Although the EU's adoption of the STS label for SRT Transactions goes beyond the scope of the Basel III framework (which does not extend the so-called "STC" (the Basel equivalent of "STS") designation to synthetic securitizations), the general view has been that this was an acceptable deviation and within the general principles of the framework.

1. Background of legislative positions

On 27 June 2023, the negotiations for the EU's amendments to the Regulation EU No 575/2013 (the "CRR"), which contains the bulk of the Basel III implementing provisions, was concluded (such amended regulation being the "CRR3"). The final text was endorsed by the preparatory bodies of the Council and the European Parliament on 14 December 2023. It is expected that the rules will come into force on 1 January 2025 (with a phased-in implementation for the output floor).

In the UK, the Prudential Regulation Authority ("PRA") published a news release on 27 September 2023 confirming that it intended to publish near-final policies on market risk, credit valuation adjustment risk, counterparty credit risk and operational risk in the fourth quarter of 2023, and near-final policies relating to the remaining elements of Basel III (including the output floor) in the second quarter of 2024. On 31 October 2023, the Bank of England published a discussion paper (the "Discussion Paper") focusing specifically on the capital requirements applicable to securitizations and how the Basel III framework impacts them. This comes in light of significant feedback from the industry which views a number of Basel III changes as being (perhaps unintentionally) adverse to securitizations without an appropriate rationale or credit-related justification. The Bank of England has invited feedback on the Discussion Paper with a view to incorporating views into new PRA rules that will replace the current firm-facing requirements in the “Securitisation Chapter” of the CRR[1]. The UK's implementation of the final legislation is expected to come into force six months after the EU (i.e. by 1 July 2025). The PRA also published a near-final part 1 of the policy statement on 12 December 2023 on the PRA's approach to implementing the Basel III standards. It should be noted that the PRA is expecting, in the second quarter of 2024, to publish part 2 of the policy statement which is expected to deal with the majority of items set out in this article (i.e. credit risk, internal ratings based approach, credit risk mitigation and the output floor).  

2. The Road to 1 January 2025

2.1 Banks' preparation for Basel III final implementation

Although the EU, US and the UK are in the process of finalizing their implementing acts, the main text of the Basel III framework was concluded in December 2017, and banks have therefore already commenced their preparations by building up reserves and buffers on a year on year basis, including through the replenishment of eligible equity capital ("Common Equity Tier 1", or "CET1") as a shock absorber for losses, frequently at well above the minimum requirements. S&P Global Market Intelligence Data suggests that on average, buffers across 22 of the largest banks exceed minimum capital requirements by 4.45%, with some of the larger banks exceeding by up to 8.71% (i.e. nearly double the minimum requirement).

The European Banking Authority ("EBA"), in its Basel III full implementation impact report found that European banks' Tier 1 capital requirements would increase by 15% as a result of the Basel III changes, with the output floor being responsible for a 7.1% overall rise, with a slightly higher percentage for global systemically important institutions than for ordinary banks. The output floor is expected to have a different impact depending on the asset class, so banks may find that they are more exposed to the output floor depending on the composition of their asset portfolios. For example, residential mortgages and residential mortgage-backed securitizations ("RMBS") are on average assigned a very low internal model risk weighting of approximately 10%, whereas the standard risk weights rank from 20% - 70% (at a corresponding output floor of 14.5% - 50.75%), meaning the output floor may have a significant effect on this asset class. Banks that specialize with this type of product may therefore be disproportionately affected by the output floor, and this incongruous impact on a relatively low-risk lending activity has been criticized. Given the output floor applies at a consolidated level, the full ramifications may be somewhat mitigated by the diversification of product lines with different RWA densities.   

2.2  Expected impact of new RWA triggers and output floor

Risk Control Limited's research report, published in November 2022 and commissioned by the Association for Financial Markets in Europe ("AFME"), reviewed the Pillar 3 reports of approximately 30 banks in Europe to assess the impact of the output floor on different asset classes. The results broadly showed that the asset classes which had the lowest RWA under their internal model relative to the standardized approach would be impacted by output floor the most. For example, residential exposures would be impacted the hardest (even with the lowest output floor in the transition period of 50%), whereas corporate exposures would only have a smaller haircut as a result of the output floor. Although this may not be as relevant for banks which are not using internal models (and therefore not subject to the output floor), IRB Banks for the specific asset classes which are most impacted by the output floor may prefer to enter into SRT transactions relating to those assets to ensure that they are not penalized by the output floor.      

