WORKI
NG DOCUMENT #7
Worki
ng Party on Financial Services
Securitisation
From: Presidency
Presidency Non-Paper
Hierarchy of Methods (Article 254 of CRR)
In preparation for the final negotiations with the European Parliament (‘EP’) and the European
Commission on the STS Package (“STS Regulation and the Amending CRR”), the Presidency has
prepared a non-paper on Article 254 of the proposal for a Regulation amending CRR. The aim
of this non-paper is to try to summarise in a concisely manner the points, arguments, facts and
issues that have been raised already, with the main aim to facilitate the discussion on the
hierarchy of methods at the upcoming Working Party on Financial Services (Securitisation).
At the 5th Political trilogue on Securitisation held on the 12 April, the EP has indicated strong
willingness to re-discuss Article 254 CRR at the next trilogue, in mind of the overall package to
be agreed among institutions. As indicated in the following Presidency Flash, the EP has made
it clear that this issue is of outmost importance and a European solution is to be found.
It should be recalled that during the Council discussions in 2015, a number wide-ranging
alternatives to the original Commission Proposal were considered which are being listed as
follows:
Strict application of the BCBS hierarchy as set forth in the Basel III document “Revisions
to the securitisation framework” (11 December 2014)1;
Removal of the ERBA approach from the hierarchy of methods. The pros and cons of this
option are set in the Annex of this non-paper.
Alternatively, the removal of ERBA from the hierarchy would apply only to STS
securitisations but would apply to non-STS securitisation. This option is favoured in the
Opinion of the European Central Bank (ECB) to the STS Proposal2.
Reversal of the hierarchy of methods with regards to SEC-ERBA and SEC-SA, i.e. the new
hierarchy of methods would be 1. SEC-IRBA, 2. SEC-SA, 3. SEC-ERBA.
1 BCBS Revised Version [July
2016) http://www.bis.org/bcbs/publ/d374.pdf
2 ECB Opinion [CON/2016/11
]https://www.ecb.europa.eu/ecb/legal/pdf/en_con_2016_11_f_sign.pdf
(p.66 -68)
WORKI
NG DOCUMENT #7
Worki
ng Party on Financial Services
Securitisation
From: Presidency
Use of 'uncapped' ratings for applying the SEC-ERBA. However, this would require CRA's
availability to disclose uncapped ratings on a voluntary basis with all the consequent risks
attached to the uncertainty around CRAs' future behaviour.
In the end, an intermediate solution was agreed building on the Commission proposal while
allowing for the framing of the flexibility to use SEC-SA instead of SEC-ERBA if the following
conditions are met (i) SEC-SA is used for senior tranches of high quality ‘STS’ securitisation
only; (ii) it is used only where the capital requirement resulting from SEC-ERBA is 25% or more
higher than the one that would result under SEC-SA for the securitisation tranche under
consideration; and (iii) where the risk weight resulting under the SEC-SA would be 25% or
lower. The competent authorities have the final say and can object to the switch and impose
the use of SEC-ERBA on a case-by-case basis.
The EP took an alternative approach to Council’s compromise text. The EP opted for a switch
between SEC-ERBA and SEC-SA (i.e. placing SEC-IRBA at the top, SEC-SA in the middle and
SEC-ERBA at the bottom of the hierarchy). During the trilogue negotiations, the EP argued that
this approach in necessary to make the capital securitisation framework more consistent across
the EU, reduce reliance on external ratings as well as reduce the dispersion of capital charges
for securitisation, and capital charges for banks’ investments in senior tranches of securitisation
in general. In addition, the EP introduced additional elements in the hierarchy allowing for a
limited possibility of inversion of the hierarchy (i.e. putting SEC-ERBA ahead of SEC-SA) in
some specific cases, such as for example when application of SEC-SA would result in capital
charges 25% in excess of the amount if SEC-ERBA was used, for rated positions. Lastly, the
EP also introduced another new element that allows the use of SEC-ERBA for pools of auto
loans, auto leases and equipment lease transactions.
