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Regulation not hurting ABS liquidity – yet

By Tom Porter
22 Sep 2014

Liquidity in many parts of the US asset-backed securities market are better now than they were pre-crisis thanks to cash-rich investors becoming more comfortable with more complex products. But there are fears that incoming regulations could force issuers into the private markets and disrupt prices in secondary trading.

On a panel asking whether new regulations and tapering of asset purchases would render liquidity a ‘mirage in the desert’ at ABS East in Miami on Monday, panelists were very positive on the current liquidity situation.

“Liquidity is great, investors have a lot of cash to put to work,” said Scott Levy, a managing director at Guggenheim Securities.

“If you look at the most illiquid products traditionally, there are now lots more investors getting involved than before, which is a good bellwether for liquidity overall.”

Levy added that the only period of real pronounced volatility since the financial crisis had been seen in the second half of 2011, when Standard & Poor’s downgraded the US Treasury’s credit rating.

Subordinate paper in more esoteric ABS still has poorer liquidity than investment grade paper, but this situation is improving with new investors from the asset management and insurance company sectors increasingly branching out to more complex products, panelists said.

Public to private?

However, a series of regulations to be finalised in the next year or so present threats to the current liquidity pool. In a snap poll some 53% of the audience said regulation would have the biggest impact on liquidity over the next 12 to 18 months, versus just 15% each for dealer inventories and dealer financing.

The panelists unsurprisingly highlighted stricter asset-level disclosure rules to come in under Regulation AB II as one of their biggest concerns. Bingham McCutchen’s Jon Arnholz said the auto ABS market was a good example of the uncertainty surrounding the rules.

“The auto market has been functioning great,” he said. “But now issuers will be required to provide a level of disclosure that they haven’t previously been required to give investors. Will that drive the highly functioning public auto market into the 144A market? There are plenty of questions like that that need to be answered over the next 12 to 18 months.”

Frank Serravalli, lead partner at PricewaterhouseCoopers, shared Arnholz’s concern about issuers opting for the private market and decreasing liquidity.

“If an institution is not ready to meet the Reg AB II requirements, they will in fact go private,” he said. “There is appetite for people to continue to go private, and I see that with our clients. The operational costs of the infrastructure required may drive issuers into the private markets, there is an imbalance there that needs to be figured out.”

There was some focus on the positives of the new rules. Arnholz said securitization was a robust market that provided a financially important function for the US economy, and that the regulation would eventually be absorbed and liquidity enhanced by its presence.

“Having more transparency in the market should help investors get more comfortable with risk and be willing to take that risk through cycles,” said Bob Behal, co-head of ABS and CMBS investments at Vanguard Group.

Leaving a TRACE 

The trading professionals on the panel said they were not yet seeing any major impact on liquidity from regulation. But Barclays’ Will Zak pointed to the TRACE regulation, which will require dealers to report prices as they happen when it arrives in April, as a particular upcoming threat to liquidity.

“That might have a dramatic effect on liquidity as the bid offer collapses with every print being public," he said. "I don’t know what dealers are going to do. They might cut balance sheet in the ABS space and direct it to businesses that aren’t on TRACE.”

Guggenheim’s Levy was reluctant to say that TRACE would exaggerate secondary market prices, but he did say revealing every price paid could have a detrimental impact.

“You might end up with an account that needs to sell a $50m position in a market that usually only trades $5 or $10m,” he said. “So the account sells $50m at 95 and that goes out on TRACE, now the market is 95 and people selling $1m or $2m will have to sell at 95.”

By Tom Porter
22 Sep 2014