SECURITISATION IS COMING out of rehab and is set to emerge from its painful period of exile.
The European Commission’s March 27 paper “Long-Term Financing of the European Economy” focuses on how to get capital flowing into the real economy. Securitisation is in there as one of the products expected to play an important role in those efforts, which broadly recognise that bank lending won’t provide the quantum of capital needed and that capital markets will need to take up the slack.
At the heart of policymakers’ attempts to kick-start securitisation are plans for a set of lighter capital requirements for institutional investors to hold paper under Solvency II, along with better disclosure, transparency around the quality of underlying assets, and greater product standardisation.
The “skin-in-the-game” risk-retention provisions in place since 2011 that require banks to retain stubs on their books have always been sensible. Intended to avoid the kamikaze originate-to-distribute situations that gave the product such a bad name around the time of the global financial crisis, they will sit nicely alongside the latest policy initiatives.
Of course, regulatory initiative alone won’t make securitisation happen. That will be a function of the range of investment options open to the institutional market. Securitisation will need to find its place and that will ultimately be down to pricing and other market-based issues. But the EC paper is a sound development.
THE CASE FOR securitisation has been building for some time. Indeed, the EC paper is the latest in a series of linked initiatives to get the European market going again. In December 2013, the European Insurance and Occupational Pensions Authority published its 190-page extravaganza “Technical Report on Standard Formula Design and Calibration for Certain Long-Term Investments”, which assessed whether current capital requirements for certain long-term investments under Solvency II could be reduced “without jeopardising the prudential nature of the regime”.
EIOPA’s key proposal was to split the one-size-fits-all 7% spread risk charge for Triple A rated securitisation into a 4.3% charge for high-quality issuance and a hefty 12.50% punitive charge for low-quality issuance. Once the criteria defining high-quality are in place, the high-quality (Type 1) charge will be reduced further to 2.1%. In its paper, the Commission said it would would work on the differentiation of high-quality securitisation products “with a view to ensuring coherence across financial sectors and exploring a possible preferential regulatory treatment compatible with prudential principles”.
Importantly, the EC also said it would take into account the better liquidity that would likely accrue once the notions of high-quality issuance and standardisation were embedded. The expectation here, of course, is that it would feed into more favourable liquidity coverage ratio treatment for banks. The EC will be teaming up with the Basel Committee and IOSCO to set rules on risk retention, high-quality standardisation and transparency “to ensure consistency and avoid regulatory arbitrage”.
Of all the innovations of the modern capital markets era, securitisation is without doubt one of the most revolutionary
CONCRETE ACTION FROM policymakers around ABS is long overdue. Securitisation is rightly being touted as a key plank in the bid to get long-term finance to European corporates. Of all the innovations of the modern capital markets era, securitisation is without doubt one of the most revolutionary. It’s not just a fabulous tool for regulatory capital relief in this new era of higher capital requirements. That’s an important but ultimately technical by-product of the impetus it creates for getting cash flowing to those that need it to finance productive growth.
Let’s face it: quantitative easing has been an abject failure in this regard while chunky capital requirements have acted as a major deterrent for banks to lend, particularly against the backdrop of a poorly performing economy. The net result is that access to cost-effective and long-term finance remains an obstacle for SMEs.
Speaking in the wake of the EC report, the EU’s Internal Market and Services Commissioner Michel Barnier was clear that access to financing is the missing ingredient holding back growth and job creation. He acknowledged the momentum building behind the importance of securitisation as a method of unblocking SME financing.
But at the same time he was at pains to stress that a key issue for the Commission, working with the ECB and EIPOA, is to distinguish between good securitisation and bad securitisation. Bearing in mind recent experience, Barnier is right to stress the focus on promoting high standards. Just like with nuclear capabilities, the right technology in the wrong hands – allied with poor regulation – can and has been a force for destruction and devastation.
LONG BEFORE SECURITISATION played its part in blowing up the world in 2008, I had never liked the idea of banks acquiring loan portfolios from third-party originators. I recall talking to investment bank CEOs who would rub their hands with glee at the money-making opportunities they saw from acquiring not just portfolios but dodgy loan originators too. The thought of it even now makes me feel quite queasy.
However the new rules come out, regulators and policymakers should seek to stamp out tendencies for banks to create what in the past I’ve called “backwardated securitisation”. Banks rapidly and blindly acquiring or originating portfolios exclusively to feed frenzied investor demand for tranched debt was always a recipe for disaster. It shouldn’t be allowed to happen again.
Securitisation needs to be a forward chain-of-event activity where accountability and responsibility remain front-of-mind not just in the corporate governance handbooks of sellers but in the rulebook, too. Thinking about JF Kennedy’s wonderful “always forgive your enemies but never forget their names” quip, I say let’s get securitisation back in from the cold, but let eyes remain firmly open.