The discussion on changes to the hierarchy have been ongoing for quite some time and
notwithstanding the extensive technical input provided, especially from supervisory institutions,
a common agreed solution that satisfies both the goal of keeping with the Basel framework
while at the same time considering certain European realities, notably concerning hard
sovereign rating ceilings, has never been identified. The main challenge has always been in
trying to merge conflicting policy objectives. Indeed, on one hand removing external ratings
from the regulatory approach to securitisation would raise the issue of the inconsistency with
the rest of the CRR framework (and the with the framework applicable to insurance
undertakings) where ratings continue to play a role (external ratings still play a significant role
WORKI
NG DOCUMENT #7
Worki
ng Party on Financial Services
Securitisation
From: Presidency
in the capital and liquidity regulatory frameworks). On the other hand giving excessive
prominence to the use of SEC-ERBA could be detrimental to sovereign rating capped
securitisations which may be more harshly treated than their likely credit performance would
imply. At the same time, giving priority to SEC-ERBA over SEC-SA maybe warranted given that
the former ratings based approach also considers other risks that may not necessarily be
addressed under the latter formulistic approach. Other factors as referred to in Annex I are to
be considered in any proposed way forward.
Possible way-forward
In view of the Presidency, by taking into consideration all the above considerations and the
issues raised in previous discussions within Council and with the EP and Commission during
trilogue negotiations, there are three possible options to take as way-forward towards a final
agreement.
1. Use the Council GA with further increased flexibility – So far the Presidency has defended
the Council GA as the most balanced approach. Nevertheless, the EP has repeatedly
advised that the Council compromise text is not satisfactory as it would still lead to a high
dispersion of capital charges for securitisation across Europe due to the extensive use of
SEC-ERBA. To unblock this deadlock, the Presidency could propose to the EP to keep the
Council GA (and thus keep with the BCBS framework) but introduce further flexibility to
address EP concerns. One solution is to lower the quantitate limit of 25%. It should be
mentioned that in the Council compromise text under Article 254 (8), which refers to the
mandate to the Commission to review through a delegated act the excess percentage of
the SEC-ERBA as compared to SEC-SA, the range of manoeuvre is set between 15% and
35%. In addition, it could be also proposed to open up to the switch from SEC-ERBA to
SEC-SA also to non-qualifying securitisation products and to non-senior tranches. This
would address the concerns of having an asymmetric regulatory framework and avoid the
‘cliff effects’ in the capital charges between qualify and non-qualifying securitisation
products. Moreover, from a theoretical perspective, it could be argued that the STS criteria
are not designed to address specifically country risks but simply ensure high quality of
structures and underlying assets. Hence it might be difficult to substantiate the argument
to exempt only STS securitisations from the ‘impact’ of external ratings.
WORKI
NG DOCUMENT #7
Worki
ng Party on Financial Services
Securitisation
From: Presidency
2. Use the EP text with enhanced safeguards – A second option would be to accept the EP
proposal subject to the introduction of very strict safeguards, in particularly to avoid the
risk of having a form of rating cherry picking where credit institutions are permitted to rely
on external rating precisely in cases where it grants a defined benefit in terms of lower
capital charges. The EP text seems to partially address such circumstances where the use
of the SEC-ERBA is based on “unduly low” external ratings. Under Article 254 (2)(2) [Line
251], competent authorities may still require the institution to switch back apply a different
method. However further clarity on this point might still be warranted. Another point to
take into consideration is whether to allow certain derogation from being eligible to the
switch such that introduced in Article 254 (2c) [Line 250]. These kinds of exceptions, could,
in theory, lead to further asymmetries and complexities in the regulatory framework, and
would be against the objective to introduce a consistent regulatory solution and minimise
regulatory arbitrage.
