The impact of new regulation on structured finance transactionsArticle 122a of the Capital Requirements Directive

ContentsIntroduction ...........................................................................................................01

Questions and answers ............................................................................ 02-12

IntroductionAs the first quarter of 2011 draws to a close, the market has had a short time to digest the final Guidelines issued by CEBS (now the EBA) on Article 122a of the Capital Requirements Directive. This new provision of the CRD has provoked much debate in the market and there is still a considerable amount of uncertainty with respect to the scope of Article 122a and the application of some of its requirements.

In this paper, we outline some of the issues with Article 122a which are continuing to cause difficulties, together with some of the areas where the EBA have provided much-needed flexibility. It is perhaps too early to identify specific market trends, but there are certainly areas of uncertainty on which some of the major financial institutions have taken a view. In our opinion, the successful implementation of Article 122a in the market depends on exactly that - investors, originators and arrangers forming a consensus view as to how compliance can be achieved. Discussions with the regulators clearly play a vital part in underpinning the market’s confidence in this regard, and we have been pleased to see those discussions continue in some key areas (eg. managed CLOs) following publication of the final Guidelines.

Lucy Oddy Banking & Capital Markets lucy.oddy@blplaw.com

As the revival of the securitisation market continues and we see more diverse asset-classes coming back to the market, market participants are struggling to interpret aspects of Article 122a in the context of the transactions they are working on. Further guidance would be welcomed from the EBA to remove these uncertainties which are dampening the market.

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Article 122a

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Article 122a of the EU Capital Requirements and its impact on finance transactions worldwideArticle 122a of the EU Capital Requirements Directive (“CRD”) came into effect in the European Union on 1 January 2011 and affects new securitisation transactions issued from that date, as well as existing securitisations which add assets after the end of 2014. Market participants from now on need to consider which transactions constitute “securitisation” for this purpose and how the requirements of Article 122a will be met in the context of those transactions.

In particular, EU Credit Institution investors need to ensure that the originator or sponsor of a securitisation transaction retains a portion of the economic risk amounting to at least 5%. Such investors will also need to ensure that they comply with certain due diligence requirements and that originators and sponsors provide them with the necessary information to do so.

Failure to comply with Article 122a will directly result in capital penalties being applied to asset-backed securities held in either the trading book or non-trading book. Furthermore, regardless of whether the investor is directly caught, failure to ensure the relevant originator or sponsor has retained the required risk will indirectly reduce the liquidity of such securities in the secondary market.

Article 122a was inserted at a late stage of the CRD2 legislative process and has generated much debate and discussion, largely due to the broad nature of its language and the lack of clear definitions. It potentially impacts a wide range of financing transactions and indirectly affects market participants worldwide, not just in the European Union.

What was the rationale behind Article 122a?Article 122a was introduced to address the perceived problem of institutions buying or originating low-quality assets and transferring them from their balance sheets without keeping any of the economic risk. Its principal aim is to align the interests of entities which originate assets (ie. originators or sponsors) with entities investing in the financing of those assets through securitisations and similar structures.

It also aims to ensure greater transparency and “greater confidence between originators, sponsors and investors”. Whether it meets these objectives will depend on the resolution of some significant outstanding issues which we explore in this paper.

Article 122a - implementation timelineDirective 2009/111/EC (“CRD 2”), which amends Directives 2006/48/EC, 2006/49/EC and 2007/64/EC (collectively, the “CRD”), was finalised in May 2009 and published in November 2009. Article 122a was inserted into CRD by CRD 2 and is a new provision.

The Committee of European Banking Supervisors (“CEBS”) issued draft guidelines for public consultation on Article 122a on 1 July 2010. Final CEBS guidelines (the “Guidelines”) were issued on 31 December 2010.

The Capital Requirements (Amendment) Regulations 2010 (SI 2010/2628) were made on 28 October 2010 and came into force in the United Kingdom on 31 December 2010. These Regulations introduced CRD 2 into English law.

