II. Clarifications
A. Securitisation
6.The Standards defines a securitisation as a contractual structure under which the cash flow from an underlying pool of exposures is used to service claims with at least two different stratified risk positions or tranches reflecting different degrees of credit risk. The creation of distinct tranches is the key feature of securitisation; similar structures that merely “pass through” the cash flows to the claims without modification are not considered securitisations.
7.For securitisation exposures, 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. The stratified/tranched structures that characterize securitisations differ from ordinary senior/subordinated debt instruments in that junior securitisation tranches can absorb losses without interrupting contractual payments to more senior tranches, whereas subordination in a senior/subordinated debt structure is a matter of priority of rights to the proceeds of a liquidation.
8.In some cases, transactions that have some of the features of securitisations should not be treated as such for capital purposes. For example, transactions involving cash flows from real estate (e.g., in the form of rents) may be considered specialized lending exposures. Banks should consult with Central Bank when there is uncertainty about whether a given transaction should be considered a securitisation.
B. Senior Securitisation Exposures
9.A securitisation exposure is considered a senior exposure if it is effectively backed or secured by a first claim on the entire amount of the assets in the underlying securitised pool.
10.While this generally includes only the most senior position within a securitisation tranche, in some instances there may be other claims that, in a technical sense, may be more senior in the waterfall (e.g., a swap claim) but may be disregarded for the purpose of determining which positions are treated as senior.
11.If a senior tranche is retranched or partially hedged (i.e., not on a pro rata basis), only the new senior part would be treated as senior for capital purposes.
12.In some cases, several senior tranches of different maturities may share pro rata in loss allocation. In that case, the seniority of these tranches is unaffected – they all are considered to be senior – since they all benefit from the same level of credit enhancement. (Note that in this case, the material effects of differing tranche maturities are captured by maturity adjustments to the risk weights assigned to the securitisation exposures, per the Standards.)
13.In a traditional securitisation where all tranches above the first-loss piece are rated, the most highly rated position should be treated as a senior tranche. When there are several tranches that share the same rating, only the most senior tranche in the cash flow waterfall should be treated as senior (unless the only difference among them is the effective maturity). In addition, when the different ratings of several senior tranches only result from a difference in maturity, all of these tranches should be treated as senior.
14.In a typical synthetic securitisation, an unrated tranche can be treated as a senior tranche provided that all of the conditions for inferring a rating from a lower tranche that meets the definition of a senior tranche are fulfilled.
15.Usually, a liquidity facility supporting an ABCP program would not be the most senior position within the program; instead, the commercial paper issued by the program, which benefits from the liquidity support, typically would be the most senior position. However, when a liquidity facility that is sized to cover all of the outstanding commercial paper and other senior debt supported by the pool is structured so that no cash flows from the underlying pool can be transferred to other creditors until any liquidity draws are repaid in full, the liquidity facility can be treated as a senior exposure. Otherwise, if these conditions are not satisfied, or if for other reasons the liquidity facility constitutes a mezzanine position in economic substance rather than a senior position in the underlying pool, the liquidity facility should be treated as a non-senior exposure.
C. Operational Requirements for the Recognition of Risk Transference
16.The Standards requires that banks obtain a legal opinion to confirm true sale to demonstrate that the transferor does not maintain effective or indirect control over the transferred exposures and that the exposures are legally isolated from the transferor in such a way (e.g., through the sale of assets or through sub-participation) that the exposures are put beyond the reach of the transferor and its creditors, even in bankruptcy or receivership. However, that legal opinion need not be limited to legal advice from qualified external legal counsel; it may be in the form of written advice from in-house lawyers.
17.For synthetic securitisations, risk transference through instruments such as credit derivatives may be recognized only if the instruments used to transfer credit risk do not contain terms or conditions that limit the amount of credit risk transferred. Examples of terms or conditions that would violate this requirement include the following:
- (a)Clauses that materially limit the credit protection or credit risk transference, such as an early amortization provision in a securitisation of revolving credit facilities that effectively subordinates the bank’s interest, significant materiality thresholds below which credit protection is deemed not to be triggered even if a credit event occurs, or clauses that allow for the termination of the protection due to deterioration in the credit quality of the underlying exposures.
- (b)Clauses that require the originating bank to alter the underlying exposures to improve the pool’s average credit quality.
- (c)Clauses that increase the bank’s cost of credit protection in response to deterioration in the pool’s quality.
