NPLs – EU Directive on credit servicers and credit purchasers

February 2023 | EXPERT BRIEFING | BANKING & FINANCE

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European Union (EU) member states are expected to transpose and apply the measures implementing the EU Directive on credit servicers and credit purchasers – the Non-Performing Loans (NPL) Servicer Directive – on 30 December 2023.

In its legislative proposal for the NPL Servicer Directive, the European Commission (EC) outlined that high stocks of non-performing credit agreements can impact the performance of a bank in two main ways. First, NPLs generate less income than performing loans and therefore reduce the bank’s profitability and may cause losses that reduce its capital. Second, NPLs tie up significant amounts of a bank’s resources, both human and financial, which reduces the bank’s capacity to lend, including to small and medium-sized enterprises (SMEs).

The Directive therefore represents another step in implementation of the European Union’s (EU’s) ‘Action Plan to Tackle Non-Performing Loans in Europe’ by further developing the secondary market for NPLs.

The basics

The scope of the Directive captures credit servicers of NPLs issued by EU credit institutions as well as the credit purchasers of such NPLs. Credit agreements are classified as non-performing in the event the payments are more than 90 days past due, or the loan is assessed as unlikely to be repaid by the borrower. Importantly, however, there are a number of areas to which the Directive does not have application, including: (i) performing loans; (ii) securitisation vehicle purchasers; (iii) credit servicers that are EU credit institutions; (iv) loans by non-EU credit institutions; and (v) EU credit institution purchasers.

Accordingly, the Directive is primarily focused on creating conditions that facilitate greater participation in the EU’s NPL servicing and secondary debt trading market by non-EU purchasers so as to enhance the opportunities for EU credit institutions to address their NPL portfolios, whether through increased servicing options or through increased disposal options.

Credit servicer authorisation regime and passporting

The Directive creates a general requirement on credit servicers to become authorised in their home member state before commencing those activities. The Directive further describes the authorisation requirements. However, a number of member states already have licensing regimes in place for servicers of such credit agreements. Where that is the case, the key task will be ensuring that the relevant member state regime reflects, at a minimum, the authorisation and licensing requirements mandated by the Directive.

Importantly, for member states that have equivalent regimes in place, credit servicers already licensed in those member states can benefit from the automatic recognition contemplated by the Directive to avoid a relicensing exercise.

Similar to the passporting framework in other EU financial services directives, the Directive introduces a ‘passporting’ regime for credit servicers. This will allow servicers approved in their home member state to provide services in other member states without going through a separate authorisation process each time, reducing costs and potentially making the NPL servicing market more attractive to new entrants.

Sharing information with prospective purchasers

A common issue that needs to be navigated by purchasers of NPLs is how to complete know your customer (KYC) checks on underlying borrowers, and potentially personal guarantors, prior to signing a binding contract to purchase the NPLs.

In this respect, the Directive recognises that selling credit institutions can provide detailed information on the relevant NPLs to prospective purchasers before they enter into a binding purchase contract. This could help allay fears of selling credit institutions about the legal consequences of providing NPL and borrower information to multiple potential purchasers that are not yet contractually committed to an acquisition.

Nevertheless it remains unclear how extensively this provision is intended to operate, particularly in relation to compliance with bank secrecy and data protection laws. Although the Directive contemplates that the European Banking Authority (EBA) will issue guidelines in this area, the Directive acknowledges that relevant member state laws regarding areas such as bank secrecy will continue to apply and therefore any such guidelines may not be as helpful as purchasers want.

Obligation to appoint a credit servicer

The Directive mandates that representatives of non-EU purchasers must appoint a credit servicer (except where the representative itself is a credit servicer) where they are acquiring NPLs with either consumers or SMEs. This contrasts with EU-domiciled purchasers that are only required to appoint a credit servicer for consumer NPLs.

This needs to be considered by non-EU purchasers in conjunction with the requirement imposed on them by the Directive to appoint a representative in a member state to liaise with applicable regulatory authorities and be responsible for compliance by the credit purchaser with the applicable member state regulations transposing the Directive, including the disclosure and reporting obligations.

