The European Commission has taken a step toward modifying the risk weighting of complex securitization products under Basel II.
The commission has opened a public consultation on further risk-weighting penalties for resecuritized products such as CDO squared instruments.
Higher risk weightings would reflect the complexity and illiquidity of such bonds, which may destabilize the banking system. Market participants have until April 29 to discuss the measure and make counter proposals. The new proposal is based on strengthening trading book capital requirements. The trading book securitization position could be given the same risk-weighting (RW) treatment as the banking book position but this might be overruled by the Basel committee's proposal to apply 100% RW to all net positions in the trading book.
The new proposal also calls for raising capital charges for certain kinds of securitization exposure. Resecuritized products such as CDOs of ABS or CDO-squared instruments would have a special RW grid with a possibly dilutive capital charge. The proposal also suggests upgrading risk management and disclosure standards for securitization positions.
The Commission said it is open to any necessary changes but considers that the European legal framework is sufficient at this stage, and coherent with the recommendations of the Basel committee. If necessary, the Commission is ready to implement further disclosure standards following accordance with requests from regulatory bodies.