Following up on a commitment made as far back as the 2009 consultative documents on the 'Basel III' framework to conduct "a more fundamental review of the securitisation framework and the reliance on external ratings…", the Basel Committee has issued a complex set of proposals for an overhaul of the risk-weighting regime for securitisation exposures that would increase capital requirements for many types of securitisation transaction and have a range of other effects.  The Consultative Document represents the Basel Committee's initial thinking on the changes required to the securitisation framework, as revised in 2009 by interim changes made under Basel '2.5' and most recently by Basel III, which has now begun to take effect in stages from 1 January 2013.  The Consultative Document is fairly detailed and technical in nature, but also sets out in some detail the Basel Committee's observations on the role of securitisation during the global financial crisis and its interpretation of the shortcomings of the existing securitisation framework (in terms of risk capture, ratings overreliance and loss adjustment, and notes the greater focus in these proposals on tranche seniority and thickness, and maturity, as measures of risk).  The proposals are intended to make capital requirements for securitisations more prudent and risk-sensitive, mitigate mechanistic reliance on external credit ratings (linking in with the revisions to the EU Regulation on Credit Rating Agencies under CRA III), and reduce procyclical cliff effects (making securitisation exposures less likely to demonstrate rapid increases in capital requirements when deeply downgraded (and vice versa), which was especially frequent in unrated transactions during the crisis, according to the Basel Committee).  The proposals may be summarised as follows:

  • Proposed revision of the existing hierarchy of approaches to calculating capital requirements for securitisation exposures, but limited changes to the approaches themselves.  Thus, the range of approaches that was set back in 2004 under Basel II remains intact, with some suggested improvements, as to which, see below.  Very briefly, the approach to be taken depends on whether the securitisation exposures are rated or unrated, and the framework allows banks a choice of the most simple Standardised Approach (SA, based on external ratings provided by Credit Rating Agencies (CRAs) for rated exposures), or the more advanced Internal Ratings Based (IRB) approach which comprises a Ratings-Based Approach (RBA) for rated exposures, a Supervisory Formula Approach (SFA) for unrated positions and a separate Internal Assessment Approach (IAA) for ABCP programmes. 
  • The proposals seek comment on two possible new hierarchies (Alternative A and Alternative B) under each of which: the SA and IRB approaches would be more closely aligned to help avoid regulatory arbitrage between the two, a modified RBA would be used that gives higher risk weights for longer term and senior tranches within securitisations and lower risk weights for thicker tranches with shorter maturities (with the definition of tranche maturity based on either weighted-average maturity or legal final), a revised, more conservative SFA (the Modified SFA, or MFSA) would be used, and a so-called Backstop Concentration Ratio Approach (BCRA) would be introduced that would act as a conservative backstop to calculate the relevant risk weight where none of the above formulae can be used (as an alternative to (or at least before) the application of the punitive 1250% risk weight).

Alternative A

The MFSA would sit at the top of the hierarchy, and if a bank could not meet the conditions for its use (which, amongst other things, require the exposures to be rated by two external CRAs and for the second-best rating to be used - so still retaining some amount of reliance on ratings despite the Basel Committee's clear intention to discourage this), it would choose to use either the revised RBA (or IAA) or a Simplified SFA (SSFA), and then as a last resort the BCRA.  This approach is aligned with the US approach to some extent, and initial industry feedback appears to be that Alternative A is somewhat preferable to Alternative B, as it avoids the potentially continuing cliff effects of Alternative B which applies different treatment for senior and non-senior tranches/exposures.  While it appears that many large banks could meet the requirements for the use of Alternative A, it is questionable whether they can generate all of the required data (e.g. detailed loan-level data is required) to comply with the conditions for use of the MFSA, within a short timeframe.

Alternative B

Alternative B distinguishes between: (i) senior "high-quality" securitisation exposures/tranches (again as defined by external ratings and other assessments of credit quality) for which both the revised RBA and MSFA sit at the top of the hierarchy and a bank could choose which to apply, provided it met the relevant conditions.  If not, it would be subject to the BCRA, which under Alternative B, would be increased by a factor of 1 for senior exposures and a factor of 2 for all other exposures, otherwise the 1250% capital requirement would be applied; and (ii) all other non-senior tranches/exposures for which the BCRA would be applied if KIRB cannot be calculated.  Alternative B could result in significant differences in the regulatory capital treatment of senior vs non-senior securitisation holdings and appears not to be the preferred option from the securitisation industry's viewpoint.  Note that the BCRA approach is the only one allowed for re-securitisation transactions, whether using Alternative A or Alternative B. 

Other key changes which may have a significant impact if adopted as proposed in the Consultative Document include:

  • The proposed removal of some of the beneficial treatments for ABCP programmes, including the 50% credit conversion factor for eligible liquidity facilities and the risk weight cap / deduction-not-required treatment for exposures in a second loss position (or better) in ABCP programmes.  Both would be replaced by the BCRA under these proposals.
  • The proposed extension of the 20% risk weight "floor" in the current SA to the IRB approach.  In practice, this would make the lowest risk weighting available for any securitisation position 20% (as opposed to the current 7% lowest weight for a senior tranche under the existing IRB approach).
  • In tandem, the proposed setting of a maximum cap on securitisation risk weights for senior exposures, based on a "look-through" approach (i.e. looking through to the risk weights applied to the underlying receivables securitised), which the Basel Committee believes should be applied irrespective of whether an exposure is rated or not.  Under both the SA and IRB, this cap would be equal to the (average) risk weight applied to the underlying exposures.
  • The potential removal of the distinction between "long term" and "short term" risk weightings is suggested, and the Basel Committee seeks feedback on this point, which seems odd given its clear preference in the Consultative Document for a distinction between lower risk weights for longer maturities and higher risk weights for shorter maturities.
  • The existing "early amortisation" provisions that currently apply to revolving deals (credit card master trusts by way of example) would be eliminated, such that originators/sellers would be precluded from applying the securitisation framework to receivables sold into a trust (in other words, the sold assets would be treated as "on-balance sheet" for regulatory capital purposes). 

Comment on the consultative document is requested by 15 March 2013.  Specific feedback on the calibration of the proposed changes is sought that will feed into a Quantitative Impact Study, the detailed results of which will be crucial in determining the next steps in this process.  Market participants are urged to respond to the Basel Committee with specific comment on the different effects of Alternative A and Alternative B, the conditions to the application of the different approaches and the formulation and calibration of the new and revised approaches. 

Useful links:

Basel Securitisation RWA Proposals

Basel Committee 2009 Consultative Document

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