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The new European securitisation regime: the first six months

When GlobalCapital and Afme came together for this year’s annual securitisation roundtable, the topics were similar to last year – but the tone was much more positive. Nationwide’s pioneering Sonia-linked deal showed the sterling market that investors would buy the new benchmark, and Afme invited the building society’s secured funding head, Krishan Hirani, to share his thoughts and lessons from the deal. Since the discussion in mid-May, the transition has only accelerated, to the point where, as the market meets in Barcelona, it’s unlikely to see a sterling consumer issue without a Sonia coupon. The new Securitisation Regulation, which came in early this year, has been far from trouble-free – but some of the biggest problems with the rules were solved, and many issuers have already adopted the “Simple Transparent and Standardised” designation. Christian Moor, senior policy advisor at the European Banking Authority, was also able to join us, and offer his thoughts on the future of the market. Further out, we discussed the potential for securitisation, as the market with the closest connection to underlying assets, to help drive the sustainable finance agenda forwards. If that happens, securitisation will have completed the transition from villain to hero – and next year’s roundtable, and Global ABS 2020, should be more positive still.

Participants in the roundtable were:

Marta Zurita Bermejo, head of European business development, DBRS

Anna Bak, associate director, securitisation, Afme

Matthew Jones, head of EMEA structured finance, S&P Global Ratings

Krishan Hirani, head of secured funding, Nationwide

Rob Ford, founding partner, TwentyFour Asset Management

Damian Thompson, head of UK FI origination and solutions, NatWest Markets

Christian Moor, principal policy advisor, European Banking Authority

Nathalie Esnault, managing director, securitisation at Crédit Agricole CIB

Pablo Portugal, managing director, advocacy at Afme

Richard Hopkin, managing director, head of fixed income, Afme

Owen Sanderson, GlobalCapital (moderator)

GlobalCapital: Many thanks to Christian for that excellent introduction! Is STS indeed the best thing that’s happened to the European EU securitisation market, and what do we think about the €100bn to €150bn a year target? 

Marta Zurita Bermejo, DBRS: I think in assessing the impact of STS in 2019, we also need to consider the numbers in 2018, as lots of deals were probably brought forward and we saw more supply in December than usual.

Also, in the first quarter STS had a very positive impact on non-STS assets — during this period we have seen NPLs, we have seen CMBS, and other areas where the activity levels have been higher.

GlobalCapital: Any other first STS reaction?

Anna Bak, Afme: I definitely echo what Christian said, if it was not for the framework which is now in place I don’t think we’d have got to where we are now with the securitisation market.

I’ve now been with Afme for more than five years and since I joined we’ve been working on this project. It’s been a really, really long process but I think we managed to indicate those aspects of securitisation which are vital in supporting Capital Markets Union, and also to shift those aspects of the securitisation which did not perform well though the crisis.

Matthew Jones, S&P: On that €150bn number, if you’re talking about €150bn of STS we’ve obviously got a long way to go, given CMBS and CLO fall out of scope. I think I’d echo the same comments in terms of we’ve lost a quarter of issuance this year, given that the rules haven’t been in place.  

We’ve also observed the EU harmonisation package on covered bonds and the fact that that’s now finally ratified, and it’s still going to take 2.5 years for local authorities to put that into law. I think the same level of transition would have been extremely helpful for this asset class, but it’s encouraging to hear that there’s more focus on evidence-based regulation, because some of the securitisation evidence that’s been put in front of regulators hasn’t had the same traction it could have done, given that the performance of most asset classes was extremely robust through the financial crisis.

What we’re spending a lot of time on now is thinking about whether or not issuance for 2019 will catch up. Not having the regulations in place has created a bottleneck, so will there be a whole wave of deals?

Krishan Hirani, Nationwide: Overall STS ought to be a positive and should be seen that way. The securitisation market is still shaking off the impacts of what happened during the crisis and it’s come a long way from there. I even think the name of ‘simple, transparent, standardised’, is a particularly good thing to call it, as it promotes the product in the right way.

It may not show immediate results, but over time, it should attract a new investor base that has historically been wary of securitisations, and create a level playing field with the other asset classes.

There’s only been a handful of transactions to date, and that’s had a lot to do with how long it takes to digest these regulations. They’re not easy, they’re not…

Rob Ford, TwentyFour Asset Management: Simple…?

Hirani, Nationwide: The outcome is simple but in terms of going line by line through the regulations, it’s a big job.

From an issuer point of view you want to be meticulous as you go through this. You can’t afford to get anything wrong. And that ties into the lack of supply we’ve seen to date. 

There is the carrot of the benefits you get as an issuer from having an STS label on the transaction — from an investor point of view, bank treasuries can get LCR treatment. For other investors you get the CRR capital benefits.

If you compare it to other regulations coming in, which have had quite long lead times, that’s kind of what you would have expected. So the fact that we’re already seeing deals is almost a testament to the people who’ve been trying to get this up and running.

Damian Thompson, NatWest Markets: Christian, I like the strategic outlook about the almost competitive advantage that securitisation could derive from this process. You could see a future where European securitisation is the gold standard for transparency and disclosure in all investable products and that I think would be a quite powerful place for it to be.

