Allen & Overy Briefing Paper No.7 The Securitisation Framework

Transcription

1 Allen & Overy Briefing Paper No.7 The Securitisation Framework

2 THE SECURITISATION FRAMEWORK This briefing paper is part of a series of briefings on the Capital Requirements Directive (CRD) and its implementation in the UK via the General Prudential sourcebook (GENPRU) and the Prudential sourcebook for Banks, Building Societies and Investment Firms (BIPRU). This briefing is for general guidance only and does not constitute definitive advice. NOTE: the UK FSA Handbook provisions referred to in this briefing are based on "intelligent copy-out" of the CRD. They should therefore be consistent in very broad terms with the CRD, and therefore the rules in other EEA States. Health warning: the CRD contains a large number of discretions for Member States in implementing the CRD. The regime in other Member States may therefore differ in a number of respects. Do not rely on this briefing as an accurate guide to regulatory capital in Member States outside the UK. BACKGROUND AND SCOPE The recast Banking Consolidation Directive (recast BCD) contains a framework for the recognition of off-balance sheet treatment of securitisations, and for the risk weighting of securitisation exposures. This briefing deals primarily with the banking book treatment of securitisations and securitisation exposures. The trading book is discussed in Regulatory Capital Briefing 8 (Trading Book). SOURCES Recast BCD Articles , Annex IX; BIPRU Chapters 4, 5 and 9. KEY CHANGES AND POINTS TO NOTE Following the implementation of the CRD there is a harmonised EEA-wide regime for the recognition of off-balance sheet transfer of securitised assets (both for traditional and synthetic securitisations). This allows for greater latitude in tranching and removing tranched risk from the supervisory capital balance sheet. The preconditions to off-balance sheet transfer of securitised assets include that there be significant risk transfer: this is an unclear term which is interpreted differently across Member States. The rules relating to sub-participation and asset transfers (other than certain transfers in the context of a securitisation) have now been repealed sub-participation should generally still be recognised as transferring assets off the supervisory balance sheet however. Risk weighting of securitisation exposures is more sensitive to the concentrative effects of tranching and is largely ratings-driven (ie certain approaches under the CRD are based on external credit assessment). The granularity of the underlying asset pool is also a factor in certain circumstances. While one of the goals of the CRD regime is to reduce the opportunities for regulatory capital arbitrage, such arbitrage remains possible as between the risk weighting of rated securitisation positions and the weighting associated with the underlying securitised assets. Certain exposures have become less attractive to regulated investors, including unrated note tranches where no look-through treatment is available. In addition, there may be new incentives for bank originators to dispose of first loss pieces. The treatment of undrawn liquidity facilities in traditional term securitisations has changed. This is because such facilities are assessed under the securitisation framework and, in their current usual form, are not likely to satisfy the criteria for "eligible liquidity facilities". Synthetic securitisations must also meet the Credit Risk Mitigation (CRM) requirements (as relevant) see Regulatory Capital Briefing 5 (Funded Credit Risk Mitigation in the Banking Book) and Regulatory Capital Briefing 6 (Unfunded Credit Risk Mitigation in the Banking Book: Guarantees and Credit Derivatives). Given current market conditions and the increased focus on perceived failings of the securitisation market in respect of transparency and disclosure, various aspects of Basel II and the CRD have come under new scrutiny. In Allen & Overy

