Market updates and sector developments

In a case involving the CFPB and the National Collegiate Master Student Loan Trust (NCSLT), the Third Circuit has found that statutory trusts used to handle securitisations are considered ‘covered persons’ for purposes of the Consumer Financial Protection Act (CFPA) and thus are subject to CFPB jurisdiction. According to a recent Cadwalader memo, this effectively means that the trusts would be treated like any other lender or servicer, accountable to the CFPB.

NCSLT has been fighting the CFPB on jurisdictional grounds for several years and the parties came close to settling in 2017, but the US District Court for the District of Delaware refused to accept the proposed consent judgment due to pending concerns regarding the constitutionality of the CFPB (SCI 9 June 2020).

Due to two Supreme Court decisions involving the constitutional issues that have plagued the CFPB (including Seila Law and Collins) (4 November 2022), in this decision, the Third Circuit found that even if the CFPB Director’s position was unconstitutional because the Director could not be removed at will by the President, that unconstitutionality did not cause actions taken by the CFPB Director to be void, because the CFPB Director’s appointment had proceeded constitutionally. The other jurisdictional ground that NCSLT challenged the CFPB on was whether the statutory trusts were ‘engaged’ in consumer financial services under the CFPA.

“The purpose of these statutory trusts is to facilitate the transfer of ownership of the loans into securitisation pools. Accordingly, these trusts have no employees and are necessarily engaged in an extremely limited set of activities, all of which occur as a result of automatic processes established by the agreements used to set up a securitisation of loans, and which activities are overseen by a party that does have employees, often called the ‘administrator’,” Cadwalader notes.

The Third Circuit ignored this automatic process aspect of the statutory trusts, commenting in a footnote that “[w]hile the Trusts purport that the Administrator is separate from the Trusts” and is “not subject to the supervision of the [Trusts] or the Owner Trustee”, the Court does not need to “. . . address th[e Administrator’s role]. It is a bridge too far. All we need to determine is whether the Trusts engaged in such agreements.” 

With that viewpoint in mind, the Court found that based upon legislative history, plain language and the language of the administration agreements used in the transactions, the statutory trusts are considered ‘covered persons’ under the CFPA. Covered persons under the CFPA are not only subject to CFPB jurisdiction, but also have primary responsibility for full compliance with consumer financial services laws and regulations.

Due to the proposed consent order between the parties that was made publicly available in 2017, Cadwalader says it has a good idea as to what the CFPB will do with this new-found jurisdiction. “Practically speaking, this means, at a minimum, that going forward statutory trusts used in consumer asset securitisations should themselves have proper policies and procedures in place [for] interpreting consumer financial services laws relating to servicing loans and collecting debts. In addition, to the extent existing securitisation trusts have significant collection lawsuits being filed on their behalf by their servicers, such trusts would be well-advised to direct their servicers to cease filing new collections lawsuits and begin a ‘look-back’ review over those collection lawsuits to ensure that none of the flaws the CFPB noted in the NCSLT case exist, starting with the cases that are pending and then proceeding into lawsuits that have already been concluded,” the firm recommends.

In other words, the decision could effectively completely undermine the non-operating nature of the trusts used in consumer asset securitisations. “Taken to its logical end, this means that trusts could need direct management, operations (perhaps including risk and compliance) and capital to manage the assets and business,” Cadwalader concludes.

In other news…

Crédit Mutuel cited for breaching RWA requirements
The ECB has imposed two administrative penalties totalling €3.54m on Confédération Nationale du Crédit Mutuel after the bank breached requirements set out in two ECB decisions on internal models. Between May 2021 and April 2022, when using its internal models to determine its RWAs, the bank did not apply floors set by the ECB for calculating credit risk for certain exposures. According to the ECB, the bank omitted to take obvious actions to avoid the breaches, preventing the ECB from having a comprehensive view of the bank’s risk profile.

The ECB had set these floors to compensate for the underestimation of RWAs resulting from deficiencies in the bank’s internal models that it needed to fix. Underestimating RWAs means the bank reported a higher CET1 ratio than it should have done.

However, in April 2022, the ECB granted Crédit Mutuel permission to revert to a less sophisticated approach (the foundation IRB approach) for calculating credit risk for these exact exposures. As a result, at present the bank no longer uses those internal models for the exposures and is therefore no longer required to implement these floors.

The ECB classified one of the breaches as moderately severe and the other as minor. The bank may challenge the ECB’s decision before the EU Court of Justice.

Non-neutrality in the balance?
The UK PRA is understood to be considering options to recalibrate the non-neutrality factor (the p-factor) in the SEC-SA framework (SCI 1 February). The move is in response to industry feedback to its discussion paper (DP) on draft rules to replace firm-facing requirements regarding securitisation under the CRR in 2H24 (SCI 1 November 2023), which made it clear that there are significant concerns about the impact of the Basel 3 output floor.

Additionally, while the CRR permits the use of unfunded credit risk mitigation (CRM) in SRT transactions, industry feedback suggested that there is a perception among many firms that the PRA won’t grant SRT in cases where unfunded protection is utilised. As such, the authority is also reportedly seeking to overcome this misperception by clarifying what is acceptable when it comes to effectively mitigating prudential risks, based on information received from the DP and CRM practices in other jurisdictions.

Finally, while respondents expressed some interest in a UK STS synthetics regime, the PRA is believed to have concerns about the benefits of such a regime and whether the associated reduced capital requirements are justified. This is a topic that may be revisited after the securitisation regulations are transferred to the PRA Rulebook.

Scope fined for conflict of interest failures
ESMA has fined Scope Ratings a total of €2.198m for breaches of the Credit Rating Agencies (CRA) Regulation. The authority found that Scope fell short of the CRA Regulation’s requirements on handling conflicts of interest, resulting from structural failures and specific breaches of the conflict of interest obligations in the CRA Regulation.

The five breaches covered by the fine specifically relate to: structural shortcomings in Scope’s policies and procedures, internal control mechanisms and organisational and administrative arrangements; two further specific breaches related to Scope’s failure linked to a potential conflict of interest regarding one particular individual; and to disclose in the final rating report the provision of ancillary services to a rated entity. All breaches were found to have resulted from negligence on the part of Scope. In calculating the fine, ESMA considered both aggravating and mitigating factors provided for in the CRA Regulation.

Corinne Smith