Given the way the securitization market has dissolved over the past 14 months, the industry needs to make a case for why securitization is needed, said a senior official of Britain's Financial Services Authority (FSA) at Information Management Network's second annual European CLOs, Structured Credit Products, and Credit Derivatives Summit held in London last week.
The official said that the industry needs to make the case that securitization indeed delivers economic benefits, and that this case needs to be made much clearer if the industry is ever to regain its footing. A clear issue with a market that was hugely liquid and then became illiquid is that any form of rebirth must establish a more stable pattern of liquidity and price stability.
Among European regulators, there remains a recognition that some form of revival of the securitization market, at an appropriate time and in an appropriate way, potentially on more stable foundations, is a desirable outcome, he said. From a capital point of view, the main concern is understanding which risks have been transferred, what has been kept on balance sheet and what new risk has been created.
"These questions are hard to ascertain as the technology is very advanced," he said. "You can draw a simple diagram that makes the technique look pretty straight forward, however, in reality, the dynamic of what is transferred is more complex."
Asked his views on the U.K. master trust structure - a managed, renewable pool of mortgages - versus the typical stand-alone ABS, the official said he saw significant arguments in favor of each. "I would not steer toward master trust or standalone structures. What I would steer toward are risk managers [who] understand what they are doing in whatever vehicle they set up," he said.
The official also questionedthe necessity of the European Commission's recent proposal that originators and sponsors of securitization transactions be required to retain, an on ongoing basis, no less than 5% of the overall risk that is being transferred to investors. In the U.K., it's already usual that originators retain a portion of the risk themselves, which, in turn, motivates them to ensure that the credit quality is secure, the official said.
"The retention of first loss pieces, and the presence of sellers' shares [in U.K. residential MBS master trusts] means that an originator typically has a very considerable interest, like the holders of rated securities do, in ensuring that the credit quality of the underlying pool is maintained," the official said.
The European Commission proposal for revisions to the capital requirements would ensure the financial soundness of banks and investment firms in the EU, and would come into effect starting January 2011.
Barclays Capital analysts have also argued that the retention requirement would make securitization less attractive when compared with other funding instruments, such as covered bonds.
It would limit any of the investors to sell any part of their position in the secondary market, since if they did so, it would be nearly impossible for the sponsor to guarantee that it has retained exactly 5% of that investors' new position.
However, the official said that regulators still see little economic benefit for structures in which ABS are packaged into even more complex securities such as CDOs.
"There is a wariness of anything that looks like a securitization of securitizations," he said. "There is very much a case to be made by the industry as to why that is needed."
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