Hopes are rising in Europe that regulators may lift their boot a little way off the neck of the securitization market, which has been prostrate since the financial crisis.
New draft rules from the European Commission last week, part of commissioner Jonathan Hill’s Capital Markets Union agenda, could ease post-crisis curbs on the market, which took much of the blame for causing the credit crunch, even though in Europe most asset-backed securities performed well.
“It’s part of a wider initiative to construct Capital Markets Union, help capital markets become more integrated, liquid and larger,” said Kevin Hawken, partner at Mayer Brown. “Since the crisis many economies are struggling, and there is a perception that compared with the US, the capital markets in Europe are undeveloped and fragmented.”
Securitization grew up as a diverse patchwork of structures appropriate to national legal systems. Markets in France and Spain used securitization formats created by statute, while in the UK and US, bankers and lawyers used any instruments they could lay their hands on, such as trusts.
Over that tapestry has been laid since the crisis a hastily assembled iron grid of regulation. That, and investor flight, has crushed the market from €450bn of annual placed issuance to €90bn.
Now at last, regulators are starting to undo their controls. “There are three things regulators need to do,” says Richard Hopkin, head of fixed income at the Association for Financial Markets in Europe. “Fix the capital requirements for bank investors; the same for insurance company investors; and the third is the Liquidity Coverage Ratio for banks, which is probably biting hardest because of the disproportionate haircuts for ABS compared with covered bonds.”
The draft reforms will alleviate the first problem somewhat; action on the second is promised; the LCR problem is hardly addressed.
The new Securitization Regulation simplifies two sets of rules. One concerns detailed disclosures required of issuers, and a special duty imposed on securitization investors to perform due diligence.
The second involves issuers’ obligation to retain part of the risk of securitizations. In both cases, single rulebooks will now apply to all investors and all issuers, regardless of type.
The main part of the reform defines something called simple, transparent and standardised securitization - a badge of structural quality. If an ABS deal meets certain criteria, it can win the STS designation, earning more favourable capital treatment.
Also tabled is an amendment to the Capital Requirements Regulation, reducing the capital banks have to hold if they invest in securitizations.
Current Basel III proposals, applicable from 2018, make banks hold sometimes five times as much capital for holding ABS as for the same underlying assets on balance sheet.
The rules are so complex it is too early to tell how much better the new proposals are, but Hopkin says if they only reduce that excess capital a little, they would not make much difference to bank investors.
Will the reforms work? “Regulatory reform is an important piece of the puzzle, but when you’re talking about regrowing markets, a lot will depend on economic factors,” said Hawken. “While these efforts are very welcome, a lot of work remains to be done” to make the rules workable.
Reform of Solvency II will come later. “What we have to do is frame the regulations in a way that encourages greater participation by non-bank investors,” says Hopkin. “That’s why Solvency II is so important.”