Thursday, 18 October 2018

IFR Securitisation Roundtable 2015: Part 2

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IFR: At some point quite soon the ECB is going to stop buying ABS. Given that – looking at the Covered Bond Purchase Programme versus the ABS Purchase Programme – there’s been a huge differential in what they’ve been buying, and of course we’ve all seen the impact it’s had on covered bonds sending it into negative territory in core markets.

Traditional Pfandbrief investors in Germany are screaming blue murder because there’s no value and they’re actually quitting the asset class. There are different dynamics at play within the securitisation market, so just to put a wrap on the ABSPP, when it stops does anyone really care?

Alex Batchvarov, Bank of America Merrill Lynch: In six months or so the total volume of purchases, I think, is €6.3bn or €6.4bn. Does it really matter? It’s a fraction of the market. Where it could have mattered significantly is if the ECB had initiated the ABS Purchase Programme to address retained transactions and priced them accordingly.

You can’t want to buy a retained Triple A at 30bp over when that same Triple A with a 10% discount can be put through the TLTRO at 5bp over – actually, it’s 5bp flat not even 5bp over. There is a lot to be desired in terms of the ABS Purchase Programme.

The issues I think that we are going to face going forward are twofold: ABS is a self-liquidating instrument, so even if the ECB decides to hold them over a few years, the €6bn will become €3bn, then €2bn, then zero. Covered bonds and the ECB are focusing on the five to seven-year maturity, and in a way it was meant to push out the maturity curve for covered bond issuance.

You have to hold them for maybe three to five years, or you have to liquidate them. That is when it’s going to get very interesting in the covered bond market, because when is a big group of investors who are lost and frustrated going to come back?

Actually, it’s much easier to come back to covered bonds as an investor than to come back to ABS. Simple regulation does not require you to set up any kind of specific framework to analyse them, and to tick boxes and prove you’ve done due diligence, which is the case for ABS. Once the relative value dynamics start changing, there will probably be investors.

On the other hand, it may be a great idea: you sold to ECB at minus 15bp and you buy back at plus 10bp. Who knows who is going to take that loss?

Scott Dickens, HSBC: We should be clear as well: these purchase programmes were supposed to be a short-term measure. They’re not the long-term solution. The key is to get the right regulatory framework and all of the right long-term structures in place to get a functioning market.

In some ways it distorts the market; it’s been good for the secondary market trading desks.

If I was going to focus on one thing, it would be the regulatory framework across banks, insurance companies, asset managers to make sure we encourage asset liability matching and make sure that these assets are going to those most able to hold them at the right price.

IFR: We’ve mentioned it already but the other area I wanted to touch on very briefly is the US, which is going gangbusters. Pat, do you have any sense of why on earth the US market has recovered so quickly and it’s just so busy.

Alex Batchvarov, Bank of America Merrill Lynch: The US needed the securitisation market. The US banks are a much smaller part of the economy, as I already stated, and so you have a lot of specialist lenders – the auto companies, the unsecured consumer lenders, equipment leasing companies etc that all fund themselves through the securitisation market.

It was always very different than Europe in that way and so it was much easier to restart. The infrastructure was there and there was a bigger buyer base there. Here you had the SIV buyer base that went away. You always had more of a real-money buyer base in the US that bought ABS and that understands ABS. There’s a huge industry there so it was just much easier to come back.

That being said, the regulators and the government knew that and so they did certain things to make sure that it came back as quickly as possible. The TALF programme, where you gave leverage to investors, was the spark that brought the market back very quickly.

I’m not sure that would have been palatable in Europe to give that type of cheap leverage to investors.

Marjan van der Weijden, Fitch Ratings: We should not forget that the European economies have been growing very slowly, if at all, in the past few years, so new asset generation has obviously been much slower than in the US. If you don’t generate the assets you have to rely on refinancing of old assets, and I think that’s also a significant barrier to growth.

IFR: Let’s move on to the policy debate as it stands in Europe today. It’s hard to know where to start on this really. We’ve seen policy and positioning papers over the past months or whether it’s the Basel Committee, IOSCO, Bank of England, ECB, the Committee of the European Supervisory Authorities (ESA) as well as the European Commission. There’s a lot of stuff out there and what the ESA highlighted is that this asset class touches half a dozen EU directives or regulations but not necessarily in the same way.