But I think we are in an absolutely critical phase and getting to that level of success doesn’t just mean issuers who were already issuing a certain amount per year restarting to issue the same amount per year. This actually means a meaningful transfer of banks’ funding coming into securitisation from other products.  

There’s a central bank element of that, with the ECB’s need to exit the market at some point. Does bank funding then become a securitised market? Also obviously there’s covered bonds. I think the core running through this, and we feel quite strongly about this, is the pragmatism of the regulatory approach. 

I think there was a very pragmatic approach to the reporting templates at the back end of last year which was critical, absolutely critical. Things could have gone very badly if that sensible approach hadn’t been taken.

But the difference now between a market that revives to €150bn in two or three years’ time, and a market that looks like it did in 2016 and 2017, is about whether issuers are able to have an open, pragmatic, sensible, common sense relationship with the various regulatory bodies involved.

Ford, TwentyFour: Perhaps I could take that to the next level and say, A, I agree, I think it’s the best thing that’s happened and, B, I don’t think that any issuer that can achieve STS going forward will do a deal without STS.

Quite clearly it opens their deals up to the widest possible investor base. Banks, insurance companies, anybody capital-constrained essentially can’t buy non-STS deals, because the cost of capital for the non-STS product is prohibitive.

In order to have that biggest audience, and therefore the best pricing, major issuers are clearly going to do STS. Which then potentially clears the path for the non-STS product, which is maybe where some of our focus needs to be in the next few years?

I’m not talking about the bad products like resecuritisations and synthetic CDOs and the like, but valid products that sit out of scope — markets like CLOs, CMBS, non-conforming RMBS, which deserve some attention and another look. 

These shouldn’t necessarily be part of STS, but perhaps STS 2 or something along those lines.

We’ve talked a lot about the difficulties when making investment choices, particularly for investors like ourselves. When investing for bank treasuries, it’s very, very simple. I’m going to look at STS deals because that’s all they can buy. But as a non-capital constrained asset manager, for the most part, I get to pick and choose which deals to look at, and for those mandates, I’ll look at the non-STS products as my first choice. But for the capital constrained mandates I’m going to go straight to the STS market, no doubt about it.

GlobalCapital: Christian, what do you think about an STS 2?

Moor, European Banking Authority: Yes, I already indicated that STS has helped to bridge the gap to other securitisation products, and two areas we are currently focusing on are balance sheet synthetics and NPL securitisation. 

The Council and the Parliament, through the Securitisation Regulation, mandated the EBA to do an assessment of whether STS criteria for balance sheet synthetics could and should be developed and introduced in legislation. So later this year we will publish a discussion paper on this topic to start the debate with the industry.

On NPLs, some banks in southern Europe still have a large amount of NPLs on their books. I am convinced that NPL securitisation could play a role here to reduce those loans held by banks — but some elements of the Securitisation Regulation currently restrict the growth of this market.

After synthetics and NPLs we could  start looking at other securitisation products, for example; CMBS and managed CLOs. However when we did our first assessment back in 2014, though, looking at the default rates of CMBS, the data would not justify any kind of improved treatment. I don’t know what the performance or structures of those products looks like now, but as always we will assess the evidence including market development and performance  over the last five or six years to see if it’s justified to intervene or not.

Pablo Portugal, Afme: I wanted to pick up on one of Christian’s comments that this framework puts securitisation in pole position compared to other products. I hope that is the case, because we believe that compared to other fixed income products like covered bonds, securitisation is subject to by far the most conservative regulatory framework, including stringent disclosure and due diligence rules.

The framework is posing short term challenges and it is regrettable that it is not complete yet. But  we shouldn’t underestimate the positive signalling from the political sector that the  STS label provides.

It is important that the political community remains engaged and monitors how the framework performs in the marketplace. By January 2022, the Commission has to issue a report on the function of the Regulation with accompanying proposals if needed, so that review is an opportunity to consider whether aspects of the framework need to be fine-tuned or reassessed.

Nathalie Esnault, Crédit Agricole CIB: I just wanted to add something on the long term perspective. STS should eventually be a positive development for the market, no question on that, but the beginning of the year has been quite difficult.

Something we’ve not yet mentioned is verification, which was not in place until the end of Q1, and subsequently delayed deals because a number of issuers would not go out without third party verification. 

The second thing which I think we need to note is the importance of private securitisation, meaning conduit or on balance sheet securitisation, a part of the market which has not been well covered by the Regulation. 

Everything was done and written for public transactions, and it seems that a number of provisions in the Securitisation Regulation are not very suitable for private transactions. This is something that we need to review, in 2022 or before. A significant part of the market is private. It’s necessary, and it’s not a bad thing. 

When the public market is not working, you could still have access to securitisation financing through the private conduit market or banks’ balance sheets.

There are also warehouse transactions, where asset pools can be built up before going to the market, which are necessary to get to the minimum issuance size required for the public market. 

