European Commission proposals to ease bank capital requirements on asset-backed securities have not yet satisfied the Europeans, but have already unnerved the Americans.

Reg Rage - Anxiety

What’s happening?

In July 2015, the European Banking Authority (EBA) sent to the European Commission its recommendations for easing the bank capital requirements on qualifying securitisations. These proposals would modify the Basel Committee on Banking Supervision (BCBS) rules published in December 2014, but only for asset-backed securities that satisfied two sets of criteria. The first set relates to a structure that is simple, standardised and transparent (SST). The second requires adequate creditworthiness on the underlying assets that are included in the securitisation. Banks could assign a lower risk weight to securitisations that fulfilled both sets of rules.

“The SST securitisation framework in itself is not sufficient to generate a preferential risk weight. In addition to that, there need to be a number of credit risk criteria, because the SST framework alone does not contain risks – you could otherwise put bad loans into a sound structure. With these two things together, we see the logic of moving toward more differentiated capital requirements,” says Lars Overby, head of credit, market and operational risk policy at the EBA.

The European Commission has indicated that it could publish first draft legislation based on the EBA’s advice as early as September 2015.

Will it help?

Crucially, the EBA has presented for the first time a detailed explanation of how the preferential risk weights could work under the EU’s capital requirements regulation.

“We have halved the scaling factor in the internal ratings-based approach, and the overall floor for the capital requirement for qualifying securitisations has been reduced from 15% to 10%. The approximate reduction in capital is 25% across the capital structure on average, excluding the equity tranche,” says Mr Overby.

The headline reduction in capital requirements is welcome in the industry. But banks are still analysing how the changes will play out in practice, and whether they will adequately improve the economics of holding securitisation tranches. William Perraudin, finance professor at Imperial College London and director of consultancy Risk Control, says the benefits of the lower capital charges are offset by the EBA’s decision to retain the BCBS hierarchy of methods to calculate risk weights.

Banks authorised to use internal models (the internal ratings-based approach) should do so for their securitisation exposures. Next in the hierarchy is the external ratings-based approach (the ERBA), and after that a standardised regulatory formula if external ratings are not available. Many ratings agencies cap the ratings on structured finance transactions at or below those of the sovereign jurisdiction in which the deal is issued. This leads to higher risk weights for peripheral Europe under the ERBA approach, which must take precedent over the standardised approach.

“Unless European authorities take some action over and above what is currently proposed by the EBA, specifically by reducing reliance on ratings or drastically modifying the current ratings-based rules, volumes of placed deals will remain small, securitisation issuance will be the preserve of small to medium-sized banks with relatively little access to alternative funding, and the market will have to rely on US institutions as the main investors,” says Mr Perraudin, who was previously an advisor at the Bank of England.

Will the world follow?

Just weeks after the EBA’s advice, the BCBS itself, together with the International Organisation of Securities Commissions (Iosco), published the final version of its criteria for identifying simple, transparent and comparable securitisations (STC). The acronym and the concept may be similar to the EBA approach, but Basel appears to be moving at a very different pace from the EU.

While the BCBS/Iosco indicated that they were “exploring how these criteria could be incorporated into the securitisation framework revised in December 2014”, the criteria are explicitly “not, of themselves, a prescription for regulatory action”. The fear among US banks is that there is little or no regulatory momentum in the world’s most active securitisation market to adopt the STC concept.

“There may well be redundant bank capital held against securitisations, and the EU may be right to reduce that burden. But even if the BCBS converges with the EBA, the US could be left behind not only by Europe, but also by jurisdictions such as Australia and Japan. It would not be right to have different rules across jurisdictions in a global market – for instance, what would be the impact on US banks as investors, and on US issuers accessing non-US markets?” says Richard Johns, executive director of the Structured Finance Industry Group in Washington.

There is scepticism among US asset-backed securities participants on whether efforts to establish standardised best practices and investor disclosure in securitisation should be so explicitly linked to the separate question of bank capital. However, US banks cannot afford to ignore developments if the EU moves ahead with preferential capital treatment for qualifying securitisations.


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