The annual Global ABS Conference 2014 was held in Barcelona during 10-12 June 2014. The key hot topic under discussion was the increasingly supportive stance of certain policymakers backing a revival within the European securitisation market, and the potential for this support to be factored into the regulatory framework. Among the key issues discussed at the conference were:
High Quality Securitisation - what and how?
The securitisation industry is pushing for the introduction of a definition of "high quality" securitisation, that would allow ABS so defined to benefit from a more relaxed risk-weighting treatment (under the proposed revisions to the Basel III securitisation framework). This is as important for insurance company investors under the Solvency II Directive as it is for banks under the Capital Requirements Directive IV and Regulation (CRD IV / CRR), as the Solvency II capital charges for securitisation exposures are even more punitive than those under CRD IV. However, agreeing on the specific detail of such a definition, let alone aligning it as between the bank and insurance capital frameworks, is likely to prove to be difficult. Terminology alone differs as between markets and products (with the Solvency II proposals distinguishing between "Type A" and "Type B" securitisations, the Bank of England and European Central Bank discussing "qualifying securitisations" (see our Feature Pieceon the Bank of England / ECB proposals in this Edition of the SCM Briefing), and others, such as the Association for Financial Markets in Europe (AFME) and the Prime Collateralised Securities (PCS) initiative, favouring "high quality securitisation" - contrast this with the Basel III Liquidity Coverage Ratio's "High Quality Liquid Assets"). What is clear is that prime residential mortgage-backed securities (RMBS) and some securitisations backed by loans to small- and medium-sized enterprises (SME ABS) could fall within the definition of high quality, while commercial mortgage-backed securities (CMBS), subprime and synthetic deals absolutely would not.
Asked about the likelihood of the Basel Committee taking forward a new definition of "high quality securitisation" with a view to applying a more relaxed regulatory treatment within its revised proposals for a new risk-weighting regime for securitisations, the ECB's Yves Mersch suggested that this was unlikely, leaving conference participants to surmise that the initiative would indeed be picked up at European level (so much for the global level playing field). Panellists queried this in terms of the impact on the level playing field with the US (with one panellist noting that, while the EU v US regulation debate was an interesting one in the securitisation space, we mustn't forget the rest of the world - Asia, Australia, South America, Africa - in terms of establishing a global level playing field for "high quality" securitisations, and in particular, the regulatory capital requirements for securitisation exposures).
Outright purchases of ABS to help revive the market?
Keynote Speaker Yves Mersch, Member of the ECB's Executive Board, noted the ECB's plan to conduct: (i) a new series of targeted longer-term refinancing operations (TLTROs) aimed at improving bank lending to euro-area households and non-financial businesses, by allowing banks a borrowing allowance of 7% of their total loans to the euro area non-financial private sector (excluding mortgages) until 2018; and (ii) outright purchases of "simple and transparent" ABS (as mentioned in our key developments section, above). News of the ABS purchases was broadly welcomed, however, market participants have noted that it is a return to a functioning securitisation market that is needed, rather than further central bank support (although the market would certainly not reject such an important source of funding for ABS at this stage). In addition, with cheap TLTRO funds available, this does not appear to incentivise securitisation issuance (at what would be surely higher costs), leaving the question open as to what exactly the ECB could buy if issuance remains flat. Mersch was at pains to point out, however, that the ECB is currently very much in the "preparatory" stage regarding the ABS purchases, and few details of the plans have as yet been released, save to note that the ECB would not be buying equity pieces. Mersch also reiterated that the focus would be ABS backed by loans to non-financial institutions (i.e. SMEs and RMBS), in order to help support the real economy. As in the past with ECB announcements, it is thought that the mere announcement itself will help revive the ABS market, even if the outright purchases do not ultimately follow. Reflecting earlier comments by ECB President Mario Draghi that ABS must have three key characteristics: they must be simple, backed by real loans, and transparent, Yves Mersch noted that the secondary market for ABS should be 'very liquid'. Related to this, the ECB's Asset Quality Review and the European Banking Authority's (EBA) bank stress tests will be completed by the end of 2014, and will highlight any problem areas in terms of required balance-sheet clean-up (or not, if no issues are highlighted) and the potential removal of illiquid assets.