Private securitisation is very important for the financing of the real economy. However, this part is not well taken into account in the current regulation.

Moor, EBA: I agree. It is unfortunate the Commission did not publish the technical standards by the end of last year. ESMA and EBA worked very hard and we published the draft legislation in June and July 2018, with the expectation that by December, the Commission would publish the final legislation, and it would be in place in time for the market to open in January and February 2019.

But unfortunately bigger events happened, including Brexit negotiations, the Commission reprioritised, and this work was basically put on hold for a couple of months. Hopefully you’ll see the Commission adopting most technical standards in the next couple of weeks. However, it will be too late for the European Parliament and  Council, so it will be probably more like  November or December before these are published in the Official Journal and become legislation. 

But you will see the final rules in June or July.

I do know that the Commission is very sensitive to the good work by the EBA and ESMA and that’s why I do not expect too many changes in the final versions. On homogeneity, for example, if anything, there may be a few positive things in there. Market participants will have to live with the uncertainty, but over the next couple of months, all will be clarified.

On the conduit side, I agree that it’s not perfect. If you go back to 2014, EBA consulted on STS term securitisation, and only squeezed in the conduits at the last moment. In addition, there has never been a proper consultation with the industry on how to create criteria on STS for private transactions. I do believe in the review Pablo mentioned, that is one of the issues that we need to reassess.

Richard Hopkin, Afme: If we do get the adoption by the Commission of some of these outstanding standards that we haven’t had yet, will that open up a big flow of pent up issuance in the market? 

Ford, TwentyFour: I think it’s already coming, to be honest. There’s only a few deals out there now that are STS but whether the delay is three months, six months, or nine months, in two years’ time we’ll have all forgotten all about it and it won’t make any difference at all.

There’s been a lot of talk about whether there could be a tidal wave of issuance coming in the second half of this year, and whether that will have an effect on spreads that we wouldn’t have expected if we’d had a smoother transition, which is not really helpful. 

But to be fair, securitisation markets have always performed slightly differently from the rest of the credit markets.

At the back end of last year, we saw lots of corporate bond volatility through September, and October, but we got to about the middle of November before ABS eventually capitulated, leading to a very quick catch up through November and December which almost felt like a crash.

If anything, the delay we had restarting the primary market in January and February was marginally helpful, because it meant we didn’t have a deluge of new issuance coming in while the market was trying to recover from a period of significant spread widening at the back end of last year.

Where it is difficult, though, is in the details. I’ve run into a number of decent sized asset management investors, who are having trouble getting permission to invest in post-2019 deals from their own legal departments. No issuers can give them absolute certainty that they will adhere to the new ESMA standards, because we don’t know what the standards are.

There are investors with money to spend in our marketplace, unable to do so because the legal uncertainty is currently preventing them.

Hirani, Nationwide: There is nothing in these unfinalised RTSs that is an absolute barrier to issuance. 

There are either workarounds, or there are views you can take based on what your current thinking is. But it is very dependent on each individual issuer’s compliance, governance and so on to decide whether you can proceed based on what you have in front of you.

One example is on the homogeneity rules. Based on the level one guidelines which are out there, which aren’t going to change, Nationwide was very comfortable based on our pool of prime mortgage assets. 

We had a very, very long discussion but we were comfortable that whatever way you slice and dice what could come out, our prime mortgage book is homogenous, full stop.  Whereas others may not be able to make the same call, based on what’s out there now.

And the same applies to all the other RTSs which are unfinalised.

Rob’s absolutely right. There are a handful of investors who take the legal point of view that, until these guidelines are fully finalised, because every single RTS isn’t published, they cannot take the risk in investing. 

If that’s their legal advice you can’t really argue with that. There’s nothing as an issuer or a bank you can say to them to make them change their mind.

What we managed to do during our transaction is a lot of educating during the marketing process. There were a lot of investors out there who were thinking: ‘How are you issuing under regulations which aren’t finalised?’ 

That’s where we come in and say: ‘Actually, they are finalised. All of this isn’t changing. There are a few things here and there which are yet to be decided but we meet all of these criteria and therefore what happens next doesn’t matter.’

I think we actually managed to swing quite a few investors towards buying STS when initially they were sceptical.

GlobalCapital: And will you be switching some of your secured funding away from covered bonds to STS securitisation?

Hirani, Nationwide: Not as a direct result of this, no. There’s always a relative value discussion to be had. We have a wide range of funding tools available, covered bonds have always been and probably will always be our cheapest-to-deliver funding tool. But if we weren’t able to issue in STS format for whatever reason, that would have changed our funding dynamic significantly, and cut out a lot of our investor base, which would have made it almost unviable to carry on with securitisation.

Thompson, NatWest Markets: But there’s an interesting knock on in the long term effects. If STS means that the treatment under LCR legislation for securitisation changes and more bank treasuries are able to invest in it, liquidity will improve, pricing will tighten and it may become a real competitor on price as well, given that there are other reasons why it does have advantages for issuers compared with covered bonds. 

It’s a potentially virtuous circle, but it has to start somewhere.

