Efficacy of STS label questioned

Once portrayed as the initiative to revitalise European securitisation, the STS label has been variously hailed as a game-changer or lamented as not fit for purpose. The truth, perhaps, may be somewhere in between.

Regulations (EU) 2017/2402 and 2017/2401 – which provide for the implementation of simple, transparent and standardised (STS) securitisations – will apply from 1 January 2019. They are the culmination of years of work, but during their long gestation the ABS market has picked itself up, raising questions as to the STS label’s necessity.

“STS is an irrelevance because the products which STS is supposed to help are already selling like hotcakes,” says David Shearer, partner, Norton Rose Fulbright.

He believes that the STS label “is an idea whose time never came”. While it has always been popular with regulators, it has held less appeal for the rest of the market. For that reason, its impact is expected to be limited.

“The STS regulation in itself will not particularly help with issuance, but nor will it make things significantly worse overall, as some people fear. There are a few technical points yet to be clarified, which may have a positive or negative effect – and we will find out when we get the RTS from ESMA and EBA,” says Markus Schaber, managing partner, Integer Advisors.

He notes that the CRR will technically change quite a lot more. Capital weightings are higher, for example.

Schaber adds: “The most significant parts of the STS regulation for all securitisations are Articles 5, 6 and 7, covering due diligence, risk retention and transparency. While the transparency regime will change quite a bit, due diligence and risk retention will not be substantially different in terms of overall requirements - albeit there are certainly some technical points which need to be clarified.”

Those due diligence requirements largely formalise processes that should already have been in place. CLOs will be particularly affected by the transparency changes, however, because certain transparency obligations appear to have been designed only with bank-originated deals in mind, not with non-bank actively managed ones considered.

Ian Bell, head of the PCS Secretariat, agrees that “STS is not a silver bullet, but it is helpful”. He does not believe regulation can ever really make a market, although it does have the potential to end one, which the STS rules should not do.

“The market’s success will rest fundamentally on banks’ needs. If banks need to issue securitisations and STS allows them to do that at an acceptable cost, then securitisation will succeed. Without STS, the new CRR and not-so-new Solvency 2 would have made it very difficult to find a price point that would work for everyone, so STS attenuates the harm of other regulations,” says Bell.

Receiving an STS label will not guarantee a transaction preferential capital treatment and not all investors will be able to benefit. “There is a very long list to fulfil, including some very specific points - such as homogeneity - which can be quite complex. The STS label is ultimately a quality label and issuers will have to check whether deals are compliant. It should have been fairly easy for prime auto ABS or prime RMBS, but it remains somewhat more complicated than many market participants had hoped it would be,” says Schaber.

A close reading of the STS regulation finds there are 101 queries for establishing STS compliance, says Bell. Those will not all apply to every deal, but for any given securitisation, around 80 would be relevant.

“Anybody who claims that the STS regulation is simple is mistaken. At PCS, we have broken down the regulation’s articles, paragraphs and sub-paragraphs into separate queries, each subject to a specific and singular answer. This helps to make measuring compliance a straightforward and binary process, but it also underlines its complexity,” says Bell.

Christopher Sullivan, knowledge of counsel, Norton Rose Fulbright, adds: “The hoops which you need to jump through for STS and preferential treatment are so high that I do not think people will meet them. Pools are required to be homogenous, so my belief is that pools which would qualify would have to be so small that there would never be the required economies of scale.”

The use of the STS label is voluntary and deals that are able to comply do not have to choose to do so. Despite this, Shearer worries that the new regime “represents the de-democratisation of the market”.

He says: “You have to prove a history of origination experience, which appears to be because the European Commission can only imagine a capital market where the originators are all banks. STS should be about making sure securitisation is opened up for more market participants, not creating a bottleneck where only a few can use it.”

Perhaps originators could finance through warehouse structures before going public, but this still presents a barrier to challenger financiers, denying them financing cost efficiencies that are available to others. The obligation for servicers to have a demonstrable servicing record in each relevant particular asset class means that there, too, new entrants are excluded.

“While implementing STS is expected to be challenging, we will not know quite how challenging until the EBA’s final guidelines in October. There are several points which the EBA could either make very simple or very problematic. Even one problematic issue makes life difficult because it is not good enough to satisfy 100 out of the 101 requirements for STS; it is all or nothing,” Bell notes.

The EBA is conducting a public consultation on its draft guidelines, which will provide a harmonised interpretation of the criteria for securitisations to be eligible as STS. The consultation was launched in April and will run until 20 July.

JL

A full discussion of the challenges and opportunities presented by the implementation of the STS label appears in the Summer 2018 issue of SCI’s print magazine. This is available to subscribers. A digital version can be downloaded here.