Mersch made it clear that the ECB's main priority is price stability, financial stability and the protection of its balance sheet, and that any support for a "more holistic and coordinated" approach to the ABS market would not be at the cost of those priorities. No single asset class would be promoted and any such support would ultimately be in pursuit of the ECB's overall stability goals. Latest press reports now suggest that it may be several months until the EBA makes an announcement about the outright ABS purchases.
Comments from Adam Farkas, Executive Director at the EBA, hinted that the treatment of securitisation in the Basel III Liquidity Coverage Ratio (LCR) may be relaxed to allow a wider range of ABS (beyond RMBS) to be categorised as "High Quality Liquid Assets", particularly if their liquidity can be improved. Earlier analysis by the EBA showed that ABS was the least liquid of all the asset classes reviewed, with Farkas defending that analysis on the basis that the historic performance of ABS was not strong enough to merit granting the product a stronger liquidity status under the LCR. The EBA is currently working on its Guidelines for HQLAs, and expects to issue its final Report on HQLAs to the European Commission by October 2014 at the latest, and the Commission will base its Regulatory Technical Standards / Implementing Technical Standards (that will accompany the provisions of the Capital Requirements Regulation relating to liquidity) on the EBA's advice.
Ashley Kibblewhite, a Manager at the UK's Prudential Regulation Authority, noted that securitisation has been given a "second chance" to make a positive contribution to real-economy lending, and that that chance should not be squandered by a return to the questionable practices of the past (such as originate-to-distribute), while Wayne Byres, current General Secretary of the Basel Committee took the opportunity to remind conference attendees that the need for reform continues to exist despite the more positive sentiment towards the securitisation industry over the past couple of years, and that the reforms required to restore the securitisation market to its previous state of health (without necessarily aspiring to pre-crisis practices and attitudes) go beyond bank capital requirements and have as much to do with credibility, transparency and standardisation, as with greater transparency of the product's treatment by Credit Rating Agencies (CRAs).
Sovereign rating caps
It was suggested (by Yves Mersch, in comments that were later seconded by others) that investors should themselves decide whether to apply CRAs' sovereign rating caps to ABS transactions, in a move that would allow deals to be rated 'AAA' in cases where a sovereign rating ceiling restricts ratings on ABS issued from the jurisdiction. By way of example, a securitisation issued by a Greek bank but with a pool originated and ring-fenced in Germany, would be limited to a maximum achievable rating of just a few notches above the Caa3/B-/B Greek sovereign ceiling, despite the assets' high credit quality. Mersch called for greater transparency in rating methodologies, while CRAs noted that they do offer research products that indicate asset quality without the influence of sovereign caps.
Other products - CLOs, CMBS, covered bonds
Other comments made during panel sessions and discussed over coffee in the exhibition hall included the continued rise and rise of European collateralised loan obligation (CLO) 2.0 transactions, with the market expected to continue its upturn during the second half of 2014 and into 2015, with appetite (among the largest investors) for these deals remaining strong. Recent structural innovations include quarterly-pay liabilities rather than semi-annual, the inclusion of higher levels of senior secured bonds in portfolios, and fewer deals featuring optional repricing as investors remain concerned about prepayment risk. With many CLOs paying out higher yield than other bond types, demand is expected to increase, and it was noted that the CLOs issued to date in 2014 have counted for one quarter of all securitised paper issued in Europe this year.
With activity gradually picking up in the European commercial mortgage-backed securities (CMBS) market (with some new CMBS activity announced recently), market participants remain cautious about banks taking on the risks inherent in warehousing loans, and several noted that this is currently a barrier to greater activity in the CMBS market.
Distinctions continued to be drawn over the (much more favourable) regulatory treatment of covered bonds as compared to securitisations, and questions raised over whether this approach is sustainable given the issues of encumbrance (with regulators possibly seeking to restrict covered bond issuance in future, under existing (or new) encumbrance limits). Insolvency and ring-fencing issues also arise in the covered bond space. The lack of a common supervisory framework and disclosure framework for the covered bond market was highlighted as slightly anomalous given that ABS have been shown to be less volatile than covered bonds in terms of liquidity. However, the Commission has announced plans to review the treatment of covered bonds in the Capital Requirements Regulation (CRR) and launch a study on the merits of introducing an EU-wide framework for covered bonds, which is likely to provide much in the way of discussion points in due course. The EBA has already issued a Report on EU covered bond frameworks which provides a comprehensive overview of EU national covered bond frameworks and identifies the key features and practices of a prudentially sound covered bond framework (see further under the key developmentssection above).