- (d)Clauses that increase the yield payable to parties other than the originating bank, such as investors and third-party providers of credit enhancements, in response to a deterioration in the credit quality of the reference pool.
- (e)Clauses that provide for increases in a retained first-loss position or credit enhancement provided by the originating bank after the transaction’s inception.
D. Due Diligence
18.The Standards requires banks to have a thorough understanding of all structural features of a securitisation transaction that would materially affect the performance of the bank’s exposures to the transaction. Common structural features that are particularly relevant include those related to the payment waterfall incorporated in the structure, which is the description of the order of payment for the securitisation, under which higher-tier tranches receive principal and interest first, before lower-tier tranches are paid. Credit enhancements and liquidity enhancements also are important structural features; these may take the form of cash advance facilities, letters of credit, guarantees, or credit derivatives, among others. Effective due diligence also should consider unusual or unique aspects of a particular securitisation structure, such as the specific nature of the conditions that would constitute default under the structure.
E. Treatment of Securitisation Exposures
1. Risk Weights for Off-Balance-Sheet Exposures
19.The Standards requires that banks apply a 100% CCF to any securitisation-related off-balance-sheet exposures that are not credit risk mitigants. One example of such an off-balance-sheet exposure that may arise with securitisations is a commitment for servicer cash advances, under which a servicer enters into a contract to advance cash to ensure an uninterrupted flow of payments to investors. The BCBS securitisation framework provides national discretion to permit the undrawn portion of servicer cash advances that are unconditionally cancellable without prior notice to receive the CCF for unconditionally cancellable. The Central Bank has chosen not to adopt this discretionary treatment, and instead requires a 100% CCF for all off-balance-sheet exposures, including undrawn servicer cash advances.
2. Adjustment of Risk-Weights for Overlapping Exposures
20.Banks may adjust risk weights for overlapping exposures. An exposure A overlaps another exposure B if in all circumstances the bank can avoid any loss on exposure B by fulfilling its obligations with respect to exposure A. For example, if a bank holds notes as an investor but provides full credit support to those notes, its full credit support obligation precludes any loss from its exposure to the notes. If a bank can verify that fulfilling its obligations with respect to exposure A will preclude a loss from its exposure to B under any circumstance, the bank does not need to calculate risk-weighted assets for its exposure B.
21.To demonstrate an overlap, a bank may, for the purposes of calculating capital requirements, split or expand its exposures. That is, splitting exposures into portions that overlap with another exposure held by the bank and other portions that do not overlap, or expanding exposures by assuming for capital purposes that obligations with respect to one of the overlapping exposures are larger than those established contractually. The latter could be done, for instance, by expanding either the assumed extent of the obligation, or the trigger events to exercise the facility. A bank may also recognize overlap between exposures in the trading book and securitisation exposures in the banking book, provided that the bank is able to calculate and compare the capital charges for the relevant exposures.
3. External Ratings-Based Approach (SEC-ERBA)
22.To be eligible for use in the securitisation framework, the external credit assessment must take into account and reflect the entire amount of credit risk exposure the bank has with regard to all payments owed to it. For example, if a bank is owed both principal and interest, the assessment must fully take into account and reflect the credit risk associated with timely repayment of both principal and interest.
23.A bank is not permitted to use any external credit assessment for risk-weighting purposes where the assessment is at least partly based on unfunded support provided by the bank itself. For example, if a bank buys ABCP where it provides an unfunded securitisation exposure extended to the ABCP program (e.g., liquidity facility or credit enhancement), and that exposure plays a role in determining the credit assessment on the ABCP, the bank must treat the ABCP as if it were not rated. The bank also must hold capital against the liquidity facility and/or credit enhancement as a securitisation exposure.
24.External credit assessments used for the SEC-ERBA must be from an eligible external credit assessment institution (ECAI) as recognized by the Central Bank in accordance with the Central Bank standards on rating agency recognition. However, the securitisation Standards additionally requires that the credit assessment, procedures, methodologies, assumptions and the key elements underlying the assessments must be publicly available, on a non-selective basis and free of charge. Consequently, ratings that are made available only to the parties to a transaction do not satisfy this requirement. Where the eligible credit assessment is not publicly available free of charge, the ECAI should provide an adequate justification, within its own publicly available code of conduct, in accordance with the “comply or explain” nature of the International Organization of Securities Commissions’ Code of Conduct Fundamentals for Credit Rating Agencies.
