UK regulators implored to look at securitization capital treatment rules
Charter Court’s deal this week shows that STS hallmarks should be reconsidered, say sources
The securitization market is accustomed to being bifurcated into a prime market which qualifies for the simple, transparent and standardised (STS) hallmark and other non-prime deals which do not, but as regulators look at the rules governing the market, some are also calling for improvements to the capital treatment that securitization receives.
Proposals to change the UK Securitisation Regulation were included as part of the Edinburgh Reforms to financial services that were announced by the UK government last December, but sources have told GlobalCapital that it is crucial that the full spectrum of rules governing the sector are reconsidered.
“People have said all along that if you’re looking at the impact of the Securitisation Regulation, you really need to look at the regulatory capital and liquidity requirements as well, because the two are very much linked," Merryn Craske, partner at Morgan Lewis, explained.
Although the UK Securitisation Regulation and STS have been in place for some time, both were brought to attention this week when Charter Court's CMF 2023-1 attracted limited demand from investors despite its STS stamp, which should have been something of a draw.
Stamp of approval
STS is the regulatory stamp of approval that qualifies most deals for preferential capital treatment, including liquidity coverage ratio (LCR). Having an STS stamp ensures a deal has access to the largest pool of investors possible and makes holding the notes more attractive.
Charter Court's case illustrates the range of deals which can qualify for an STS label. Despite the additional regulatory implications with which it was made to comply, it still did not attract the demand the issuer may have hoped for.
The idea of STS emerged out of the global financial crisis as a way of marking out securitizations where the deal structure was exactly as it appeared, so that investors could be confident of what they were buying. STS was not designed to be the equivalent of a credit rating; a triple-A rated tranche can qualify just as a single-B rated tranche can.
Perhaps one problem for improving the capital treatment of STS securitization is the range of deals that qualify. Lloyds’ Permanent 2023-1, one of the deals which priced inside covered bonds, is a natural STS deal.
But Charter Court’s deal, which priced a week later 15bp outside the level of Permanent, is also an STS deal. That deal had 30% help-to-buy loans and 34% self-employed borrowers with one year of income verification.
A blog post from TwentyFour Asset Management said CMF trades with “similar levels of liquidity to non-prime deals”, though those non-prime deals are excluded from LCR eligibility.
The European Banking Authority’s approach to reform has been incremental. The qualifying asset classes for STS have been expanded since the regulation was introduced, notably with the addition of SRT. While there have been hints that they may be taking a softer stance on securitization, there is no suggestion they would radically depart from that route.
The UK inherited the EU’s rules after Brexit so has its own STS provisions. The Treasury and the Bank of England now control their own regulation and the securitization rules are currently being reviewed. What they will decide to do is unclear, though they have not chosen to add SRT to their own STS regime yet.
An uneven playing field
According to Craske, securitization received harsher regulatory treatment than many in the market were hoping for after 2008, and this is a clear example of how.
“We had hoped that STS securitizations would be treated as level 2A assets and other securitizations which meet certain requirements might be treated as level 2B," she said. "Instead, STS securitizations qualify as level 2B, and covered bonds get better treatment, despite the fact that securitizations have been shown to have a good track record of liquidity.”
The uneven playing field with covered bonds has been a constant concern in the market, so there was much excitement when two RMBS deals recently priced inside the level of covered bonds. However, a covered bond from Nationwide on Thursday was priced tighter than those deals, dampening suggestions that RMBS may be able shrug off its regulatory disadvantages.
Certain asset classes struggle to qualify for STS treatment due to the nature of their collateral. Buy-to-let deals rarely obtain an STS stamp, for example, because they often contain a few owner-occupied mortgages, since issuers are often small and specialised so have limited origination volumes.
CMBS is another asset class which is excluded from STS because deals rely on sales or refinancing of the underlying asset. CRE CLOs, another form of securitization financing for real estate, are also generally excluded. Managed portfolios are not STS and static portfolios suffer from the same problem as CMBS.
In fact, the very existence of STS securitization has been painful for CMBS, according to Iain Balkwill, partner at Reed Smith, despite some issuance remaining possible.
“It is definitely a thorn in the side, but it’s not a disaster,” he said. “It’s very frustrating to have a label out there that credit cards, auto loans and RMBS can all benefit from but CMBS and CRE CLOs will never satisfy due to the very nature of their underlying collateral. It just seems grossly unfair.”
There are also reputational problems for CMBS, as a result of not qualifying for STS.
“Obviously there is preferential capital treatment for having the label,” Balkwill said. “But I think the bigger issue is the general impression. The whole idea that CMBS is something really funky and toxic. It’s not really. [STS] is just a label.”
Balkwill did think that STS had been good for the overall securitization market, but he thought that CMBS needed a tailored approach.
“I think STS has been a good thing for securitization as a whole, but there needs to be an acceptance that CMBS and CRE CLOs are unique,” he said. “It’s got different features, different qualities and therefore it shouldn’t really be penalised.”