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04 May 2016

Securitisation: the next low-hanging fruit of CMU?

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CMU is designed to be a major building block in a genuinely single market. Yet the proposal to leave many key roles in the hands of national regulators may finish up fragmenting the market along national lines. Surely this cries out for regulation to be at the European level.

Commissioner Hill recently published his first status report on progress towards Capital Market Union (CMU). He struck a note of measured optimism on his programme of 33 measures but he may not fully appreciate that he is already more than a third of the way through his effective term – even assuming it is not brutally cut short by Brexit. The Parliament is likely to stop accepting new proposals around a year before his term ends. So there is no time to lose.

On the face of it, the proposal for Simple, Transparent and Standardised (STS) securitisations got off to a cracking start as Council agreed the Commission’s plan in record time last December and he expects Parliamentary Committee votes in November. Once the co-legislators agree, the Commission then expects to revise the capital requirements for insurers holding these securities, as well as recalibrating banks’ capital requirements as part of the CRR review.

However, industry specialists continue to harbour serious doubts about the workability of the proposal. These will need to be resolved in the texts agreed by Parliament, and then by Council in trialogue. If the industry’s fears are not assuaged, then it is easy to see a fine piece of legislation that does not actually trigger the new supplies of credit that everyone so desperately wants to flow into the economy – especially to the SME sector. The numbers are stark: according to S&P, public issuance of securitisations fell from €500 bn in 2006 to €75 bn in 2015 – despite the excellent loss record of European issues that stood in such dramatic contrast to US securitisations’ performance. 

Recently, 32 associations and market participants published a note that sets out – again – the modifications to the Commission proposal that they believe are required. The signatories represent a good cross-section of potential issuers as well as investment institutions who would purchase the securities – both asset managers and insurers. Without their support, not much will happen and the report uses the powerful analogy from a major European auto-manufacturer: “Just because you have 90% of the essential parts of a motor in place does not mean that the car will travel at 90% of the expected speed. You need all the key components there for the car to move at all.”

Four of the major professional associations documented 10 areas for modification or clarification: Due diligence; Risk retention; Disclosure; Compliance with the framework; ABCP; Grandfathering and legacy transactions; Sanctions regime; Third-country provisions; Capital for banks and insurer investors; LCR Treatment of securitisations. Sadly, the appalling record of the financial services industry has produced an atmosphere of public mistrust that seems to linger on – often with good reason. However, these association’s comments need to be thoroughly examined in full detail to ensure that no self-serving points slip through yet the STS securitization market is indeed re-started with a volume that is big enough to make an impact on the €15 trillion EU economy.

This is a market whose very existence hinges on its regulatory treatment and a few examples from the associations illustrate the point: A 30 year pool of European residential mortgages with 80% LTV will attract approximately 3% capital under Solvency 2 while the AAA tranche of a simple, transparent and standardised securitisation of the same pool benefiting from credit support will attract 10.5% capital. The report makes the point that these particular senior tranches suffered no losses in the Great Crash.

To achieve the magic label of an STS securitisation, 55 criteria must be met – but these market participants argue that many remain very vague yet an unexpected loss of the STS label would leave investors nursing a serious loss. Indeed, the absence of grandfathering provisions means that those holding existing securities that look very similar to an STS securitisation will suddenly face losses – hardly an encouragement to become involved in the new market.

In a very cost-conscious world, regulated investors cannot delegate `due diligence’ so they must each duplicate its costs– a hangover from the complete breakdown of trust in the rating agencies. Yet these bodies came into existence a century and a half ago precisely to help investors faced by the costs of doing such processes themselves.

Perhaps the most ironic example is that CMU is designed to be a major building block in a genuinely single market. Yet the proposal to leave many key roles in the hands of national regulators may finish up fragmenting the market along national lines. Surely this cries out for regulation to be at the European level. When the Single Supervisory Mechanism (SSM) controls directly around 85% of the Eurozone’s €30 trillion of banking assets, it does not seem excessively revolutionary to locate the supervision of a few tens of billions of securitisations at the European level.



© Graham Bishop

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