Regulation (EU) 2017/2402 (Securitisation Regulation) introduces new internal monitoring and reporting challenges for institutional investors. EU AIFMs are already subject to internal monitoring and reporting in relation to securitisation positions under the EU Alternative Investment Fund Managers Directive 2011/61/EU (AIFMD). As of January 1, 2019, due diligence, transparency, and risk retention requirements will also impact both UCITS and non-EU AIFs in securitisation positions. How will they be impacted is the question that we look to answer here.
It is worth noting that from 2019 on, if an institutional investor (such as an AIFM or UCITS manager) delegates responsibility for fulfilling due diligence, monitoring, and reporting requirements, then any sanctions may be imposed on the delegate rather than the institutional investor.
With the possibility of sanctions in mind, institutional investors and their delegates will need to use systems to verify that the originator of credit has also used an effective system to stress the underlying exposures and, in so doing, ensure that the credit is sound. Just as the money laundering directives brought rules-based systems to the fore for money laundering reporting officers (MLROs) and compliance officers, rules-based systems will also now be at the fore for both AIFMs and UCITS managers to robustly support securitisation due diligence checks.
A robust rules system will combine factor analysis with exposure calculations for risk assessment; have rules based on specific limits (such as the 5% rule which is applied to verify that the sponsor, originator and original lender retains at least 5% economic interest throughout the securitisation’s lifetime); and perform stress tests.
Data points required for rules analysis will no doubt extend further than the payment, credit and liquidity details captured today. Further data analytics will be required to capture cash flow trends, late repayment trends, default rates and frequency of loan modifications.
Once the data and data analytics are in place, institutional investors will further require management and regulatory reports on securitised positions and associated exposures. It is anticipated that from 2019 onwards, regulators will increase their interest in the verification workflows, audit trails and record retention of AIFMS and UCITS managers with regards to securitised positions. Automated corrective action workflows will somewhat support the institutional investors, however manual tasks will still be required to ensure that the UCITS manager acts in the best interest of the investors at all times and that the AIFM has truly validated that its corrective action is the best course of action available at a specific point in time. No doubt regulators will look for proof that these manual tasks were completed and that even data pertaining to manual tasks was comprehensively and consistently captured in a robust system.
To date, neither UCITS firms nor non-EU AIFMs may have given much thought to how best to comply with the securitisation regulation, but that must change by January 2019. Systems with rules engines, workflow, audit trails and reporting will become the new norm for UCITS and non-EU AIFMS going forward.