IFPRU 4.12 Securitisation

An originator of securitisations is able to use the securitisation risk weights (and not calculate own funds requirements on the assets underlying its securitisation) in either of the following cases:

1. (1)

   the firm transfers significant credit risk associated with the securitisedexposures to third parties; or

2. (2)

   the firm deducts from common equity tier 1 capital or applies a 1250% risk weight to all positions it holds in the securitisation.

The significant risk transfer requirements in articles 243 (Traditional securitisation) or 244 (Synthetic securitisation) of the EU CRR provide three options for a firm to demonstrate how it transfers significant credit risk for any given transaction:

1. (1)

   the originator does not retain more than 50% of the risk-weighted exposure amounts of mezzanine securitisation positions, where these are:

   1. (a)

      securitisation positions to which a risk weight lower than 1250% applies; and

   2. (b)

      more junior than the most senior position in the securitisation and more junior than any position in the securitisation rated credit quality step 1 or 2;

2. (2)

   where there is no mezzanine position, the originator does not hold more than 20% of the exposure values of securitisation positions that are subject to a deduction or 1250% risk weight and where the originator can demonstrate that the exposure value of such securitisation positions exceeds a reasoned estimate of the expected loss on the securitisedexposures by a substantial margin; and

3. (3)

   the competent authority may grant permission to an originator to make its own assessment if it is satisfied that the originator can meet certain requirements.

A firm should notify the FCA of each transaction on which it is seeking capital relief.

Where the FCA considers that the possible reduction in risk-weighted exposure amounts (RWEA) achieved via the securitisation is not justified by a commensurate transfer of credit risk to third parties, significant risk transfer will be considered to not have been achieved. Consequently, a firm will not be able to recognise any reduction in RWEA due to the transaction.

The FCA intends to grant permission for an originator to make its own assessment of significant risk transfer only where it is satisfied that:

1. (1)

   in every relevant case, the reduction in own funds requirements achieved would be justified by a commensurate transfer of risk to third parties;

2. (2)

   the firm has appropriately risk-sensitive policies and methodologies in place to assess the transfer of risk; and

3. (3)

   such transfer of risk to third parties is also recognised for the purposes of the firm's internal risk management and internal capital allocation.

Where the FCA grants permission for multiple transactions, then that permission is expected to cover a defined scope of potential transactions. The permission is expected to enable a firm (within certain limits) to carry out these transactions without notifying the FCA in each individual instance.

A firm seeking to achieve capital relief by deducting or applying a 1250% risk weight to all retained securitisation positions does not need to comply with the notification and permissions requirements. However, in such cases, a firm should consider whether the characteristics of the transaction are such that the FCA would reasonably expect prior notice of it.

Under IIFPRU 4.12.1 G, within one month of a securitisation transaction closing, a firm must notify the FCA of the transaction if it has relied on options 1 or 2 to achieve significant risk transfer.

Notification under IFPRU 4.12.1 G should include sufficient information to enable the FCA to assess whether the possible reduction in RWEA which would be achieved by the securitisation is justified by a commensurate transfer of credit risk to third parties. The FCA expects this to include the following:

1. (1)

   details of the securitisation positions, including rating, exposure value and RWEA broken down by securitisation positions sold and retained;

2. (2)

   key transaction documentation and any relevant supporting documents (eg, a summary of the transaction);

3. (3)

   details of the governance process for the transaction, including details of any committees involved in approving the transaction;

4. (4)

   a copy of the significant risk transfer policy applied to the transaction, including details of the methodology and any models used to assess risk transfer;

5. (5)

   a statement of how all relevant risks are incorporated into the significant risk transfer assessment and how the full economic substance of the transaction is taken into consideration;

6. (6)

   the significant risk transfer calculation, setting out why the firm believes the capital relief proposed is commensurate with the credit risk transferred to third parties;

7. (7)

   the EU CRR

8. (7)

   requirements the firm is relying on;

9. (8)

   copies of investor and internal presentations on the transaction;

10. (9)

    the rationale for the transaction;

11. (10)

    details of the underlying assets (including asset class, geography, tenor, rating, spread, collateral, exposure size);

12. (11)

    details of the transaction structure;

13. (12)

    description of the risks being retained;

14. (13)

    details of the cashflow between parties involved in the transaction;

15. (14)

    details of the ratings and pricing of bonds issued in the transaction;

16. (15)

    details of any connected parties involved in the transaction;

17. (16)

    details of any termination options (for example, call options); and

18. (17)

    details of reliance on ECAIs in the significant risk transfer assessment.

