STS self-certification? Barking up the wrong tree

Certification by a third party: the regulatory authorities could play a supervisory role in determining the criteria for a qualifying securitization and then appoint one or more independent bodies to issue certifications. The infrastructure Prime Collateralised Securities (PCS) already has in place for certifying compliance with PCS criteria could readily be adapted to the proposed criteria for qualifying securitization. But clearly the fact of not benefiting from this labelling certification or licensing system should not prevent other types of securitisations from continuing to be marketed and invested.

Self-certification: it seems to us that the measures recently taken by the AFG could be duplicated, adjusted or at least serve as a starting point to promote qualifying securitisations at the EU level. In December 2014, AFG established and made public its code of good conduct aiming at promoting a simple, transparent and sound securitisation …

The compliance with the AFG code of good conduct is subject to self-certification by the investment manager which is itself subject to supervision. We do not consider that a public entity or an independent private organization shall take responsibility for certifying such compliance. It would have the effect of shifting the responsibility to a third party while we believe that such responsibility shall remain, first, with the investment manager and then, second, with the investors (who are deemed sophisticated and therefore capable of challenging the self-certification).

In any case, to avoid “fire-sales” or other distortions of the market, transitional relief should be required for existing transactions. Finally, risk features should not be part of the compliance monitoring provided that they are not part of the Qualifying criteria under the principle based approach.

Given that relatively few of the criteria are issuer‐ or originator‐based, an issuance‐led approach to certification seems most appropriate. A number of bodies already exist to assign similar labels in the debt capital markets. To the extent that they are willing and able to administer the criteria for qualifying securitisations eventually decided upon, they are natural candidates to act as certifying bodies. Of these bodies, the PCS label is the only Europe‐wide securitisation label and resulted from the work undertaken from 2009 to 2012 involving a broad range of European market participants (arrangers, originators, investors and legal experts) led by EFR and AFME.

As such, and also because PCS has been designed to be responsive to the needs of issuers and investors in terms of giving certainty around the receipt of the label prior to pricing (as mentioned above), PCS is an obvious and strong candidate to act as a certifying body. True Sale International (TSI) and the Dutch Securitisation Association (DSA) are other securitisation labels but currently only have a national scope. The lead regulator should also play a supervisory role, reviewing the criteria regularly to adapt to market evolutions, ensuring that standards are applied uniformly and regulating the conduct of the certifying bodies generally.

Clarity, certainty and confidence might be given to investors that the eligibility criteria were being met via certification system. Public accountants, statutory auditors and legal counsels are well equipped to carry this task. Implementation of certification by public accountants/ auditors/ legal counsels neither requires additional infrastructure developments, nor puts significant additional cost pressure on investor.

The AMF believes that the STS certification should not be self-awarded. The certification of the STS status should be granted by a public authority, which is legitimate and powerful enough to withdraw the certification during the life of the securitisation if necessary.

Moreover, the AMF would like to emphasise the importance of a consistent interpretation of STS criteria in all EU members states, especially given the mobility of special purpose vehicles. In order to achieve such consistency, the certification will either have to be done directly by a European supervisory authority (ESA) or by National Competent Authorities. In the first case, where an ESA were to award the STS status, the day-to-day analysis of securitisation vehicles could be externalised to a private entity as long as the ESA retains responsibility and takes all key decisions.

In the second case, a certification by a National Competent Authority could be done together with approving the monitoring actor. Any solution would have implementing costs associated; nevertheless, it is worth pointing out that it is already very common for NCAs to grant authorisations on a day to day basis to both funds and fund managers.

We can understand concerns with a pure issuer self-certification process as regards implementation of the qualifying criteria – however, we do believe that this can be part of the process. We could also see a role for independent third parties – for example, an existing body such as Prime Collateralised Securities (PCS) – to be involved in the certification process (which should be done prior to closing).

Ultimately, we believe that issuer certification in the seller representations and warranties (whether or not it is verified by a specialist third party body) will be an investor’s most important point of ensuring that the transaction has [been] put together in compliance with the qualifying criteria. We would also expect to see a detailed outline of exactly how this has been achieved (e.g. details of product structure and governance, relationships with third parties, data availability).

We are of the view that originators are best-placed to understand the underlying assets in a securitisation pool and therefore to confirm that they do indeed meet the STS criteria, ideally using a standardised notification template. We therefore believe that a self-certification process would be the most appropriate and make the most sense.

The originator would ratify this in the issuance prospectus which would be subject to independent advisor review at the time it is finalised. The SST label would be disclosed on a centralised list that could be managed by an independent third party, perhaps an industry body or markets regulator. This independent third party would also be responsible for auditing, on a sample basis, originators’ procedures to ensure that they are properly implementing the STS securitisation criteria and notifying them to the centralised list.

