Global ABS 2023: KBRA's Day 3 Recap
A peak outside Europe, then back to regulation, ESG, and project BIRD for the final day of panels
The third and final day of the annual Global ABS conference tends to see a slowdown in the programme — but not this year. Day 3 consisted of many interesting panel discussions on wide-ranging topics including opportunities outside of Europe, before quickly returning to focus on green bonds, social bonds, and regulation. Below we provide a recap of a selection of some of the final day’s panel topics:
Keynote: David Wright
David Wright, a senior advisor at Flint-Global, provided a keynote address, covering the development of European capital markets and potential changes. Europe needs well-functioning capital markets, as they play a valuable role in the economy. Mr. Wright said that development of the European Commission’s (EC) Capital Markets Union (CMU) initiative needs more market participants expressing to politicians the need for stronger capital markets in Europe. Market participants need to prove the financial case for capital markets, provide empirical evidence, and explain how various elements of the capital markets differ versus the US.
For capital markets to play an integral role in economic growth, they need good regulation, good supervision, open markets, strong competition, and first-class infrastructure, according to Mr. Wright. Capital markets regulation needs constant attention and review. A good example has been the recent US bank failures—while US bank supervision came up short, the US crisis management systems were fast and effective. In the European Union (EU), there is a long way to go to deepen and integrate capital markets. The EC is working on further development to its CMU programme, which it expects to deliver in Q1 2024, but it is still being negotiated and is expected to be tough. A risk to progress is that if the current adjustments are not agreed by Q1 2024, it will spill into the next EU political cycle (2025-29). Accordingly, time is short to move forward with the CMU plan, as work is unlikely to progress in the election and period of changeover.
With regards to securitisation in Europe, some stigma remains from the global financial crisis (GFC). Reviving these markets is key for banking and insurance competitiveness, especially as Europe seeks to grow and expand strategic sectors. On a global basis, there is a risk that European banks are unable to compete with other large banks and banking markets without a well-functioning securitisation market. Securitisations are key to dynamic capital markets, as they provide depth, liquidity, and circulation of funds back into the economy. Today, European ABS and RMBS markets are roughly 10%-20% of what they were at their peak. In Mr. Wright’s view, it is important to bring back the insurance sector as a purchaser of ABS, and to improve disclosure requirements for issuers that are currently excessive and should be simplified. He also highlighted the need to adjust the p-factor of the simple, transparent, and standardised (STS) and non-STS categories, which is being considered in the EU parliament. However, he noted that the adjustment is facing challenges, with some parties not happy with adjustments.
Green & Social Bonds
The Green & Social Bonds panel focused on the regulatory side of the market. This is very topical given the announcement that the providers of compliance opinions and consultants will likely be regulated by the European Securities and Markets Authority (ESMA). Volumes of green and social ABS are still low, and there remains a focus on the use-of-proceeds approach. The audience was polled on whether use-of-proceeds or green collateral should be required for a green securitisation. The majority (36%) felt that either option should qualify, 28% said both should be needed to qualify, and another 28% also believed use-of-proceeds should be sufficient. The remaining 8% felt that green collateral should be required to qualify. However, what truly defines a securitisation as sustainable is yet to be determined by the market and the various competing standards. Currently, issuance of labelled products is focused in RMBS and CLOs, with five different possible types of structure and only a few to be tested in Europe so far.
The audience was polled on what could drive the adoption of European Green Bond Standards (GBS), and the majority (67%) said it was important to have investor confidence in the product, with 25% concerned about taxonomy alignment. A further 8% felt that EU market access was important to drive adoption.
Europe has the strongest expertise in the market regarding environmental, social, and governance (ESG) evaluation. However, with regards to the securitisation market, roughly 30% of the non-agency issuance is somewhat linked to ESG. In Europe, there is still a lack of eligible assets, and there are still many uncertainties around regulation.
