Divergence on ABS is healthy, just don't touch STS
As the securitization regimes in the UK and the EU begin to diverge, the changes made so far will do little long-term damage and there are even potential benefits, as long as rule makers on both sides of the English Channel stay true to the 'simple, transparent and standardised' (STS) principle.
When the EU first announced amendments to its securitization framework, there were concerns that some asset classes might be regulated out of existence. And the European Parliament did little to calm those fears when it selected Dutch MEP Paul Tang as rapporteur for talks over the incorporation of synthetic securitization.
But six months later, the regime has been finalised and the market has greeted the text with nods of approval. Whether the turn of speed was prompted solely by the pandemic or not, regulators should be congratulated for taking quick(ish) action. While issues remain to be solved in the areas of disclosure and templates, the European Commission has, broadly, done its job.
On the surface, the changes look set to send the securitization regimes in the EU and UK in two different directions, the treatment of the STS regulatory label being a prime example.
As of April, the Commission has extended its STS stamp of approval to synthetic securitizations — one of the most complex niches within securitization.
This seems to leaves the UK regime flapping in the wind, its own STS label having been stranded when the Commission decided not to recognise it as equivalent.
But even after update to the EU rules, the two regimes are not a far cry from each other.
For example, take the new rules around synthetic excess spread — the amount of cash left for the issuer at the end of a transaction when all the noteholders are paid, usually used to absorb losses, but now banned when being used for arbitrage purposes.
The Bank of England's Prudential Regulation Authority already applies a capital charge to synthetic excess spread in the UK. This was one of the rules at which structurers took umbrage when the idea of implementing them for the euro market first arose.
And while the EU does not recognise the UK's STS designation as equivalent, legal practitioners are confident the two markets will eventually somehow come to terms.
This is to be celebrated. After all, the purpose of the regime was not just to create a European standard for ABS, but to set a bar for the whole world, which investors could push issuers to adhere to.
But securitization is a diverse market. By its nature, not every transaction will be able to qualify as STS, no matter how in-depth the regulators go.
Instead of obsessing over a one-size-fits-all regulatory framework, legislators should focus on consolidating the gains they have made with the existing framework by removing transparency headaches for investors and perhaps taking a look at how to get the insurance market back on board.
Meanwhile, the UK is also going its own way with securitization amendments around UK SPVs, making them more tax efficient.
It’s healthy and natural for different countries or regions to compete for business in this way but they should stick to their guns on the basic ground rules they have already set, such as STS, whether that is in Brussels or London.