3 particular, there has been some debate on the topics of the capital treatment of certain structured products, credit risk transfer requirements and management of off-balance sheet exposures. Based on preliminary indications from the Basel Committee on Banking Supervision, it appears that the Basel II framework may be revised on these fronts. In addition, the European Commission is currently consulting on proposed changes to the CRD, which changes extend to the topics of large exposures, significant credit risk transfer and risk weighting of securitisation exposures. Finally, there has been some focus on the market discipline requirements under the CRD and whether the corresponding disclosure requirements may improve market transparency and disclosure. PREVIOUS EUROPEAN POSITION The Banking Consolidation Directive (BCD) did not provide for the recognition of off-balance sheet treatment of securitised assets. Most European regulators had implemented domestic requirements associated with securitisation. PREVIOUS FSA REQUIREMENTS Chapter SE of the Interim Prudential sourcebook for Banks (IPRU (BANK)) set out the previous UK rules on securitisation and asset transfers. This provided for recognition of transfers off the supervisory balance sheet subject to a number of conditions. Chapter CD also provided for the recognition of CRM in respect of credit derivatives, again subject to certain conditions. These requirements have now been repealed. IPRU (BANK) did not apply a separate risk weighting regime for securitised assets. Securitisation exposures were typically 100% risk weighted, subject to a requirement that first loss pieces retained by originators be deducted from capital. KEY CONCEPTS Basel II contemplates an explicit regulatory capital framework for securitisations, which is intended (inter alia) to establish harmonised standards for the removal of credit risk from the originator's or sponsor's balance sheet under securitisation structures, and to align regulatory capital more closely to actual credit risk with respect to the risk weighting of on- and off-balance sheet exposures, including a new risk weighting framework for notes issued by securitisation vehicles and other exposures to such vehicles. Effect of tranching on risk weighting A securitisation repackages and tranches exposures to an underlying pool of assets. A perceived failing under Basle I is that it did not distinguish between senior and junior tranches of securitisations for the purpose of risk weighting them for regulatory capital purposes despite the very obvious difference in credit risk between the two. Basel II attempts to align the effect of tranching on credit risk by requiring deduction of junior exposures to securitisation vehicles, and differential risk weighting of other exposures. Risk transfer A connected issue associated with tranching is risk transfer. Recognising that the regulatory capital benefits associated with off-balance sheet treatment of securitised assets should reflect the transfer of economic risk, Basel II includes an anti-arbitrage requirement that significant credit risk transfer must occur as a precondition to off-balance sheet treatment of securitised assets. External rating and look-through A key element of the revised framework is reliance on external credit assessment and, in the case of firms on the internal ratings based approach (IRB approach), internal credit assessment. In a securitisation context, Basel II defaults to the use of external credit assessment for risk weighting securitisation exposures where possible. Where external ratings are not available, the most relevant measurement of credit risk associated with a securitisation structure is the risk weighting of the underlying pool of assets. Accordingly, in the absence of a rating, the revised framework allows for the risk weight of the underlying assets to be used under certain circumstances. Allen & Overy

4 Granularity Under the IRB approach, granularity (ie diversity of exposures in the underlying pool of assets) is important where the securitisation vehicle is rated the approach of the framework being that non-granular pools are insufficiently diverse, and should therefore attract a higher risk weight. Given the differences between the weighting of exposures to rated and unrated securitisations, and between the treatment of granular and non-granular pools, in certain deals (particularly those involving non-granular pools) consideration should be given to whether a rating is likely to be counterproductive (ie by resulting in higher regulatory capital requirements for investors which are regulated). NEW REQUIREMENTS Scope and definitions The securitisation framework applies to exposures arising from all "traditional" and "synthetic" securitisations. 1 In general, the regime requires the "economic substance" of the transaction to be taken into account by a firm when determining whether the securitisation framework will apply. A "securitisation" is a "transaction or scheme, whereby the credit risk associated with an exposure or pool of exposures is tranched, having the following characteristics: (a) payments in the transaction or scheme are dependent upon the performance of the exposure or pool of exposures and (b) the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme". In addition, the CRD includes a definition for "traditional securitisations" and "synthetic securitisations". A traditional securitisation is defined as "a structure where the cash flow from an underlying pool of exposures is used to service at least two different stratified risk positions or tranches reflecting different degrees of credit risk. 2 Payments to the investors depend upon the performance of the specified underlying exposures, as opposed to being derived from an obligation of the entity originating those exposures". A synthetic securitisation is defined as a securitisation (within the above definition) where the tranching is achieved by the use of credit derivatives or guarantees, and the pool of exposures is not removed from the balance sheet of the originator. Leaving asset-backed commercial paper (ABCP) and other non-tranched deals aside, the securitisation definition includes the term securitisation structures commonly used in the UK market. However, based on the definitions of securitisation and traditional securitisation, certain deals involving tiered loans may fall within the former definition but outside of the latter (and outside the definition of synthetic securitisation as well). While there is scope for different views to be taken, there is a good argument (given the copy-out approach taken by the FSA to the CRD) that exposures in respect of these deals should not be treated as securitisation exposures. 3 It should be noted that covered bond deals (including those involving traditional or structured covered bonds) fall outside the securitisation framework and are instead treated as a type of "secured borrowing" under the recast BCD. In general, the secured borrowing framework is more flexible than the securitisation framework (eg by permitting more active portfolio management) and there are relative incentives from a risk weighting perspective to issue products treated as secured borrowing. It should also be noted that, in certain circumstances, the specialised lending framework may apply with respect to certain corporate exposures. This framework will be available if the exposure relates to a deal which falls within one of the six specified classes of specialised lending activity. These activities include funding provided in respect of incomeproducing real estate (IPRE), which may include certain finance arrangements in connection with commercial mortgagebacked transactions. At present, it is not clear how the specialised lending framework and the securitisation framework should fit together and how exposures are to be treated where they relate to both a traditional securitisation and the specialised lending activity of funding in respect of an IPRE. There are incentives to confirming this as using the specialised lending framework would be more efficient from a regulatory capital perspective, particularly where the relevant exposures are unrated Or similar structures containing features common to both, see BIPRU G. Securitisation tranches are distinguished from ordinary senior/subordinated debt instruments on the basis that subordinated securitisation tranches can absorb losses without interrupting contractual payments to more senior tranches (whereas subordination in an ordinary debt structure is a matter of priority of rights to the proceeds of liquidation). BIPRU G provides that a firm must apply the securitisation framework for determining its regulatory capital requirements "on exposures arising from traditional securitisations and from synthetic securitisations and from structures that contain features of both". BIPRU 9 is not expressed to cover other structures. Accordingly ABCP and other non-tranched structures, and tranched structures which do not fall within the traditional securitisation definition, also remain outside the scope of BIPRU 9. Allen & Overy