The FCA's review will focus on the proportion of credit risk transferred, compared to the proportion by which RWEA are reduced in the transaction. Where the FCA judges that the reduction in RWEA is not justified by a commensurate transfer of credit risk to third parties, it will inform the firm that significant risk transfer has not been achieved by this transaction. Otherwise, the FCA will inform the firm that it does not object to the transaction.

The FCA does not intend to pre-approve transactions. The FCA will provide a view on whether it considers that commensurate risk transfer has been achieved at a point in time, which may be provided after a transaction has closed. The FCA may reassess its judgement of the achievement of commensurate risk transfer if the level of credit risk transfer in a transaction changes materially.

A firm may apply for permissions under articles 243 (Traditional securitisation) or 244 (Synthetic securitisation) of the EU CRR to consider significant risk transfer to have been achieved without needing to rely on options (1) or (2). The scope of such permission canbe defined to cover a number of transactions or an individual transaction.

Where a firm applies for such permission, the FCA would expect the scope should be defined according to a range of characteristics, including the type of asset class and the structural features of the transaction. The characteristics the FCA would expect a firm to consider when scoping a permission application include:

1. (1)

   asset class (eg, residential mortgages, commercial mortgages, credit card receivables, leasing, loans to corporates or small and medium-sized enterprises (SMEs), consumer loans, trade receivables, securitisations, private finance initiative (PFI), insurance, other assets, covered bonds);

2. (2)

   further asset class distinction (eg, geography and asset quality); and

3. (3)

   structural features (eg, by distinguishing between securitisation and re-securitisation, traditional and synthetic securitisation and non-revolving structures and revolving structures).

It is likely for it to be more straightforward for the FCA to assess relatively narrowly scoped permissions than those covering a wide range of assets and/or with complex structural features.

To assess a firm's ability to use its own policies and methodologies for assessing significant risk transfer, the FCA's permission reviews will focus on:

1. (1)

   the firm's understanding of the risk of any potential transactions within permission scope, including for potential underlying assets, securitisation structures and other relevant factors that affect the economic substance of risk transfer;

2. (2)

   the governance around significant risk transfer assessment (including sign-off procedures) and systems and controls relating to risk-transfer assessment and determination of significant risk transfer;

3. (3)

   significant risk transfer calculation policies and methodologies, including any models used;

4. (4)

   the firm's historical experience with relevant securitisation origination; and

5. (5)

   the use of third-party risk assessments (eg, ECAI ratings) and the relationship with internal assessments.

The information the FCA expects a firm to provide in a permission application includes the following:

1. (1)

   details of the firm's governance processes for significant risk transfer, including details of any relevant committees and the seniority and expertise of key persons involved in sign-off;

2. (2)

   a copy of the firm's significant risk transfer policy, including details of the significant risk transfer calculation policies, methodologies and any models used to assess risk transfer (this should set out how the firm ensures it only takes capital relief in proportion to the amount of risk transferred on any given transaction);

3. (3)

   a statement of how all relevant risks are incorporated in the significant risk transfer calculations and how the full economic substance of transactions is taken into consideration;

4. (4)

   details of the firm's systems and controls regarding risk transfer in securitisations;

5. (5)

   a copy of the firm's capital allocation strategy;

6. (6)

   details of any securitised assets that have come back on the firm's balance sheet and the reason why; and

7. (7)

   details of reliance on ECAIs in determining significant risk transfer.

The FCA intends to apply two materiality limits to the proportion of risk-weighted exposure amount (RWEA) relief that can be taken under any permission covering multiple transactions:

1. (1)

   transaction level limit any transaction that would, in principle, be within the scope of the permission, but that resulted in an RWEA reduction exceeding 1% of the firm's credit risk-related RWEAs as at the date of the firm's most recent regulatory return, will fall outside the scope of a multiple transaction permission and will require a separate permission or require notification (if the transaction would satisfy option 1 or 2); and

2. (2)

   aggregate limit once the aggregate RWEA reduction taken on all significant risk transfer transactions executed within the scope of a permission exceeds 5% of the firm's credit risk-related RWEAs as at the date of the firm's most recent regulatory return, no additional transactions may be executed within scope of the permission. In such circumstances, a firm should take one of the following actions:

   1. (a)

      reapply to renew the multiple transaction permission; or

   2. (b)

      apply for a new permission covering the specific transactions exceeding the RWEA limit; or

   3. (c)

      notify the FCA of the transaction, following the significant risk transfer notification procedure (if the transactions would satisfy option 1 or 2).

Multiple transaction permissions can be expected to be granted for a period of one year. The FCA's review of permission renewal will focus on any changes to the firm's significant risk transfer policies and methodologies since the previous review.