Self-certification may be possible for certain criteria, but ultimately verification by an external party will be the best approach. Our main objection against self-certification is that it will be seen by investors, politicians and the public as a return of the bad habits that stigmatised the securitisation industry in the last 7 years. The external labelling party can be a government organisation or a private sector entity like PCS.

We would prefer a private sector solution, more or less comparable to the European Datawarehouse where the regulator has an effective mechanism to influence decision making, but the actual process is run in a cost effective and flexible way by a private enterprise. For the purpose of to influence decision making, but the actual process is run in a cost effective and flexible way by a private enterprise. For the purpose of labelling qualifying securitisations combining the governance of PCS with an EDW style enterprise would be the most efficient solution in our view.

… The priority aim of monitoring compliance with the eligibility criteria for high-quality securitisation is achieving legal certainty and avoiding potential liability risk should the criteria not be regarded as fulfilled in the eyes of, for example, supervisors. Legal certainty is the only means of building trust and restarting the securitisation markets.

The party entrusted with verifying/monitoring compliance should therefore be given the power to issue an opinion in this respect. As we see it, this job could be given to the industry or supervisors themselves. Should verification be carried out by the industry itself, this should be done by an independent party with no connection to the investor or originator. Already established certification companies such as TSI15 or PCS16 would be suitable, but new companies could also be set up.

Legal certainty would presuppose these companies being given the required powers to ensure that their opinion can be used for the relevant supervised sectors. Most legal certainty could of course be achieved if supervisors were to issue an opinion themselves. We have reservations about monitoring or verification by investors themselves. If they were required to perform those duties, this obligation might tend to have a dissuasive effect on potential investors. This would be at odds with the aim of broadening the investor base.

… certifications from supervisors and third parties should be avoided, as such certifications would obviate the need for both investors and the Securitising Party to retain responsibility for their role in the process … A process might comprise the following elements: implementation by the Securitising Party of processes to ensure the STS criteria are met; self-attestation by the Securitising Party of compliance with the criteria based on an appropriate level of assurance; and an appropriate degree of supervisory oversight of the Securitising Party by market regulators.

Originators/original lenders/sponsors of securitisations would be the parties most familiar with the assets underlying a securitisation, the servicing requirements and portfolios’ structural characteristics. Therefore, they would be best placed to establish the processes needed to ensure compliance with the STS criteria, supported by a sufficient level of assurance.

Self-attestation of compliance with the criteria would place the onus clearly on the Securitising Party to ensure they were met in practice. Those attestations would need to be disclosed clearly in offering documents for STS securitisations. To ensure the criteria were met, and to maintain market confidence in STS transactions, some degree of supervisory oversight would be needed. This could involve market regulators reviewing the Securitising Party’s processes for ensuring compliance with the criteria and sample transactions as well as developing appropriate sanctioning mechanisms.

… we would welcome the enforcement of independent (from the issuers) certificate or label providers that would ensure that the prospectus of the instruments duly reflects those elements … Clarity, certainty and confidence might be given to investors that the eligibility criteria were being met via a certification system. Private labelling initiatives (such as PCS), public accountants, statutory auditors and legal counsels are well equipped to carry this task.Implementation of certification by public accountants/ auditors/ legal counsels neither requires additional infrastructure developments, nor puts significant additional cost pressure on investor. We would also encourage the European Commission to force those “certificate providers” to review the prospectus of those securities on a regular basis (at least every two years) and to remove automatically and publicly the certificate, should the criteria ceased to be respected.

An important step to implement an efficient qualification process for the STS securitisations would be the existence of one or several independent “notified bodies” or agencies that would certify the qualifying instruments across the entire European Union. This would ensure a homogeneous interpretation and application of the EU criteria for qualifying instruments, across all European Union jurisdictions and over the life of each transaction.

Moreover the eligibility of the securitisation could be made available to the market as a whole, in a similar way to the list of ECB eligible assets on the ECB website, thus saving the originator and/or investors the time and effort in checking the eligibility themselves. The certification by an independent third party would also provide comfort to the regulator in terms of the quality, consistency and impartiality of the analysis. A situation of this kind exists between the ECB and the European DataWarehouse, which certifies the quality of the loan level data for all ECB eligible ABS.

Legal certainty is the only way to create trust, and to re-start the securitisation market. Against this background, the party entrusted with reviewing fulfilment of the criteria should have authority to make such a judgment – in our view, this might be the financial sector or the regulatory authorities themselves. In the case of a review by a financial sector, the party carrying out the review should be independent from the investor or originator. Established certification bodies such as TSI or PCS would be obvious choices for this task. As a prerequisite for legal certainty, corresponding authority would need to be transferred in order to ascertain that the respective judgement can be applied to the respective regulated sectors. As an alternative, a review might be conducted by an external auditor, who would issue an opinion certifying that the transaction is ‘qualifying’.