5 Requirements The primary requirements under the regime relate to (a) conditions associated with off-balance sheet treatment and (b) risk weighting of securitisation exposures. Originators are also subject to a high-level requirement on systems and controls (BIPRU 9.1.6R), which applies to all securitisations (including on-balance sheets deals). Unlike the IPRU (BANK) regime (which provided conditions to the off-balance sheet treatment of any exposures, including by way of sub-participation), there is no guidance on the off-balance sheet treatment of exposures other than when securitised. It is worth noting that the requirement to risk weight arises in respect of "exposures", which is assessed on the basis of the accounting treatment of the bank's assets. Where the risk in an asset has been transferred, then it may not fall to be an exposure on accounting grounds. The FSA has indicated informally that sub-participations should continue to be recognised as removing the sub-participated exposure from the supervisory balance sheet for this reason. Similar principles should apply to other asset transfers, including to non-tranched securitisation structures. Conditions to off-balance sheet treatment originators The conditions to off-balance sheet treatment are split into conditions common to all securitisations, and separate conditions for traditional and synthetic securitisations. These conditions do not apply in respect of securitisations which remain on the balance sheet of the originator. Given the lowering of capital requirements in respect of certain asset classes, and the requirements for deductions in respect of junior exposures to securitisations, there has been an increasing tendency for originators to treat securitisations of low risk weighted assets (particularly residential mortgages) as on-balance sheet. Originators will need to determine on a case-by-case basis whether off-balance sheet treatment results in a lowering of regulatory capital. Conditions common to all off-balance sheet securitisations significant risk transfer and implicit support An originator of a traditional securitisation may obtain regulatory capital relief in respect of a securitisation exposure "if significant credit risk associated with the securitisation exposures has been transferred" (BIPRU 9.3.1R(1)). There is some fairly general guidance from the FSA (currently, there is no guidance at a European level) on the meaning of this term in BIPRU 9.3 (Requirements for originators). This states that significant credit risk transfer occurs only if the (economic) risk transferred is "broadly commensurate with, or exceeds, the proportion by which risk weighted exposure amounts are reduced". It further states that where the residual exposure(s) retained by the originator would, if risk weighted at 1250% (the same as a deduction from capital), give rise to a lower amount of capital than the capital required to be held against the securitised exposures, then significant risk transfer is achieved. In situations outside this safe harbour, firms will have to make their own determination and be able to justify it to the FSA. A number of banks have, as a result of the change to the rules, chosen to regard certain pre-2008 securitisations as not transferring significant risk particularly deals involving assets such as retail mortgages where the risk weighting has been significantly reduced as a result of the new regime (for which the safe harbour is less likely to be available). Other Member States are taking different approaches to this test, resulting in potentially different treatment for the same exposures between Member States. The European Commission appears to be aware of the issues in this regard and its working document on potential changes to the CRD includes (among other things) proposals for changes to the requirements related to significant credit risk transfer. 4 Under BIPRU 9.6 (Implicit support), an originator must not, with a view to reducing potential or actual losses to investors, provide support in respect of the securitisation beyond its contractual obligations. This imports an element of intention into the requirements on the part of an originator or sponsor: however, the FSA has indicated informally that it will take a strict approach to determining whether implicit support has been given. Where a firm is entitled (but not obliged) to give support, then certain conditions must be met (including that the nature of the support is precisely described in the securitisation documents and the maximum degree of support that can be given can be ascertained at the time of the securitisation, and the firm's risk weighted exposures to the securitisation are assessed on the basis that the firm has provided support to the maximum extent permitted). 5 The consequences of providing implicit support are potentially very damaging the originator is required to hold capital against the securitised exposures as if they had not been securitised, and publicly disclose that it has given support. There is an open question in the context of implicit support 4 5 See the proposed changes to paragraph 1.1 of part 2 of Annex IX of the CRD set out in the Commission document entitled "CRD Potential Changes" (document accessible at BIPRU G and G. Allen & Overy