Permissions relating to individual transactions do not need to be granted prior to the execution of a transaction. The FCA does not intend to specify the timeframe in which a firm should submit an individual transaction permission, but the firm should note that capital relief from a specific transaction will not be available until a firm has obtained permission covering the significant risk transfer assessment and capital treatment (unless the transaction is being notified under option 1 or 2, or falls within scope of a multiple transaction permission).

The information the FCA expects to receive in an individual transaction permission includes that in IFPRU 4.12.10G (2) and IFPRU 4.12.10 G (6) to IFPRU 4.12.10 G (17), as well as that in IFPRU 4.12.17G (1) to (3).

Depending on the nature of a transaction, the FCA may grant an individual permission for the duration of the transaction, or may impose a time limit on the permission. Where a firm sought to take capital relief on a transaction beyond the expiry date of the relevant permission, the firm would need to renew the permission prior to its expiry date.

Given that significant risk transfer should be met on a continuing basis, permissions will typically include a requirement to notify the FCA of any change in circumstances from those under which the permission was granted (eg, where the amount of credit risk transfer had changed materially). Any reduction in credit risk transfer subsequent to the permission being granted will require the firm to take a commensurate reduction in RWEA relief. If a firm does not effect a commensurate reduction in the RWEA relief, the FCA may revoke the relevant permission.

An originator must transfer a significant amount of credit risk associated with securitisedexposures to third parties to be able to apply the securitisation risk weights set out in Part Three, Title II, Chapter 5 of the EU CRR (Securitisation), and any associated reduction in own funds requirements must be matched by a commensurate transfer of risk to third parties.

As part of the notification and permissions process, the FCA expects the firm to inform it of the methodology it intends to use to calculate securitisation capital requirements.

As part of a firm's ongoing consideration of risk transfer, the FCA expects it to consider the support it has provided to securitisation transactions.

1. (1)

   If a firm is found to have provided support to a securitisation, the expectation that the firm will provide future support to its securitisations is increased. The FCA will take account of this increased expectation in future assessments of commensurate risk transfer to that firm.

2. (2)

   The FCA expects securitisation documentation to make clear, where applicable, that repurchase of securitisation positions by the originator beyond its contractual obligations is not mandatory and may only be made at fair market value.

3. (3)

   Where a firm provides support which it is entitled, but not obliged, to provide under the contractual documentation of the securitisation, the FCA will consider the following factors in assessing if that support has been appropriately reflected in the assessment of significant risk transfer:

   1. (a)

      whether the fact that the firm may provide such support was expressly set out in the contractual and marketing documents for the securitisation;

   2. (b)

      whether the nature of the support that the firm may give is precisely described in the documentation;

   3. (c)

      whether the maximum degree of support that could be provided could be ascertained at the time of the securitisation by the firm and by a person whose only information came from the marketing documents for the securitisation;

   4. (d)

      whether the assessment of whether significant risk transfer was achieved and the amount of that risk transferred was made on the basis that the firm would provide support to the maximum degree possible; and

   5. (e)

      whether the firm'sown funds and own funds requirements were appropriately adjusted at the time of the securitisation on the basis that the firm provided support to the maximum degree possible.

4. (4)

   If a firm fails to comply with article 248(1) of the EU CRR, the FCA may require it to disclose publicly that it has provided non-contractual support to the transaction.

Some transactions can transfer little or no economic risk from the protection buyer to the protection seller, but may still result in a reduction in own funds requirements. A particular example of a transaction-type of concern involves protection being purchased on a junior tranche and a high premium is paid for that transaction.

Generally, the amount of premium paid will not materially affect the assessment of whether significant risk transfer has occurred. This is because either:

1. (1)

   the protection payment payable upon default from protection seller to protection buyer is significantly larger than the overall premium payable to the protection seller; or

2. (2)

   the payment of premium leads to an immediate incurred cost.

However, there comes a point at which the premium payable for the protection can reduce significantly the actual economic risk that is transferred from the protection buyer to protection seller. A premium payable of 100% of the protection amount could leave the protection buyer in a position over the life of the transaction that was no better than if protection had not been purchased.

The FCA expects originators seeking to apply the securitisation risk weights to synthetic securitisations to take into account all relevant factors to assess the amount of risk transferred. As well as the size and timing of amounts payable to the protection seller, the circumstances in which those amounts are payable can undermine the effectiveness of risk transfer. The FCA expects a firm seeking capital relief through synthetic securitisations to incorporate premiums in their assessment of significant risk transfer. In particular, the following transaction features may have a significant impact on the amount of risk transfer:

1. (1)

   premium which is guaranteed in all or almost all circumstances, for example, premium which is payable upfront or deferred; or

2. (2)

   those that could result in the amount of premium payable for protection being significantly greater than the spread income on the assets in the portfolio or similar to the size of the hedged position; or

3. (3)

   those under which the protection buyer retains the expected loss through higher transaction costs to the counterparty, in the form of premium or otherwise.

