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WorldJanuary 27 2014

Securitisation still suffering capital punishment

New regulations for banks and insurers governing capital requirements on holdings of securitised assets include some improvements, but may not be enough to make the product viable in Europe.
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What’s happening?

On the same day in December 2013, the Basel Committee on Banking Supervision (BCBS) and European Insurance and Occupational Pensions Authority (EIOPA) published papers setting out a new capital framework for holdings of securitised assets by banks and European insurers, respectively. The BCBS paper has a consultation period that closes on March 21, 2014, while the EIOPA report will now be considered by the European Commission.

What has improved?

The attitude of regulators in general. European Central Bank executive board member Yves Mersch warned in November 2013 that it was wrong to regulate the whole securitisation asset class based on the problems caused by US subprime securities. He argued that securitisation could be vital, especially for funding European small business lending.

“This regulation is like calibrating the price of flood insurance on the experience of New Orleans for a city like Madrid,” he said.

The EIOPA report explicitly mentioned the industry’s Prime Collateralised Securities (PCS) initiative, launched in 2012 to provide a labelling scheme for the most senior tranches of European asset-backed securities (ABS) issues that fulfil certain quality criteria. In line with this concept, EIOPA proposed distinguishing high-quality securitisations, altering its blanket 7% risk charge for insurers’ holdings of AAA rated securitisations to a charge of 4.3% on high-quality deals and 12.5% on riskier ones.

“Irrational fear of securitisation has been replaced by rational fear. Regulators are not going to forgive and forget the mistakes made in ABS, but it has been rehabilitated conceptually, with differentiation between good and bad uses of securitisation,” says Ian Bell, head of the PCS secretariat.

Meanwhile, the BCBS paper cuts the proposed floor on bank risk-weights for securitised assets from 20% to 15%. It also seeks to remove some of the flaws inherent in the interim Basel 2.5 framework for securitisation that was imposed in haste in the months after the subprime crisis peaked.

“In particular, Basel 2.5 had introduced cliff effects because securitisations were fully deductible from capital once they fell below a certain credit quality or rating. That could potentially and unnecessarily provoke firesales of such securitisation exposures. The new draft has preserved a sliding scale of risk-weightings that can be linked, for example, to external ratings, but has softened the cliff effects significantly,” says James Ahern, global head of securitisation at Société Générale Corporate and Investment Banking.

What hasn’t?

The relative treatment of securitisation. Capital requirements are still much higher than equivalent unsecured debt assets, and also far higher than needed to absorb historic loss experiences except one – early 2000s vintage US subprime mortgage securities and associated collateralised debt obligations of their repackaged debt.

Reg rage - exasperation

“Based on preliminary calculations we have made, it would generally be cheaper for banks to lend directly to clients via a borrowing base collateral framework or without collateral at all, rather than financing clients with the tighter security package offered by bankruptcy-remote vehicles and tranched credit enhancement. That simply does not make sense from a risk management perspective,” says Mr Ahern.

This all sounds painfully similar to Mr Mersch’s New Orleans/Madrid analogy.

Mr Bell sees a fundamental gap between recent official pronouncements on reviving securitisation and the details of the reports. “Unfortunately, it’s a question of sequencing. The good news is the emerging supportive consensus. The bad news is that work on these reports started when attitudes to securitisation were still completely hostile. We have to hope that the response period allows us to show the Basel Committee and European Commission that while the new approach is helpful, the current capital numbers will not work for the economy,” he says.

Do we need it?

Quite possibly not. Regulators have already taken a raft of measures to change incentives and ensure that securitisation stays on the straight and narrow. These include rules on risk retention to ensure alignment of interests between securitisation issuers and investors. This has gone a long way towards curtailing the bad underwriting at the root of the US subprime crisis. The US and EU have also begun to regulate credit ratings agencies and introduce liquidity rules that should minimise poor asset/liability management. And global securities regulators or central banks have passed rules to ensure proper levels of disclosure, standardisation and transparency in securitisation deals.

“The massive regulatory change already implemented when taken together is more than sufficient to curtail the bad behaviour. As an industry, all we have asked for is a level-playing-field treatment for securitisation as compared with how these real economy assets would be treated from a capital standpoint pre-securitisation or if financed in an alternative form of securitisation such as covered bonds,” says Mr Ahern.    

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