6 around the treatment of master trust structures which provide for variable credit support which benefits existing, as well as new, investors in the structure. The FSA guidance appears to allow such support as permitted support: but the capital treatment of the potential credit support to be supplied under subsequent transfers may be an issue for originators of such structures, if they are treated as off-balance sheet. In Q4 2007, the FSA disciplined Egg Banking for alleged implicit support in connection with its decision to buy back certain lower quality assets from Pillar Funding (an SPV used in respect of certain credit card securitisations). 6 Unfortunately, limited information has been made publicly available about the FSA's ruling. As a result, there is some confusion in the market in respect of the FSA's application of the implicit support rules. The implicit support requirements replace certain rather more restrictive requirements in Chapter SE restricting originators from repurchasing securitised assets (other than in very limited circumstances) or from holding positions in the securitisations they originate. A consequence of the loss of any restrictions on repurchase of assets is that, in principle, general calls may be included in deals provided that exercise of the call does not constitute the provision of implicit support (which is prohibited), or explicit support against which the originator would be required to carry capital. To our knowledge the FSA is accepting that such calls may be included, but there is an expectation that originators will obtain clearance from the FSA before using them. They will also need to be able to demonstrate to the FSA that their exercise does not constitute implicit support. With respect to regulatory calls (which appear in certain existing deals due to uncertainty around the operation of the securitisation framework), we note that the FSA has expressed concerns in respect of the inclusion and/or exercise of such calls following the implementation of the CRD. Following discussion with certain industry groups, it was determined that, at the time of exercise, firms will be required to satisfy themselves that such action meets the BIPRU 9 rules in respect of repurchase and implicit support (ie that the risk has been genuinely transferred and that the call is not being used as a support mechanism). 7 In practice, the FSA should be notified reasonably in advance in circumstances where it is proposed that a general call or a regulatory call will be included or exercised. The rules on clean-up calls are described below. As a result of the loss of the prohibition on purchasing securitisation positions, originators are now free to securitise and retain any part of the capital structure (provided that they achieve significant risk transfer). There appears to be an increasing tendency for originators to use securitisation to sell out junior tranche(s) of risk a reversal from the normal position under Basle I. Traditional securitisation other conditions The other conditions which apply to traditional securitisation are set out in BIPRU 9.4 (Traditional securitisation). In general, the BIPRU 9 rules are less detailed than the previous rules. Rather than including detailed "clean break" criteria like the Chapter SE rules, 8 BIPRU 9.4 provides for a series of relatively straightforward conditions including that: the securitisation documentation reflects the economic substance of the transaction; the securitised exposures are put beyond the reach of the originator and its creditors, including in bankruptcy and receivership: legal opinions from qualified legal counsel are required in this regard (and the opinions must be reviewed and updated as needed from time to time); the transferee is a special purpose vehicle; the originator does not retain effective or indirect control over the transferred exposures; 9 10 any clean-up call is exercisable at the option of the originator when 10% or less of the value of the securitised exposures remains unamortised, and such call is not structured to provide credit enhancement; and The disciplinary action apparently included a determination that no regulatory capital relief would be available on any existing Egg securitisations or on any future Egg-branded credit card securitisations for five years. For further information, please see the FSA issues progress document for this issue (linked at Interestingly, unlike the Chapter SE rules, there is no reference in the BIPRU 9 rules to evidence of auditor satisfaction that the transfer complies with the relevant accounting standards for de-recognition (other than with respect to insurers). This does not prevent the originator from retaining servicing rights. This restriction against control includes the obligation to reassume transferred risk (BIPRU R). This raises the question of whether repurchases for breach of warranty are allowed: unlike under the Chapter SE rules, there is no explicit exception for repurchases for a breach of warranty. However, it is believed that the absence of such a rule is not intended to prevent such repurchases, but rather to reflect that off-balance sheet treatment should not be available in respect of assets sold in breach of warranty. Allen & Overy