1 CEBS became the European Banking Authority (the “EBA”) on 1 January 2011.

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What are the key provisions?In summary, the key requirements of Article 122a are as follows:Retention EU credit institution investors must ensure that the originator, sponsor or original lender has “explicitly disclosed” that it will retain a material net economic interest of not less than 5%. There are four methods by which this may be achieved (see below).

Due DiligenceEU credit institutions investing in securitisation positions or which otherwise take an exposure to the credit risk of a securitisation must comply with specific due diligence requirements both before investing and on an on-going basis for the life of the transaction.

Underwriting EU credit institution sponsors and originators are required to use prudent and well-defined underwriting criteria when they originate assets to be securitised and to apply the same underwriting standards to exposures to be securitised as to those held on their books.

Transparency Originators and sponsors must ensure they provide sufficient information to investors to comply with the due diligence requirements.

Additional risk weights Non-compliance will result in additional risk weights being applied to the positions held by the investors or entities with the exposure.

Are there prescribed methods of retaining a material net economic interest of not less than 5%?Yes, the requirement must be fulfilled by compliance with any one of the options below:

Option (a) Retention of no less than 5% of (i) the nominal value of each of the tranches sold (ie. retaining a vertical slice of the notes, OR (ii) the credit risk of each of the securitised exposures (ie. the underlying assets).2

Option (b) Retention of no less than 5% of the nominal value of revolving exposures or a revolving pool3 For example, a seller interest in a credit card master trust or an RMBS master trust would fall within this option.

Option (c) For granular portfolios with at least 100 exposures, retention of randomly selected exposures equivalent to not less than 5% of the nominal amount of the exposures which would otherwise have been securitised. The retained exposures must (i) be identified at origination, (ii) be identified and tracked for the life of the transaction and (iii) comprise a static pool and cannot be substituted.

Option (d) Retention of the first loss tranche and, if necessary, other tranches having the same or a more severe risk profile than those transferred or sold to investors, so that the retention equals in total no less than 5% of the nominal value of the securitised exposures. The tranche retained must not mature any earlier than tranches transferred or sold to investors.

The Guidelines have confirmed that the retention requirement cannot be satisfied by a combination of these four options and the form of retention cannot be changed during the life of the securitisation except under “exceptional” circumstances (eg. a restructuring).

2 Note that part (ii) of Option (a) does not appear expressly in Article 122a but was added by the Guidelines.3Note that the option for revolving securitisations does not appear expressly in Article 122a but was added by the Guidelines.

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The level of retention is measured at “origination”, ie. when exposures are first securitised rather than when they were created. Measurement is by reference to the “nominal value” of the exposures before any impairments and value adjustments. If any of the exposures are wholly or partially undrawn or contingent, then the retention requirement only applies to the extent they are drawn.

The interest must be retained on an ongoing basis and must always rank pari passu with, or be subordinated to, the credit risk that has been securitised.

The retention does not need to be “topped up” if the retained exposures pay down early, provided that they are not designed to amortise at a faster rate than the securitised exposures or the tranches sold. However, the retained interest may need to be re-adjusted on an ongoing basis if the characteristics of the transaction are such that the credit exposure increases over time (eg. where the securitisation is of revolving exposures and the drawn amount of the exposure goes up). It is arguable that trading gains which are re-invested in a dynamically managed pool should not result in the need to increase the retained amount even if they result in an increase in the nominal amount of the exposures in the pool. However, the FSA has indicated that this would indeed require an increase in the retained amount.

The retained interest cannot be specifically hedged or sold. It can be used for funding purposes as long as credit risk is not transferred (for example repos of the retained exposures are acceptable as the credit risk is designed to stay with the transferor). Furthermore, hedging the macro level of risk to allow effective risk-management across a bank’s business is permissible, but hedging of the specific risks is not. The EBA has indicated that this means that a hedge on a credit default swap index such as an iTraxx index would be acceptable as long as the specific retained exposures are not hedged.

