Update on the ECB's risk control framework for ABS

Background

Under Guideline ECB/2011/14 of 20 September 2011 on monetary policy instruments and procedures of the Eurosystem, as amended by Guideline ECB/2012/25 of 26 November 2012 (the ECB Guideline), ABS issued on or after 01 March 2011 are required to have two triple-A credit ratings in order to be eligible as collateral under the Eurosystem framework. These Guidelines have been replaced by  Guideline (EU) 2015/510 of 19 December 2014.

ECB review of risk control framework

On 17 July 2013, the European Central Bank (the ECB) announced that it was extending the range of asset-backed securities (ABS) which it accepts as collateral from banks under the Eurosystem framework. The ECB announced that it would replace the requirement of two triple-A ratings with two single-A ratings for all six classes of ABS subject to loan-level reporting requirements (residential mortgages, loans to small and medium-sized enterprises (SMEs), commercial mortgages, auto loans, leasing and consumer finance). For other ABS which are not subject to loan-level reporting requirements, the existing requirement of at least two triple-A ratings was retained.

The ECB also announced that it was reducing the haircuts on eligible ABS from 16% to 10% under the permanent and temporary collateral frameworks, but increasing the haircuts on covered bonds, including an additional valuation haircut for retained covered bonds of 8%. The changes reflected the ECB’s view of the improved transparency and standardisation of ABS and revaluation of covered bond risk. The changes were also aimed at helping to revive the European market for ABS as well as indirectly enabling more lending to SMEs. The changes came into effect on 01 October 2013.

On 22 May 2014, the ECB announced that certain short-term debt instruments issued by non-financial corporations may be eligible provided they comply with specified eligibility criteria and risk control measures. These criteria and measures are set out in Guideline ECB/2014/31 of 09 July 2014 which also recasts and consolidates all the temporary measures adopted to date by the ECB in amending Guideline ECB/2011/14.

On 04 September 2014, the ECB announced that as of 01 October 2014, auto loan, leasing, consumer finance and credit card ABSs for which the mandatory level of compliance with loan-level reporting requirements has not been attained and for which the data provider has neither given an explanation for that non-compliance nor provided an action plan for achieving full compliance, will become ineligible as Eurosystem collateral. However, the ECB has also stated that, as of 01 October 2014, the Eurosystem may temporarily accept non-compliant auto loan, leasing, consumer finance and credit card ABSs as eligible collateral, on a case-by-case basis and subject to the provision of adequate explanations for the failure to achieve the mandatory score required. For each adequate explanation, the Eurosystem will specify its tolerance stance.

Guideline ECB 2011/14 has been replaced by Framework ECB/2014/60, Guideline (EU) 2015/510. The relevant changes regarding the eligibility criteria of asset-backed securities are the following:

• Exclusion of ABS comprising receivables with residual value, with a 4 month grandfathering period for those ABS that will be on the list of eligible assets on 01 May 2015 (Article 73.7).
• Introduction of additional criteria for the place of incorporation of mortgage trustees or receivables trustees in ABS transactions, with a one year grandfathering period for those ABS that will be on the list of eligible assets on 01 May 2015 (Article 74.3).
• The issuer of ABSs may only be an SPV established in the EEA. The originator and an intermediary who sell the cash-flow generating assets to the SPV have to be incorporated in the EEA. A mortgage trustee or receivables trustee shall be considered intermediary.
• ABSs on the list of eligible marketable assets as on 01 May 2015 that do not comply with regards to the place of incorporation of a mortgage trustee or receivables trustee shall remain eligible until 01 May 2016, provided all other applicable eligibility criteria are met.
• Further specification of the rules governing the provision of liquidity support in respect of ABS. These provisions shall apply as from 01 November 2015 (Article 142). The article basically states that liquidity support providers for ABS cannot have close links to the posting counterparty in certain cases.
• Article 63.2 removes negative rated instruments. Debt instruments with a floating coupon, as referred to in paragraph 1(b), shall be considered ineligible if at any time following the application of the coupon rate formula, the coupon rate results in a negative value.

1. Further details are set out in Title II of the ECB Guideline.

2. Further details are set out in Title III of the ECB Guideline.