European Securitization Regulation: what’s next for CLOs?
By Tom Ahern. The European Securitization Regulation became applicable from January 1, 2019. It has a number of goals, including consolidating and recasting existing European regulations, establishing a framework for Simple, Transparent and Standardised securitization and introducing new transparency and disclosure requirements.
This Q&A addresses the application of the new transparency and disclosure requirements for managed CLOs, following recent adoption of the reporting templates by the European Commission.
What are the Securitization Regulation1 disclosure and transparency requirements and what is their objective?
Article 7 of the Securitization Regulation addresses disclosure and transparency; it is just one small piece of the European Securitization Regulation. Its goal is to enhance transparency for investors including through the imposition of stricter transparency requirements for originators, sponsors and securitization special purpose entities (SSPEs).
Disclosures and reporting required under Article 7 need to be made available to the relevant EU regulators and national competent authorities. These also need to be available not only to current investors but, on request, to potential investors to enable them to make informed decisions.
Information to be disclosed on private securitizations (which includes most managed CLOs) includes the following:
all transaction documents essential to the understanding of the deal (in draft form pre-pricing and in final form on closing);
- a transaction summary (pre-pricing in draft form and on closing in final form) describing the key characteristics of the deal (which can be incorporated into the prospectus if the deal is listed);
- quarterly template-based loan-level and investor reporting;
- disclosure (without delay) of significant events and/or inside information if the deal is within the scope of the EU Market Abuse Regulation (MAR) regime. Private securitizations are not required to use a template for such disclosure.2
What is the regulatory timetable following the publication of the finalised technical standards prescribing the new reporting templates?
The European Securities and Markets Authority (ESMA), as the body tasked with drafting the regulatory technical standards (RTS) prescribing the applicable templates and other operational requirements for the disclosures required to be made under Article 7 of the Securitization Regulation, published updated templates in January 2019. On October 16, the European Commission adopted the templates with no significant changes. The templates will now progress to the European Council and Parliament for scrutiny, which could take up to three months. The final templates will be published in the Official Journal of the European Union and will come into effect on the 20th day following publication, which is expected to be early in the first quarter of 2020.
What are the implications of the new disclosure and transparency requirements for CLO issuers, sponsors and originators?
The new reports have a prescribed form and template for all securitizations with the underlying exposure template specific to the asset class. The rationale for this decision is that a standardised approach will aid comparison regardless of issuer as data fields provided for every CLO will now be identical. Consequently, the Regulation will impact issuers, sponsors and originators as well as administrators.
The new templates for loan-level disclosure and investor reporting relate to all CLOs within the scope of the Regulation, and must be used from the relevant date of application of Article 7 technical standards. They represent a significant shift from existing post-closing reporting practices and are more onerous.
What is the level of readiness in the CLO industry?
Managers, administrators and legal firms have been working together to prepare for the new disclosure requirements. In particular there have been detailed discussions about data fields for Annex 4 (underlying exposures – corporate), which is the most onerous in terms of data requirements, and Annex 12 (underlying exposures – investor reports). General consensus has already been reached on Annex 4 and is expected to be reached shortly on Annex 12. Subject to certain remaining challenges described below, the CLO market looks fairly well prepared for reporting utilising the published templates and in its understanding of the processes involved.
What are the greatest challenges associated with the new reporting requirements?
The main challenge is the data requirements and how they can be fulfilled. This is still a work in progress for both managers and administrators (the latter hold most of the required data but not necessarily in a format that makes completing mandatory templates straightforward). Careful analysis will be required in order to identify the availability of the required data/information and, in cases where it is difficult to provide or obtain the required data/information, whether the relevant field in the reporting template provides for any flexibility with regard to the use of “no data” options. Interpretation of the requirements of certain fields in the applicable templates is another challenge, and it will be necessary to refer to the ESMA Q&As for any additional guidance and to engage with industry associations in order to seek further clarifications from ESMA.
More generally, the Regulation requires new data points that must be captured upfront and also greater detail on assets. As a typical CLO will have more than 100 assets and as most information is reported at the asset level, dealing with the volume of data will be challenging.
What practical steps should managers take in the coming months?
The most important thing is to be engaged with industry and regulatory developments and be aware of the requirements and their timing: there is a need to keep on top of new information as it is published, such as ESMA’s Q&A publications. Once the detail of the templates is finalised, managers need to ascertain how they will generate data for reporting purposes. The responsibility for these tasks rests with a number of different individuals depending on the manager involved. However, operations oversight, compliance and legal teams should work together to ensure the manager can fulfil the requirements of the Securitization Regulation.
Does Brexit have any implications for Article 7 of the European Securitization Regulation?
CLO issuers are mainly based in the Netherlands or Ireland and Brexit will therefore have no implications in terms of the transparency and disclosure requirements applicable to the issuer. It is also expected that corresponding transparency and disclosure requirements will be implemented in the UK. Although the requirements are expected to be broadly similar, CLO issuers and investors will need to keep abreast of developments and understand their implications.
Do CLO issuers and managers need to concern themselves with new requirements associated with making reporting available via an authorised securitization repository (SR)?
SRs play a central role in enhancing the transparency of securitization markets and thus of the financial system. Under the Securitization Regulation, ESMA has direct responsibilities regarding the registration and supervision of SRs. The Securitization Regulation requires the uploading of documents and reports to a website that has met qualification criteria regarding data protection, backup and other concerns in order to become an authorised repository. While a CLO is a public transaction, they are deemed to be private securitizations for the purposes of Article 7 as, post-January 2019, they have been typically listed on the Global Exchange Market (GEM) of Euronext Dublin and are not in scope of the Prospective Directive. Therefore, they are not required to report via an authorised repository. Our understanding is that all CLO issues this year have been deemed private for these purposes and we anticipate that all future CLOs will be private as well.
What characteristics should managers seek in an administrator to assist them with the European Securitization Regulation?
Ultimately, it is about credibility in the marketplace and a thorough understanding of the underlying data requirements. BNY Mellon is at the forefront of engagement with all market participants and has been working closely with managers, legal firms and other administrators in analysing, debating and seeking consensus on the data points across the published reporting templates, as well as applying the additional requirements to meet the interim reporting requirements. There is a high level of familiarity with the Regulation. For those managers eager to know more about the specifics and technical requirements associated with the reporting and transparency requirements under the Securitization Regulation, BNY Mellon can share information about matters such as validation checks or format conversion to XML.
Further details of the Securitization Regulation can be found at the ESMA website.
1 Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for securitization and creating a specific framework for simple, transparent and standardised securitization, and amending Directives 2009/65/EC, 2009/138/EC and 2011/61/EU and Regulations (EC) No 1060/2009 and (EU) No 648/2012
2 Note that MAR/inside information and significant event disclosures are also relevant for private securitizations, although MAR/inside information disclosures will be relevant only if the CLO is on a MAR trading venue that is in scope.