Which investors need to be concerned about Article 122a?If an investor (a) is a “credit institution” for the purposes of CRD (ie. is regulated in the EU) and (b) has invested in, or otherwise has an exposure to, a transaction falling within the scope of Article 122a, then it needs to consider whether Article 122a applies to it. It is important to note that Article 122a may apply even if an investor’s position is held through one or more of its consolidated group entities (see below).

The key test is whether the institution is exposed, directly or indirectly, to principal losses on the underlying assets. Thus it will catch investors in the bonds, but also those who invest directly or indirectly in asset-backed transactions (including through credit default swaps or similar arrangements) and certain counterparties including liquidity facility providers and hedge counterparties to the extent they are exposed to principal losses (eg. total return swaps). It will not capture, for example, swap counterparties who are simply providing interest-rate or currency swaps which only reference performing receivables.

What is a “credit institution” for the purposes of CRD?A credit institution, as defined under the CRD, is an entity whose business is either to (a) receive deposits or other repayable funds from the public and to grant credits for its own account or (b) issue means of payment in the form of electronic money (ie. issue credit).

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The CRD is an EU directive. Should non-EU investors be concerned?Potentially, yes. Despite strong challenges by industry participants during the consultation process, the Guidelines confirmed that Article 122a applies to a credit institution which is exposed to securitisation positions by entities within its consolidated supervision group. Therefore, Article 122a must be considered where non-EU subsidiaries of a European credit institution invest in securitisations. This raises obvious operational difficulties, particularly where such subsidiaries are situated in non-EU jurisdictions where there are local law requirements which conflict with Article 122a or provide exemptions which Article 122a does not provide. Under the Dodd Frank Act in the U.S., for example, the proposed retention rules provide exemptions for certain mortgage-backed securities and other securities which meet certain underwriting standards which are not provided in Article 122a4. How the U.S. origination market adapts to this remains to be seen - there are some signs that U.S. Originators are complying with Article 122a and retaining 5% to attract EU investors. In any event, if EU credit institutions wish to access the U.S. markets there may be two sets of rules which apply to the transaction.However, all investors (regardless of whether or not they are credit institutions) will be indirectly affected by Article 122a as a failure of the originator or sponsor to satisfy the retention requirement will adversely affect the liquidity of the securities in the secondary markets.

What about hedge funds, insurance companies and other investors in the market?Regulations are in the pipeline which will introduce similar requirements to Article 122a to insurance companies and reinsurance companies and, potentially, pension funds (by virtue of the Solvency II proposals) and hedge funds managed by EEA fund managers (by virtue of the Alternative Investment Fund Managers Directive).5

Which originators and sponsors need to be concerned? Although the penalties for breaching the retention requirement are imposed at the investor level, any originator of an asset-backed transaction (regardless of whether it is an EU credit institution) should ensure that such transaction complies with the requirements of Article 122a if it expects that EU credit institutions will invest.

The disclosure requirements are however imposed only on originators or sponsors which are credit institutions. Nonetheless, other originators and sponsors will need to comply with the requirements if they want to ensure there is a liquid market for the securities.

Which entity should fulfil the retention requirement? The original lender, originator or sponsor of the transaction must hold the retained interest.

Under the CRD, “originator” is defined as:• “an entity which, either itself or through related

entities, directly or indirectly, was involved in the original agreement which created the obligations or potential obligations of the debtor or potential debtor giving rise to the exposure being securitised; or

• an entity which purchases a third party’s exposures onto its balance sheet and then securitises them.”6

Under the CRD, “sponsor” is defined as “a credit institution other than an originator credit institution that establishes and manages an asset-backed commercial paper programme or other securitisation scheme that purchases exposures from third party entities.”