So, while we have direction of travel that’s relatively clear, the devil is in the detail so I wanted to spend a bit of time on this. If the end-game is that securitisation becomes a plank of Capital Markets Union and the building blocks to that are standardisation, transparency, and disclosure and so on and so forth, Marjan, can I just ask you to kick us off on this huge topic? The direction of travel is the right one, is it?

Marjan van der Weijden, Fitch Ratings: That’s a big question. If you look back a couple of years, I would have been a lot more pessimistic. I think the direction of travel and the intentions are constructive and positive, and I think we have to recognise that.

There’s been a big step forward in regulators and policymakers talking to each other. They still have quite a long way to go in harmonising and making sure that it all works together; all the pieces of the puzzle are hovering and they need to fall together. That’s a real challenge, but I think the direction and the intention is there.

As an industry we need to be constructive but also to contemplate, anticipate, and get attention for possible side-effects and consequences that, maybe in five or 10 years, we might be regretting. Things that might seem a good idea today might not work in five to 10 years.

We can’t predict the future, but I think there are elements that if we’re being too prescriptive rather than principles-based, there is a risk that we end up in a place that is hard to turn back from. There’s a lot of work for us all to do and make sure our voice is heard but in a constructive way to enhance the direction of travel.

IFR: You mentioned side effects: there have been a lot of what I call unintended consequences around the general theme of regulation; others would call them intended consequences and I guess that depends on your political viewpoint – CMU is a political construct first and foremost.

It will take several years, realistically, to get to full agreement across Europe on all aspects of securitisation. Do you think that the approach policymakers are taking is the right one?

Scott Dickens, HSBC: We’ve been working on this for a number of years, and all we’re really trying to achieve is a level playing field where the capital weightings really reflect the risk of the asset class. The problem was initially that wasn’t the case; there was an overreaction, there was a lot of negativity around the asset class.

In the long run everyone is looking to try and accurately reflect the risks in the asset class. We still have work to do but we’ve made a lot of progress. There is a lot more acknowledgement as to the credit performance of the asset class in Europe, and there’s still work to do there as well.

AFME has done an enormous amount of work and the ratings agencies have also helped in terms of the data that’s available showing the performance of this asset class. All we’re really trying to get is a position where that is reflected. Until we get there, we’re not going to get the result that we need and we’re not going to build a long-term securitisation market.

In its best form, it can be a simple, transparent, standard asset class that has a lot to offer, and it would be a shame if we threw the baby out with the bathwater and we didn’t reflect that.

If we look at the global situation, we’re faced with youth unemployment, anaemic GDP growth. Securitisation can help all of the incentives and stimulus that we want to try and get into the economy. So there is a role for the non-bank lenders, there is a role in terms of autos and SMEs; there are a lot of potential uses for securitisation. We need to encourage that.

Alex Batchvarov, Bank of America Merrill Lynch: If the European political class in Brussels and our European regulators want securitisation to restart, they have to do it. You cannot achieve re-launch of the securitisation market on a piecemeal approach.

The general problem with regulations, in my view, is that they are all done on the basis of silos. Where the umbrella co-ordination body has to step in and put things in perspective, the effort seems to be lacking. As a result, we’re already seeing intended or unintended consequences of shift of asset allocation and things across asset classes.

But we are talking here about potentially 19 different regulations and acts which need to be amended. It’s not only Alternative Investment Fund Managers Directive, it’s not only CRA; it’s not only Solvency II; you can find things which are problematic in MiFID II, in EMIR, pretty much across the board. There is already a precedent; a lot of these wrinkles were ironed out very quickly when it came to covered bonds at the highest level. Why can’t they be ironed out for securitisation?

The other issue is that if we are going to wait for every single Delegated Act or other regulation become due for review between 2017 and 2020, the market will be dead by then. What I think we need right now is an Omnibus Act which puts securitisation in perspective and realigns the treatment across all the different regulations that exist in Europe.

However, that alone won’t be enough because we have such preferential treatment for other sectors. My view is that we shouldn’t be bringing down some parts of the securitisation market to the preferential treatment of the other sectors, where that preferential treatment is not justified; we should actually review the preferential treatment of other sectors and bring that to much more realistic and risk-adjusted levels and restore the level playing field in the markets.

