STS Criterion 34. Early termination events

Description

Early termination events

Content

Other than as a result of insolvency of the protection provider, or a failure to pay (in respect of any premium or other amounts payable by the originator to investors under the synthetic securitisation), or breach of a material contractual obligation by the protection provider, the originator should only be permitted to terminate a transaction prior to its scheduled maturity when either of the following occurs:

• relevant regulatory events which should:
  • include changes in all relevant law and/or regulation (or official interpretation of that law and/or regulation by competent authorities) directly affecting the contractual relationship defining the transaction and/or materially affecting the allocation of benefits among the parties of the transaction. In this regard, relevant law/regulation should include relevant taxation and accounting provisions.
  • exclude other factors affecting the economic efficiency of the transaction that are not enshrined in law or regulation, such as credit rating agencies’ methodologies or a central bank’s collateral framework.
• a time call is exercised, at a point in time, where the time period measured from the securitisation’s closing date is equal to or higher than the weighted average life of the initial reference portfolio at closing]. The time call should not be structured to avoid allocating losses to credit enhancement positions or other positions held by investors and should not be otherwise structured to provide credit enhancement.
• a call as per Article 245(4)(f) of the amended CRR is exercised [clean-up call].

If any of these call rights are included in a transaction, they should be clearly specified in the documentation.

Any other originator calls should not be allowed under the terms of the synthetic transaction.

Rationale

Synthetic STS securitisations should not feature complex call clauses for the originator. Whereas the merit of time calls is acknowledged from the originator’s perspective, in particular to ensure that the economic sustainability of a transaction is accounted for, originators should not use synthetic securitisation transactions with very short-dated time calls with the aim of temporarily changing the representation of their capital position on an ad-hoc basis.

The originator’s bankruptcy as an additional clause of early termination in synthetic transactions is reported as widespread market practice of the synthetic securitisation market. It should be seen from two perspectives:

• Investor (protection provider) perspective: the originator’s bankruptcy exposes the investor to the following risks: (i) subordination vis-à-vis other creditors of the insolvent originator, (ii) deterioration of the originator’s servicing standards/incentives during the bankruptcy phase. The early termination clause allows investors to mitigate these risks as the originator’s bankruptcy occurs, thus maintaining an incentive for the protection provider to participate in such market;
• Originator (protection buyer) perspective: with respect to the originator’s bankruptcy, in case of termination of the credit protection agreement in a scenario of originator’s bankruptcy, the originator’s insolvency estate may not rely on credit protection on the securitised portfolio and is faced with reduced regulatory capital resources against the portfolio under consideration due to the previous achievement of significant risk transfer (SRT) and consequent capital relief since origination. In this respect the recovery prospects of the originator’s other insolvency creditors are at stake as the credit protection contract is terminated upon the event of bankruptcy. The originator’s bankruptcy should therefore not be permitted as early termination event.

Taking into consideration the above, the bankruptcy of the originator should not be allowed as an early termination event for the STS synthetic securitisation.

It is however also to be noted that with the introduction of the BRRD, as an alternative to liquidation, originators may be subject to resolution measures. The BRRD foresees that, as originators enter resolution, structured finance transactions and other specific classes of arrangements are subject to specific provisions safeguarding the transactions’ counterparties, in the context of partial property transfers and other resolution measures. In these cases contractual clauses such as termination upon originator’s bankruptcy may be dis-applied and the rights and interests of the counterparties in the transaction would be dealt with by BRRD-specific measures and tools (It should be noted that a number of (small) firms are likely to be excluded from such BRRD provisions).