It is therefore necessary to consider whether the entity which will retain the 5% interest will meet these definitions.7

4The FDIC issued proposed retention rules on

29 March 2010.5Directive 2009/0064/COM.6Point 4(41) of Directive 2006/48/EC.7Point 4(42) of Directive 2006/48/EC.

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Going forward, it will be interesting to see to what extent investors negotiate a greater level of comfort with respect to compliance with Article 122a in transaction documentation. In particular, given the impact that non-compliance may have on the liquidity of securitisation positions, investors will demand protection in the form of covenants provided by the originator or sponsor to the trustee to hold on behalf of noteholders.

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If there are multiple originators or original lenders, then each such originator or original lender must retain 5% of the portion of the exposures it has sold into the transaction, or the sponsor should hold the retained interest for the whole transaction.

For some transactions, particularly managed CLOs, there may not be a party to the transaction who meets the relevant definitions of originator or sponsor (and typically in a managed CLO the original lenders will not be involved). Although some suggestions for dealing with the retention requirement for managed CLOs were included in the Guidelines, this is still very much an area under discussion with the regulators. We expect that CLO managers and arrangers will need in each case to take a view on whether the retention is held in a manner which meets the requirements.

What type of finance transactions are caught by the scope of Article 122a? Is it only traditional balance sheet securitisations?The definition of “securitisation” for the purposes of Article 122a is as follows:“A transaction or scheme, whereby the credit risk associated with an exposure or pool of exposures is tranched, having the following characteristics:• payments in the transaction or scheme are

dependent upon the performance of the exposure or pool of exposures; and

• the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme.”9

This language is very broad and could potentially capture a wide range of asset-backed finance transactions. There is no need for a true sale of assets, nor even the issue of securities. Market participants therefore need to consider on a case by case basis whether any asset-backed finance transaction falls within the scope of the new regulation.

Of particular concern is the reference in the definition to tranching of credit risk with respect to one or more assets which determines the

distribution of principal losses. Single tranche transactions (such as most covered bonds issued in the United Kingdom) do not fall within the definition of “securitisation” and therefore Article 122a will not apply to them. However, many financings which would not be thought of by the market as “securitisations” include an element of tranched credit risk. This has caused some anxiety in relation to Article 122a, as investors and originators clearly need to agree which deals are caught if they are to comply with the requirements in structuring and selling or investing in the securities. We expect market practice will develop in identifying the types of transaction which are caught, and, in the meantime, market participants will need to engage in dialogue with their regulators with respect to transactions which may not be thought of as securitisations but nonetheless fall within the definition above. In the United Kingdom, despite dialogue between the industry and the FSA around the intention behind the definition, there has to date been no clear statement about which types of transaction will be treated as falling within or outside the scope of these provisions.

Are there any exemptions?Article 122a includes some exemptions for certain transactions which could potentially fall within the wide definition of “securitisation”. Note that these exemptions only apply to the retention requirement and not the due diligence and transparency requirements (see below).

The exemptions are as follow:• “transactions based on a clear, transparent

and accessible index, where the underlying reference entities are identical to those that make up an index of entities that is widely traded, or are other tradable securities other than securitisation positions; or

• syndicated loans, purchased receivables or credit default swaps where these instruments are not used to package and/or hedge a securitisation that would be otherwise caught by Article 122a.”10

8Please note that the terms “original lender” is undefined and it is not clear how it would differ from the entity described in the definition of originator.10Chapter 2, Section 7(3) of Directive 2006/48/EC, as amended by CRD 2.

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These exemptions were added at a very late stage in the legislative process, and the wording in some cases has generated possibly more confusion than clarity. However, the CEBS Guidelines have lent some assistance in interpreting the meaning of these exemptions. The exemption for transactions based on an index is intended to exempt positions which fall within the correlation trading portfolio as defined in CRD 3.11 Thus correlation trading desks do not have to retain risk on single tranches of baskets of securities on which they sell or buy protection. CEBS also clarified that credit default swaps will not be caught at all within article 122a if they are simply selling protection on a corporate entity without constituting a securitisation. However, where a credit institution is selling protection on a securitisation position, it is treated as providing a hedge to the securitisation position, and is caught by all the requirements of Article 122a including the retention requirement.

