Global regulators have been expected for several weeks to announce measures to remove barriers to "high quality" securitisation, and the Bank of England (BoE) and the European Central Bank (ECB) jointly released a Paper at the recent International Monetary Fund (IMF) Spring Meeting in Washington (11-13 April 2014). The Discussion Paper appears to be broadly positive and supportive of a well-functioning securitisation market, both as a funding tool to support the real economy as well as imposing useful discipline for risk management purposes. Noting initially that the European securitisation market remains "impaired", and that the market is shrinking, the Paper assesses the current state of the market and considers how it may look in future, although without making any specific recommendations at this stage. Reflecting on the ability of securitisation to provide liquidity and maturity transformation, risk distribution, liability funding, and more generally, lower costs of capital and higher economic growth, its benefits in supporting monetary and financial stability (from a Central Bank perspective), and facilitating the provision of finance to households and small- and medium-sized enterprises (SMEs), are also highlighted. While the Global Financial Crisis (GFC) demonstrated that securitisation (particularly the much-criticised originate-to-distribute model) has the ability to damage financial stability, steps have been taken to rectify certain of those damaging aspects (such as the Financial Stability Board's efforts to regulate "shadow banking", the risk-retention and due diligence provisions of the Capital Requirements Directive IV, the EU Regulation on Credit Rating Agencies as amended, and the introduction of loan-level data requirements as part of Central Banks' asset-repurchase initiatives). However, these steps have not necessarily led to an improvement in investor sentiment, the combined result being that securitisation issuance remains at a historically low level across Europe. This is the case despite there having been very low default rates on asset-backed securities (ABS) during and after the GFC (particularly when compared to the US market which saw high levels of default rates, particularly on sub-prime loans). Reviewing the remaining structural roadblocks to a functioning securitisation market in Europe (while acknowledging that there are a range of other factors, including investor sentiment, the perceived stigma of ABS and persistently negative deal economics that are also affecting issuance levels), the Paper highlights three issues that, if addressed, could help catalyse the return of ABS to Europe: (i) proposed changes in the regulatory treatment of ABS is creating uncertainty, in particular the Basel Committee's proposals for a revised risk-weighting framework for securitisation (see our Feature Piece in Edition 8 of this Briefing for a summary of those proposals), but it may be helpful to follow recent proposals of the European Insurance and Occupational Pensions Authority (EIOPA) for a distinction between "Type A" (high quality) and "Type B" (lower quality) securitisations; (ii) overreliance on credit ratings may lead to unwarranted pro-cyclical effects (although this is being addressed somewhat by other initiatives); and (iii) market participants continue to cite the lack of transparency and standardised data on underlying assets as a key constraint (although loan-level data initiatives should be helping with this). The Paper concludes that the definition of the concept of "high quality" securitisation is crucial to reinvigorating the market, and global regulators (the Basel Committee and the International Organisation of Securities Commissions) are urged to accelerate their work in this regard and develop actual criteria on which a definition of "high quality" would be based (with Central Bank eligibility criteria suggested as a staring point for this). The Paper noted that a longer, more substantive joint discussion paper would be issued in May 2014. That Discussion Paper has, at the time of writing, just been released, with comments on the various policy options (which include the possible development of a set of high-level principles identifying "qualifying securitisations") requested by 4 July 2014. There is a substantial number of questions on which specific industry comment is sought. A more in-depth analysis of the Discussion Paper (taking into account industry and market commentators' views expressed during the Global ABS Conference) will be provided in the next Edition of the SCM Briefing.

 

Useful links

Bank of England and European Central Bank Paper (April 2014)
Bank of England and European Central Bank Discussion Paper (May 2014)