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A solution to ABS rating caps — do it yourselves

Yves Mersch 230

Now even the European Central Bank is having a go at the poor ratings agencies for having the wrong opinions on ABS ratings. More investors should be taking the decision into their own hands, but to do so they need greater transparency.

ECB board member Yves Mersch considers the rating agency practice of applying a maximum rating uplift to ABS transactions from their sovereign so detrimental to the revival of the market in Europe, that it was one of three ‘next steps’ for the market outlined in his keynote speech to the Global ABS conference in Barcelona last week.

“Investors should decide whether to apply sovereign caps or not,” he said.

Delta Lloyd’s Hendrik Jan Luikinga spoke for much of the market this week when he said the caps were “ridiculous”.

But rather than moan about the restrictions placed on investors by rating agencies’ considered credit opinions, maybe the market needs to look at the restrictions it places on itself. Why do investors continue to rely so heavily on rating agencies, when they are the ones paid to make credit decisions on ABS?

There are reasons — and good ones — for rating-restricted mandates. They reassure risk-averse investors that their money resides in the safest assets. That particularly applies to pension funds, who are cornerstone buyers of ABS and many of whose contributors rarely know or care where their pot is invested as long as there is plenty left in it at the end.

But these are what the ratings agencies say are the safest assets. Rating-restricted mandates did not save investors during the subprime crisis in 2008, and they will not save them the next time a particular product’s performance does not match the agencies’ expectations.

It is churlish to get ratings agencies to do a lot of your due diligence for you and then complain their judgement is wrong. Accounts should be able to convince their own investors they know how risky a Greek RMBS, for example, is compared to its sovereign.

That is why the push to improve the transparency of ABS transactions is an important one. The ECB and Bank of England in their joint paper earlier this month proposed a set of improvements to the data behind securitizations, potentially including a European credit register, and further work on existing initiatives to disclose loan-by-loan data on securitization collateral pools.

The ABS market needs to deliver those improvements to become the simple, transparent and liquid market the ECB is hoping for.

When buyers make decisions in any amount of darkness it distorts market prices and turns others away from the asset class. Investors should back themselves and their own credit work. If better data was universally available, more of them might be willing to do so.

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