Some confusion remains over what is meant by the exemption for “syndicated loans”. There had been some concern that the wide definition of securitisation could encompass syndicated loans where credit risk is tranched. This exemption was intended to mitigate this concern. However, our view is that the exemption causes confusion by failing to refer to “tranched syndicated loans” - as tranching is required before a transaction falls within article 122a at all, it seems logical that the exemption is intended to cover loans where there is tranching (otherwise the exemption for syndicated loans is redundant). We would hope that national regulators would not require the members of a syndicate of lenders to comply with any of the provisions of Article 122a, but a statement in the Guidelines to this effect would have been welcome.

How does the retention requirement apply to asset-backed commercial paper conduits?During the consultation process, market participants were concerned that ABCP transactions should be treated differently from term-funded securitisations due to their bespoke structures. In effect, the CP investors are exposed in most cases not to the underlying assets directly, but to a liquidity facility or letter of credit provided by a sponsoring bank. In many cases, the liquidity facility covers non-performing assets and is therefore exposed to credit risk itself. ABCP participants were keen to ensure that such liquidity facilities or letters of credit would be deemed to meet the retention requirement without the sponsor having to retain further risk.

The Guidelines take some of these concerns into account. They state that when liquidity facilities are provided to ABCP programmes, the retention requirement may be met under retention option (a) by the liquidity facility provided that it is granted to the ABCP conduit by the conduit sponsor. It must also rank senior to other obligations in the waterfall, and cover 100% of the credit risk of the underlying exposures (ie. not just funding against performing receivables or market disruption), and have terms that ensure it is available (on a contingent or drawn basis) for as long as the commercial paper is outstanding. The Guidelines also confirm that a standby programme-wide letter of credit provided to a conduit can meet the retention requirement under retention option (d), provided certain conditions are met, including that it covers credit risk of the exposures for as long as the originator or sponsor is required to do so. This is permitted even though effectively the letter of credit may technically be a second-loss position at programme-wide level (as first loss may have been assumed by the sellers into the programme on a transaction by transaction basis).

11Directive 2010/76/EU.

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How will Article 122a impact on legacy transactions? Are they grandfathered or will they need to be amended?All new transactions entered into from, and including, 1 January 2011 are captured by Article 122a. Transactions which were issued before that date will only be caught by Article 122a if new underlying exposures are added to the portfolio from 1 January 2015 and will only have to comply from the point of first substitution on or after 1 January 2015. The Guidelines clarified that substitutions for breach of warranty or other specific contractual breach would not cause transactions to be captured by Article 122a.

However, transactions which provide for active substitution of assets, such as master trusts and managed CLOs, will be captured by Article 122a if assets are substituted from, and including, 1 January 2015. Such transactions will need to comply with the requirements of Article 122a from 1 January 2015 and investors in such transactions will seek comfort now that the requirements of Article 122a will be complied with from 1 January 2015.

The question has also been raised as to whether re-investment of unexpected repayments in a managed CLO would amount to substitution. If this were the case, existing CLOs would be brought within Article 122a after 2014 unless the manager were to choose to amortise the notes rather than re-invest, which may be practically impossible if noteholders who are not caught by Article 122a were to object. As many CLOs have a reinvestment feature, further guidance on this point would be welcome.

