European securitization poised for new year regs
The European Union’s new securitization regulations come into effect on January 1, a year after publication. Market participants hope they will help spark an industry revival, 10 years on from the global financial crisis. But lingering concerns could stall issuance of European ABS as 2019 gets under way.
European regulators have been racing against time to provide detailed rules for compliance in the form of the draft Regulatory Technical Standards (RTS) and Implementation Technical Standards (ITS). These are awaiting European Commission approval. With small print yet to be clariﬁed, the market is set for a slow start to 2019. While pre-crisis European securitized bonds performed far better than those in the US, the market was tarred with the same brush, turning EU authorities against complex and opaque products. Securitized paper placed with investors, in excess of €450bn in 2006, has struggled to reach €100bn a year since 2008. The EU has begun to soften its attitude towards the product, increasingly seeing it as a mechanism to bolster lenders’ capacity to fund household and business needs and an important plank of the Capital Markets Union project. The new regulations apply to deals issued on or after January 1, 2019, and cover all investors, doing away with separate rules in the Capital Requirements Regulation, Solvency II and the Alternative Investment Fund Managers Directive that apply respectively to banks, insurers and fund managers.
The regulation seeks to foster a better risk framework through enhanced transaction disclosure, transparency and preventing adverse credit selection — imposing obligations on originators, sponsors and original lenders — while ensuring that investors (now also including pension funds and Ucits) bolster due diligence discipline.
Complex re-securitization deals are banned, as are deals with riskier self-certiﬁed mortgages.
In addition, a distinct label is carved out for simple, transparent and standardised (STS) securitizations from issuers established in the European Union, targeted at homogenous pools such as prime residential mortgages, credit card receivables and auto loan pools. These bonds will carry a lower risk weight of 10% compared with 15% for non-STS senior bonds. Managed CLOs and CMBS, however, failed to make the grade for STS eligibility.
Issuers looking to bring an STS eligible deal will need to notify The European Securities and Markets Authority (ESMA), provide a liability cashﬂow model and disclose certain environmental data. This could be a stumbling block for issuers who have not previously captured that information. Commitment for the label is already evident with some recent deals billed as ‘STS-ready’, a nod to investors that the bulk of requirements are in place.
ESMA has pushed out 16 draft reporting templates, including 10 for speciﬁc asset classes and two covering investor reports. With some templates requiring 100 or more ﬁelds to be ﬁlled, issuers are anxious to avoid potential ﬁnes and reputational damage and have sought clarity on ﬁner details, including options such as leaving some ﬁelds blank. But the level of preparedness varies. The European DataWarehouse, a securitization repository in waiting, notes that larger repeat issuers have started testing their deals against the ESMA templates on their platform, whereas smaller issuers are struggling, lacking in-house expertise.
Meanwhile, ESMA issued further guidance in November, pending approval of its draft technical standards. “EU securitization regulations will be a major inﬂuence on the market, particularly in the ﬁrst half of 2019,” says Kevin Ingram, partner and head of the London structured debt group at Clifford Chance. “Ultimately the extent to which market participants are prepared to accept questions and ambiguity as the new regulations bed in will impact the number of transactions undertaken. The approach of the regulators during this initial period will be crucial.”
Wins, disappointments and hopes
Key wins for the industry include a risk retention requirement kept at 5% and lower capital charges for insurers investing in senior STS bonds. However, revised capital charges for non-senior STS are too high, say advocacy groups, discouraging insurers from buying tranches with higher yields that would be a better match for their business. For bank investors, only STS deals will count as level 2B high quality liquid assets (HQLA) for bank liquidity coverage ratios, leaving investors with legacy investments worse off once the 18 month grace period expires. The industry hopes that, once teething problems are resolved, securitization will be more attractive for issuers and investors alike, but reduced 2019 ﬁ rst quarter supply is likely to pull spreads tighter.