7 the securitisation documentation does not include provisions that require positions in the securitisation to be improved by the originator (other than in the case of early amortisation provisions), including provisions which alter the underlying credit exposures or increase the yield payable to holders of positions in the securitisation in response to a deterioration in the credit quality of the underlying pool. It is not clear whether regulatory legal opinions (such as those previously provided to originators under the Chapter SE rules) will be required under the new regime, although this seems unlikely given the nature of the conditions set out in BIPRU 9.4. The restrictions around implicit support and improvement of positions in the securitisation have given rise to some debate in the context of asset replenishment and substitution (both in the traditional and synthetic context). Rating agency requirements prohibit replenishment or substitution where to do so causes a deterioration in the credit quality of the pool of securitised exposures. The BIPRU requirements prohibit either where to do so causes improvement in the credit quality. Originators will need to be careful to manage the risks in this regard. Synthetic securitisation other conditions The other conditions which apply to synthetic securitisation are set out in BIPRU 9.5 (Synthetic securitisation). Like the conditions which apply in respect of traditional securitisations, BIPRU 9.5 provides for a series of relatively straightforward conditions including that: the securitisation documentation reflects the economic substance of the transaction; the credit risk is transferred via credit protection which complies with certain eligibility and other requirements for CRM under BIPRU 5 and, as applicable, BIPRU 4.10; certain terms are not included in the credit risk transfer instruments (including termination provisions related to a deterioration of the credit quality of the exposures and terms similar to the restrictions set out above in the context of traditional securitisations); and a legal opinion is provided confirming that the credit protection is enforceable in all relevant jurisdictions. Risk weighting of securitisation exposures As noted above, as a general rule, credit institutions and investment firms must hold regulatory capital calculated in accordance with the securitisation framework against all of their securitisation positions. These are defined to include exposures to securitisations (including exposures arising under derivatives with securitisation vehicles), and the provision of credit protection to securitisation positions. This includes an originator's exposures to its own off-balance sheet securitisations, but should not include exposures to on-balance sheet securitisations (for which the originator is to be regarded as having continuing exposure to the underlying assets 11 ). Whereas the previous UK rules on securitisation and asset transfers set out in Chapter SE were focussed on credit institutions acting as originators, sponsors and repackagers (and their various roles) and certain securitisation exposures provided by third party credit institution parties were dealt with separately, 12 the new securitisation framework applies more generally to securitisation exposures held by credit institutions and investment firms, regardless of connection to the originator, sponsor or repackager. Approaches under the securitisation framework When calculating minimum capital requirements under the securitisation framework (as under the CRD in general), banks are permitted to use the standardised approach or the IRB approach The CRD is silent on the question of whether exposures to on-balance sheet securitisations should be separately risk weighted. The European Commission has consulted on whether such exposures should be assessed for large exposures purposes: the Commission consultation indicated that a "look-through" approach be taken (looking to the underlying assets), but is unclear as to whether the look-through is in substitution for or in addition to assessing exposures to the securitisation vehicle itself. For example, liquidity facilities provided by such parties were dealt with as an undrawn commitment of one year or less under Chapter BC of the IPRU (BANK). Allen & Overy

