One of the lessons of the financial crisis was that originators had little incentive to underwrite carefully if they could pass on the entire credit risk to investors. The Securitisation Regulation responds with the risk retention requirement: a defined "material net economic interest" of at least 5% must remain with one of the deal's economic principals throughout the life of the transaction.
Key points
- Minimum 5% of the securitised portfolio retained throughout the life of the transaction.
- Four eligible retention holders: originator, sponsor, original lender — and, for NPE securitisations, the special servicer.
- Only one entity may retain — the obligation is single and undivided.
- The retained interest cannot be hedged through credit protection or used as collateral.
- Five permitted methods of holding the retention.
Who can retain
The Regulation identifies four possible "principals" of a securitisation that can act as risk-retention holder:
- the originator — usually the seller of the receivables;
- the sponsor;
- the original lender; and
- for NPE securitisations, the servicer.
All four can be the same entity. Where they differ, the parties may decide who retains. The risk retention must then be borne in full by that single party.
The five methods
The material net economic interest can be retained in different forms:
- Vertical slice: at least 5% of the nominal value of each tranche issued in the securitisation.
- Revolving exposure share: for revolving securitisations, 5% of the nominal value of each securitised exposure.
- Random selection: for static securitisations, an aggregate share of randomly selected exposures equal to at least 5% of the nominal value of the securitised portfolio.
- First-loss tranche: the originator retains the first-loss tranche (and, if needed, additional junior tranches) so that the retained nominal value equals at least 5% of the securitised portfolio.
- First-loss exposure on each securitised exposure: a first-loss exposure of at least 5% of the nominal value of each securitised exposure (used in some bilateral structures).
For NPE securitisations, the 5% threshold is applied to the net value of the non-performing exposures rather than the nominal value — recognising the discount at which distressed assets typically trade.
Anti-circumvention
The retained risk must remain genuinely on the retention holder's books. The Regulation prohibits two main circumvention strategies:
- The retained interest may not be hedged through other credit-protection transactions — economic offsetting defeats the purpose of the rule.
- The retained interest may not serve as collateral for another transaction.