Nobody would have said so in 2008 or 2009. Many are still sceptical now. However, the European Commission's action plan for a "Capital Markets Union" has made the revival of securitisation a key objective. Why? In the Commission's words: "to help diversify funding sources and unlock capital, making it easier for credit institutions (banks) to lend to households and businesses".
The Commission has recently published two new draft laws, the Draft Securitisation Regulation and the Draft Capital Requirements Regulation, to refine the concept of risk retention and create a market standard of transparent and comparable securitisations. It is hoped that they will help remove some of the stigma attached to securitisation. The benefit for banks of the new regime, whether acting as originator or investor in securitisations, will be a more risk-sensitive regulatory capital approach.
The Draft Securitisation Regulation
In the wake of the financial crisis, there were many allegations about the misuse of securitisation. Banks and financial institutions - in Europe and in the US - had been originating loans and then getting the loans off their balance sheets by selling asset-backed securities in the capital markets. Once they had done this, some questioned why the original lender would care if its securitised loans were repaid. One of the changes brought in after the financial crisis to make sure they did care was the rule on risk retention: EU (institutional investor) buyers of securitised bonds, or "securitisation positions", must now make sure the originator retains a net economic interest of 5 per cent in the loans. An originator can include a company that has bought a portfolio of loans, and not just the original lender that advanced the loans.
The Draft Securitisation Regulation aims to address two perceived shortcomings of the current risk retention rule:
The burden of ensuring compliance with the risk retention rule is on the purchasers of securitisation positions, and not on the originator itself. This can deter financial institutions from investing in a securitisation: the regulatory capital requirements on the investor become punitive if the securitisation breaches the risk retention rule.
The new regulation will change this so that an EU originator is under a direct obligation to retain risk of 5%. This should give investors more comfort that the regulatory capital treatment (and, by extension, the value) of their investment in a securitisation position will not adversely change because of non-compliance with the risk retention rule.
- There has been unease about the use of special purpose vehicles (SPVs) to get around the risk retention rule. The Draft Securitisation Regulation states that an SPV set up solely to buy and securitise a loan portfolio will not be permitted to hold the 5 per cent risk. This does leave open the question of what other activities the SPV must be carrying on so as not to have a "sole purpose". However, this proposed change is preferable to a "primary purpose" test, which was put forward in an earlier consultation paper.
Simple, transparent and standardised (STS) securitisation
This is a new market standard for a securitisation, meeting various minimum qualitative criteria. It is intended to give comfort to investors that the bonds they buy are structured in a way considered to be market-standard. It does not mean the structure is risk-free – the investor evaluates the risk. But it enables the investor to focus on reviewing the creditworthiness of the underlying loans rather than spending excessive time on the securitisation’s structural aspects.
Another big attraction of STS bonds is that they should receive more favourable regulatory capital treatment than non-STS bonds (see below) because an STS securitisation can reduce structural and modelling risks.
The Draft Capital Requirements Regulation
One of the big criticisms of securitisation after the financial crisis was that it relied too much on credit ratings. These ratings, awarded by credit rating agencies, also determined how much regulatory capital banks needed to hold against their securitisation positions. Under the Draft Capital Requirements Regulation, financial institutions (if they have received permission) will use the "Internal Ratings Based Approach" to assess for themselves – subject to supervisory oversight - how much regulatory capital they should hold against their securitisation positions (whether senior or otherwise). This should help ensure the amount of regulatory capital a bank holds is a more accurate reflection of the risk.
This change is based on an earlier proposal by the Basel Committee on Banking Supervision. However, the European Commission has gone ahead of Basel by also saying that STS securitisation positions should receive more favourable regulatory capital treatment than non-STS positions. Basel has published a consultation paper indicating that it will likely follow suit in 2016. The EU's approach will probably then shift to reflect any agreed Basel standard, creating a level playing field for original lenders and investors globally. It is currently unclear how the regulatory capital treatment will change for investors other than banks and financial institutions. However, the Commission has indicated that the changes proposed for banks in the Draft Capital Requirements Regulations will be rolled out for insurers in other legislation.
It is unlikely that either of these regulations will become effective before the end of 2016. Both will also probably change to reflect the outcome of the Basel consultation paper. However, it is possible that market participants will begin to react to these changes well in advance of their coming into force to ensure that securitised bonds are eligible for the more beneficial regulatory capital treatment once the laws become effective.