Time will tell whether credit purchasers opt to use their appointed credit servicer groups to fulfil this additional representative function (and credit service groups may want to develop their offering for this this purpose) or go with other options depending on their own specific set up.

Duties to and communications with borrowers

The Directive mandates a number of requirements for member state licensing regimes regarding duties to, and communications with, borrowers under the relevant credit agreements. The extent to which these requirements influence or alter the approach that purchasers of NPLs take going forward is debatable, particularly for those seasoned NPL purchasers that have established relationships with servicer groups in the member states of primary interest to them.

Securitisation exemption

The securitisation exclusion may not cover all transactions that market participants may expect. Firstly, article 2(4) defines ‘securitisation’ by reference to the definition used in Article 2(2) of the EU Securitisation Regulation. This definition focuses on tranching of credit risk and the allocation of losses across tranches. This definition is not consistent with the definition of securitisation used in most national securitisation laws (e.g., Law 130 in Italy or Law 3156/2003 in Greece). It is possible that a transaction could be structured in compliance with one of those national laws and yet not amount to a securitisation for the purposes of the EU Securitisation Regulation. In such case, it is not clear that satisfaction of the servicer appointment requirements under those national securitisation laws would exclude the operation of the Directive.

The second issue is that not all national securitisation laws impose licencing requirements on servicers. It is possible to conceive of transactions where it is permissible under the relevant national securitisation law for the servicer to be an unregulated entity. In that scenario, the requirements of article 2(4) of the Directive might lead to the conclusion that the servicer appointed to such transaction would need to be licenced in accordance with the Directive, notwithstanding the apparent carve out of securitisations.

Accordingly, while ‘securitisations’ are prima facie excluded from the need to comply with the Directive, it is not clear that this exclusion will apply to all transactions which market participants might characterise as securitisations, and it will probably be prudent to ensure that servicers appointed to such securitisations have permission to act as an NPL servicer under the Directive.

Servicer agreements

The Directive mandates certain clauses that the servicing agreement between a credit purchaser and the credit servicer must contain. Although these required clauses are mostly perfunctory in nature, there is a requirement to include a clause requiring fair and diligent treatment of borrowers. Although the standard service agreements that most servicers use generally include an obligation to comply with applicable laws in the provision of the services and in dealing with the borrowers, how this fair and diligent treatment clause should operate alongside the relevant member state laws will potentially need to be addressed in the relevant servicing agreements.

Review of charges and potential impact on pricing

The Directive contemplates that the EC will submit a report, by the end of 2023, regarding the adequacy of the regulatory framework regarding caps on charges arising from defaults in NPL agreements with consumers, SMEs or with any other borrowers where there is a personal guarantee or security over property or assets of an individual.

This last category is noteworthy and may have implications for how credit purchasers assess and structure NPL portfolio purchases going forward. This is because it is not uncommon in certain member states to find that corporate borrowing is supported by personal guarantees from, or property of, ultimate beneficial owners of the borrower. Accordingly, where an NPL portfolio coming to market has any such security arrangements, credit purchasers will want to understand how the outcome of this future regulatory review could impact their pricing of the portfolio and whether the review could ultimately result in protective measures that undermine the anticipated returns.

Conclusion

A number of member states already have licencing regimes in place for credit servicers and many credit purchasers are already familiar with appointing credit servicers in those jurisdictions. In that sense, the Directive is not transformative for the NPL secondary market landscape. However, the introduction of a passporting regime for credit servicing and the requirement to appoint a servicer, for both consumer and SME NPLs in the case of non-EU credit purchasers, represents another important step in harmonising the EU-wide approach to NPLs.

Ultimately, the Directive may have less impact on the non-SME secondary market for NPLs, albeit the EC report due at the end of 2023 could still prove a ‘sting in the tail’ that impacts that market too.

Jochen Vester is counsel and Alan Bainbridge is a partner at Norton Rose Fulbright LLP. Mr Vester can be contacted on +44 (0)20 7444 2004 or by email: jochen.vester@nortonrosefulbright.com. Mr Bainbridge can be contacted on +44 (0)20 7444 3279 or by email: alan.bainbridge@nortonrosefulbright.com.

Jochen Vester and Alan Bainbridge

Norton Rose Fulbright LLP