EU regulation delays threaten $50bn in UCITS funds
Around $50bn of ABS may be trapped in undertakings for the collective investment in transferable securities (UCITS) funds across Europe, unable to be put to work if US securitizations are deemed uncompliant with EU regulation.
UCITS funds in Europe account for around $3tr worth of investment, around $500bn of which is denominated in dollars. According to market participants, approximately 10% of these are invested in ABS deals which are currently held in regulatory uncertainty due to delays around European legislation.
“It is a big change for us,” said Kyra Fecteau, vice president and investment strategist at Loomis, Sayles & Company. “It makes the understanding of US deals marketed to European investors subject to a lot of interpretation, and frankly, pretty confusing.”
The European standardisation criteria for securitization, called the ‘simple, transparent and standardized’ (STS) regulatory framework, came into place on January 1 of this year, and allowed all deals issued before 2019 to be grandfathered into the regime.
One clause in the new regime outlined UCITS funds as falling under the discretion of the new framework. But uncertainty around the new regulation is preventing fund managers from circumventing EU regulation and selling US deals to European investors.
UCITS fund providers who meet the standards are usually exempt from national regulation in individual European countries, but the new STS regulation standardized compliance across all EU countries, challenging the viability of UCITS funds as an investment vehicle in the continent.
“UCITS are in a place where we find it difficult to put risk on and are really in wind-down mode,” said Fecteau.
The European Securitisation Regulation stipulates that “where [UCITS] are exposed to a securitisation that no longer meets the requirements provided for in the [Securitisation Regulation], they shall, in the best interest of the investors in the relevant UCITS, act and take corrective action”.
A UCITS fund is expected to be able to purchase non-compliant securitizations that were issued before January 1, 2019, but cannot purchase non-compliant securitizations issued after the January implementation date.
“But if you assume that the vast majority of the ABS universe has a [weighted average life] of three years, and  is already done, that opportunity set of viable investments is winding down very quickly,” said Fecteau.
If a formerly compliant securitization ceases to be compliant after January 1 2019, then the UCITS fund will be obliged to consider “corrective action”. This can include fines and even implies potential jail time, according to the provided deal documentation.
Managers are left uncertain as to whether current issuance will be compliant because not all of the regulatory standards have been finalized. The standards scheduled to clarify any ambiguity were delayed at the start of 2019, and further pushed back when a new European Parliament was elected in May.
The recent securitization regulation has been in the works since 2015 and UCITS funds have always been subject to some level of regulation, but the new clause represents the biggest change to US securitization investment in European in the new regulation, said panellists.
Michael Mazzuchi, partner at Cleary Gottleib, called the market separation an “unfortunate split” and said that such developments could market the “death knell” of integrated reporting requirements across the ABS market.