This Client Alert assesses the most recent updates on the Servicing Directive and the merits of the discussion outlined in the “progress report”.1 One should read this Client Alert, and any updates to it, in conjunction with the July 11, 2018 alert2 assessing the impact of the proposed Servicing Directive.
Credit servicers play an important role in a variety of transactions, including securitizations, and such reforms are perceived by EU policymakers as highly needed in order to harmonize the applicable EU regulatory regime in this area and to prevent emergence of new but also support the reduction of legacy stocks of non-performing loans and exposures (collectively herein NPEs). The Consilium’s progress report however does suggest that specific changes could affect the proposed Servicing Directive as it continues to advance on its legislative path and ultimately could do so in a very different and ultimately perhaps less pragmatic form.
Regardless of the final version, the definitions of some proposed terms have the ability to introduce further wide-reaching consequences for many financial market participants. As such, the amendments to the proposal made along the way since its inception on its journey to become a Directive are especially important, in particular as the Servicing Directive also could be supplemented by a primary of the Commission Delegated Regulation. Either way, the Servicing Directive conceivably will not only translate into documentation but also into operation-based changes. This will presumably affect a wide range of stakeholders and may yield costs over and above those highlighted by the EU Commission in its communications on the Servicing Directive.
Despite all of this, the proposal is still seen as a necessary step towards both creating a more “single” Single Market for financial services across the EU but also allowing pockets of talent, often borne out of the depths of the 2008 Great Financial Crisis, to be rolled out across the wider EU. This has the potential for wide-reaching opportunities for a wide range of stakeholders and transactions, including further changes from the supervisory actions of the European Central Bank, acting in its Single Supervisory Mechanism capacity (ECB-SSM).
Both the Consilium’s progress report and the note3 are dated December 14 and as such concern discussions conducted under the Austrian leadership of the rotating presidency of the Consilium. The Austrian presidency decided to split the discussion on the Servicing Directive into two workstreams (1) for the secondary market and (2) on the AECE (as defined below). The progress report’s general discussion covers discussions on the Servicing Directive concerning, amongst others, the NPE prudential backstop proposal, discussion on which started during the Bulgarian Presidency. The report presents the presidency’s views on the progress achieved and is keen to stress that there is no intent to prejudice the decision of the Romanian Presidency of the Consilium on the matter which commenced at the start of 2019 and which will hand over to Finland as of June 30, 2019.
One should note that the European Commission submitted the Servicing Directive’s proposal in March 2018 aiming to foster the development of secondary markets for NPEs by tackling undue obstacles to credit servicing and to the transfer of bank loans to third parties, so called credit purchasers, across the EU. They transmitted the proposal to the national parliaments the following month, with the European Economic and Social Committee also adopting an opinion on the package in July 2018. Then, the Association for Financial Markets in Europe, the European Consumer Organisation, Finance Watch and the European Banking Federation, amongst other stakeholders, also had an opportunity to share their views. Finally, the Council’s Working Party on Financial Services reviewed the proposal, the outcome of which can be found in the section “2019 developments” below.
By means of a high-level summary, the Consilium concluded that Member States are generally supportive of the direction taken by the Austrian Presidency on the “secondary market” workstreams in the Directive but still identify issues meriting further discussions as well as some covering the need for clearer legal drafting. The overall scope in connection with performing and non-performing credit agreements and the potential exclusion of credit agreements deemed as unlikely-to-pay and the role of the credit services in respect to transfers of credit agreements to non-authorized entities are seen as meriting further discussion.
With regard to one of the key “game changers” in the Servicing Directive, the Accelerated Extrajudicial Collateral Enforcement (AECE),4 the progress report concluded that sufficient progress was not achieved on this workstream but concludes that a welcome way forward on all points would be to outline a landing zone with an involvement of a public official in the process to achieve broad consensus among Member States.
The Servicing Directive overall aims to foster the development of a secondary market by removing any impediments to the transfer of NPEs by credit institutions to non-credit institutions. The Directive encourages credit institutions to employ a credit servicer,5 especially in the event of involvement of an unregulated credit purchaser or in relation to the sale of NPEs to third parties.
In terms of scope, the progress report provides that during the discussions, the majority of the Member States have agreed to restrict the scope of action for non-licensed purchasers to non-performing credit agreements as a means of guaranteeing a higher level of borrower and consumer protection. This would potentially reduce the availability of buyers.
Many Member States agreed with the Commission that a credit servicer should be able to conduct services for non-performing as well as performing credit agreements and agree to clarify in a recital that the scope of credit servicer’s authorization can be extended on a national level to credit agreements issued by non-credit institutions. What is important to note is that such service, certainly in respect of consumer loans, is not permitted to be passported on a services basis to other Member States. This may cause a number of issues as it goes against the original scope and aims of the Servicing Directive which would have provided for a range of commercial opportunities that might arise for pools of talent that have proven themselves during the Great Financial Crisis to replicate standards and solutions across the EU.