Ford, TwentyFour: Clearly Nationwide was the leader from the UK, and Obvion was the leader from Europe in bringing those deals. But we’re probably a bit early in the game for people to get their heads around it. If I remember the Silverstone distribution stats, there were actually more asset managers as investors in the senior classes of both the dollars and the sterling tranches by quite a margin.

Hirani, Nationwide: Yes.

Ford, TwentyFour: It was 69% if I remember and maybe higher in the dollars?

Hirani, Nationwide: I think that ties into your earlier comment — this matters for asset managers. You think that the bank treasuries are going to be the investors to most benefit from this, but actually it’s just as important for asset managers. Approximately one in four investors would not have played if the trade wasn’t STS.

Ford, TwentyFour: But some of those asset managers are investing money on behalf of capital-constrained investors.

Hirani, Nationwide: Absolutely. So we saw orders a lot bigger than we normally would have, and we’ve got to attribute that to STS.

Ford, TwentyFour: Yes. On the other hand, there was a French consumer loan deal recently that had six times oversubscription. And it wasn’t STS at all, albeit was tiny.

Esnault, Crédit Agricole CIB: This transaction was issued by a fintech and it was quite small in absolute terms. We’ve been recently involved in an auto ABS deal in euros and we’ve seen more bank demand. Definitely some banks that weren’t active for a while are coming back because of the new LCR regulation, and their presence is crucial.

Moor, EBA: I also agree, and that’s why the EBA prioritised the use of internal models before other initiatives, like NPLs or CLOs. We realised that bank investors are crucial, and obviously, the sooner banks can use the SEC-IRBA approach with internal models and the long term historical data sets, the better that would be for the market. This will also increase the investor base.

The EBA prioritised what we called the technical standards on the purchased receivables approach, which allows banks to use third party information to build internal models and use the SEC-IRBA. Also, the EBA is finalising a consultation paper around the calculation of the tranche maturity, which again will offer banks a more risk sensitive method to calculate capital requirements. I  am aiming to publish the consultation paper by the end of July

GlobalCapital: So while we all welcome the standard, is there the right spread between non-STS and STS?

Ford, TwentyFour: There should ultimately be a spread advantage. It’s hard to tell at the moment, because there aren’t very many examples where it’s directly comparable. The Nationwide transaction also had a Sonia-based coupon on it, and so the difference, the basis between Sonia and Libor will also potentially have an effect on being able to easily assess the spread differential.

And it depends on the type of issue. For a prime bank, master trust-type issuer or a large Storm-type deal from Holland, then I would have thought you could see 20bp to 30bp in say the three year maturity. Maybe a bit more in five years.

If anything, what we should end up with is somewhere sitting between…  I hate to say this… Between where covered bonds are and then STS and then an equivalent non-STS. Perhaps for the smaller issuers it will be slightly different because I think there could also be a liquidity premium.

GlobalCapital: So shall we now turn to Sonia? Krishen, as the Sonia issuer in the room, any chance you can give us some of the lessons from the first deal? 

Hirani, Nationwide: I think the lesson is, don’t change anything. If we rewind to when we saw Sonia really start to take off, the SSAs started, and then the banks followed in covered bond format. It got to the place where towards the start of this year, the fact that a covered bond transaction referenced Sonia didn’t matter. It was just a sterling covered bond — of course it’s going to be Sonia. 

We hadn’t seen any securitisation though. I think STS had a part to play in there, we just didn’t see that many transactions full stop. Securitisation is slightly different in many ways to other asset classes.

But there was no reason to create another way for securitisation to be different from covered bonds or any other asset classes by saying: ‘We’re going to use Sonia but it’s going to be structured in a completely different way from what people know and are comfortable with already.’

So it was really important for us to bring the same structure of Sonia coupon — i.e. daily compounding with a five day lag, which again the covered market is absolutely comfortable with pretty basic things which people are happy with and can buy. And the feedback we had on our roadshow was that consistency was a very important thing.

If we went into something completely different, that might have been detrimental to our transaction, and might have impacted investor readiness to buy a deal with Sonia coupons. Obviously we had to go through various considerations when it comes to our programme, our structure, how does Sonia flow through the liabilities and through the asset side, where the mortgages were swapped to Libor. We had to therefore introduce Sonia swaps on the asset side.

Again, relatively simple solutions. And it works. People are talking about and potentially waiting for a term Sonia which may or may not ever come.  But I think the fact of the matter is that Libor’s not going to be around by the end of 2021, and Nationwide absolutely isn’t comfortable issuing a Libor-linked security longer than that date.

So we could have decided to not issue at all, or issue short. But there was a credible sense that Sonia works, so let’s use it. I know now that the market is absolutely okay with it, has adopted it, and we’re already starting to see other transactions follow, again using the same conventions.

Ford, TwentyFour: Can I ask what’s the reversion rate for your underlying mortgages? Are they SVR-based, are they Libor-based?

Hirani, Nationwide: Fixed to SVR. There’s no Libor. We were converting to Libor to match liabilities.  We’re now converting to Sonia to match the Sonia liabilities.

