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Produced for LexisPSL Banking & Finance and in partnershipwith Alexander Collins and Nick Shiren ofCadwalader, Wickersham & Taft LLP

This Practice Note describes the position as at January 2021

The risk retention requirement currently applicable in the EUand the UK consists of obligations on:

This is explained in more detail below.

The objective of the risk retention requirement is to create analignment of interests between those of the suppliers of asecuritisation, ie sponsors, originators and original lenders, andthose of investors. It is sometimes referred to as the requirementfor 'skin-in-the-game'.

The introduction of the risk retention requirement reflected thecriticism of the securitisation markets following the globalfinancial crisis. There was widespread concern about the'originate to distribute' model in which banks did not holdthe loans that they originated, but repackaged and securitisedthem. It was thought by global policymakers that some of theparticipants in the securitisation chain were incentivised toengage in behaviour which, while furthering their own interests,was not in the interests of others in the securitisation chain orof the broader market. In the 'originate to distribute'model lenders did not have an incentive to apply stringent creditgranting standards, since they knew that the related risks wouldeventually be sold to third parties. A consequence of thesemisaligned incentives or conflicts of interest led to a weakeningof due diligence along the securitisation chain. This resulted inpoorly-underwritten assets being securitised by originators andthose securities being bought by investors who did not alwaysunderstand the extent of the risks that they were acquiring. TheG20 Leaders' statement from the 2009 Pittsburgh Summittherefore recommended that securitisation 'sponsors ororiginators should retain a part of the risk of the underlyingassets, thus encouraging them to act prudently'.

A 5% risk retention requirement was first introduced in the EU(including, at the time, the UK) by way of the Capital RequirementsDirective II to new securitisations issued on or after 1 January2011. These provisions were superseded by an equivalent requirementin the Capital Requirements Regulation (EU) No 575/2013 (EU CRR) andsimilar to those in the EU CRR, in the Solvency II regime inrelation to insurers and in the Alternative Investment FundManagers Directive (AIFMD) regime in relation to certainalternative fund managers.

Commission Delegated Regulation (EU) No 625/2014 (the CRR RiskRetention RTS) supplements and provides further detail in respectof the risk retention requirement in the EU CRR by way ofregulatory technical standards including providing further detailon the modes of risk retention, the fulfilment of the retentionrequirement through a synthetic or contingent form (eg a totalreturn swap (TRS)), and on multiple originators, original lenders,or sponsors.

The European Commission (EC), following review of the variousrequirements applicable to EU securitisations, published Regulation (EU) 2017/2402 on 28 December 2017(the EU Securitisation Regulation) and an accompanying Regulationamending the EU CRR (the EU CRR Amendment Regulation). Theseregulations entered into force on 17 January 2018, superseding theEU CRR, Solvency II and AIFMD risk retention requirements, largelycombining requirements applicable to EU investors and creating newrequirements in respect of originators, sponsors or originallenders of EU securitisations, and applicable to securitisations,the securities of which are issued (or where no securities areissued, the securitisation positions of which are created) on orafter the application date of 1 January 2019.

Article 6(7) of the EU Securitisation Regulation requires theEuropean Banking Authority (EBA) to develop draft regulatorytechnical standards (Securitisation Regulation RTS) to specify ingreater detail the risk retention requirement including themodalities of retaining risk, the measurement of the level ofretention, the prohibition of hedging or selling the retainedinterest and the conditions for retention on a consolidated basis.On 31 July 2018, a final draft of the Securitisation Regulation RTSwas published by the EBA. However, the draft SecuritisationRegulation RTS have not yet been adopted by the EC. Thetransitional provisions of the EU Securitisation Regulation providethat until the draft Securitisation Regulation RTS apply,originators, sponsors or the original lender shall apply ChaptersI, II and III and Article 22 of the CRR Risk Retention RTS tosecuritisations the securities of which are issued on or after 1January 2019.

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Reprinted from: LexisNexis |March 24, 2021

The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circumstances.

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