Prudential Regulation Authority Rulebook

7.1

No standardised definition of excess spread exists in market practice, however it can be considered as ‘finance charge collections and other fee income received in respect of the securitised exposures net of costs and expenses’. The PRA recognises that excess spread can be formulated in a range of different ways, and expects firms to take a ‘substance over form’ approach to the treatment of excess spread features in SRT securitisations. The PRA considers that the presence of excess spread in synthetic securitisations (SES), when junior in the capital structure to sold or protected tranches, impacts the transfer of credit risk to third parties by providing credit enhancement, such that the protection buyer has retained risk.

7.2

If SRT transactions are structured such that SES provides credit enhancement, firms should assess the risks retained by SES, adequately quantify such risk, and reflect this retained risk in their post-transaction capital requirements. For the purposes of calculating capital requirements, the PRA considers it appropriate to treat SES as an off-balance sheet securitisation position.

7.3

Firms should measure the nominal value of the off-balance sheet securitisation position as a reasoned and prudent estimate of the credit enhancement provided by SES, for example as compared to a retained first loss tranche. Firms should apply a 1,250% risk weight to this nominal value, or alternatively deduct from capital.^[4]

7.4

The presence of excess spread in traditional securitisations (TES) may, in certain transactions where accounting derecognition has not been achieved, impact the transfer of credit risk to third parties, where it is used to absorb losses thus providing credit enhancement to more senior tranches. The PRA is primarily concerned where the excess spread results from the securitised exposures being sold below their market value, for instance, where the securitised exposures are sold at par value despite their fair value being higher than par. In these circumstances, the PRA expects firms to treat the credit enhancement provided by TES in a similar manner to the approach described for SES, by measuring the credit enhancement provided and applying a 1,250% risk weight or deducting from capital accordingly. The PRA is open to considering alternative methods for firms to measure the credit enhancement provided. As the PRA considers excess spread a complex feature, firms may approach the PRA to discuss potential transactions with such a feature ahead of execution, as set out in paragraph 2.8.

(CRR Articles 242, 243 and 244)