The growing number of EU institutions intervening on the drafting of Europe’s vital new liquidity requirements is piling uncertainties on banks and capital markets.

What is it?

Capital Requirements Directive (CRD) IV is the EU's customised implementation of the global Basel III accords on bank capital and liquidity, intended to incorporate the lessons of the financial crisis into bank regulation and supervision. The first draft of CRD IV was published by the European Commission (EC) in July 2011, and Part Six set out the creation of a harmonised EU Liquidity Coverage Ratio (LCR). This would require bank treasuries to hold a buffer of most liquid assets that could be easily sold to repay maturing liabilities in the event of a funding squeeze.

What’s the latest?

The EC now hands over responsibility to the European Banking Authority (EBA) to finalise specific binding rules for CRD IV. But before then, other European institutions are queuing up to have their say.

The Danish presidency of the European Council of Ministers (ECM) proposed a new draft in January 2012 designed to meet criticisms from the UK government in particular. Article 404 clause 2a of this draft referred to the possibility that a liquidity buffer might include “asset-backed instruments of high liquid and credit quality”.

So securitisation survives?

Not according to Article 404 clause 2b, which stated that “assets constituting securitisation positions” would be specifically excluded from the buffer. The resulting confusion prompted a redraft in March 2012, which removed both the conflicting phrases.

The ECM left it to the EBA to decide by June 2013 whether such assets would be eligible for the Part Six buffer. But it mooted including “other categories of central bank eligible assets, for example, RMBS [residential mortgage-backed securities] of high liquid and credit quality and other non-central bank eligible but tradable assets, for example, equities listed on a recognised exchange and gold”.

The European Central Bank (ECB) joined the argument in February 2012, urging “the adoption of a single and transparent list of the items to be reported”, and adding that “in view of the significant interaction expected between liquidity requirements and monetary policy operations, the ECB recommends being consulted by the EBA when developing a uniform definition of high quality assets.”

Rage-ometer MAY

What will regulators say?

At the moment, the only clear technical definition of liquidity is cash and deposits at the central bank. The ECB’s intervention may have influenced the ECM's decision to explicitly refer to central bank eligible collateral as a possible definition of liquid assets in its March redraft. David Covey, European asset-backed securities (ABS) analyst at Nomura in London, is cheered by the ECB’s involvement. “The ECB seems to understand the rationale for broadening the definition of liquid assets, and there is a strong argument to include other high-quality securities on which the ECB already provides liquidity. The definition, as currently proposed, is very limited,” he says.

But Mark Bearman, director of prudential regulation at the Association for Financial Markets in Europe (AFME), cautions against excessive optimism at a time when the regulatory mood towards securitisation remains sceptical. He says the industry’s interaction with the EBA has been positive so far, but the EBA's relative infancy makes it difficult to predict what the final liquidity definitions will be.

What does the industry say?

More speed, less haste. Mr Covey says tentative suggestions that the EBA might publish its final definitions well before June 2013 would help to lift a shadow of uncertainty from the ABS market one way or the other. In the meantime, he says European issuers are looking to the US market, where the absence of both CRD IV and the Solvency II insurance regulations allows a steadier appetite for ABS.

“In the second half of 2011, more than 50% of European RMBS and credit card-backed ABS issuance was in US dollars. Such heavy reliance on foreign markets is something that should concern regulators in Europe, and encourage them to implement rules that better reflect the economics of European securitisation,” says Mr Covey.

Mr Bearman says AFME is approaching regulators and members of the European Parliament with two arguments. The first is the cumulative effect of new regulations on banks’ ability to lend to the real economy. The second is the high quality of European securitisation compared with the US subprime experience – AFME calculates actual default rates on European RMBS since 2007 at just 0.07%.

“Changing eligibility for the liquidity buffer can have quite a substantial effect on what mix of assets banks will have to hold. The narrower the definition, the more low-yielding assets banks will have in their liquidity buffers, which will inevitably hit return on equity,” says John Macdonald, head of IBM’s banking and markets risk analytics division.


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