The passporting principles originally proposed both a branch passporting, i.e. physical presence, and a services passport. Cross-border supervision of credit servicers is covered by supervisory colleges—a proven concept in EU financial services regulation—which here is also extended to “agents” of the credit servicer appointed in another Member State—as a result of outsourcing or an EU domiciled “representative” in the case a credit purchaser is domiciled ex-EU. This latter concept allows the EU authorities to monitor and hold credit purchasers (and respective credit servicers) accountable where these are otherwise domiciled outside of the EU. For US investors this likely may lead to additional costs. In many ways, this move away from passporting is a missed opportunity.
The Consilium draft also modified the definition of a credit servicer, and further restrictions are placed on the activities for which an authorization is required. A credit servicer needs to apply for an authorization in the Member State where its registered office or principal place of business is established. Views are split on whether the credit servicer should only be a legal person or could also be a natural person. The current reference to a legal person in the text is not in line with some other European regulations. Discussions in this area also led to a more fundamental debate on whether the European Banking Authority (EBA) or national competent authorities (NCAs) of Member States ought to lead on drafting authorization guidelines – not giving this fundamental area of harmonization to the EBA would be a missed opportunity.
In terms of purchaser obligations, it was proposed that a notification requirement was be added for credit purchasers where the purchaser or its representative has to notify the competent authority immediately about the home Member State of the first purchase on the secondary market of a respective Member State. The authority would then submit this information to EBA, which will then publish a regularly updated list on its website regarding credit purchasers being active on the European secondary market.
Most Member States also express agreement on the proposal by the Austrian Presidency to modify the information requirements in a way to oblige the seller of a credit agreement to submit information to the competent authority. Articles 13 and 19 govern this for sellers as a credit institution and a credit purchaser respectively and stipulate that the information provided should be about the legal entity identifier (LEI) of the purchaser or its representative or its identity or that of its representative or members of the purchaser’s management or administrative organ or the persons who hold qualifying holdings in the purchaser should no LEI exist as well as the address of the purchaser or its representative.
Other definitions highlighted in the progress report discussed include those of “credit agreement”, which is now agreed to be in line with the Consumer Credit Directive and the Mortgage Credit Directive, i.e. the definition initially given by the Commission would be kept and just the wording “creditor’s rights”, or “creditor’s claims” as some Member States would prefer, would be added in the text. Additionally the definition “credit servicing agreement” and the modified definition of “home Member State” are agreed.
To recap, the AECE is conceptually simple, i.e. it offers out of court work-out options in the form of a “common menu” of solutions–many of which were used in Ireland and Spain—albeit the Servicing Directive balances the needs of consumer protection and workable divestment and secondary market channels in a much more pronounced manner. This ties on to the ECB-SSM’s rules on NPLs that are being rolled out to the wider EU in the form of the EU Action Plan. In many ways, the Servicing Directive aims to expand the reach of the menu to all EU Member States. The AECE is part of the beginning of offering further work-out options and thus greater increase in certainty of recovery of collateral. That alone should be applauded as a quantum leap and an important tool for investors and originators alike.
The progress report confirms that Member States agreed that a creditor should have the choice between AECE and judicial enforcement proceedings and that neither the creditor nor the debtor should be prevented from seeking judicial protection in an AECE proceeding. “In this respect Member States agreed on spelling out this right to seek judicial protection at any stage of the AECE proceeding.”
In the original Commission proposal, AECE applies only to enforcing the outstanding debt under a secured credit agreement concluded by a credit institution or another undertaking authorised to issue credit in accordance with the national law of a Member State and by a “business borrower”. The scope of the Commission proposal foresees the including of a movable and immovable collateral to secure a loan covered by AECE and views amongst Member States are split in this regard. The Commission also foresees an application of AECE on the creditor side limited to a credit institution or another undertaking authorized to issue credit and this also generates split views.
When a loan becomes past due, the decisive factor to initiate AECE is the enforcement event. The Commission proposal outlines that the conditions for the enforcement event need to be agreed upon in the initial credit contract. Here, the Member States are concerned about creating a directly enforceable title without the involvement of a public official and are positive in terms of the involvement of notaries, bailiffs or other public officials. Many are also of the opinion that it should be decided with national discretion upon the degree of involvement or the activities conducted by the public official.
Views are also split in respect of the inclusion of appropriation as means to realize collateral and on Article 28 which provides for legal protection of the business borrower before a national court, as the latter limits the scope of judicial protection to the realization of the collateral and thus to the ultimate phase of the enforcement procedure.
Some Member States want to restrict AECE to first ranking security interests and most support the definition “[a] consumer means a natural person who, in credit agreements covered by this Directive, is acting for purposes which are outside his trade, business or profession.” The Austrian Presidency had also proposed a less complex and burdensome procedure in which competent authorities supervision credit institutions should only collect information from the creditor regarding the number of AECE proceedings initiated, pending or realized.
