The U.K. Financial Services Authority (FSA) will apply banking book risk weights to securitization trading positions following the position adopted under the capital requirements directive (CRD 3) passed by the European Parliament at the end of July.

In a 126-page discussion paper looking at different approaches to tightening up the rules, the FSA looked to make a fundamental change that would end the distinction between trading and bank books. The FSA recommendation would tighten up how banks price trading positions.

The FSA has also moved forward in line with the CRD 3, where amendments state that ABS bonds will have the same risk weight in both books, with either the Standardized Approach or the Internal Ratings Based (IRB) Approach applied across both.

"Given the headline-grabbing number of structured finance accounting for 75% of all crisis losses (10 investment banks were surveyed), it is easy to see why securitization has been singled out," Deutsche Bank analysts said. "However, in our opinion, regulation is focused on the wrong areas."

The analysts said that policy makers have failed to take into account that stripping out super senior structured finance CDOs (including monoline protection), ABS accounts for 20% rather than 75% of losses, while if trading books are taken in isolation it reduces further to 7%.

"It appears to us therefore that the rules penalize mezzanine vanilla ABS that have performed as expected, while senior super senior positions — responsible for the highest proportion of losses, would in theory benefit from a low triple-A risk weighting," Deutsche Bank analysts said.

However, Barclays Capital analysts noted that most banks had already moved their ABS holdings out of the trading book many quarters ago to avoid having to mark their holdings to (a dysfunctional) market and suffer hits to their regulatory capital.

"At this stage, these particular amendments would seem to mostly affect dealers who hold ABS bonds in their trading book to provide liquidity in the secondary market," Barclays analysts said. "Hence, we think it quite plausible that trading desks may at some point face higher internal inventory funding costs or lower inventory limits to reflect any increases in capital dealers must set aside for their ABS trading operations."

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