8 Firms using the standardised approach to determine capital requirements for securitisation exposures 13 are required to do so by reference to a table which applies a risk weight based on any relevant external credit assessment/rating (detailed in Table 1 in the Appendix). For off-balance sheet exposures, the institution must apply a credit conversion factor (CCF) and then risk weight the resultant credit equivalent amount. If the exposure is rated, then a CCF of 100% must be applied (except in respect of certain specified exposures under unrated eligible liquidity facilities and cash advance facilities, which attract lower CCFs and therefore lower regulatory capital requirements). 14 If the relevant rating is below a certain level or the position is unrated (except if the position is the most senior exposure in a securitisation or is in respect of an eligible liquidity facility), a risk weighting of 1250% or deduction from capital is required. 15 Notwithstanding these general rules, the exposure values may be modified using CRM in accordance with BIPRU 5 and BIPRU As noted above, as an exception to the general rule for unrated exposures, where the composition of the underlying pool of securitised assets is known at all times, a firm may look through to the risk weighting of the pool and apply a weighted average risk weight by multiplying the risk weight of the underlying assets by a concentration ratio equal to the nominal amount of all tranches in the structure divided by the nominal amount of all tranches junior to or pari passu with the tranche in which the firm has a holding. 17 In broad terms, compared to the regime under Basle I, the effect of the standardised approach is to provide a more sensitive (and more favourable) credit risk framework for the holding of rated securitisation positions (although less sensitive than that under the IRB approach), while penalising unrated securitisation positions by requiring deductions in respect of unrated exposures, subject to certain limited concessions for certain (limited) eligible liquidity facilities and cash advance facilities. Firms using the IRB approach to determine capital requirements for securitisation exposures 18 are required to do so using (a) for rated positions (or where a rating may be inferred), a ratings based approach (RB approach) (similar to the standardised approach, although RB approach charges are generally lower and contemplate greater differentiation between certain positions) 19 or (b) for unrated positions, a supervisory formula approach (SF approach) (using a specified formula based on the relevant structure and underlying assets). 20 For further details on the risk weights applied under the RB approach, see Table 2 in the Appendix. If the IRB approach is used, then the capital requirement in respect of any securitisation exposure is capped at the requirement that would have applied in respect of the underlying assets/exposures had they not been securitised, where known. 21 In certain respects, the approaches are applied differently between different kinds of exposures (and accordingly, different parties). Please see Table 1 in the Appendix for a summary of the approaches under the securitisation framework, which apply as between originators and investing banks except as indicated. As noted above, under the RB approach, securitisations with underlying pools which are non-granular (ie which have six or fewer underlying obligors) attract higher risk weightings. Early amortisation provisions in securitisations of revolving exposures Originators of securitisations of revolving exposures subject to early amortisation provisions are subject to additional capital requirements where early amortisation may be triggered other than for non-economic reasons (such as material changes in tax laws or regulations). 22 An originator of such a securitisation is required to hold additional capital against its exposure to the investors' interest in the structure (weighting the exposure on the basis of the weighting applicable to If an institution uses the standardised approach for credit risk of the types of exposures securitised, then it must also use the standardised approach for its securitisation exposures. BIPRU R and BIPRU R to R. BIPRU R to R and R. BIPRU R and R. BIPRU R. If the institution has received approval for the use of the IRB approach for credit risk of the types of exposures securitised, then it must also use the IRB approach for its securitisation exposures. Conversely, an institution may not use the IRB approach for securitisation exposures unless it has received the approval referred to above. If the institution is using both the IRB approach and the standardised approach, then it should use the approach used with respect to the greater share (although the supervisor may deviate from this rule to ensure appropriate capital levels). BIPRU R. BIPRU R. Certain other approaches are available in limited circumstances. For example, if the relevant exposure is an eligible liquidity facility and it is not practical for the institution to use the SF approach, subject to supervisory consent, an approach based on the standardised approach for eligible liquidity facilities (as per BIPRU G). In addition, if the exposure relates to an ABCP programme and certain conditions are met (including if the firm's IRB permission allows it), then an internal assessment approach (IA approach) (using an internal risk management system) may be used (BIPRU R). BIPRU G provides that, if both the IA approach and SF approaches are available, then a firm may use either but it must use that approach consistently. BIPRU R. A similar cap applies under the standardised approach in cases where the relevant institution is subject to early amortisation treatment (because the relevant off-balance sheet exposure contains an early amortisation feature and involves receivables of a revolving nature, eg credit cards). BIPRU R and BIPRU R. Allen & Overy

