The European Commission has released its long awaited and landmark report on securitisation this week. The report outlines a set of proposals on securitisation and follows growing calls over the last two years from the highest levels of EU decision making to resurrect the European securitisation market as part of plans for a capital markets union that will channel financing into investment in the real economy.
Overall, the report has been welcomed by the industry for the introduction of a risk sensitive floor and an STS label for unfunded synthetic securitisations. However, the introduction of a ‘’resilient’’ label is expected to lead to thicker and more expensive tranches for synthetic securitisations, while controversial eligibility criteria for unfunded STS from an earlier draft that was leaked last month remain in place.
According to the Commission report that was released this week, unfunded credit protection can be eligible for the STS label if accompanied by requirements related to diversification, solvency, risk measurement, and minimum size of the protection provider.
First, when it comes to risk measurement, the insurance or reinsurance undertaking should use an approved internal model to calculate capital requirements for such credit protection agreements.
Second, on solvency, the insurance or reinsurance undertaking should comply with the Solvency Capital Requirements and Minimum Capital Requirements referred to in Articles 100 and 128 of Directive 2009/138/EC, respectively, and should have been assigned to credit quality step 3 or better.
Third, when it comes to diversification, the insurance or reinsurance undertaking should effectively operate business activities in at least two classes of non-life insurance, which should reduce overexposure to any single risk type.
Finally, when it comes to minimum size, the insurance or reinsurance undertaking should have total assets above Є20bn.
Another important development is on the risk weight floors. Risk weight floors are minimum risk weights that credit institutions issuing and investing in securitisations must apply to their securitisation exposures, even if the capital requirement calculations under SEC-SA and SEC-IRBA approaches suggest a lower risk weight.
The report reiterates what market participants have been saying for some time, namely, that the current framework is quite risk-insensitive, since it only allows for two fixed risk weight floors for senior positions. First, a 10% risk weight floor for the exposure to a senior position of an STS trade. Second, a 15% risk weight floor for the exposure to a senior position of non-STS transactions.
Hence, the proposal introduces the new concept of a risk-sensitive risk weight floor, where the risk weight floors for senior securitisation positions are proportionate to the riskiness or average risk weights of the underlying pool of exposures. However, not all asset classes benefit from these changes.
Jo Goulbourne Ranero, consultant at A&O Shearman notes: ‘’the Commission’s risk weight floor and ‘p factor’ proposals are bold if complex. Overall, they should increase prudential risk sensitivity and reduce unjustified non-neutrality. The risk sensitivity of the risk weight floor favours lower risk weight asset classes, notably facilitating residential real estate SRT.’’
The risk sensitivity of the risk weight floor favours lower risk weight asset classes, notably facilitating residential real estate SRT which it will make sense to draft in a synthetic format where the desire to avoid crystallising accounting losses through true sale-as well as speed and cost efficiencies-outweigh the leverage ratio and funding benefits associated with traditional SRT.
On the other hand, ‘’higher risk weight asset classes lose out under the floor with potentially significant risk weight floor increases for asset classes such as leveraged lending and pre-operational project finance, where the underlying asset risk weight is over 100%” says Ranero.
The Commission report builds on the proposals in the 2022 Joint Committee advice on the review of the securitisation prudential framework and introduces therefore a new concept of ‘’resilient’’ securitisation positions. The resilient securitisation positions are senior positions in securitisations which satisfy a set of eligibility criteria that ensure low agency and model risk and a robust loss absorbing capacity for the senior positions.
Indeed, the label consists of various eligibility criteria but the one that has caught the attention of industry participants is the minimum credit enhancement that aims to ensure that sufficiently thick non-senior positions can cushion the senior tranche against potential losses.
A specific formula is introduced for calculating the minimum attachment point of the senior position under the SEC-IRBA approach. The formula for calculating the minimum attachment point under the SEC-IRBA approach uses the weighted average life (WAL) of the initial reference portfolio as one of the inputs. For SEC-SA, the minimum attachment point of the senior position is simply set at 1.5 times pool capital.
The ‘’resilient’’ label wouldn’t cause any complications from the perspective of industry participants and it was something that was expected with the introduction of more risk sensitivity into the securitisation framework. However, the requirement for a higher attachment point for the senior tranche would require certain structural changes.
Georges Duponcheele, senior credit portfolio manager at Munich RE explains: ‘’if you reduce the risk weight floor you have to make assumptions about the granularity and assumptions about the structure where the senior is paid first. Pro-rata structures don’t work like this so you need a switch from pro-rata to sequential amortization.’’
He continues: ‘’in terms of calibration, when you make it risk sensitive, then the securitisation has to have a higher attachment point for the senior tranche to achieve minimum risk weight. The higher attachment point isn’t an issue but the fact that it will have to be determined on an ongoing basis is a challenge. The solution in this case would be an upper mezzanine that would be a large enough buffer to absorb the variation in underlying loan defaults.’’
Further industry participants have reiterated similar concerns and the higher CDS premiums that would have to be paid as a result of the thicker tranches, but banks will have to go through some number crunching to see if the resulting tranches will in fact get thicker.
Perhaps the biggest elephant in the room are the proposed changes in relation to the quantitative economic SRT tests. Effectively, the report is proposing the introduction of the PBA test which is a test whereby banks have to show that they have transferred the bulk of unexpected losses but it relies on unrealistic assumptions that make it hard to pass.
Ranero comments: ‘’the report proposes wholesale replacement of the current Level one first loss and mezzanine tests by the principles based approach (PBA) commensurateness test envisaged in the EBA SRT Report and no proposal to implement the commensurate risk transfer (CRT) test envisaged in the EBA SRT Report.’’
She continues: ‘’In contrast, the ECB’s current supervisory assessment and ‘fast track’ SRT pilot scheme, focus on the CRT test. It is to be hoped that the helpful and pragmatic positions reached by the ECB with supervised banks in the context of the CRT test-especially in relation to certain cashflow modelling requirements such as loss allocation assumptions and the required approach to time calls-are not lost as a result of the switch over to the PBA test and development of the tests in delegated regulation by the EBA.’’
The Commission report is broadly in line with the earlier draft that was leaked last month (see: Green light – 28/05/2025 | RTRA Intelligence Ltd). However, some changes were made to the latest document that has attracted the attention of industry participants.
Duponcheele notes: ‘’there was an item in the earlier draft regarding counter-guarantees that was cross-referencing insurers but because the layout of the items has changed in Article 26e(8), it is no longer in the published proposal. Counter-guarantees would allow new insurers to participate in unfunded STS, by building up expertise, since they would be counter-guaranteed by larger reinsurers that qualify under new item (aa).’’
He continues: ‘’This looks like a drafting issue with the relevant item (b) needing to cross-reference the new item (aa). It’s nothing major, but cross-referencing details matter since the various items need to be compatible with each other. Another change has been the requirement for an at least CQS3 as opposed to CQS2 rating. It’s not clear what this adds in terms of value since most insurers are already CQS2 or better.’’
Under this new stipulation insurers would need to continually qualify, so if the rating drops below investment grade the unfunded SRT wouldn’t qualify for STS.
Nevertheless, one notable continuity with the original draft is the fact that insurance firms should have total assets above Є20bn.
The operational problem with this threshold is that the subsidiaries of large insurance or reinsurance groups who are the actual counterparties in these trades aren’t able to invest under this condition since they simply don’t meet the threshold.
Hence, either this will mean costly and cumbersome reorganizations or lawmakers can just make some simple adjustments to the proposals by looking at the size of the parent company, otherwise unfunded STS will just not be possible (see: Downward trend – 12/06/2025 | RTRA Intelligence Ltd).