AFME’s paper didn’t go far enough in what needs to be done. Hopefully the European Commission understands that and will put out a comprehensive document in September and move on very quickly, because if we are going through the regular legislative process, that may take another two or three years.

IFR: Oldrich, is the covered bond lobby just better than the securitisation lobby?

Oldrich Masek, JP Morgan: The covered bond product has been around for a lot longer than securitisation; it’s got a lot more users and it’s got that critical mass I mentioned earlier. I agree with Alex’s point: there’s just much more weight behind getting initiatives through.

What’s very difficult about securitisation is directionally it’s all moving the right way. The regulation, the intentions are correct but it’s very difficult to co-ordinate everything. Then again, for people to get excited back about securitisation, investing in research, infrastructure, it’s got to stabilise.

I agree completely with the idea that other sectors are getting extraordinarily beneficial treatment and should be risk-adjusted the other way because you can’t have them all treated differently in terms of the support that the system gives to one set of asset classes versus the other, because it doesn’t create a market mechanism at all.

IFR: How will that equalisation work in practice? Should ABS maybe get credit for the capital relief that it provides?

Oldrich Masek, JP Morgan: It’s pretty simple to understand what you have at risk in a securitisation. It’s complicated by nomenclature but if you’re a bank and you sell a portfolio and you retain the bottom 2%, the maximum you can lose is 2%. There are anomalies where capital charges can be three or four times your actual notional position. That doesn’t make for a healthy type of economic value.

Alex Batchvarov, Bank of America Merrill Lynch: The problem is that when this started the securitisation industry probably couldn’t have been weaker. I’m involved internally with the lobbying effort, and when all these things first started what you were fighting against was a feeling that we don’t really want the securitisation industry around any more, and so you were starting from that point.

The body language has gotten much better in dealing with the regulators over the last 24 months but you’re starting from such a hard point where you’re constantly swimming upstream against what they started out proposing so even though it’s getting better, it’s getting better from such an onerous level that really didn’t make securitisation viable. So, it’s baby steps.

IFR: Is that because of the toxicity that was embedded in some parts of the market that Alex mentioned earlier? Is that because it’s got a bad reputation?

Patrick Connor: It had a terrible reputation. We all know that. Sure, the securitisation market had issues, which we’ve all made the point; the reality was those issues really didn’t exist in Europe. European securitisation performance was very good; mostly it was senior-tranche capital-structure type funding and the asset performance has been good.

The issues were in the US, funnily enough, where it’s come back, where you had the correlation on ABS CDOs that was vastly under-rated and then there was a real origination problem in the sub-prime market so those two main issues caused 90% of the problems, but we’re feeling the repercussions of that more in Europe than they are in the US.

IFR: Is the debate on high-quality securitisation the right way to go to start to revise the capital treatment of securitisation in general? Or is it going to create discrimination against non-compliant and non-eligible tranches?

Scott Dickens, HSBC: High-quality securitisation has helped with the regulators and the political supporters, and it was definitely the way the industry needed to move. As Patrick said, apart from CDOs and US sub-prime, there was a lot of good in terms of the securitisation markets, but a lot of that was forgotten.

Certainly, making it more transparent, more standardised, making sure that we’re whiter than white will help us get the right regulatory capital treatment, and so I think it’s been positive. There was a suspicion that we were selling the product to investors who weren’t able to analyse the credit and didn’t have access to the data.

Actually, if you look at the European market now, the investor base is incredibly sophisticated and has the ability to analyse these credits. These guys are more than capable of taking a structure, doing credit analysis, and coming to a view as to whether or not they would like to buy it and at what price.

There’s been an over-reaction, where we’ve tried to solve for something that probably was a problem pre-crisis but has gone away. It’s just a necessity; it is where we are. High-quality securitisation is a good starting point, but I think there are still other issues that need addressing.

IFR: Can I ask you, Andrew, to comment on the high-quality piece? And the issue of transparency, will data disclosure, standardisation and harmonisation provide non-specialist investors with what they need, or are they just going to get killed in the flood of data?

