that these measures should be fully funded and available at all times. From an information disclosure and transparency perspective, it would be appropriate for similar quantitative information and sensitivity analysis to be carried out and disclosed to facilitate investors, in particular, to fully understand the risks and the mechanisms used to mitigate these risks.
Q20. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
The guidelines are considerably more restrictive than the STS Regulation in relation to the use of sectoral rates reflective of the cost of funds allowable reference rates. The guidelines require institutions to provide sufficient data to allow investors to assess their relation to other market rates. While some institutions disclose the factors which they use in setting their SVR’s, the actual data and formula are not actually published.Indeed, there is an additional issue in relation to the proposed definition of a “complex formulae” which is determined by meeting the definition of an exotic instrument by the Global Association of Risk Professionals (GARP). It defines a financial asset or instrument as one with features making it more complex than simpler, plain vanilla, products. But this is a definition by exception and relies on the concept of a plain vanilla product, which is not defined! It is likely that the formula used in setting bank SVR’s would be defined as complex formulas!
The more restrictive approach adopted by the guidelines relative to the STS Regulation means that deals back by loans linked to bank SVR rates would be precluded these deals from achieving an STS certification, which would seem contrary to the aims of the STS Regulation.
Q21. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
We agree with this interpretation.Q22. Do you agree with this balanced approach to the determination of the expertise of the seller? Do you believe that more rule-based set of requirements should be specified, or, instead, more principles-based criteria should be provided? Is the requirement of minimum of 5 years of professional experience appropriate and exercisable in practice?
We agree with this interpretation.Q23. Should alternative interpretation of the “similar exposures” be provided, such as, for example, referencing the eligibility criteria (per Article 24(7)) that are applied to select the underlying exposures? Similar exposure under Article 24(18) could thus be defined as an exposure that would qualify for the portfolio, based on the exposure level eligibility criteria (not portfolio level criteria) which has not been selected for the pool and which was originated at the time of the securitised exposure (e.g. an exposure that has repaid / prepaid by the time of securitisation). Similar interpretation could be used for the term “exposures of a similar nature” under Article 24(18), and “substantially similar exposures” under Article 24(14). The eligibility criteria considered should take into account the timing of the comparison. Please provide explanations which approach would be more appropriate in providing clear and objectively determined interpretation of the “similarity” of exposures.
We agree with this interpretation.Q24. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
We agree with this interpretation.Q25. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
We agree with this interpretation.Q26. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
We agree with this interpretation.Q27. Do you agree that the external verification should only cover the criteria referenced in paragraphs (9), (10) and (11) of Article 24, or should it cover all criteria mentioned in Article 24? Do you agree with the approach on determining the frequency of the external verification?
We agree with this interpretation.Q28. Concerning the sample, should a minimum sample size be prescribed (in absolute or relative terms)? Should a statistical method for evaluating the outcome of the external verification of the sample be specified? Do you agree that it should be representative covering all underlying exposures of all transactions? Do you see merit in further specifying that the sample should be representative by properly representing the various asset categories of the transactions; or that representativeness may be assumed when the sample is gathered via a random selection?
We agree with this interpretation.Q29. Do you agree with the interpretation of this requirement, and the aspects that the interpretation is focused on? Should other aspects be covered? Please substantiate your reasoning.
We agree with this interpretation.Q30. Should the calculation of the weighted average life follow the concept of weighted cash flows or of weighted (residual) maturities? Should there be a facilitation for a simplified calculation of the WAL (e.g. to use the longest contractually possible remaining maturity of the exposures in a transaction as an upper bound)?
We agree with this interpretation.Q31. Do you agree with the interpretation of this criterion, and the aspects that the interpretation is focused on? Should interpretation be amended, further clarified or additional aspects be covered? Please substantiate your reasoning.
The guidelines do not state how the liability cashflow model should be made available to potential investors. We agree that the model must accurately represent how cash is applied through the waterfall and therefore the model’s code should be open for inspection and review so that investors can access whether or not the cash flow model is reflective of the deal structure as outlined in the deal documentation. Users should have the ability to perform their own user defined stresses and also have the ability to save or download the results of their analysis.Any barrier to entry in the provision of the model should be precluded and access should be free of charge to all potential investors.