Market updates and sector developments

The UK PRA has launched a consultation on draft rules to replace firm-facing requirements regarding securitisation under the CRR in 2H24. As such, it has published a discussion paper (DP) that raises certain key issues for feedback, in order to inform its approach - including the use of unfunded credit risk mitigation (CRM) in SRT transactions.

In particular, the DP considers: the calibration of the Pillar 1 framework for determining capital requirements for securitisation exposures and their interaction with the Basel 3.1 output floor; the hierarchy of methods for determining capital requirements for securitisation exposures; and the specification of securitisations that qualify as STS and associated preferential prudential treatment. In general, the PRA considers that broad alignment with the Basel standards would advance its primary objective of promoting the safety and soundness of PRA-authorised firms by addressing prudential risks associated with securitisation exposures.

However, the authority says it supports a wider review by the Basel Committee of Basel standards relating to the Pillar 1 securitisation capital requirements. “These have not been implemented uniformly across jurisdictions and their interaction with the Basel 3.1 output floor raises questions about their design and calibration,” the DP states.

Regarding the output floor, the PRA is considering a range of policy options while monitoring the impact of the proposals. One option would be to go ahead with implementation of the Basel 3.1 output floor without any adjustment to the Pillar 1 framework for determining capital requirements for securitisation exposures. Another option would be a targeted and evidence-based adjustment to the Pillar 1 securitisation capital framework.

Another topic addressed in the paper is the hierarchy of methods for determining securitisation capital requirements; in particular, the divergence of the current hierarchy of methods in the Securitisation Chapter of the CRR from the Basel standards. The consultation explores the possibility of better aligning this hierarchy.

Finally, the DP discusses the scope of the UK framework for STS securitisations, which is currently aligned with the Basel standards in that it covers traditional (funding) securitisations meeting the eligibility criteria, but not synthetic securitisations. The PRA sets out policy considerations that would on balance support maintaining this approach.

Specifically regarding significant risk transfer, the authority says it expects firms to ensure that any reduction in capital requirements achieved through securitisation continues to be matched by a commensurate transfer of risk throughout the life of the transaction. Firms are expected to take a substance-over-form approach to assessing SRT: they should be able to demonstrate that the capital relief post-transaction adequately captures the economic substance of the entire transaction and is commensurate to the retained risks.

Nevertheless, the PRA is seeking information on CRM in synthetic SRT securitisations to assist it in identifying any prudential risks from CRM practices in SRT securitisations and, if necessary, in considering policies to mitigate these risks. While the authority understands that UK originators of SRT securitisations generally use CRM in the form of funded credit protection, it would like to engage with SRT market participants to better understand current market practice and also market interest in using unfunded CRM in SRT securitisations.

As part of this, the PRA is seeking to “understand more fully” the potential prudential risks associated with the use of unfunded CRM in SRT securitisations - including the risk of late payment or non-payment of credit protection when a counterparty defaults, as well as the risk that the unfunded CRM provider may be downgraded and then cease to be eligible to provide unfunded credit risk mitigation. The paper is also seeking feedback on how such risks could be mitigated, including through contractual features of unfunded CRM, so that unfunded credit protection remains robust and that SRT continues to be achieved on an on-going basis.

Responses to the DP are requested by 31 January 2024.

In other news…

Call to eliminate ‘redundant’ due diligence requirements
The Managed Funds Association (MFA) has submitted letters encouraging the UK FCA and the PRA to enhance the UK capital markets by eliminating redundant securitisation due diligence regulations. The association argues that removing duplicative regulations will increase capital investment in the UK and optimise risk management on behalf of UK investors.

Specifically, the letters explain that duplicative due diligence requirements for securitisations will continue to place UK-based fund managers at a competitive disadvantage to managers in the US and other non-EU countries. Limiting UK-based manager access to foreign securitisation markets has impeded their ability to manage risk and deliver returns for their investors, according to the MFA. It has also dampened alternative investment fund manager (AIFM) participation in the securitised markets generally, preventing UK capital markets from recovering more fully from the global financial crisis.

The letters point out that AIFMs are already subject to the robust requirements from the Alternative Investment Managers Directive (AIFMD). However, UK-based managers are also subject to duplicative requirements from the Securitisation Regulation.

The MFA suggests that these regulations are better suited to market participants, such as banks and insurance companies, that mainly serve a domestic client base of retail investors and are not subject to the AIFMD. AIFMs serve global clients primarily comprised of institutional investors and already operate in a highly regulated environment. The association therefore calls for AIFMs to be excluded from the additional due diligence requirements when investing in securitisations.

Challenger debuts dedicated ABS fund
Challenger Investment Management (CIM) has launched the Challenger IM Global Asset Backed Securities Fund, which builds on the firm’s existing range of products that aim to exploit inefficiencies in the pricing of credit risk across public and private markets. The fund marks CIM’s first offering providing dedicated access to securitised credit. With over A$8bn invested in securitisation markets, investment experience dating back to 2005 and 14 investment professionals dedicated to ABS investing, the team believes it has developed a strong edge in this part of the credit landscape.

The fund will target a 3%-4% per annum through-the-cycle return before fees over the Euro Short Term Rate by investing predominantly in publicly rated investment grade opportunities across global developed securitised markets, with a particular focus on Europe, UK, Australia and opportunistically in the US. By selectively blending attractive private market opportunities with public market transactions, the fund seeks to offer incremental yield in addition to diversification away from more traditional strategies. It will focus on floating rate assets, with interest rate and currency exposures hedged.

The fund is structured as a Qualifying Investor Alternative Investment Fund (QIAIF) and is euro-denominated, with share classes in alternative currencies available. It will be managed by lead portfolio manager Chris Whitcombe and co-portfolio manager Justin Voller.

EIB, ICO support Sabadell deal
The EIB Group and Instituto de Crédito Oficial (ICO) have invested in senior and mezzanine tranches of a new ABS originated by Sabadell Consumer Finance to address the investment constraints of Spanish SMEs and mid-caps. Part of the financing generated will be channelled into green projects and a large proportion of the final beneficiaries of this agreement will be based in less developed regions, where per capita GDP is less than 75% of the EU average and where it is particularly difficult to access financing.

As part of the transaction, the EIB is purchasing different securitisation tranches amounting to €350m, while €30m is invested by the EIF. ICO’s participation in the transaction translates into a total investment of €95m. This deal will enable the Banco Sabadell Group to channel €936m into the real economy.

The deal’s green component stems from the EIF’s €30m investment. Banco Sabadell will originate a new portfolio of SME loans totalling €60m, of which about one-third will be financing granted for green projects.

Legacy RMBS fund launched
Deer Park Road Management Company has launched a closed-end fund focused on legacy non-agency RMBS. Dubbed Deer Park Mortgage Opportunity Fund I, the fund will invest in RMBS with the principal objective of realising long-term capital appreciation and cashflow from its investments, while also seeking to provide access to the current trade opportunities in the structured credit market.

Deer Park has been active in the non-agency RMBS market since the early 2000s and is committed to providing fundamental credit analysis, an adaptive approach to sourcing investment opportunities and a deep focus on risk management. The firm will seek to leverage its decades of credit investment experience across cycles to identify and invest in bonds trading at less than their intrinsic value, with the intention of holding them to term.