Securitisation issuers could soon lose their ability to hedge mismatches between receivables and funding, as new European Commission proposals would require special purpose vehicles to centrally clear their derivatives and post margin against those swaps.
As part of a review of sweeping derivatives reforms under the European Markets Infrastructure Regulation, the EC intends to reclassify securitisation firms as financial counterparties. That would subject them to the swaps clearing obligations and uncleared margin rules, requiring millions of euros of collateral to be posted against their hedges, potentially strangling issuance in Europe’s €500bn-a-year securitisation market.
“Most securitisation companies will not be in a position to provide collateral,” said David Shearer, securitisation partner at Norton Rose Fulbright. “Many securitisations will either fail to comply due to lack of funds available to acquire collateral, or will need to avoid hedging altogether.”
Currently classified as non-financial counterparties, SPVs are exempt from clearing on derivatives used for direct hedging. The reclassification - subject to approval from the European Parliament and Council - would apply to securitisation special purpose entities, alternative investment funds registered under national law (including real estate and infrastructure funds) and central securities depositories, according to the EC proposal.
Market participants argue that SPVs created for securitisation purposes are not run as businesses and should not be treated in the same manner as other corporate entities.
“When you raise a securitisation, all the funds are used to acquire those receivables, so there is nothing left over to use to acquire collateral for the purposes of posting,” said Shearer. “The sorts of receivables that are securitised are generally not liquid and not capable of being posted in the way that you would normally collateralise a derivative.”
The proposal comes alongside plans to introduce a threshold that would exempt small financial firms from the clearing obligation.
While larger, programme issuers are likely to be affected, smaller SPVs currently in the NFC category (with interest rate swaps exposure below €3bn) could remain exempt, though all derivatives would count towards threshold calculations, compared with only speculative positions for non-financial counterparties.
Despite widespread implications, the proposal attempts to align Europe with the US, where securitisation vehicles are deemed financial counterparties under Dodd-Frank. It would also close a regulatory arbitrage opportunity that has seen some US banks move hedging activities to Europe in a bid to relieve the collateral burden.
“While the proposal takes some steps towards cross-border harmonisation, there are other ways in which that is not exactly the case,” said Matt Hoffman, director of global regulatory solutions at Chatham Financial.
“It’s clear that there are winners and losers within the end-user market in that certain elements of the proposal actually would increase the compliance obligations that certain entities will face.”
Market participants note that the US rules have little impact on domestic securitisations given the lack of currency mismatch between funding and loan assets, negating the need for derivatives hedges.
The proposals could put the brakes on a booming market for European collateralised loan obligations. Although issued as euro-denominated debt, a scarcity of assets means that CLO deals are backed by European leveraged loans dominated in a range of currencies. That requires the CLO to enter into derivatives to hedge the currency mismatch.
“If the CLO starts having to collateralise its position with the hedge banks, it’s uneconomical,” said Nigel Dickinson, derivatives and structured finance partner at Norton Rose Fulbright. “There aren’t enough euro-denominated leveraged loans out there to have CLOs buying only euro assets, so in the absence of an ability to hedge, the CLO market is likely to shrink considerably.”
One solution could see CLO issuers sell tranches of debt in a range of currencies to match the portfolio of loans, subject to investor appetite.
“When it comes to hedging assets, the rating agencies tend to prefer a derivative which can perfectly track the underlying loan to ensure there’s no mismatch,” said Dickinson.