Ford, TwentyFour: Most of the bigger banks are probably in the same position. But outside the banking sector, the specialist mortgage lending market is almost entirely linked to Libor resets. And it’s a much bigger hurdle for those guys to get over.

There’s been a deal in the market which has now got a step-up and call in June 22. It’s a Libor-based deal, and it’s going to have one coupon that’s taking the risk that it might not have a Libor rate to fix off. There’s probably a pretty good chance that 2.5 months into the new year of 2022 there’ll probably still be some form of Libor submissions going on, so it’s not a bad bet.

There’s a lot of originators out there who are still originating mortgages today with Libor as their reversion rate benchmark. They’ve got some language that says they can change the benchmark, and probably the obvious thing is moving to Bank Base Rate.

But it’s not happening yet. I think that perhaps people are holding back, because they don’t have certainty about whether some form of term benchmark could be out there to replace Sonia. I’ve heard that from a lot of originators that are saying: ‘We want to hang on, we want to wait and see what the market’s going to be’. Because no-one wants to be an outlier.

Thompson, NatWest Markets: Well, I think that pressure will build very quickly.

Ford, TwentyFour: I think it will, yes.

Thompson, NatWest Markets: The transition of covered bonds to Sonia was remarkable. Even for us, who were closely involved in it, it was just remarkable. It went from an innovative to de facto market standard within two or three weeks. Or at least it felt like it.

Ford, TwentyFour: There’s another deal in the market that’s got a Sonia coupon and it readily admits in its investor presentation that all its underlying mortgages have benchmarks that fall back to Libor. And they haven’t said in any way how they’re going to deal with that. All of the fixed-rate periods on those loans are hedged to Sonia, so that’s fine. But it’s when they get to the reversion date that they potentially run into issues.

Thompson, NatWest Markets: What I was trying to get at, Rob, is in a few months’ time, we could well see a world where all of the large sterling RMBS issuers are issuing Sonia.

Ford, TwentyFour: Undoubtedly.

Thompson, NatWest Markets: So if you’re a specialist lender in that world and you’re still originating with Libor, it’s starting to look increasingly old fashioned.

Moor, EBA: Are Intex and Bloomberg ready now?

Thompson, NatWest Markets: They are now.  That was one of the big delays for the market getting going actually, was the infrastructure.

Zurita Bermejo, DBRS: I guess the main thing as well is what’s going to happen with the legacy deals. Who is going to be the contract party taking the decision about which other reference rate will we use?

Ford, TwentyFour: What are the rating agencies going to do when it comes to those legacy deals? Even for those deals that refinance in the next two years, lots of them still have Libor underlying benchmarks on the assets, and they can’t do anything about that.  

There may not even have language in those loans that allows the originator to change the benchmark. At the time those loans were written, there was no concept that there was going to be a removal of Libor. So what are the agencies going to do in terms of asking for extra credit enhancement to deal with the basis between Libor loans and Sonia coupons?

Jones, S&P: Well I think some of those issuers that you’re referring to are having conversations with the regulators now. These types of issues are being put in front of the regulators and they’re being asked to say: ‘Look, help us. We want to do something about this but help us explain to our clients if we are going to reprice them to Sonia, then we need your help in making sure that there’s full transparency about how they do that.’

Hopkin, Afme: It’s a matter of public knowledge that the Bank of England has run a consultation on the possibility of building a term Sonia, and there are sectors of the market which I think are still quite vocal about that, for understandable reasons. But as Damian said, the facts on the ground changed incredibly quickly in covered bonds.

I’m not in the markets but I would fully expect something very similar to happen with  securitisations pretty soon. There is a challenge definitely on the asset side of things though, and interestingly that’s one reason that was cited in the eurozone for the decision by the ECB to keep Euribor and emphasise reform rather than replacement.

Moor, EBA: But at the end of the day the market for Euribor-linked product is just too big for it to be allowed to go away or be disrupted. So I think a solution will always be found.

GlobalCapital: Could we hear, maybe from one of the arrangers, when market conditions might be favourable for a specialist originator to make that transition, given that there’s possibly a first-mover disadvantage. 

Thompson, NatWest Markets: You’ve got a range of factors involved — investor acceptance, plus you’ve got the internal constraints around the product they’re originating that Rob referred to.

Does there come a point where it is very inconvenient for an investor to buy Sonia from one institution and Libor from someone else? 

Secondly, do you get to the point where as an issuer, you look like you’re taking too much risk as to what’s going to happen after the reset? 

It’s one thing to have fallback language in your bonds to cover contingencies. Fallback language isn’t great to cover certainty.  

If you know something’s going to happen and you haven’t got certainty in the documents as to how the deal’s going to behave in those situations, it becomes increasingly uncomfortable.

Ford, TwentyFour: I think we’ll be quite happy as bond buyers to buy bonds linked to Sonia or buy older or shorter bonds linked to Libor. Right now the vast majority of bonds in the sterling part of my book are linked to Libor and there’s a tradable basis market out there as well.

