30 May 2014

BoE/ECB discussion paper on a better functioning securitisation market

Asset-backed securities, where mortgages, loans or other debts are bundled up and sold on to other investors, were used by almost every large bank before the financial crisis. But the device was tainted by spectacular failures, such as Northern Rock, which had sold mortgages to investors as asset-backed securities, as well as toxic securities made from US sub-prime mortgage loans that spread contagion through the financial system. Securitisation is now back in vogue as it is seen as a cheap source of funding when many investors are still struggling to get credit.

Sir Jon Cunliffe, one of the Bank's deputy governors, said that with the right safeguards in place, asset-backed securities were a useful mechanism for lending. He argued, "Securitisation is a mechanism, it could be exploited, it could be abused. And what happened in the financial crisis, particularly with assets originating in the US, is that it was exploited and abused and it spread risk, the so-called toxic assets through the system. But in the end securitisation is a just a mechanism for banks to make loans, to bundle up those loans and to be able to sell on those loans to other investors who want to be lending to the real economy, to households, to businesses." He added: "We want to see if the market can develop standards and ways of doing this that actually deals with the risks … and can enable securitisation to happen in a beneficial way."

The Bank of England and the European Central Bank believe the revival of "plain vanilla" securities can play a useful role in ensuring risk does not build up in the system, as well as a source of funding. The change of heart has come about as the industry has sought to persuade policymakers that only a small part of the market, securities linked to US sub-prime mortgages, were responsible for much of the damage. Acknowledging that the market had been abused in the past, Cunliffe said it was important that banks keep part of any investment, so they would share in the losses if things turned bad. "If all they do is originate poor quality loans and bundle them up and sell them to investors who don't understand them they will take some of the risk on that." He also said standards needed to be developed to ensure asset-backed securities were transparent and easy to understand.

Full Discussion Paper

Further reporting by The Guardian and WSJ (subscription)

The Association for Financial Markets in Europe (AFME) has welcomed the discussion paper, saying it poses several interesting ideas for further discussion – most significantly, the concept of 'qualifying securitisations'. This fits well with recent calls by the European Commission to revive a sustainable market for high‐quality securitisation in Europe, as well as the analysis currently being undertaken by the European Banking Authority. "Much work remains to be done, and there remain difficult challenges to resolve – for example, how to avoid cliff effects; how to address the different motives behind any single definition of 'high quality'; and how to strike the right balance between meeting the needs of the real economy, while maintaining high quality", commented Simon Lewis, Chief Executive, AFME.

Full AFME Position Paper

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