The differential treatment for each asset class is important to consider in light of the relatively fragmented concentration of asset classes on a jurisdictional basis in the EU: for example, UK, Dutch, Spanish and French RMBSs represented €467bn (or 79%) of all European RMBS deals. On the other hand, Italy, Belgium and Spain represented 74% of corporate SME exposures, whereas Germany and Italy together represented 73% of the auto securitization amounts generated.

In addition, an uneven application for risk-weighting for un-securitized pools ("Pool RWAs") compared to the equivalent risk-weighting for the securitized pool ("Securitization RWAs") creates an arbitrary distinction. This is particularly the case for IRB Banks where the output floor applies at different levels depending on whether a particular asset is held on balance sheet or securitized. For example, the average Pool RWA for exposures to SMEs was 53.8% (for IRB) and 85% (for SA). Under the current proposed EU rules, this would mean that the output floor would only bite during its transitional period when it reaches the 65% floor (i.e. 65% of 85% being 55.3%). In contrast, the Securitization RWA (for an STS transaction) would be 59.5% (for the internal model) and 127.5% (for the standardized approach), meaning the output floor would immediately bite (i.e. 50% of 127.5% being 63.8%). This may therefore indicate that a bank may prefer to be exposed to this asset on its balance sheet (rather than indirectly through a securitization). It does not seem likely that this distinction was intentional to create a non-credit linked dichotomy between the Pool RWAs and Securitization RWAs, but may unfortunately have the impact of disincentivizing certain business lines from SRT trades for reasons unrelated to the creditworthiness of such assets.

A number of industry bodies such as AFME, as well as market participants, responded to consultations by the EU and the UK, and the current legislative proposals incorporate some (although not all) of the concerns raised by the market.

3. Comparison of Key Issues

3.1 Output Floor

(a) Substantive implementation

Both the CRR3 and the Discussion Paper implement materially all elements of the output floor set out in the Basel III framework.

The CRR3 proposes to amend Article 92 of the CRR to incorporate the output floor. Institutions will be required to calculate the total risk exposure amount ("TREA") as follows:


where TREAU is the RWA of an asset under the internal model (if applicable), and TREAS being the RWA of the same asset under the standardized approach. The "m" modifier is the output floor of 72.5%, essentially flooring the minimum RWA at 72.5% of the RWAs under the standardized approach (ie. the RWA of an asset under the internal model cannot be less than 72.5% of the RWA of the same asset under the standardized approach). This is expected to lead to a substantial increase in the minimum capital requirements for banks, as even in scenarios where banks calculated low RWAs under internal models for portfolios with historically low delinquencies and defaults, the impact of m x TREAS would mean that they would be required to hold an artificially higher amount of capital for the same position.

The Discussion Paper similarly expects to implement the 72.5% output floor.

(b) Timing

Both the UK and the EU have accepted a phased implementation of the output floor, with the only expected difference being that UK banks will have a 4.5 year period for the entire transitional phase (given the UK's legislative proposal is expected to come into force 6 months after the EU).

As a result, to avoid the cliff effects, the CRR3 and the Discussion Paper propose the following transitional implementation:


EU: 1 January 2025 – 31 December 2025

UK: 1 July 2025 – 31 December 2025


1 January 2026 – 31 December 2026


1 January 2027 – 31 December 2027


1 January 2028 – 31 December 2028


1 January 2029 – 31 December 2029


1 January 2030 onwards (the final position)

3.2 Securitization capital surcharge (supervisory parameter "p")

(a) General Application

The supervisory parameter "p", a variable input in the capital calculations seen as a premium charge payable for securitization transactions plays a significant impact in the calculation of Securitization RWAs. The parameter is a non-neutrality correction factor intended to reflect the embedded modelling costs (i.e. that the credit and/or the cashflow modelling in a securitization is deficient) and agency costs (i.e. that the information asymmetry and interests of the investors and the originator are not aligned) associated with securitizing assets (which are in excess to the un-securitized equivalent of the Pool RWAs). The supervisory parameter is incorporated in addition to any credit risk mitigants which may be applied at an asset-level (for example, low delinquency rates on a safe asset), and therefore acts as a capital premium against securitizing a particular asset (or being exposed to the securitization position created by such asset).  