9 the securitised exposures), multiplied by a CCF. The CCF is determined by the nature of the amortisation (a "controlled" amortisation generally receiving a lower CCF than an "uncontrolled" amortisation), and the nature of the securitised exposures (differentiating retail and non-retail securitised exposures, and committed and non-committed securitised exposures). In summary, however, committed credit lines and uncommitted non-retail credit lines receive a CCF of 90% (controlled) or 100% (uncontrolled). 23 Retail credit lines receive a staggered CCF (ranging from 0% to 40% for controlled early amortisation securitisations, and 0% to 100% for uncontrolled early amortisation securitisations). 24 Accordingly, securitisations of revolving retail credits with provision for early amortisation will require careful modelling in respect of excess spread early amortisation triggers to mitigate the regulatory capital impact on the originator. MARKET DISCIPLINE REQUIREMENTS The market discipline requirements under the CRD aim to encourage market discipline by developing a set of general disclosure requirements for firms. Under the UK rules, disclosure of certain information relating to a firm's capital, risk exposures and risk assessment processes is required. Most UK firms will be required to make their first disclosures under the UK rules in 2008 (as the requirements turn on calculation of CRD capital requirements) and there is some speculation that such disclosures may improve market transparency generally. RELATED AREAS See Regulatory Capital Briefing 5 (Funded Credit Risk Mitigation in the Banking Book), Regulatory Capital Briefing 6 (Unfunded Credit Risk Mitigation in the Banking Book: Guarantees and Credit Derivatives) and Regulatory Capital Briefing 8 (Trading Book) BIPRU R and BIPRU R. BIPRU R to R. Allen & Overy

10 CONTACT INFORMATION For further information please speak to: Bob Penn Partner Damian Carolan Partner Paul Phillips Partner Irina Molostova Associate Charlotte Phipps Business Development Co-ordinator or your usual Allen & Overy contact. Allen & Overy

11 APPENDIX TABLE 1 APPROACHES UNDER THE SECURITISATION FRAMEWORK 25 Credit assessment of position Standardised approach IRB approach Rated 26 Prescribed risk weights (RWs) Long-term ratings: AAA to AA- 20%, A+ to A- 50%, BBB+ to BBB- 100%, BB+ to BB- 350% (deduction for originators), B+ and below: Deduction Short-term ratings: A-1/P-1 20%, A-2/P-2 50%, A-3/P-3 100%, all other short-term ratings: Deduction Ratings based approach, prescribed RWs (see Table 2 below) 27 Max. capital requirement: K IRB 28 (if known) Unrated Most positions: Deduction Limited exceptions for (i) most senior exposure and (ii) eligible liquidity facilities Supervisory formula approach 29 Max. capital requirement: K IRB (if known) This table reflects the position applicable for both originators and investing banks, except where differences are noted. Under the standardised approach, the term "rated" refers to positions with an external rating only; under the IRB approach, an inferred rating may also be used. BIPRU R to R. BIPRU R and in accordance with Part 1 of Annex IX of the recast BCD, this is 8% of the risk weighted exposure amounts that would be calculated under the IRB approach in respect of the securitised exposures, had they not been securitised, plus the amount of expected losses associated with those exposures calculated under the IRB approach. If K IRB is unknown, then all positions must be deducted. Allen & Overy

12 TABLE 2 RB APPROACH RISK WEIGHTS 30 Credit assessment of position Senior positions 31 Base case 32 Tranches backed by non-granular pools 33 AAA / A-1 / P-1 [6 / 7]% 12% 20% AA 8% 15% 25% A+ 10% 18% 35% A / A-2 / P-2 12% 20% 35% A- 20% 35% 35% BBB+ 35% 50% 50% BBB / A-3 / P-3 60% 75% 75% BBB- All positions 100% BB+ All positions 250% BB All positions 425% BB- All positions 650% Below BB- / all other ratings / unrated All positions: Deduction Based on BIPRU R and R. Long-term and, where relevant, short-term ratings are indicated. Under the IRB approach, the term "rated" includes an external rating or an inferred rating. The risk weights set out in this column should be used if the effective number of underlying exposures is six or more and the position is senior (see BIPRU R to R for further information as to what constitutes "senior" for these purposes). The risk weights set out in this column should be used if the risk weights for senior positions and tranches backed by non-granular pools do not apply (BIPRU R). The risk weights set out in this column should be used if the number of underlying exposures is fewer than six (BIPRU R). Allen & Overy

13 NOTES Allen & Overy

14