One matter which caused a degree of concern among market participants in the consultation process was the statement by CEBS in CP40 that Article 122a would apply where new underlying exposures are added or substituted after 31 December 2014 even where the credit

institution investor acquired the position prior to 1st January 2011. If this statement were to be enforced this would mean that existing investors who bought ABS before 2011 could be left holding paper which suddenly became illiquid due to doubts over whether the transaction would be compliant following the end of 2014. After consultation, CEBS have clarified that such investors would only receive punitive risk weights if the non-compliance were due to their own negligence or omission or where meeting the retention requirement after 2014 is not possible due to contractual restrictions or voting by other investors. We would expect that this mitigating language would apply in all but the most exceptional cases where the investment was made prior to 1 January 2011, but we will have to wait and see what happens after the end of 2014. The uncertainty that remains around this paragraph is unfortunate and a clear statement that investments made before 1 January 2011 are outside the scope of Article 122a ought to have been made.

For originators and sponsors which are “asset rich”, the 5% retention requirement will be easy to comply with. What about other institutions which need liquidity but do not necessarily have a large amount of unencumbered assets on their balance sheet - are there any other methods of compliance? The CEBS Guidelines confirmed that the retention requirement may be achieved synthetically, for example, (eg. via derivatives, such as credit default swaps or total return swaps) or on a contingent basis (eg. via guarantees). Furthermore, a sale of exposures to the financing vehicle at a discount of at least 5 per cent may satisfy the retention requirement, provided that it is structured as a sale at a discount for credit risk purposes.

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What are the new due diligence requirements for investors? Article 122a provides that before investing in a securitisation, a credit institution must demonstrate a comprehensive and thorough understanding of the following:• information disclosed by the originator/

sponsor to specify that they maintain the retained interest;

• risk characteristics of the securitisation position (such as the tranche seniority level, rating, historical performance of similar tranches, credit enhancement etc);

• rick characteristics of the underlying exposures (such as delinquency rates, default rates, prepayment rates, credit scores, LTV ratios, etc);

• reputation and loss experience of the originator or sponsor in earlier securitisations;

• statements/disclosures of originators (or agents/advisors) about due diligence on the securitised exposures and collateral;

• methodologies underlying valuation of the collateral; policies that ensure independence of the valuer; and

• material structural features of the securitisation such as waterfalls, triggers, swaps, liquidity facilities and reserve accounts.

Institutions are also required to have implemented policies for analysing and recording this information.

After investing, continued surveillance of the performance of the underlying assets is required.

The provisions in the Guidelines regarding due diligence are deliberately not overly prescriptive. They are intended to allow market best practice to develop as to how investors will satisfy their due diligence and monitoring requirements.

Rather than relying heavily on credit ratings, investors are required to regularly perform their own stress tests on their securitisation positions. Rating agency models or other financial models may be used for these purposes. However, the key requirement is that investors actively run the financial models themselves and do not simply rely on the view of a rating agency or other third party. Therefore, investors need to demonstrate that, prior to investing, they took due care to validate the relevant assumptions in, and structuring of, their models and to understand the methodology, assumptions and results.

Article 122a covers securitisation positions in the non-trading book and the trading book. Do the due diligence requirements differ for buy-to-hold investments held in the non-trading book, compared to investments held in the trading book?As a starting point, investors should apply the same policies and procedures to assets in the non-trading book and trading book. However, the intensity of the due diligence for exposures held in the trading book and banking book may be different if an investor can justify applying different standards. During the consultation process, investors argued that the intensity of due diligence possible for positions to be held in the non-trading book is not possible for positions to be held in the trading book due to the dynamic nature of trading activity. CEBS rejected the idea that an investor could pre-approve a list of permitted securitisations in which its trading desk could invest without further due diligence. However, CEBS did offer some concessions to differentiate between trading book and non-trading book due diligence. They agreed that if a trading desk cannot obtain all of the relevant information about every securitisation position in a basket on which they are asked to trade, then if the missing information is not material in the context of the basket, and the exceptions are commensurate with the risk profile of the trading book, the trade can proceed. However, more leniency would have been appreciated, and would have helped remove inconsistency between individual institutions in applying the rules to the trading-book.

