The troubled past of some securitisation products is making the comeback of this financial tool in Europe slow and fragile, but unless a bridge can be built from the current situation to an active securitisation market, the hopes for any growth in the continent will dim dramatically. Maybe the new Prime Collateralised Securities label can be that bridge.
In Europe, trust in banks is very low and still falling. This is not just about the perception of bankers, but about the long-term health of banks. The shape of banks to come is still shrouded in uncertainty, but some things are known. Through new regulatory rules they will need to be much better capitalised. Through new tough prudential measures they will not be able to participate, or participate to the same extent, in some types of activities seen as risky (but also highly profitable). The bursting of the credit bubble has left them with legacy assets that will need long work-outs.
All of this casts a shadow over the long-term health and profitability of the banks. This in turn will make it more difficult and expensive for them both to borrow on an unsecured basis and to raise new equity. All of this spells just one word: deleveraging.
Yet, if it is to avoid a deflationary spiral, Europe needs finance; and a lot of it. A recent report by ratings agency Standard & Poor’s estimated that Europe needs between €1500bn to €1900bn of additional finance to fund any growth in the next few years. A traditional Keynesian would feel very comfortable with such a conclusion and would turn to government for the additional funds that the banking system is no longer able to provide. But today, that prospect also looks dim.
What about securitisation?
Banks can fund the bulk of their lending in one of three ways on the wholesale markets: senior unsecured borrowings, covered bonds and securitisations. (They can also fund themselves with their central banks on a senior secured basis but no one sees this as a long-term answer.) Senior unsecured and covered bonds both use the balance sheet of banks and so eat up scarce capital. Investors in those instruments also take the credit risk of the bank. If a client does not trust the banks as he or she once did this is unappealing. Covered bonds do offer security but also create encumbrance issues and so have natural capacity limits. But securitisation is perfect: by allowing investors to invest directly in the assets generated by financial institutions without taking on the credit risk of the bank itself, it is the ideal way to increase financing in Europe, even when banks shrink or find capital hard to come by.
Yet it can appear that the policy-makers are intent on ensuring that the securitisation market can never return to Europe. A swathe of recent or upcoming EU regulations appears punitive, even at times vindictive, towards securitisation. If those rules remain, it is hard to see where the additional finance for European growth is ever going to come from.
A swathe of recent or upcoming EU regulations appears punitive, even at times vindictive, towards securitisation. If those rules remain, it is hard to see where the additional finance for European growth is ever going to come from
But the reticence of policy-makers and investors can be understood. In the great securitisation family there were some truly dangerous siblings: US subprime mortgages, squared and cubed collateralised debt obligations – instruments built on bad credit underwriting (albeit in the US) or piling leverage on leverage. Many of the recent regulatory measures are a reaction to these bad products. European securitisations have, on the whole, performed incredibly well from a credit standpoint. But they are paying the price for their errant family members and for a seeming complexity that makes it, at first blush, appear difficult to tell the good from the bad, and the bad from the truly ugly.
The need for a bridge
Europe is in a place where securitisation remains distrusted by investors and policy-makers because of the troubled past. It needs to get to a place where there is enough finance to fund growth and escape the dreadful spiral: realistically, that means a place with a vibrant securitisation market which has the support of regulators, investors and policy-makers. Between the two, there needs to be a bridge and that bridge could well be the Prime Collateralised Securities Initiative (PCS).
Set up by the industry but as an independent, not-for-profit initiative, PCS has identified those aspects of securitisation that are needed for a robust and safe market: simplicity, transparency, standardisation and quality. It also understands that securitisations must assist the real economy and not the arbitrage desks of investment banks. With an extensive set of rules, it aims at awarding a quality label to European securitisations that meet all those criteria. If it can gain the trust of investors, regulators and policy-makers, it might just be the bridge European finance needs.
Ian Bell is head of the Prime Collateralised Securities Secretariat.