3. Revert to the original Commission proposal – The Commission Proposal could be
considered as a middle option solution that bridges the differences between the Council
and EP approaches. To recall, the Commission Proposal respects the hierarchy of methods
as provided by the BCBS, but grants a certain amount of flexibility to use SEC-SA instead
of SEC-ERBA if the RWA resulting from the application of the SEC-ERBA are not
commensurate to the credit risk embed in the exposures underlying the securitisation.
During the Council negotiations, this option was in general accepted by many Member
States as a fall-back solution to the adopted framed flexibility solution, without having to
deviate from the BCBS hierarchy order.
The Presidency would like to invite Member States to express their views and
preferences on the possible proposed way forward listed above, keeping in mind
the importance of the overall balance that needs to be reached and agreed with the
institutions.
WORKI
NG DOCUMENT #7
Worki
ng Party on Financial Services
Securitisation
From: Presidency
ANNEX I
Considerations regarding excluding the SEC-ERBA approach from the hierarchy for
qualifying securitisations
Views in favour
Views against
The
regulatory
capital
framework
for Enhanced complexity for less sophisticated
securitisation positions becomes less reliant on investors, as the formulae-based approach (SEC-
external ratings, promoting the EU and G20 SA) is operationally more complex than the look-
general regulatory objective of reducing such up table approach (SEC-ERBA).
reliance. The reduced reliance on external ratings
would be undertaken in a prudent manner, as
securitisations with low underlying credit quality
would not qualify as STC.
The high non-neutrality of securitisation capital The overall risk-sensitivity of the framework may
charges due to sovereign rating ceilings is be reduced as sovereign risk and other risks taken
addressed, improving the level playing field for into account within ECAIs’ rating methodologies,
issuers belonging to those sovereigns and helping but not fully addressed by the ‘qualifying’
re-establish the principle that approaches which requirements, are likely to affect the credit risk of
rank lower in the hierarchy cannot lead to lower the securitisation tranche in a number of ways.
capital charges than approaches ranking higher.
Regulatory level playing field is enhanced Overall prudence of the capital requirements
between EU and US securitisation markets; in the framework may be reduced if the use of external
latter, the use of the external ratings for ratings is materially reduced as the rating activity
regulatory capital purposes is already banned by constitutes a third-party analysis of the features of
regulation.
riskiness of the transaction, analysis which would
be left to issuers and investors (and regulators).
Potential double counting of the ‘qualifying’ The overall risk-sensitivity of the framework may
features of the transaction would be avoided: be reduced to the extent that issuers/originators
ECAI’s rating methodologies take into account will not be able to use the IRBA (due to a lack of
many of the features that the SST framework is necessary information and data inputs). They will
setting in rules. A better rating resulting from the have to adopt the SEC-SA approach, which is
assessment of these features by the ECAI would designed to be the least risk-sensitive.
result in a better risk weight treatment, where the Increased use of the SEC-SA may also result in:
transaction has already been assigned a relatively
transactions backed by lower quality
better risk weight treatment due to the proposed
portfolios receiving lower capital charges as
differentiation in the rules. The double counting
the conservative credit enhancement levels
WORKI
NG DOCUMENT #7
Worki
ng Party on Financial Services
Securitisation
From: Presidency
would
not
result
from
formulae-based
structured to address such risk, lower the
approaches (i.e. SEC-IRBA, SEC-SA) to capital
capital charges in the formulae of the SEC-SA;
requirements;
an amplification of the potential deficiencies
of the standardized approach of the credit
risk framework, upon which the SEC-SA is
based.
The consistency of capital requirements should
increase, as SEC-IRBA and SEC-SA are based on a
similar formulae based approach and result in
limited dispersion of risk weights, while the look-
up table approach of SEC-ERBA results in more
dispersed capital requirements, versus both SEC-
SA and SEC-IRBA.
Source: EBA Report on Qualifying Securitisation (Table 7, pg. 100)