… a third party certification body might be the best way to certify qualifying securitisations; part of this certification might be the on-going compliance with the risk retention requirement … Self-certification is not sufficient to give investors confidence about compliance with the criteria. We believe that the best option for such a certification system would be a licensing requirement imposed by the national competent authority (i.e. the regulator). However, national regulators may find the need to certify and ensure on-going compliance with the criteria onerous. Therefore, a third party body may be considered, perhaps using the existing expertise and structures available in the Prime Collateralised Securities (PCS) or, in Germany, the True Sale Initiative (TSI) initiatives. In practical terms, we favour a process that is essentially a set of criteria that the certifying body would confirm with the issuer.

Sound underwriting practices – Prohibition of self-certification: Assets are only eligible for securitisation if their origination includes a complete verification of all obligor information relevant for the credit assessment, that is, excluding loans that were marketed and underwritten on the premise that the loan applicant and, where applicable, their intermediaries, were made aware that any information provided might not be verified by the lender (“self-certification”). If the securitised assets are residential loans or consumer credit (such as auto loans or leases, consumer loans or credit facilities), the creditworthiness of the borrowers must be assessed in accordance with the requirements as set out in Art. 14 Par. 1 and Par. 2(a) of the Mortgage Credit Directive (Directive 2014/17/EU) and Art. 8 Par. 1 Consumer Credit Directive (Directive 2008/48/EC), respectively. This requirement effectively excludes flawed securitization business models, relying on unsound underwriting practices.

… a self-certification process gives rise to potential conflicts of interest and would not give enough confidence to investors … Compliance with criteria that have a direct prudential impact should be checked and assessed by an independent, private or public body and could be rewarded by the granting of a label (similar to the label provided by the Prime Collateralised Securities (PCS) association or the TrueSale International certificate), which should become compulsory and delivered before any new issuance.

… it is essential that the certification process is trusted by the investor community, and that the “qualifying securitisation” label is not permitted simply to become a rubber stamping exercise … In the interests of market efficiency, the best approach to implementation may be to set up an independent certification body subject to supervision by both the EBA or ECB and a relevant national competent authority.

This certification body would apply standards set by central supervisory authorities such as the EBA or ECB. It will also be important to ensure that such a certification body is seen as only one element of the requirements for qualifying securitisation alongside other requirements … such as investor due diligence, that it does not address credit assessment issues and that it does not therefore become over-relied on by investors in the way that credit rating agencies were prior to the crisis …

Procedures for assigning certifications should presumably be put in place by the relevant certification authority, subject to appropriate supervisory oversight. In the interests of transparency and market certainty, these procedures should preferably be made public. We note in this respect that the Prime Collateralised Securities Association has already developed templates for a third party certification process, which could serve as a useful model. There are also bodies in Germany (True Sale International) and the Netherlands (the Dutch Securitisation Association), which carry out a similar function.

We see two possible avenues for the implementation and enforcement of the qualifying framework: 1) self-attestation by issuers; 2) certification by an independent non-profit party, not being a supervisory authority.

Having the originator check whether the securitisation complies with the qualifying criteria provides timely certification. Also it may not weaken the incentives for thorough due diligence by investors. In addition the administrative burden may be lower due to the fact that in-depth knowledge of the securitisation is already available at the originating party.

In this scenario, prudential supervisors could however still be responsible for verifying whether issuers have adequate internal processes and arrangements in place that would justify self-attestation …
Certification by an independent and non-profit third party could on the other hand increase market confidence in the qualifying framework. Putting the certification process in the hands of a single third party moreover prevents interpretation differences of the applicable criteria.

However, supervision of this independent party is necessary to ensure correct implementation of the qualifying framework. As both options have merits and drawbacks, we want to advocate further discussions with market parties and supervisors. In either scenario it will be important to make sure that investors themselves retain a large responsibility for verifying compliance with retention requirements and to continue engaging in proper due diligence.

This is key in order to minimise moral hazard risks. One way to ensure on-going enforcement of the qualifying criteria is to introduce a responsibility for the originator to report any significant change to the structure of the securitisation.

The Investment Association is opposed to a purely self-certification process is it may give rise to conflicts of interest and would not give sufficient confidence to investors. We appreciate that originators/sponsors are the best placed to attest that the securitisation is in compliance with the STS criteria as they would be the most familiar with the underlying assets, the servicing requirements and the portfolios’ structural characteristics.

Therefore, we propose that all originators/sponsors/original lenders should be required to state whether or not the securitisation is a STS as part of the listing process. Alternatively, certification for qualifying securitisations could be provided by an independent private entity. In the event that a securitisation is stated to be compliant with the STS criteria, this could be independently verified by a third party.

The third part could be: a regulator – therefore creating a framework similar to that for regulated covered bonds; a non-profit certification provider at European level that built upon existing national initiatives such as the True Sale International in Germany and the Dutch Securitisation Association; or an independent auditor.