As European parliamentarians grapple with how to amend the European Commission's securitization package, some might wonder what the purpose is of having so many people without market experience or knowledge weigh in.
Scrutiny, however, is part of a healthy democracy and particularly when so many of securitization’s strongest proponents have a vested interest in the market’s success, the market will have to win the argument that reform is necessary.
Indeed, for the reforms to have legitimacy, MEPs and the political class have to be willing to get behind them.
That is because whatever the Level 1 text says, regulators still have a key role to play in how regulation influences the market. Regulators are a risk-averse bunch by nature, knowing that they are likely to take the fall if anything goes wrong. Decisive action from politicians can help give them the cover to act.
The text under debate is technical and jargon heavy, drafted after a comprehensive consultation at the end of 2024. Most of the knowledge about the market belongs to those who support its development. As such, a lot of criticism of it is based on misunderstandings of how the market works.
The latest fashionable criticism, for instance, conflates the funding with risk transfer.
Banks are significant securitization buyers, because they buy a lot of triple-A rated notes which are the largest part of the market, but their appetite dries up lower down the capital stack. As a result, banks involved in securitization aren’t transferring much risk to each other, but the market does offer a diversification of funding as well as low risk collateral in which banks park their cash.
However, some look at the overall level of bank demand and conclude the market is just banks selling risk to each other to benefit from better regulatory capital treatment. When you separate out the funding and risk transfer markets, the fallacy is clear.
These sorts of details matter when haggling over the precise wording of the final text. Here, the EU could perhaps learn from the UK approach of leaving the fine print to the regulator.
Scrapping over the details also distracts from the bigger issue at stake. You don’t win hearts and minds by pointing out your critic’s factual errors.
That more securitization is good for Europe is a statement of belief rather than fact, so it is possible to be a principled and decent person who disagrees. As such, proponents of securitization need to try to win the argument with their critics over matters of principle.
In essence, securitization allows investors to put their money to work buying the debt of households and firms, at various levels of risk tolerance. The theory is that should mean more financing at a cheaper rate for borrowers, hence better use of resources and better returns for savers.
It’s a case that is built upon the premise that markets are a good way to allocate resources and that it is fair for investors to lose or accumulate money based upon the price they are paid for the risks they chose to take.
Taking those concepts to the extreme does not end well in the real life context of asymmetric power and information. For example, few would disagree that consumer protection regulation is paramount to a healthy securitization market.
That is perhaps where the debate should have begun, but for the legitimacy of these regulatory reforms, it’s better late than never.