The capital surcharge is calculated using an exponential decay function and by deriving the area (determined as the interpolation between the tranche attachment and detachment points) under the curve, with the supervisory parameter p being layered into the inputs as a denominator to determine the decay rate (meaning it is inversely proportional to the rates at which the Securitisation RWAs increase). The imposition of the parameter therefore slows down the decay rate (i.e. the rate at which Securitization RWAs decrease as you move up the seniority in a securitization position).  

The industry had recommended a slight relaxation of the supervisory parameter, arguing that the modelling and agency risks which the parameter is intended to address is more limited than the impact of the parameter suggests. Industry participants have recommended halving the supervisory parameter for SEC-SA and lowering the floor for SEC-IRBA to 0.1 (for STS) and 0.25 (for non-STS). This may be particularly beneficial for SRT originators: IRB Banks will have the requisite information to calculate the inputs required for the SEC-IRBA and may benefit from a lower capital floor and a lower RWA calculation under SEC-IRBA, and even SA Banks will benefit from preferential treatment for the retained tranches.

(b)  EU Approach

Under CRR3, the minimum p for SEC-IRBA is set at 0.3 (regardless of whether the transaction is STS compliant or not). The p for SEC-SA is a fixed 1 for traditional securitizations and 0.5 for STS securitizations – this is notwithstanding the standard capital charge (KSA) of the underlying exposures and/or any credit enhancement through the attachment (i.e. the point at which a tranche starts absorbing losses) and detachment points (the point at which a tranche is completely wiped out), so the equivalent p (1 or 0.5) will now apply to all SA Banks holding positions in a securitization, regardless of the seniority of the notes they hold. This arbitrary addition of the relatively rigid parameter for the SEC-SA approach now has the dual negative effect of not only making it more expensive for SA Banks, but also for IRB Banks which are now caught in the crosshairs through the application of the output floor locking in higher TREAS.

The EU has seemingly acknowledged the market concerns somewhat by the addition of Article 506ca to the CRR3, which requires the EBA (in collaboration with the European Securities and Markets Authority ("ESMA")), by 31 December 2026, to report to the European Commission on the prudential treatment of securitization positions, and in particular differentiating for synthetic securitizations and where significant risk transfer has been achieved. Article 506ca also expressly allows the EBA to consider a downward recalibration of the non-neutrality factor for SRT Transactions depending on evidence. The European Commission would then be required to submit a legislative proposal by 31 December 2027 (although this would have to take into account "internationally agreed standards developed by [the Basel Committee]").

(c)  UK Approach

The Discussion Paper has, however, gone further than the CRR3 in outlining potential options for recalibrating the supervisory parameter on a more permanent basis (this is somewhat alluded to in Article 506ca of the CRR3 which requires a report by the EBA on potential prudential treatment of synthetic securitizations, but the implementation timing is expected to be no earlier than 2028). The Discussion Paper outlines three potential options:

(i) Option 1: implementation of the output floor as is (i.e. no changes to supervisory parameter);

(ii) Option 2: implementation of the output floor with targeted and data-based adjustments, including to the supervisory parameter; or

(iii) Option 3: implementation of carve-outs from (or other qualifications to) some or all securitization exposures.

Option 1, whilst aligning with the current proposals, is acknowledged by the PRA to be constraining for firms subject to the output floor and queries whether it adversely affects UK bank SRT originators, is proportionate and advances the PRA’s objectives to achieve competitiveness and growth.

Option 2 would seem to be a more permanent variation of the EU CRR3's transitional output floor relief for supervisory parameters and is seen by the PRA as being a persuasive alternative to Option 1 as benefiting PRA firms and facilitating SRT transactions; however, whilst advancing the PRA’s objectives it does not align entirely with the Basel framework. The PRA analysis suggests that there is scope to reduce the supervisory parameter for SEC-SA, although there was reluctance to significantly reduce it so as to create parity with STS and non-STS positions (which the PRA wants to avoid). The PRA also considers having a risk-based approach to calculating the supervisory parameter, where different factors and structural features of a securitization could result in a different supervisory parameter. This is currently not the case for SEC-SA, and would address one of the biggest issues with the imposition of a one-size-fits-all surcharge on all SEC-SA positions. It would also mean that senior tranches of SRT Transactions could get more favorable treatment under the output floor where they could demonstrate they meet some of the criteria (which could be based on variables such as delinquency rates and pool granularity) as a result of their deep knowledge of the underlying assets in question.