So I can easily convert the yield on the handful of bonds currently based on Sonia using the basis swap, and tell my investors that’s what the yield is against Libor. At some point, when the portfolio has more Sonia in it I’m going to have to turn the conversion around the other way and tell them what the yield is against Sonia.

Hirani, Nationwide: Just one thing to pick up on. As I mentioned earlier, the structure and methodology of Sonia is very important, but one thing I didn’t touch on was the operational readiness aspect of this whole transition. As an issuer we’ve had to go through a number of system upgrades, to make sure that not only can we book the trade, and it will settle, but we can report to management and the accountants are happy with how we’re looking at it. This is probably one of the major barriers to entry in terms of the Sonia market.

We can see from our trade that the vast majority of the investor base is there and it’s ready, and the covered bond markets helped.  But there is still a handful of investors who aren’t there. It’s not a question of if, it’s a question of when they’ll be ready. Every issuer and every investor of varying magnitude and sizes will have resource they can allocate to that sort of project work, so we need time for that to play out as well.

GlobalCapital: Moving on again, could we turn to green securitisation? Christian, you touched on that a little bit in your opening remarks. Could you expand that vision of the future a little?

Moor, EBA: Well, yes, I can give you my personal view on it. There are two things going on with the sustainable finance topic, at the moment. 

At the G20, at the Financial Stability Board, at the Central Banks and Supervisors’ Network for Greening the Financial System there are many fundamental discussions going on around climate change and the two degrees target, financial stability, macroeconomic approaches and how these relate to financial risk and stress testing. What should the role of the public sector, central banks, supervisors and regulators be? How much regulation, and how much should regulators and supervisors be involved in this market?

On the other hand, you have a unit at the Commission that is already working to drilling down together with industry working groups definitions and standards on taxonomy, disclosure, governance, green bonds in order to stimulate the green finance market.

However, what is lacking, in my opinion, is some kind of framework. Something in between the high-level principles-based policymaking and those things that the working groups at the Commission are working on.

You don’t have detailed aspects in covered bonds. You do not have loan by loan templates. You only have very aggregated information. So covered bond issuers cannot classify loan by loan if an asset is green or not. However at the moment, green bonds are usually defined by use of proceeds and not by the assets backing the bonds. 

Thompson, NatWest Markets: But does that risk making green securitisation more difficult rather than less difficult, because it would be held to a higher data standard than any other product?

Moor, EBA: Well, that’s the question. What is the standard for green bonds going to be? If we are talking about green bonds receiving better regulatory treatment, the standard will be very high. At the moment, though, I understand that the industry is not interested in regulatory criteria and standards. They want inclusive voluntary standards in order to ensure that many products can meet those standards. Which is obviously their choice.

However, I also see that this discussion is a bit all over the place. My worry is that in no time everything will be called green, and then what’s the value of green?

There is a lot of work to do in this area. However, I do think with the full data transparency of securitisation, the third party verifying, the due diligence that investors are used to doing... Securitisation issuers and investors are very sophisticated and have high levels of knowledge and experience monitoring asset pools. Whatever the green criteria will be in the future, in my opinion, it is important that those criteria are met not only on day one but also during the life of the transaction.

Portugal, Afme: I think this is an area that has been positioned as one of the key elements of the EU’s financial services strategy. Much emphasis is being given to sustainable finance at the moment, not least because it’s seen as one of the areas where Europe is leading the way globally.

But I think there’s not been much discussion around the potential of green securitisation. It’s not something that is commonly mentioned, at least in Brussels, when we are talking about sustainable finance. So there’s an opportunity here for the industry to articulate what role securitisation can play in that domain.

Do we need definitions of green securitisation?  A definition of  an energy efficient loan?  A new framework for these products? Or do we leave this to the private sector? I feel there would be a receptive audience in the political sector if we can tell the securitisation story in sustainable finance.

We’ve talked about the stigma earlier. That’s been largely removed. I think a growing market for green securitisations would contribute even more towards the positive story to tell.

Jones, S&P: We’ve done a lot of work with the various working groups that you’ve alluded to, Christian. I think everybody’s agreed on the need for a taxonomy, but for that to be practically applied, I think it’s all about the data that issuers have.

In Europe so far, there’s been two Obvion deals. Obvion has been able to capture the energy certifications of all the properties within those pools. So it is able to articulate exactly the energy efficiency of those mortgages in their securitisations.

But in the handful of covered bonds we’ve seen, they’ve been labelled green on the basis that the properties in the cover pool were all built after a certain date, and building regulations after that date meant that houses could only be built if they met a certain energy standard.

We’ve also been doing a lot of work on what a sustainable project finance infrastructure CLO looks like? Obviously those types of loans are typically longer tenor, lower spread, so it’s going to be harder to find some kind of equity return that makes sense. What does that arbitrage need to look like? Institutions like the Bank of England are also looking at developing this market.

Thompson, NatWest Markets: CLOs are an interesting market, actually, because I think there could be more pressure there than in other markets. If you look at where a lot of CLO equity comes from, a lot of it has traditionally come from Scandinavia where there’s a lot of focus on these issues.

