Guiding principles (with examples) of Eurosystem-preferred eligible ABSs

6 July 2015

Eurosystem purchases of eligible asset-backed securities under the ABS Purchase Programme (ABSPP) have been ongoing since November 2014. As part of the pre-purchase process, the Eurosystem conducts intensive due diligence on proposed transactions prior to purchase, with a view to safeguarding the Eurosystem's balance sheet.

Taking into account the experience gained since November 2014, the current status of wider regulatory discussions, and the potential benefits of providing greater clarity to potential market participants on the ABSPP's preferences, the Eurosystem has developed the following set of high-level, non-binding, and non-exhaustive guiding principles.

These guiding principles should be interpreted as distinct from the ongoing work on simple and transparent securitisation criteria (which the ECB continues to support). In contrast to those criteria, the guiding principles are designed solely in order to illustrate the Eurosystem's preferences in relation to the ABSs that it considers for purchase in the context of the ABSPP.

The extent to which the guiding principles are complied with will be taken into consideration particularly when assessing and pricing newly-issued ABSs for purchase.

These principles are not listed in order of importance and the relevance of each principle is weighted in the context of each unique ABS.

At the same time, these principles are not intended to serve as eligibility criteria like those set out in Decision ECB/2014/45 (furthermore, these are guidelines and should not be construed as "pre-issuance advice"). In addition, they are not in any way intended to exclude for consideration for purchase any ABS meeting Decision ECB/2014/45's eligibility criteria. They also do not signal a change in the objectives of the ABSPP generally. Indeed, the Eurosystem recognises that both existing and newly-issued ABSs may not fulfil one or more of the principles below, and the Eurosystem will continue to consider such ABSs for purchase, subject to their satisfaction of the eligibility criteria set out in Decision ECB/2014/45 and subject to the Eurosystem's credit risk assessment and due diligence in relation to such ABS. Equally, the Eurosystem still retains discretion to consider ABSs for purchase (i.e. not automatically accept them), even though all principles may be met.

1. The collateral should be a diversified pool of granular and performing assets.

Examples of this principle include:

  • At the time of inclusion in the securitisation, a loan should not be in dispute, default, or unlikely to pay. The borrower associated with the loan should not be deemed credit-impaired (as defined in IAS 36).
  • Where applicable, only a small share of the loan pool is constituted of second-lien loans whose first lien is not included in the pool.
  • The pool should be exhibiting good performance in terms of delinquencies and defaults relative to credit enhancement.
  • Where appropriate, the overall pool should show a significant degree of diversification and granularity.
  • For SME and Leasing ABSs, at issuance, the majority of a portfolio is not concentrated in a single industry.

2. The underlying exposures are originated according to sound underwriting criteria.

Examples of this principle include:

  • Any underlying exposures should be originated in the course of the originator's ordinary business and in accordance with sound and prudent credit granting criteria as required under Article 79 of the CRDIV and Article 408 of the CRR.
  • Such criteria should include at least an assessment of the borrower's creditworthiness in accordance with paragraphs 1 to 4, 5(a) and 6 of Article 18 of Directive 2014/17/EU or Article 8 of Directive 2008/48/EC, to the extent such standards would, according to their terms, in any case apply to the individual underlying exposures.
  • Only a small proportion of the pool contains loans to unemployed borrowers at the closing of the transaction.
  • For RMBSs, the percentage of the pool composed of interest-only or otherwise 'bullet' loans does not substantially deviate negatively from the norm for that jurisdiction, unless appropriate safeguards (such as guarantees or other repayment vehicles) exist.
  • For RMBSs, the weighted average original loan-to-income ratio and original loan-to-value ratio of the pool does not substantially deviate negatively from the norm for that jurisdiction.

3. The transaction structure is straightforward and robust.

Examples of this principle include:

  • The pool is static – there are no revolving arrangements or 'ramp-up' arrangements unless the underlying collateral is short-term in nature (e.g. credit cards). In the latter case, the transaction documentation contains clearly-defined criteria to prevent a deterioration of the quality of the pool as a result of any substitutions or additions.
  • The pre-enforcement priority of payments as well as the post-enforcement priority of payments is sequential. For currently-outstanding transactions that do not meet this example, there are clearly defined triggers for any potential changes to the waterfall structure or for the calculation of any amounts due thereunder, if any, ensuring investors can accurately forecast expected changes and model the expected cash flows. The transaction documentation also contains a clearly-defined trigger allowing for a switch back to sequential payment in case of deterioration of performance, ensuring that the senior tranche(s) benefits from the highest possible level of protection.
  • Credit enhancement on the senior class of notes (i.e. tranche) is sufficient to withstand a severe (i.e. a 'worst-case' equivalent) stress scenario.
  • Any performance and rating triggers are clearly disclosed in the transaction documentation and, provisions are in place for swift remedy of any breaches.
  • Ideally, there exist clearly-defined mechanisms to trap other available funds (e.g. excess spread or amortising reserve fund) for the benefit of senior noteholders, though preferably credit enhancement should be achieved via more static features (e.g. a funded cash reserve fund).
  • Trustees', or persons exercising an analogous role, responsibilities are clearly defined, and trustees are obliged to act in the interests of the noteholders.
  • If there is an option for the issuer or originator to call the transaction prior to maturity, the Eurosystem prefers transactions where such call option is structured in line with best market practice and it does not negatively affect the riskiness of the transaction.
  • Ideally, the terms and conditions of the notes provide that the originator's note holdings are not taken into account for the purposes of establishing a quorum, a majority for note holder meetings, or for resolutions on matters such as the termination and replacement of the servicer.

