Our expert responds to readers' questions

Is STS doing what it is designed to do for the securitisation market?

Daniel Hill, partner at Allen & Overy, gives his view

The STS regime, introduced in the EU for traditional securitisations on 1 January 2019 (and then for synthetic securitisations in April 2021), aimed at increasing issuances, widening the securitisation investor base and cementing securitisation at the centre of the European economy. Traditional securitisation STS issuance momentum began to build up from March 2019, but the increased activity of central banks since early 2020 has muddied the waters in terms of the effectiveness of the regime.

The synthetic securitisation STS regime, which was introduced in the EU in April 2019, remains in its infancy, with some of the legislative framework that is required for full implementation still outstanding. Therefore, while the synthetic STS regime has not yet been fully tested, the clear signs for traditional STS are that it needs tweaking to assist it in achieving the intended aim.

The requirements of the STS regime in both the EU and the UK remain a burden for issuers and investors – over 100 criteria must be met for a transaction to achieve the STS label. This increases costs for both issuers and investors.

The label itself is seen as unnecessary for sophisticated investors that do not get any regulatory benefit and there is a preference among some investors to put the extensive due diligence work to use on higher-yielding non-STS transactions. Indeed, more than twice the number of non-STS transactions as STS transactions have been issued in Europe and the UK since the introduction of the STS regime. 

While an EU or UK STS designation creates work for issuers and investors, the associated capital benefits could be improved. In the case of traditional STS, STS tranches remain at Level 2B for the purposes of EU and UK LCR (as opposed to Level 1 or 2A for covered bonds of equivalent credit quality) and from a capital perspective are not treated as advantageously for investors regulated under EU or UK Solvency 2 or EU or UK CRR as other investments.

The regulatory benefit under a synthetic STS securitisation is only available to the EU CRR bank originator. It is therefore a stringent regime, in relation to which the regulatory benefits could be improved.

In terms of developments, the Securitisation Regulation in both the EU and the UK (including as it relates to STS) is under review by the European Commission and HMT respectively. In the UK, there is already more flexibility on jurisdictional requirements than in the EU, but it remains to be seen whether any further changes (for example, clarifying that DD requirements apply only where an investor is relying on STS designation for regulatory benefit or introducing a permanent equivalence regime for EU STS securitisations) will be implemented. Likewise, the question of equivalence in the EU for third country STS securitisations has been raised in the review, but legislative proposals (if any) would take some years to be finalised and be implemented.

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