In terms of general application, the Directive does not cover any rules regarding the acquisition in good faith of collateral connected to a loan covered by AECE. Member States agree that there should not be any harmonization of this issue in the Directive and thus should stay as defined in Member States in national law. The proposal also does not limit the use of AECE to the original contractor but extends the application to the purchaser as well. Here Member States were also split with some being concerned about adequate debtor protection while others advocating for a restriction of the use of AECE to institutions which are allowed to issuer credits or other supervised entities.
In respect to the notification of the borrower of the intention to realize the assets through AECE, the creditor has to notify the borrower of his intention to apply the contractual AECE clause, at the latest within four weeks of the enforcement event. Some Member States believe it would be beneficial to reconsider the length of the notification period and its starting point. Finally, regarding Article 32 on restructuring and insolvency proceedings, Member States were divided as to whether a reference to the Directive on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures is necessary due to the applicability of the “stay of individual enforcement actions” to AECE.
In January 2019, the European Data Protection Supervisor made comments6 on the Servicing Directive proposal relating to the requirements for the authorization of credit servicers, the contractual relationship between a credit servicer and a creditor, and the transmission of personal data to the competent authorities of the Member States.
Further, in March, the Council published7 another “I” item note8 with amendments made to the proposal by the Romanian presidency. It was also established9 then that the presidency reached a compromise on the credit servicers and credit purchasers part of the directive (the “secondary market” part) but could not reach an agreement on the accelerated extrajudicial collateral enforcement part of the Directive (the “AECE” part). As such, it was agreed that the proposal would be split in two parts, and the secondary markets part is currently included in the voting agenda10 of the Parliament for April 16. With regard to the AECE part of the proposal, the Council would continue working on it in the Working Party on Financial Services.
The agreed amendments state, inter alia, that the Servicing Directive is without prejudice to the national rules imposing additional requirements for the credit purchaser or servicer as concerns renegotiations of the terms and conditions under a credit agreement. This goes against the principle of creating a common menu of options. The Servicing Directive will also not affect the restrictions in national laws regarding transfer of creditor’s rights under a non-performing credit agreement. Nor will it affect a credit agreement itself that is not terminated in accordance with national civil law with the effect that all amounts payable under the credit agreement become immediately due, where this is required for the transfer to an entity outside the banking system.
The outsourcing by credit institutions of credit servicing activities is explicitly excluded from the scope of the Servicing Directive on grounds that this is regulated elsewhere. The Servicing Directive also explicitly provides that a credit servicer authorization covers credit servicing activities irrespective of the type of credits. Member States that have already in place equivalent or stricter rules than the Servicing Directive are given the opportunity to recognize in their national law implementing the Directive the possibility for existing entities providing credit servicing activities to be automatically recognized as authorized credit servicers.
Member States are also entitled to impose the same obligation in relation to other credits than those granted to consumers and/or credit purchasers established on their territories, which are not a supervised creditor or credit servicer. Finally, with relation to anti-money laundering (AML) requirements, credit servicers should have adequate AML and counter terrorism procedures in place, where national legislation transposing Directive 2015/849/EU designates credit servicers as obliged entities and thus subject to AML rules and on-going obligations to prevent and combat money laundering and terrorist financing in accordance with EU and national laws.
The Committee on Economic and Monetary Affairs of the European Parliament issued its own draft report on the Servicing Directive with a range of amendments on March 16, 2019.11 Related to NPEs albeit not to the proposed Servicing Directive, in early April12 the Council also adopted a new framework for dealing with banks’ bad loans, which are discussed in our standalone coverage. The proposed new rules are in the form of a regulation and introduce a “prudential backstop”. They set capital requirements applying to banks with non-performing loans on their balance sheets with different coverage requirements applying depending on whether the NPEs are classified as “unsecured” or “secured” and whether the collateral is movable or immovable.
Whilst the Servicing Directive’s authorization requirements may build upon EU principles and obligations applicable to other financial services market participants, there will be a degree of specialist legal and regulatory input required into the regulated business plan along with other core documents and policies that are submitted as part of an application pack or which are to be implemented and maintained by a servicer following receipt of its license.
The Servicing Directive’s policymaking and legislative development path is certainly advancing. It is also doing so faster in relation to the secondary markets workstream, in particular following the “I” item note. However, as the progress report shows rifts amongst Member States where the original proposal on the Servicing Directive was perhaps comparably simpler and more pragmatic then what might come out of the drafting works following this most recent progress report have arisen. This causes uncertainty notably against what is likely to be a very different European Parliament that in its new constellation might be tasked with approving measures that make up this new legal and regulatory framework. Lastly, against all of this uncertainty, the call for some elements to find their way back into the form of an EU Regulation and/or Commission Delegated Regulation could be catapulted back onto the table so as to avoid the risk that the rifts on certain provisions of the Servicing Directive lead to it being documented in a fragmented manner.