4. The originator is in good financial health and has ideally demonstrated (or intends to have) a regular presence in the ABS markets. The interests of originators and investors should be clearly-aligned.

Examples of this principle include:

  • The originator is currently complying with all applicable supervisory requirements.
  • The originator is not under special administration by the responsible supervisory authority, has passed the applicable regulatory stress tests (or has taken adequate capital measures following failure of said regulatory stress test), and does not currently need (and is not anticipated to need) government support.
  • The transaction complies with the CRR risk retention requirements.

5. If applicable, interest rate risks are mitigated and the transaction documentation clearly specifies the mitigation measures for these risks.

Examples of this principle include:

  • Any hedging arrangements in the transaction are structured in a simple and proportionate manner and the hedging arrangements do not implicitly provide credit support for the transaction as a result of the hedging counterparty paying interest for delinquent or defaulted loans.
  • Any hedge arrangement is simple and transparent, and can easily be replaced in case of trigger events.
  • Any hedging arrangements is structured to, and the relevant counterparties comply with, the requirements or the exemptions available per Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories ('EMIR'), including any relevant Commission Delegated Regulations and the relevant regulatory and legislative rules of ESMA and/or the relevant national competent authorities that are applicable to securitisation related hedging arrangements and the relevant counterparties.

6. The transaction documentation should clearly specify the processes and responsibilities necessary to ensure that:

  • The default or insolvency of the current servicer does not lead to a disruption of the servicing of the underlying assets. This does not necessarily imply that a back-up servicer or a back-up servicer facilitator must exist.
  • Upon default and specified events, the replacement of the hedging counterparty is provided for all hedging arrangements entered into for the benefit of the securitisation.
  • Upon default and specified events, the replacement of the liquidity facility provider or account bank is provided for in any liquidity facilities or account bank agreements entered into for the benefit of the securitisation, with triggers set at appropriate levels to protect note holders.
  • Further, the Eurosystem assesses each ABS regarding its de-linkage from the originator or other transaction parties, beyond the true sale of the underlying pool of assets (e.g. if the same transaction party simultaneously performs the roles of originator, servicer, swap counterparty and/or accounts bank). In this regard, a high degree of de-linkage is desirable to counterparty risk so as to ensure that weaker transaction parties do not impact negatively the future performance of the ABS. Notably, this does not affect the originator's role as servicer for the transaction, but the Eurosystem views the existence of a back-up servicer or back-up servicing provisions as beneficial in case of reasonable doubts regarding the originator's financial strength.

7. The transaction displays a high degree of transparency.

Examples of this principle include:

  • The loan-level data score is currently A1; there is no need to apply 'comply or explain' tolerance thresholds. In addition, for SME and Leasing ABSs, it is preferable if several specific optional fields are appropriately completed, i.e., AS17 (Geographic Region), AS30 (Internal 1-year probability of default of the obligor), AS31 (Last internal obligor rating review), AS38 (Bank internal loss given default estimate—downturn), AS61 (Weighted average life), AS100 (Turnover of obligor), AS110 (Number of employees), and CS4 (Collateral value).
  • Ideally loan-level data and investor report pool cut-off dates are identical, and loan-level data and investor report data can be easily reconciled.
  • Definitions of events relevant for assessing the performance of the transaction are provided in transaction documentation (and in investor reports). For example, clear definitions are provided for measures of pool delinquencies, default, loan repurchases, and loan modifications. Data relevant for assessing the performance of the transaction is made available in the investor report, which should be freely available to both current and potential investors. In particular, the investor report should clearly set out the extent to which loan terms have been modified (and in what way), and also clearly set out the extent to which loans have been repurchased. Reasons are provided for both the modifications and repurchases.
  • At least one liability cash-flow model is made available for the transaction in a manner that does not raise concerns over conflicts of interest. Where applicable, the transaction fulfils the requirements of the Prospectus Directive  (Directive 2003/71/EC of the European Parliament and of the Council of 4 November 2003) and Prospectus Regulation  (Commission Regulation (EC) No 809/2004 of 29 April 2004 implementing Directive 2003/71/EC of the European Parliament and of the Council) and relevant subsidiary legislation, each as amended.
  • The transaction structure and the relevant documentation available to investors is presented in a manner that is sufficiently clear and not misleading, in order to reasonably assist an investor to fulfil the due diligence and investor disclosure obligations imposed on investors pursuant to the CRR, Solvency II and/or AIFMD and delegated or secondary legislation, as applicable and as may be amended from time to time.
  • In the event that rating triggers have been breached, the contractual consequences of such a breach are clearly documented (e.g. a waiver in relation to the breach has been obtained, the rating trigger has been amended so as to remove the breach, etc.).
  • All underlying transaction documentation is available at the time the transaction is marketed, where legally feasible.
  • Transaction documentation and investor reports are available in English.