It’s been exactly one year since ‘Prime Collateralised Securities,’ (PCS) the prestige label for European deals that meet certain criteria, was announced at IMN’s Global ABS Conference in Brussels in 2012. 

The label was designed to be a simple way of communicating and identifying securitizations that meet predefined best practice standards with regard to quality, transparency and standardization.  Its sponsors hoped that promoting these standards would make this asset class more appealing to a broader base of investors, and that this, in turn, would boost issuance and improve liquidity in the secondary market.
So far, the initiative’s success has been limited.

PCS can boast that, since it was introduced, roughly 70% of all investor-placed issuance that has come out of Europe has opted to obtain the label. But this high rate of adoption is less impressive than it might seem, because that 70% amounts to only 12 deals as of April 2013. 

In an interview with ASR, Ian Bell, head of the PCS Secretariat, said that the fact that only 12 deals have been issued with the new PCS label is not a “reflection on the label,” but rather a consequence of efforts by both the European Central Bank’s (ECB) and the Bank of England to inject liquidity into their respective banking systems.

“It is very difficult to convince a treasurer to do a structured finance deal which will, all in all, come back at over 100 basis points, when they can turn around and get free funding from the central bank”  by using a securitization as collateral in a sale and repurchase (repo) agreement, said Bell.

The impact that this has had on the securitization market is unfortunate, but unavoidable. “The central bank liquidity program is about preserving the banking system in Europe and it has done a great job in this respect, but how to extricate ourselves from this position is a really continent-wide deep conundrum,” he said.

Now that Europe’s banking system is on life support, the central bank faces the challenge of weaning banks from its liquidity support program, without killing them. Bell says that, especially for peripheral countries in the European Union, such as Spain, Portugal and Greece, there is no easy solution. 

A ‘Credible, Independent Voice’ in Policy Debates

At the onset, part of the impetus for PCS was a desire to impact the development of European regulation affecting securitization.  On that level, Bell said, PCS has had a great start. “We have in a very short amount of time been able to establish PCS as a credible, independent voice in the policy debates,” he said.

Bell, the former head of European securitization at Standard & Poor’s, spoke to ASR from Brussels. He said that PCS has been able to quickly establish its credibility with regulators. He attributes this success in part to the independent status of the PCS initiative.

The group has a two-tier structure: the PCS Association, which is comprised of a group of independent directors from outside the securitization industry; and the PCS Secretariat, led by Bell, which is responsible for the day-to-day administration and management. The PCS Secretariat grants the PCS label to securities and monitors the transactions for compliance after they are issued.

“It is clear that we are less shy about saying that things went wrong and this approach has been refreshing for policymakers,” Bell said.

However, PCS must first establish a track record before regulators are able to formally endorse the label in regulation – it has to be seen as a success in the market and it must show that it has credibility with investors.  Bell pointed out that, although the PCS initiative was announced in June 2012, the first issue to carry the label, Bilkreditt 3, a Norwegian auto deal issued by Santander Consumer Bank, was only completed in November of last year. 

“Regulators are always going to be the last movers and [are] never going to be the first movers – they haven’t closed the door on using labels like PCS in regulations but they need to ensure that the PCS is successful and credible  [before endorsing it], and that could take another year or more,” he said.

Bell is encouraged by the good reception the label has received so far. The latest endorsement comes by way of Benoît Coeuré, a member of the executive board of the ECB.

On April 11, in a speech delivered in Dublin on the “challenges and feasibility of diversifying the financing of EU corporates and SMEs,” Coeuré  mentioned securitization as a possible funding source for SMEs in Europe, indicating further support from policy makers for a return of a strong, high-quality market.  In particular, Coeuré cited PCS, commending its efforts.

For now, the endorsement may only be verbal, but Bell believes Coeuré’s comments indicate that as some point “it will be more than words.”

Basel III and High-Quality, Liquid Assets

The 2007-2008 financial crisis led regulators to revise standards for the capital that banks need to hold against loans they make. As a result, new, tougher liquidity coverage ratios (LCR) were introduced under Basel III that require banks to hold enough high-quality, liquid assets (HQLA) to survive a 30-day period of credit stress. In January 2013, the Basel Committee on Banking Supervision amended the definition of HQLA to include two tiers, or buckets; the first tier, known as Level 1, includes cash, highly-rated government bonds and debt from the strongest multinational agencies; just one type of securitization, certain highly-rated RMBS, was included in the second tier, or Level 2B. 

This amendment was encouraging, but securitization market participants don’t think it went far enough. What they really want to see, over the short- to medium-term, is for the definition of Level 2B to be broadened to include a wider range of RMBS and other types of securitizations.

“At the moment its limited to RMBS transaction that are triple-A rated assets and the loans have to have full recourse and it basically ends up being that the only eligible assets are prime U.K. RMBS and Australian market transactions – it cuts off a large portion of the market even on a prime triple-A market perspective,” said Douglas Long, an executive vice president at Principia, a portfolio management software provider.

The hope is that the PCS label could eventually be one of the criteria used to determine eligibility for the inclusion of securitizations as HQLA. This would encourage banks to keep such deals on their books.
Another regulatory stumbling block to the securitization market’s recovery is the introduction of high capital charges of between 7% and 42% for even triple-A rated securitizations under Solvency II, the capital adequacy regime for the European insurance industry. It aims to establish a revised set of EU-wide capital requirements and risk management standards that will replace the current solvency requirements.

Solvency II and Insurers

Bell said that, from the start, the PCS Secretariat assumed that “it would have to devote considerable effort to educating high-level policy makers about the importance of the securitization market to the recovery of the economy, and it turns out that part of the job has already taken care of itself.”

He added, “our job now is to alert policymakers to the problem that the proposed technical regulations [that] are just about to kill the market.”

The insurance industry’s new capital adequacy regime is chief among these. “We need to convince regulators and policymakers that securitization is an incredibly important market but also need to give them good technical arguments on why 7% capital per year of duration in Solvency II is totally indefensible,” he said.

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