He also pledged to distil the alphabet soup of securitization quality labels into a single set of criteria to be applied across different sectors.
Rule poked holes in market participants’ focus on issuance numbers, saying it ignored significant changes in market dynamics since the financial crisis.
“Comparing current issuance with pre-crisis levels misses the point that the pre-crisis market was fragile, based on investment by leveraged funds and bank treasuries,” he said. “Building a stable market will require a broader, real money investor base.”
While he advocated the sale of full capital stacks (subject to risk retention), he cautioned against structures at the more fanciful end of the risk transfer spectrum.
“The market also needs to be based on genuine risk transfer and not regulatory arbitrage such as synthetic sales of thin mezzanine tranches intended to maximise the reduction in regulatory capital at minimum cost,” he said.
He also said a stronger RMBS market could help ensure the housing market was weighted properly.
“In the long run… we will need robust RMBS markets so that at least part of the risk on long term housing lending is financed from long term savings rather than short term bank deposits,” he said.
Simple, transparent labels
He promised that the “bewildering range of acronyms” for Simple, Transparent and Comparable (STC) securitizations would be homogenised by European policymakers.
“I can reassure you that these will be brought together into a single set of criteria in European legislation,” he said.
“I believe the intention is that they will then be applied consistently across different sectors — for example, banks, insurers and funds — and different regulations — for example, capital and liquidity.”
Regulatory aid
In addition to helping investors analyse deals and issuers make deals more robust, STC should help regulators, added Rule.
“Setting risk sensitive capital requirements for securitization tranches is challenging,” he said.
“One solution is to use credit ratings, but the shortcomings of that approach were exposed during the crisis. Another is to use a regulatory formula capturing dimensions of risk such as the credit quality of the underlying pool, tranche seniority and maturity.”
“In our view, including a differentiation based on STC in that capital calculation helps to capture other important dimensions of risk related to structure, transparency and governance.”
In terms of capital requirements, Rule said the risk weightings set in December by the Basel Committee were “broadly right” but that STC deals could get lower risk weightings because of lower structural risk.
“A stronger argument can be made that Solvency 2 standardised capital requirements for EU insurers are still too high, especially at longer maturities,” he said.
“For banks and insurers, part of the issue with securitization capital requirements is the comparison with covered bonds, which tend to be treated favourably in EU regulation,” he said. “Issuers looking to raise secured funding may therefore see covered bonds as a more cost effective alternative to securitization.”
“Covered bonds have a legitimate role in the market as a source of stable long term funding. But securitization has the advantages of risk transfer and lower encumbrance of underlying assets. We would support moves to put securitization and covered bonds on a more level playing field.”
Information asymmetry
Dmitri Rabin, senior securitized analyst at Loomis Sayles, said the challenge for ABS was to attempt to align investors and issuers’ interest more — a key attraction of covered bonds for most buyers.
“The reason that alignment matters is that the originator will always have better information on the quality of the loan than the investor,” he told GlobalCapital. “So knowing that the originator is retaining some of the risk is in and of itself part of the credit decision.”
Transparency can also help ensure that information asymmetry is kept to a minimum, said a senior director at a top data firm, although he cautioned that issuers’ systems needed to be improved.
“We’re happy with regulators forcing loan-level data and transparency in general, but the problem it sometimes creates for issuers is that their systems weren’t built to meet those requirements. They may have the data, but it’s not necessarily in a repository that is accessible, even to themselves. It’s a technology and infrastructure question.”
Phew
Policymakers handed another olive branch to securitization sponsors this week, scrapping a proposed amendment to a resolution on Capital Markets Union that aimed to double or triple the percentage of their own deals issuers must hold to satisfy risk retention rules.
Tim Conduit, a partner at Allen & Overy, said that showed that regulators were adopting a more “informed and nuanced” view of the securitization market.
“Risk retention was intended to disrupt originate-to-distribute, and that was a fair compromise in a new regulatory settlement,” he told GlobalCapital. “But in reality, 5% retention must be enough, because it amounts to a very significant part of a deal.”
“If you were going to move it to 10% or 15% then it would put into question the rationale for doing securitization transactions at all, and that would really hurt the market.”