Article 238 of the EU CRR (Maturity of credit protection) requires maturity to be assessed in considering significant risk transfer. When considering the effective maturity of synthetic securitisations, the FCA expects a firm to consider whether the transaction contained an option to terminate the protection at the discretion of the protection buyer.

The FCA considers the following to be examples of features which generally indicate a positive incentive to call or, at least, to constitute grounds for discussion with the FCA prior to the conclusion of the transaction:

1. (1)

   the transaction contains terms, such as payments at maturity or payments upon early termination or significant premiums, which may reduce risk transfer;

2. (2)

   the transaction includes a requirement for the protection buyer to incur additional costs or obligations if they do not exercise their option to terminate the protection; and

3. (3)

   there are pre-agreed mechanisms, for example 'at-market unwinds', where the protection seller and protection buyer agree that the transaction can be terminated in the future at a 'market' value and specifies aspects of how the value is calculated.

Significant risk transfer is an ongoing requirement. Accordingly, the FCA expects firms to ensure that any reduction in own funds requirements achieved through securitisation continues to be matched by a commensurate transfer of risk throughout the life of the transaction. The FCA expects firms to take a substance over form approach to assessing significant risk transfer. Firms should be able to demonstrate that the capital relief post-transaction adequately captures the economic substance of the entire transaction, and is commensurate to retained risk.

When risk transfer transactions are structured as a group of linked transactions rather than a single transaction, the FCA expects the aggregate effect of linked transactions to comply with the EU CRR. The FCA expects firms to ensure that analysis of risk transfer incorporates all linked transactions, particularly if certain transactions within a group of linked transactions are undertaken at off-market rates.

The FCA expects the instruments used to transfer credit risk not to contain provisions which limit the amount of risk transferred. For example, should losses or default occur in the pool(ie, deterioration in the credit quality of the underlying pool) the FCA expects the originator's net cost of protection or the yield payable to investors should not increase as a result.

To ensure continued appropriateness, the FCA expects firms to update the opinions of qualified legal counsel, required by the EU CRR, as necessary to ensure their continuing validity. For example, an opinion may need to be updated if relevant statutory provisions are amended, or where a new decision or judgment of a court has a bearing on the continuing validity of counsel's opinion.

The FCA expects relevant senior management of a firm to be appropriately engaged in the execution of securitisation transactions that lead to a reduction in RWEA where the firm is providing or purchasing structured trades.

The FCA does not operate a pre-approval process for transactions. The FCA expects a firm to discuss with its supervisor at any early stage securitisation transactions that are material or have complex features. Where a firm claims a regulatory capital reduction from securitisation transactions in its disclosures to the market, the FCA expects such disclosures to include caveats making clear the risk of full or partial re-characterisation where this risk is material in the light of the FCA's stated policy.

Although this section sets out the FCA's expectations regarding securitisations, these expectations are also relevant for other similar credit protection arrangements.

The FCA will seek to ensure that the securitisation framework is not used to undermine or arbitrage other parts of the prudential framework. For other similar credit protection arrangements (eg, those subject credit risk mitigation or trading book requirements), the impact of certain features (such as significant premiums or call options) may cast doubt on the extent of risk transferred and the resulting capital assessment. Features which result in inadequate own funds requirements compared to the risks a firm is running may result in the credit protection not being recognised or the firm being subject to extra capital charges in their ICG in Pillar 2 add-ons. Credit protection arrangements in general are subject to the same overarching principles as those in the securitisation framework.

Where a firm achieves significant risk transfer for a particular transaction, the FCA expects it to continue to monitor risks related to the transaction to which it may still be exposed. The firm should consider capital planning implications of securitised assets returning to its balance sheet. The EU CRR requires a firm to conduct regular stress testing of its securitisation activities and off-balance sheet exposures. The stress tests should consider the firm-wide impact of stressed market conditions on those activities and exposures and the implications for other sources of risk (eg, credit risk, concentration risk, counterparty risk, market risk, liquidity risk and reputational risk). Stress testing of securitisation activities should take into account both existing securitisations and pipeline transactions. A firm should have procedures in place to assess and respond to the results of that stress testing and these should be taken into account under the overall Pillar 2 rule.