Lawyers highlight grey areas in securitisation regulation

Securitisation regulation recently passed by the European Union could have problematic legal implications for originators and investors, according to lawyers.

David Shearer, London-based partner at Allen & Overy (A&O), noted that a potential conflict between existing data protection legislation and new EU rules requiring originators to provide transaction disclosure remains unresolved.

"The European Commission hasn't done anything to resolve the potential conflict between bank secrecy data protection rules and this new disclosure requirement; there needs to be some thought given to how these rules will apply in the different European Union member states, with suitable carve-outs added if need be," he explained.

The European Parliament passed amendments to article 122a of the EC's Capital Requirements Directive (CRD) on May 6. Under the amended legislation, originators of securitisations will be required to retain 5% of securitised transactions from 2011 onwards and increase disclosure of transactions. In particular, the originator will have to disclose its level of retention in the transaction and provide investors with access to all relevant underlying data (including exposures, collateral and cashflows).

It appears the concerns around bank secrecy could extend to the proposed US regulation on securitisation originators too. In the Financial Regulatory Reform report released on June 17, the US Treasury recommended imposing a 5% retention requirement for securitisations and also proposed originators should be obliged to provide information on underlying assets to investors, including loan-level data. Furthermore, the compensation received by originators and sponsors, as well as their risk-retention level, will have to be made available.

But as market participants begin to digest the US Treasury's proposals, lawyers continue to raise other concerns surrounding the EC's regulation. Under the CRD, investors will have to carry out rigorous due diligence, stress tests and ongoing monitoring on securitised positions. Failure to comply will incur capital charges of 250% of the risk weight of the securitised position, capped at a maximum of 1,250%. However, the EC has yet to release guidelines on how this regulation will be enforced in practice.

"The new diligence requirements raise questions about how firms can show a 'comprehensive and thorough understanding' of various aspects of their investments. We expect firms and regulators to develop practical standards over time, but some firms may be dissuaded from investing because of the risk of higher capital requirements if they don't meet the test," said Kevin Hawken, London-based partner at Mayer Brown.

Investors concede the due diligence requirements could prove too onerous for some of the European banks investing in securitisations. "It may prevent some small banks from investing in this market. One of the main issues is that traditional asset-backed securities (ABS) investors, including structured investment vehicles, have all disappeared and you really need to have a large enough investor base to be able to fund all of the bank's balance sheet," commented Stephane Caron, head of ABS investment at Natixis Asset Management in Paris.

The 5% retention requirement for securitisations has also incited debate among investors, analysts and lawyers as to whether this mechanism will achieve the purported goal of both US and European regulators: aligning the interests of originators and investors of securitisations.

"I am very sceptical that the 5% retention charge will achieve anything useful, and I am very disappointed that the EC didn't do any proper empirical research or impact studies before proposing the legislation. To some extent, they confused the baby with the bathwater, and there is a danger that by focusing on certain products, you're leaving yourself open to another bubble in a different asset class," said A&O's Shearer.

Many analysts also lament the lack of quantitative research on the potential economic effect the retention charge could have on structuring securitisation deals. But Natixis's Caron said any potential additional costs will be justified if the EC's rules succeed in restoring a sense of security to the market.

"It's true that for very good prime assets, 5% is perhaps more expensive than the level of credit enhancement issuers put in transactions previously. But it is bearable, especially if it helps investors come back to this asset class," he concluded.

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