We’ve certainly spoken to CLO managers recently who are now saying that ESG is now question number two they get from investors.

Ford, TwentyFour: The same in regular asset management mandates as well. It’s not just at the CLO level. Every single RFP that we get now has an ESG question right up front. 

STS, actually, has put a fantastic governance framework around the way that investor due diligence works, which is a very nice tick when it comes to talking about the G in ESG. But bizarrely CLO managers don’t have a similar framework. 

We have to do that work when we’re looking at a CLO manager managing a CLO, but the CLO manager doesn’t necessarily have to do that work under a regulatory framework when looking at buying a leveraged loan for that CLO.

Moor, EBA: Actually, I just read an article on green bond reporting, which mentioned that more than 50% of all the green bonds that are certified are not doing any post issuance reporting at all.

Just because the issuer says: I will use the proceeds for this or that, if they do not follow it up with reporting, it does not mean much. If you look at it from a securitisation perspective that would not be enough. That’s why I said that securitisation could be a standard for the rest of the market.

CRR2 has just been agreed, and the EBA received two mandates around ESG. We got one to write a report around disclosure on environmental, social and governance risk, and a mandate to write a report around the regulatory treatment of exposures that relate to environment and social objectives. The interesting thing about the latter one is that we need to write this report six years after the CRR 2 regulation comes into place.

In the previous draft, this was two years after. The European Parliament and Council have given us four more years. 

I think there is now an understanding that first, regulators and banks need to collect data, implement the governance, have the disclosure in place and only then start looking at the regulatory treatment of green assets and bonds.

Ford, TwentyFour: I do think that’s really important. One of the issues with green bonds is that they typically aren’t expected to yield as much as non-green bonds, and therefore there has to be an incentive for investors in the capital-constrained world to go and buy them.

Jones, S&P: Yes. The Climate Bonds Initiative just published their H2 paper last week which just looked at all the green bond issuance in the second half of last year, and I think there were only two where they could establish this concept of a ‘greenium’, which is where issuers priced inside their curve.

Ford, TwentyFour: I think that green Storm deal priced really tight compared to regular Storm deals.

Jones, S&P: To participate in that deal, I understand you had to fill a questionnaire in on your green credentials. I’m not sure how many people were kicked out because of that.  But it was quite a nice way that they held investors to account.

Esnault, Crédit Agricole CIB: Another application which is interesting is capital relief deals.

We did a balance sheet deal some years ago. It was capital relief, in the context of our ESG policy. We have reporting in place so we track the capital allocated to a new green project. There’s definitely a number of investors active in this market who are interested in green or sustainable finance. It’s a highly visible way for a bank to show how it is reallocating capital to sustainable finance.

Jones, S&P: To some extent the instrument level green bond story is going to be surpassed by the focus that investors are going to have on the ESG credentials of the issuers themselves.

Esnault, Crédit Agricole CIB: It’s quite critical, because if the issuer is not right in terms of overall ESG profile, the green bond, or the green RMBS, is not going to be accepted by a number of investors in sustainable finance.

Moor, EBA: That’s why at the end of the day there is a need for some kind of framework. Should it be entity-issuer based?  Should the assets or only the bonds be included? What about the level of data disclosure? Duties for due diligence for investors?  Monitoring and reporting obligations on use of proceeds? After defining the objective, you need to build a framework in order to guarantee the quality of green bonds.

Jones, S&P: Just to use a couple of examples from the US. We’ve seen an increase in solar ABS in the US, which is a growing industry over there.

Then there are the PACE deals in the US, which is rooted in a tax system which enables cash to flow from the tax authority to the SPV. I think with an exception of a region in Spain, that really doesn’t exist as a framework to promote the development of those types of loans. But the types of products that are being financed by those PACE loans can be seen as having a demonstrable impact on climate change.

GlobalCapital: Another big theme this year has been the use of securitisation for NPLs. Maybe Marta, you could give us a health check on the market? 

Zurita Bermejo, DBRS: So far we have seen 28 deals happen across Italy, Portugal and Ireland, with more expected this year. I think all of us are waiting to see Spain and Greece, and maybe as well Cyprus, come through in NPL securitisation. I think that when the second wave of NPL sales started in 2016, we internally were debating whether it’s a one-off or whether NPLs are here to stay as an asset class in their own right.

I think they will stay, for two reasons. One is because I think that there’s enough NPLs still in the European banks to guarantee a flow of deals, but also I think that the market participants are different in the different countries. In the case of Italy, all the NPL activity is off the back of the guarantee scheme and coming from the banks.

In Portugal, though, we have seen very recently that it is not just the banks doing their own securitisations but also one investor-led transaction with a portfolio from the banks. There’s a question mark over whether this will be the case as well for Spain, but even in Italy we have already rated deals which are non-GACS. So it’s a healthy market, if non-performing assets can truly be healthy.

[Since the roundtable on May 14, DBRS has since issued its first public rating on a Greek NPL deal, Eurobank’s Pillar Finance]

GlobalCapital: Christian, can you fill us in on the regulatory activity in this area?