Another audience poll asked about the credit profile of green assets versus non-green assets. KBRA covered this topic in a recent research report, European Auto ABS: Accelerating Towards Green, finding that investors are not pricing in a difference for green auto ABS over non-green transactions. As for the audience poll, 52% of the audience agreed with this approach, stating that they felt there is no difference. A proportion of 32% felt that there should be a lower credit risk, and 16% thought there is a higher credit risk. Panelist views differed slightly as they felt that ESG assets can exhibit higher credit risk. However, these types of assets tend to be originated at better interest rates. More credit enhancement may be required to compensate for the credit risk.
In Conversation on Article 5
Many attendees may not have been aware of the issues surrounding Article 5 of the EU Securitisation Regulation—or even aware of the regulation altogether. As a result, the panel began with an explanation of Article 5, which focuses on investor due diligence requirements, and the need for adjustments to be made or clarification provided on the regulation. To begin with, there is a divergence in Article 5 requirements between the UK and EU, as changes were made within Europe since Brexit, mainly around the adjustments made for nonperforming loan transactions.
While the main aspect of Article 5 is due diligence, there are other elements of the market that are impacted by it. Panelists focused on the issue of “proportionality” within the regulation, as the inclusion of the word is both helpful and confusing. Panelists would like to see guidance on what proportionality means and clarification on delegation.
Currently, there is no market standard for how to approach compliance with the article. Investors are competitors, so they are unlikely to share with each other how they approach compliance. Further, regulators in each market are at risk of treating compliance differently.
Panelists feel that the article is too prescriptive, and as the market has evolved with more transaction types, not all structures fit and allow for perfect compliance.
One panelist emphasised that investors do the credit work; it is the compliance with an overly prescriptive process that is the challenge. The universe of investors is relatively small to begin with, and Article 5 creates a high barrier for entry. In particular, if someone has not done credit work on a transaction, they will struggle to meet the terms of the article to rapidly bid on a transaction in the secondary market. Therefore, this shrinks the investor base on a deal even further. This creates a risk of a reduction in liquidity, which can then impact pricing. It further creates a challenge for competition with US investors. Using the pension liquidity issues in Q4 2022 as an example, there was a great deal of liquidity available, but a large proportion of that was from overseas investors that do not have Article 5 requirements.
Impactful Ideas on the Horizon: Project BIRD, Scaled SSFA
Project BIRD (Banks’ Integrated Reporting Dictionary) and the scaled simplified supervisory formula approach (SSFA) are important to the securitisation market, as they are helping impact the banking market to the benefit of securitisation. The proposed SSFA looks to adjust the p-factor to a more logical and dynamic approach. This would help to alleviate concerns in the market about the current capital constraints. It is hoped that the proposal will be helpful in the ongoing regulatory discussions.
Project BIRD is a collaboration between a number of European banks and the European central bank to provide a data dictionary and data model as well as transformational rules to create a non-regulatory harmonised European approach to banking information. The idea is to reduce the regulatory burden and simplify the compliance of banks with reporting regulations. It is important for the securitisation market to be aware of the progress of this project, as it helps banks meet the reporting requirements of the various regulations, including loan-level data requirements of the European Central Bank, ESMA templates, and others.
For the final panel of the day, there was a notably large audience to hear the panelists’ expertise. The session began with a discussion on trends occurring in the market, such as deconsolidation and the use of a mezzanine piece. There was some discussion on the competition of various products with securitisation, including inventory financing and asset-backed loans. Investors are still keen on the market with business-to-business receivables still attractive despite inflation and cost pressures. As with all panels at Global ABS, there was discussion on the topic of regulation, particularly the need to incorporate ESG factors. Popular collateral types currently include energy, commodities, telecoms, and intellectual property rights. Further, there was some discussion about technological innovations such blockchain, tokenisation, and electronic signatures.
Gordon Kerr, Head of European Research
+44 20 8148 1020
Christopher Noonan, European Structured Finance
+353 1 588 1225
Gianfranco Di Paolo, European Structured Finance
+353 1 588 1205
Stacy Gross, European CMBS
+44 20 8148 1058
Yee Cent Wong, European Ratings
+353 1 588 1260
Adam Tempkin, Director of Communications
+1 (646) 731-1347