Europe’s securitisation dreams stumble on parliamentary road block

What is happening?

The European Parliament has made a number of proposals that could hinder the development of Europe’ securitisation market, shut down new sources of funding and make it harder for banks to transfer risk from their balance sheets.

The European Commission and the Council of Ministers agreed a framework called simple and transparent standardised (STS) securitisations – designed to be easy to evaluate by investors, straightforward to package, with mass market appeal and, crucially, safe.

The proposals should reduce the cost of securitisation for issuers, namely banks, and open the way for institutional investors in Europe, such as insurance companies, to hold securitisations at lower capital charges – in an environment where they are anyway set to rise steeply under Basel rules from 2018 onwards.

Nonetheless, STS securitisations should make it easier for banks to package some illiquid loans into more liquid bonds, which investors can buy. This helps banks free up capital and transfer risk.

Also, STS securitisations are supposed to be a building block of the much-vaunted European capital markets union, meant to bring cheaper and better capital availability to the continent’s borrowers.

One fly in the ointment in these ambitious plans is Paul Tang, a member of the European Parliament who oversees its work on securitisation. He has proposed a number of amendments that the banks warn could kill off Europe’s already lethargic public securitisation market, which is still well below its pre-financial crisis peak.

Why is it happening?

Among the proposals made by Mr Tang is that issuers should retain 20% of securitisations sold into the market rather than the 5% backed by the European Commission and the Council of Members and begrudgingly accepted by the banks. As one banker put it: “It’s not ideal, but we can live with 5%.”

He has also made other proposals, which would restrict investor types – largely to so-called financial conglomerates (ie, big banks). This would narrow the already wafer-thin European securitisation investor base of maybe no more than 40 financial institutions.

Mr Tang’s argument is that the burden of proof lies with the banks to show that securitisations are safe, and once demonstrated, the retention rate can be gradually lowered. He also believes his proposals would ensure that Europe’s securitisation market would be very robust, thereby reinforcing investor confidence.

What do the banks say?

The European Parliament has left Europe’s banks and policy-makers feeling frustrated. The main argument from the banks is that a 20% retention rate would hardly make securitisations worth doing, as they are already expensive, and they would not be able to transfer enough risk from their balance sheets.

Indeed, many bankers and policy-makers are puzzled that the retention rate is being discussed again. After all, there was an intense debate about it in 2008 and 2009, and 5% was seen as a generally acceptable figure – high enough for banks to have skin in the game after the product is sold, but low enough to still make it worthwhile.

Also, Europe’s securitisations did not implode on anything like the scale of their US counterparts, as most were supported by higher quality assets and overall weathered the financial crisis well. And even in the US, where most of the problems happened, the minimum retention rate agreed upon is 5%.

Even more galling for bankers and policy-makers is that some parliamentarians are drawing inspiration for their proposals from a popular Michael Lewis book, since made into a film, called The Big Short: Inside the Doomsday Machine. Mr Lewis is a writer of bestselling books that often feature the shenanigans of financiers. However, The Big Short is about the US market not the European one, which is less developed and sophisticated and certainly a lot smaller.

Will it provide the incentives?

Will the European Parliament’s recommendations make securitisation safer? Yes, maybe, in that there could be even fewer securitisations if it gets passed. But that is a bit like making air travel safer by grounding most of the world’s aircraft with unnecessarily burdensome rules – this would deprive people of a fast and efficient means of travel, which is hardly ideal.

However, the European Parliament is far from united over the Tang proposals, which could be watered down. Within the next few months it will form its position and from there a trialogue will begin between the European Parliament, the European Commission and the European Council.

This usually involves reaching a compromise, probably by the first or second quarter of 2017, at which point a securitisation law will be enacted. Many bankers already view STS as too complex and restrictive. The concern is that any new compromises could create more hurdles and further hinder attempts to revive Europe’s securitisation market.