Moor, EBA: Two or three years ago I wanted to do something around NPLs, and actually the first move was adding a chapter on NPLs to a discussion paper on significant risk transfer in 2017. 

But now I can really start as the new Securitisation Regulation is in place. I think the market will not revive to a level sufficient to help the banks deal with their NPL legacy assets if we don’t solve the problem around NPL securitisation transactions in the Securitisation Regulations.

To take one example, in my personal opinion, the capital calibration is off. It’s wrong. The capital requirements for the SEC-IRBA and SEC-SA approaches were calibrated on performing portfolios and not defaulted loans, which have a different risk form the start. 

When NPLs are transferred from the banks, those loans usually have have massive purchase price discounts. 

After transfer, the expected loss is very low or there is no expected loss. The current calibration is off for that reason, and this is something that needs to be looked at. The reason why capital calibration is so important in my view is because banks will sell the portfolios but might retain a senior tranche.

Another scenario is that banks sell the portfolios to hedge funds or private equity firms, these institutions will buy the portfolio leveraged, and they will need bank lending on the senior tranche.  

So that capital requirement on the senior tranche in particular is very important to create enough volume in order for banks to transfer the assets out of their balance sheets, and also to reduce the bid-ask. Obviously, the backstop introduced in CRR 2 and other supervisory measures that are already happening will increase the provisioning with banks, so banks will be able to sell at a bigger discount without hitting their capital too much.

However NPL securitisation is still not very much discussed in the public space and definitely not in the political world or in Brussels. 

Two or three years ago I would not have been able to even discuss this, because NPL securitisation was still seen as the problem and not as a possible solution. 

I think the capital treatment is a crucial point that I am looking into and am trying to educate people on, and hopefully fix through a short term and a long-term solution.

The second problem is that the Securitisation Regulation includes a number of articles, for example around due diligence and on risk retention that might not be helpful for the specific issues around NPL securitisation. 

So also there we’re looking at possible solutions.

Thompson, NatWest Markets: Would that need primary legislation or is that something the EBA can do itself?

Moor, EBA: I think in order to fix everything a level 1 change is needed. However, I do think that there are some issues that can temporarily be solved. I am working on it and I hope to publish something later on this year.

Hopkin, Afme: To be fair to everybody involved, I do think when the Level One text was being drafted NPLs were not really at the top of people’s thinking, were they? So I don’t think we should beat ourselves up too much over that.  

Portugal, Afme: I think we should be actively informing the policy community about the positive role securitisation is playing in tackling the NPL issues across Europe. The level of NPLs is coming down consistently and I think the securitisation schemes in Italy and elsewhere have been helping there. 

Jones, S&P: Italy has dominated the numbers that you just outlined there Marta.  If you take out Italy the number’s more like six or seven. I think that’s because what we’ve seen in Italy is the use of securitisation technology to lower capital risk weights for the banks. It’s not a securitisation market in the traditional sense, it’s more of an application of the technology.

You’re not dealing with traditional securitisation investors here, you’re dealing with people that are trying to just get the most efficient disposal for the banks.

Thompson, NatWest Markets: And I think the challenge with that is it’s a very process, servicer dependent market. You can do your diligence in buying assets, but what drives you getting your money back in an NPL transaction is mostly how well the servicer performs through the life of the transaction.

There’s been a huge amount of external leverage come to the NPL market in Ireland and in Spain. It’s largely come from the banking market, and it’s largely coming from the banking market because I think at the moment the bank market is best equipped to do the detailed, transaction by transaction diligence that you need to do to make the right investment decisions.  

I think the challenge for securitisation as a commoditised investment product as opposed to a structural technique to package things up, is that I don’t think we’ll bridge that gap of due diligence. Can you ever get to the point where NPL investors don’t have to do that level of face to face diligence on the servicer to satisfy themselves?

Where we have seen successful securitisation of non-performing loans, or re-performing loans, it has typically been in situations where somebody bought the portfolio, they serviced it for two or three years, they developed a very clear track record as to how the servicing was going to work and what the performance was like, and then they were able to get good rating outcomes and satisfy investors that the data was there.

But I don’t think that challenge is solved yet. It’s how do we bridge the gap between being a very bespoke and commoditised investment product?

Jones, S&P: Italy’s a great example for that. You look at all the private securitisations that are going on in Italy. They’re by the PE firms that own the special servicer. They’re unlikely to be nterested in buying generic NPL class A, because they’d rather own the whole portfolio and get the benefits of really understanding how to service that portfolio.

Moor, EBA: I think the real reason why it works in Italy is because of the GACS.  You don’t follow the capital rules of securitisation, you just have a sovereign guarantee instead.

What I am trying to work on is to improve the securitisation framework, because I think that the real problem is the mis-calibration of capital in senior tranches, and finding a way for banks to invest in them without the need of a government guarantee.

Portugal, Afme: This exchange also reminds us of the importance of explaining why the non-STS sector is important. Hopefully STS will contribute to the market as a whole growing. What we don’t want to see is a new stigmatisation against what is non-STS, which of course includes securitisations of NPLs.