Option 3 seems to go much further than the current CRR3 approach and is most in line with feedback from the industry suggesting the creation of "resilient" securitizations which would grant capital relief to, among other "safe" securitizations, senior retained tranche of SRT Transactions. Although the PRA invited feedback on Option 3, they have made clear that it raises prudential concerns, is not in line with Basel standards and they are currently not minded to adopt this approach. It remains to be seen what the feedback to this will be, although it is possible that market participants will focus their feedback on optimizing the non-neutrality factor under Option 2.   

3.3 STS treatment for synthetic securitizations

The EU had already extended STS treatment to synthetic securitizations through Regulation EU 2021/668 and Regulation EU 2021/558 (which amended the EU Securitisation Regulation and CRR, respectively). The PRA has in the past cast doubt on whether the STS label should be extended to synthetic securitizations. This effectively means that such trades would be excluded from the beneficial capital treatment available to STS "true sale" securitizations. It is not entirely clear why this approach has been adopted, as there has been significant positive evidence from the EU of the benefit this has provided to SA banks (in respect of which the STS label remains the key regulatory capital relief they are able to rely on, given their inability to use SEC-IRBA).

Although the EU's adoption of the STS label for SRT Transactions goes beyond the scope of the Basel III framework (which does not extend the so-called "STC" (the Basel equivalent of "STS") designation to synthetic securitizations), the general view has been that this was an acceptable deviation and within the general principles of the framework.

The PRA has stated that it remains unconvinced of the real economy benefits of SRT Transactions and is minded not to extend STS treatment to synthetic securitizations. It has also noted the bespoke nature of SRT transactions and questioned to what extent complex structural features could be streamlined into a "standardized" securitization. An obvious argument against this line of reasoning is that the STS rules never intended to standardize every aspect of a securitization – that would have a dampening effect on innovation. The rules on standardization simply require certain features – those which are deemed by regulators to be most crucial to investors – be aligned, and this is in line with the EU approach (with the STS rules for SRT transactions being more numerous and comprehensive than the true sale securitizations). 

In the context of evidence for tangible benefits, it is hoped that industry feedback would be able to evidence the real economy benefits of SRT and that UK securitization is enormously disadvantaged by this limitation. One of two ways in which this can be done include (i) the ability for banks to remain in capital-intensive markets and therefore continue originating financing to the real economy (as a result of the more favorable capital treatment available to them) and (ii) the excess capital which may be unlocked as a result of SRT Transactions which can be used to either originate further reference obligations in respect of an SRT Transaction or be targeted at other product lines of the bank. In a joint response, on 30 October 2023, to the consultations on draft securitization rules published by the PRA and the Financial Conduct Authority, AFME, UK Finance and CREFC Europe supported the extension of the STS framework for synthetic securitizations.[2]   

3.4 Impact on significant risk transfer securitizations

Both the EU and the UK have acknowledged the unique position of significant risk transfer securitizations (predominantly in the form of synthetic securitizations) in the capital requirements discussions. SRT Transactions are frequently used by banks as an effective capital management tool to ensure that credit risk is transferred to an investor and/or a guarantor (which itself may not be subject to capital requirements). This has been seen by a number of regulators as a prudentially advantageous position to ensure that banks are able to manage their risk without having to liquidate and/or exit capital-intensive product lines. Unfortunately, one of the common structures of SRT Transactions involves the originating bank retaining a thick senior tranche position which, although in theory could have a relatively low RWA if using the SEC-IRBA approach (given the higher amount of principal losses which need to accrue before the senior tranche starts absorbing losses, being determined by the tranche attachment and detachment points), the imposition of the output floor would mean that the originating bank may be subject to holding a significantly higher amount of capital as a result of the SEC-SA floor. This is even in scenarios where such originating bank may have significant knowledge of the reference portfolio in question, and may have a substantial amount of historic data (including delinquencies) which would allow them to properly assess the actual credit risk under the SEC-IRBA approach. Even though the output floor is applied at a consolidated aggregated level across the entire portfolio, evidence in the Basel and EBA monitoring reports suggests that there will be material increases in RWAs for SRT Transactions. The Discussion Paper has asked for feedback from industry participants in respect of the perceived costs and benefits for SRT Transactions. 

