The EU stands at a crucial point where it will decide whether the securitization market will undergo fundamental regulatory change or continue with business as usual. It must be bold and choose the former.
The market has been mulling draft amendments on the securitization regulatory framework from the European Parliament’s ECON Committee and the Council of the European Union, which were released in the last couple weeks before markets shut for Christmas.
These amendments concern the Capital Requirements Regulations (CRR) and the Securitization Regulation, which are Level 1 changes to the regulations, meaning Parliament and the Council have the ability to amend the Commission’s proposals.
The next couple of weeks are especially important as MEPs have until January 27 to propose changes or additions to the ECON Committee’s amendments, with the deadline for finalising these amendments into an official Parliamentary draft by May 5, according to Parliament’s self-imposed timeline.
When the European Commission first put out its proposals for reforms to the existing securitization regulatory framework in June, the goal of these reforms was no less than to relaunch the European securitization market.
Every proposed reform should therefore be looked at through the lens of whether it will relaunch the market, bringing in new investors, since it is still a long way from its pre-2008 financial crisis peak.
While in the past the Commission has often been closer to the industry’s demands than the Parliament, this switched in December with Parliament wanting to go further in changing the regulations.
Undoing the controversial
While the ECON Committee’s amendments are much closer to the industry’s demands than the Commission’s proposals from June, especially around CRR, a lot of the major victories consisted of rejecting or softening some of the Commission’s more controversial proposals which do not exist in the current securitization regulations.
A key example of this is the amendment to the Commission's proposal to include investors into the group of parties which can be sanctioned for due diligence breaches under Article 5 of the Securitization Regulation.
Due diligence regulations ensure that investors properly assess the risk of holding a securitization before buying the bonds, for example by making sure the originator or sponsor has made all the required disclosures under the Securitization Regulation and is compliant with risk-retention requirements.
The Commission’s proposal was controversial as it is necessary to bring in more investors to truly relaunch the securitization market, but by introducing possible fines of up to 10% of a firm’s annual net turnover for even an unintentional breach of the due diligence requirements, this measure appeared counterproductive.
Parliament’s ECON Committee suggested amending this to fine investors a maximum of twice the invested amount, which will almost always be lower than the Commission’s proposals, although still a considerable penalty.
Parliament did ease this blow by clarifying there would be no duplication of sanctions, meaning each member state can set its own sanctions, and the Securitization Regulation sanctions would only be used if a state does not have a process for sanctioning due diligence breaches.
It is fair to propose that investors be included in the group which can face sanctions for due diligence breaches, otherwise there is less reason to make sure due diligence reporting is being done properly.
The disproportionate size of the fine is what bodies like the Association for Financial Markets in Europe (Afme) are contesting. They argue a fine should be directly linked to the profit derived from the breach.
This whole debate has created something of a distraction from the goal of these proposed regulatory changes, which is to relaunch the European securitization market.
It is difficult to argue that if this proposal is dropped during the trilogue process it could even be seen as a victory for the market, as it would just mean a continuation of the status quo for investor due diligence regulations.
There are still lots of regulatory issues which the three parties have not fully addressed yet, like setting out a clear definition for what counts as a public and private securitization, which would enable simpler reporting templates for private deals.
The focus as we get closer to the trilogue process should be on simplifying the regulations and making sure they are consistent, with a good example of this being the Council’s approach to the CRR, setting out a progressive system which takes into account risk sensitivity when calculating securitized assets' risk weights.
As MEPs prepare to propose their changes or additions to the ECON Committee’s amendments, this sort of bold simplification and the removal of barriers should be at the front of their minds.