LONDON - The not to distant future for Basel II has arrived and the securitization industry can expect to see some structural changes as early as this year. Just around the corner is another series of consultative paper that's expected to better define the regulatory treatment of credit derivatives and other trading book items slated for an early April release.

"Some amendments are expected for the second quarter and if they don't go far we expect to start seeing some changes in structuring," said one speaker at last week's European Structured Finance Conference hosted by Moody's Investors Service.

Basel II issued its completed guidelines last June and is slated to come into force by the end of next year. Japan said it intends to apply the new Accord, while China and India have each indicated that the Accord will not be applied immediately but will be at a later date. In the U.S. only 20 to 30 of the largest banks are expected to implement the new guidelines by 2006, with the remaining 8,000 banks continuing to report under Basel I. "This will be creating some strange temporary results initially. In all, about 60 countries worldwide are expected to move to Basel II by 2007," said one industry source.

Implementation in the European Union will be via a new Capital Adequacy Directive, expected to come into force at the same time as Basel II. The European Union released its new capital requirements directive last July, which followed closely with the Basel II text. The capital requirements directive, with a targeted implementation date in 2006, will be discussed and amended by the European Parliament and the European Commission throughout 2005.

The biggest question for structured finance originators is whether securitization still makes sense from a regulatory standpoint? Securitization was born out of a need to better define the rules under Basel I and the new accord signals an end to regulatory capital arbitrage, a key driver for securitization, said Moody's. The rating agency ran an audience poll a majority of the banks attending last week's conference said that they would be applying the IRB approach, with a majority expecting the new guidelines to negatively impact structured finance, the most affected area being investment in CDOs and credit derivatives.

"In our view, Basel II forms a critical factor for the future development of ABS in Europe and many markets in Europe and many in Asia, particularly Australia," reported analysts at The Royal Bank of Scotland. "Not only does it affect bank originators and issuers, this regulatory change also influences the investor side of the equation. The effect of these two influences - issuer and investor - conspires to impact on the likely future volume and complexion of the market."

Calculations for the advanced IRB approach favor securitizing poorer credit, and encourage banks to retain higher quality loans. For banks holding low-grade assets, securitization still makes sense, as it will be more costly for a bank to maintain these on balance sheet assets, explained analysts. Larger mezzanine and subordinate tranches are likely under Basel II, said analysts. But for high-grade and retail assets Moody's said it expected to see more on-balance-sheet structured financing (like structured covered bonds and collateralized issuance and secured funding) and less securitization.

On the investor side, Basel II appears to favor securitization investments. RBS analysts calculated the amount of capital requirements for banks holding both ABS debt and secured as well as unsecured corporate debt. The loss, given assumed defaults under the Foundation IRB approach and the schedule under the IRB approach require considerably less capital for ABS, regardless of the underlying assets. "The restraining factor remains granularity within the pool; however granularity is defined as greater than five assets, a hurdle we find reasonably low to surmount by savvy structurers and investors," said analysts.

Banks will still look to securitization for regulatory capital arbitrage, as well as a platform for the diversification of funding sources. And its likely to remain a strategic tool for banks to achieve higher ratings at cheaper funding costs. The immediate issues that banks now face are the cost burden running the new process has had across the board - initially banks will be required to run the new accord concurrently with Basel I. At the moment, the largest banks were reporting these costs to be somewhere between 100 million to 200 million ($260 million to $130 million) said Moody's.

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