Andrew Dennis, Aberdeen Asset Management: There is a huge temptation to over-complicate things, which the securitisation industry indulges itself in ad nauseam. Whenever anybody says: “there was never, ever any problem in the credit side in Europe; it was all the US” I always wonder why nobody mentions European CMBS, which was a massive value destroyer for investors.

There’s a saying in the US, which is very apposite to these things: “There ain’t no cure for stupid.” Regulation shouldn’t or can’t be a substitute for making good investment decisions, and that’s true whether you’re buying covered bonds, bank Tier 1, convertibles, or ABS.

If you make the wrong decisions that are misguided, then you’re going to get carried out. That’s how it should be, probably. There isn’t any getting away from the fact that sometimes securitisation as a technology can be quite complicated. It’s a poker game: you’ve got to understand who’s doing what to whom, and why, and whether you’re the guy who’s getting fleeced or whatever.

Whenever somebody walks into our door and says, “We’ve got this product; it’s an arbitrage CLO,” you think, “Am I getting arbitraged? Am I doing the arbitrage?” “No, you’re providing it”, they’d say. It’s stuff like that.

The AIFMD checklist that we have to perform on certain assets in certain funds is just bananas. It’s almost insulting: “have you checked that they actually tested the credit?” It’s stuff that anybody in this asset class should be doing as 1.01 Credit Analysis.

But we can debate the logic about what high quality is and what is not high quality as much as we want. This is the direction that all these regulations are travelling in. If we care about the development of the industry, what we need to do is pick the battles we fight very carefully.

I’m involved on a committee in the Investment Association, which is the UK investment management talk shop/pressure group/lobby group. How do we get CLOs into high-quality securitisation? How do we get CMBS in? How do we do this synthetic securitisation in high-quality securitisation?

To me, that defeats the object; I think that what we need to say is there are asset classes and structures that clearly serve a legitimate economic purpose. Those are residential mortgages, those are SME loans, those are autos, those are credit cards or other consumer assets. There should be a series of standards that have disclosure and transparency that those transactions abide by.

Whether it’s necessary to know what every single borrower had for breakfast is a moot point. I don’t think we, as an investor community, spend enough time looking at things like servicing standards and so forth. That ultimately is where a lot of credit risk lies. Then there’ll be the rest.

One of the potential unintended consequences of bifurcating, creating a tick mark or flagged market and a non-approved market is you get a lot of people involved in the market as direct investors who really don’t understand the weirdness that’s not credit-related, the weirdness of cash flows in securitised bonds, the way that cash moves through transactions and so forth.

The market can survive with 10, 15, 100 specialist investors. What we need to do is move the regulations so that the people who allocate funds to them – the pension advisors, the insurance companies, the endowments and so forth, – say: “that’s fine, that’s an asset class, boom, on to the next one”.

That’s where we need to travel. It would be lovely if all those regulations were to be harmonised, and all the definitions were consistent, and the risk weightings adequately reflected the genuine economic risk in transactions. For instance, in off-balance-sheet presumably it should be a nil-sum game: the capital relief that the seller gets should be distributed in terms of risk capital into the system.

As an industry we do have a duty not to blot our copybook again by doing a lot of funky stuff, a lot of synthetics and a lot of stuff where tranches collapse very quickly and so forth. I don’t necessarily see that manifest itself in the primary market. I do have a concern about the amount of leverage that’s available to people, which is not obvious, but the direction of travel is right.

I quickly read the AFME response. We don’t want to make the market so difficult that no-one can access it, where It becomes something like the Imperial Chinese Civil Service exam where only three people ever stay long enough to pass. We need to toe the line, but we also need to acknowledge this is the direction it’s travelling in. Not much we can do about that.

IFR: Arun, what are your thoughts? What’s the endgame? More to the point, are we ever going to reach it?

Arun Sharma, Credit Suisse: The high-quality securitisation label is a very pragmatic beginning. I don’t necessarily think it’s the desirable end-game because ultimately you want people to make decisions based not on something being labelled ‘high quality’, and you also don’t want to create cliff risk, where there are assets that are sensible and which contribute to the real economy but are excluded from the menu.

As a starting point and as something that helps regulators help us, it was definitely the right thing to do.

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