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What are the disclosure requirements on originators and sponsors?Sponsors and originators who are credit institutions are obliged to disclose to investors the level of their commitment to retain their economic interest. They are also obliged to ensure that prospective and investors have readily available access to all materially relevant data on the credit quality and performance of the individual underlying exposures, cash flows and collateral as well as such information that is necessary to conduct the requisite stress tests, both before investing and as appropriate afterwards.

As discussed below, it is likely in practice that sponsors and originators will disclose the required information to investors using templates currently being developed by the industry in conjunction with the Bank of England and the European Central Bank.

What is the consequence of non compliance for an investor? If an investor is in breach of Article 122a in any material respect by reason of its own negligence or omission, then an additional risk weight will be applied to the exposure. The additional risk weight will be at least 250% of the risk weight which would otherwise apply to the relevant exposure. The total resulting risk weight is capped at 1250% (ie. under Basel II, equivalent to a deduction from capital).12 The securitisation positions held in the trading book are not currently subject to securitisation risk weights, but this is set to change with the introduction of trading book amendments as part of the changes being introduced by CRD 3. Competent authorities are required to take into account both the materiality of the breach and the risk context of the breach when applying the additional risk weights.

In the absence of negligence or omission on the investor’s part, the investor will not be penalised with an additional risk weight if the retention requirement is not in fact fulfilled by the originator, sponsor or original lender at any point in time.

In response to overwhelming protests from the industry during the consultation period, the Guidelines include a formula for calculating the applicable additional risk weights which should reduce the risk of having to make a deduction from capital for inadvertent or one-off breaches. The formula applies additional weights based on duration of the breach (in 12 month periods). The Guidelines also urge competent authorities to avoid applying additional risk weights which require capital to be held which exceeds the exposure value of the position.

12Note potentially this could differ from a deduction from capital under the new definition of capital in Basel III.

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What is the consequence of non compliance for a sponsor or originator? Failure by a sponsor or originator to disclose the level of its commitment to maintain the 5% net economic interest or to provide materially relevant data and information to investors to enable them to perform their due diligence will result in additional risk weights being applied to the originator’s or sponsor’s retained position. If an originator or sponsor does not hold a retained position (which may of course be the breach concerned), additional risk weights will have no position on which to attach. CEBS rejected arguments by the industry that this made a nonsense of applying the penalty provisions to originators and sponsors and not just to investors. However, in practice, sponsors and originators will need to comply with Article 122a due to the reputational damage that could result in reduced ability to access the securitisation market for funding purposes.

If an originator or sponsor fails to comply with the underwriting criteria, then it will not be allowed to exclude securitised exposures from its capital requirements calculations.

How can investors ensure that a transaction complies with Article 122a?It is clearly important that originators and sponsors cooperate with investors and provide them with the information and data which they require in order to comply with the due diligence and stress test requirements.

In a fragile market with a contracted investor base, market participants will have to do as much as possible to assist investors in complying with these requirements, particularly as the investor is penalised for non-compliance. To this end, market participants have been working with the regulators on various transparency initiatives intended to encourage investors back to the market. For example, the Bank of England has been working with market participants to produce standardised prospectus summaries for certain asset-classes, which will facilitate the comparison by investors of similar transactions and thereby promote a better understanding of their structural features. To date, prospectus summaries have been produced for RMBS stand-alone transactions, RMBS master trusts and covered bonds, each of which are available on the Bank of England website. Later on this year, these prospectus summaries will need to be used for all new transactions to be positioned with the Bank of England’s Discount Window Facility.

In addition, template asset level reports are beginning to be developed by the industry for each asset class which will cover the information required by investors to monitor the performance of the assets on an ongoing basis. Issuers will use these templates on transactions going forward to give investors comfort that they are being provided with the information they need. So far, RMBS loan-level reporting templates which have been developed by the European Central Bank and the Bank of England for the purposes of their liquidity schemes and are being used by issuers on new RMBS transactions.

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