25.Under the Standards, a bank may infer a rating for an unrated position from an externally rated “reference exposure” for purposes of the SEC-ERBA provided that the reference securitisation exposure ranks pari passu or is subordinate in all respects to the unrated securitisation exposure. Credit enhancements, if any, must be taken into account when assessing the relative subordination of the unrated exposure and the reference securitisation exposure. For example, if the reference securitisation exposure benefits from any third-party guarantees or other credit enhancements that are not available to the unrated exposure, then the latter may not be assigned an inferred rating based on the reference securitisation exposure.
4. Standardised Approach (SEC-SA)
26.The supervisory formula used for the calculations within the SEC-SA has been calibrated by the BCBS to generate required capital under an assumed minimum 8% risk-based capital ratio. As a result, the appropriate conversion to risk-weighted assets for the SEC-SA generally requires multiplication of the computed capital ratio by a factor of 12.5 (the reciprocal of 8%) to produce the risk weight used within broader calculations of risk-based capital adequacy. This multiplication by 12.5 is reflected in the requirements as articulated in the Central Bank’s Securitisation Standards.
27.If the underlying pool of exposures receives a risk weight of 1250%, then paragraph 5 of the Introduction of the Standards for Capital Adequacy of banks in the UAE is applicable.
28.When applying the supervisory formula for the SEC-SA to structures involving an SPE, all of the SPE’s exposures related to the securitisation are to be treated as exposures in the pool. In particular, in the case of swaps other than credit derivatives, the exposure should include the positive current market value times the risk weight of the swap provider. However, under the Standards, a bank can exclude the exposures of the SPE from the pool for capital calculation purposes if the bank can demonstrate that the risk does not affect its particular securitisation exposure or that the risk is immaterial, for example because it has been mitigated. Certain market practices may eliminate or at least significantly reduce the potential risk from a default of a swap provider. Examples of such features could be:
- •cash collateralization of the market value in combination with an agreement of prompt additional payments in case of an increase of the market value of the swap; or
- •minimum credit quality of the swap provider with the obligation to post collateral or present an alternative swap provider without any costs for the SPE in the event of a credit deterioration on the part of the original swap provider.
If the bank is able to demonstrate that the risk is mitigated in this way, and that the exposures do not contribute materially to the risks faced by the bank as a holder of the securitisation exposure, the bank may exclude these exposures from the KSA calculation.
F. Treatment of Credit Risk Mitigation for Securitisation Exposures
1. Tranched Protection
29.In the case of tranched credit protection, the original securitisation tranche should be decomposed into protected and unprotected sub-tranches. However, this decomposition is a theoretical construction, and should not be viewed as creating a new securitisation transaction. Similarly, the resulting sub- tranches should not be considered resecuritisations solely due to the presence of the credit protection.
30.For a bank using the SEC-ERBA for the original securitisation exposure, the bank should use the risk weight of the original securitisation for the sub-tranche of highest priority. Note that the term “sub-tranche of highest priority” only describes the relative priority of the decomposed tranche. The calculation of the risk weight of each sub-tranche is independent from the question of whether the sub-tranche is protected (i.e., risk is taken by the protection provider) or is unprotected (i.e., risk is taken by the protection buyer).
2. Maturity Mismatches
31.For synthetic securitisations, maturity mismatches may arise when protection is bought on securitised assets (when, for example, a bank uses credit derivatives to transfer part or all of the credit risk of a specific pool of assets to third parties). When the credit derivatives unwind, the transaction will terminate. This implies that the effective maturity of all the tranches of the synthetic securitisation may differ from that of the underlying exposures.
G. Simple, Transparent, and Comparable Criteria
32.In general, to qualify for treatment as simple, transparent, and comparable (STC), a securitisation must meet all of the criteria specified in the Standards, including the Appendix to the Standards. The criteria include a requirement that the aggregated value of all exposures to a single obligor as of the acquisition date not exceed 2% of the aggregated outstanding exposure value of all exposures in the securitisation. However, the BCBS has permitted flexibility for jurisdictions with structurally concentrated corporate loan markets. In those cases, for corporate exposures only, the applicable maximum concentration threshold for STC treatment can be increased to 3%. This increase is subject to ex ante supervisory approval, and banks with such exposures should consult with the Central Bank regarding STC treatment. In addition, the seller or sponsor of such a pool must retain subordinated positions that provide loss-absorbing credit enhancement covering at least the first 10% of losses. These credit-enhancing positions retained by the sellers or sponsor are not eligible for STC capital treatment.