The PRA has acknowledged the difficulties with the imposition of the output floor and invites feedback in respect of a (potentially) permanent recalibration of the output floor. The PRA has also gone further than the CRR3 on the recalibration of the supervisory parameter (including in the context of SRT Transactions) by suggesting potential avenues where a more proportionate and potentially risk-adjusted non-neutrality factor could be applied. This goes beyond the CRR3 approach, which has only offered a temporary transitional relief for now.

3.5 Securitization hierarchy of methods

The current hierarchy for calculating RWAs in a securitization position under Basel III are:

(a)  SEC-IRBA for a pool which is eligible for internal-rating (an "IRB Pool"); or (if not possible)

(b)  SEC-ERBA (provided this meets the jurisdiction and external credit assessment requirements); or (if not possible)

(c)  SEC-IAA (for unrated securitization exposures to a pool which is not eligible for internal-rating (an "SA Pool"); or (if not possible)

(d)  SEC-SA; or (if not possible)

(e)  a risk-weighting of 1,250% (i.e. the maximum RWA under Basel III).

The EU position, as onshored in the UK, broadly elevated limb (d) as a new limb (b) (i.e. the second ranking item), with a number of exceptions set out where the hierarchy would revert to the default Basel III standard. The Discussion Paper proposed reverting to the existing Basel III framework at all times for the hierarchy.

There are a number of embedded parameters in SEC-ERBA which could create issues in these circumstances, particularly where no ratings are obtained or are available for a particular transaction, or where the maturity exceeds the permitted 5-year maturity under the SEC-ERBA model (thereby leading to an increased capital allocation compared to what could have been achieved under SEC-SA).

4.  Next steps

Market participants may continue submitting feedback in respect of the Discussion Paper until (subject to any extensions) 31 January 2024. The PRA then intends to publish a consultation paper in H2 2024 on draft rules to replace relevant firm-facing requirements in the securitization chapter of the CRR, once HM Treasury takes steps to effect the repeal of the securitization chapter. We expect that industry participants will be keen to respond both the Discussion Paper and the future consultation to try to secure much needed improvements to the current framework. In the meantime, there are not expected to be substantial changes (if any) to the final legislative text of the CRR3.

5. Final thoughts

Although it remains to be seen what the ultimate feedback and updated PRA position will be, it seems like the PRA has taken on board a number of industry criticisms and feedback which were raised in the context of the CRR3. This may be positively received by UK banks, which may have hoped that the PRA would use the divergence from the EU post-Brexit as a platform to increase the competitiveness of UK banks by removing and/or recalibrating unnecessarily punitive capital parameters.  

Allowing for the possibility of a permanent recalibration of the output floor and a more proportionate and potentially risk-adjusted non-neutrality factor  gives some room for optimism. Hopefully this should pave the way for SRT market participants to provide further evidence of the important role of such transactions and to argue for a proportionate regime which encourages the re-deployment of capital through SRT Transactions. This also shows a clear departure by the UK from the EU position, which has largely delayed the Pillar 1 re-calibration discussion by interposing a temporary transitional relief on the application of supervisory parameter in the context of the output floor.  

Regrettably, the PRA has not moved on its earlier statements on the application of STS treatment for synthetic securitizations. The STS treatment has the advantage of significantly reducing the supervisory parameter under SEC-SA and therefore allowing banks using SA to really participate in the SRT space. Not extending this treatment has the dual negative consequence that SA banks may be discouraged from entering into SRT Transactions, but also that IRB banks may be impacted with an artificially higher output floor (given the SEC-SA calculations will not include the STS relief). This also has the impact of gold-plating capital treatment under Basel III as compared to the EU, which could be very detrimental to UK banks compared to their EU counterparts, where the extension of the STS label to SRT Transactions in 2021 has seen a significant revival of the SRT pipeline (including the entry of more than 10 new banks into the market). Given that the PRA acknowledges the need for improving competitiveness and growth, and that the EU has already demonstrated that the application of STS to synthetics is in alignment with international standards, it would seem a missed opportunity to dismiss the extension of the STS label at this juncture, and industry participants may be hopeful that the position may ultimately be conceded by the PRA. 


[1]  Part Three, Title II, Chapter 5 of the CRR contains the securitisation chapter.

[2]  Response by AFME, UK Finance and CREFC Europe to the consultation on draft securitisation rules published by the PRA and FCA