European regulators are coming around to the idea that strict rules on securitizations are hurting efforts to jump start the region’s economy, in particular by restricting smaller companies’ access to financing.
On April 11, the Bank of England and the European Central Bank published a joint paper that called for a single definition of high quality’ securitizations as well as regulations based on the actual performance of deals in that category.
“A market for prudently designed ABS has the potential to improve the efficiency of resource allocation in the economy and to allow for better risk sharing,” the paper states. “It does so by transforming relatively illiquid assets into more liquid securities.”
The BoE and ECB follow in the footsteps of the European Commission, which in March pledged its support for a “high quality” securitization label.
The European securitization market has shrunk by approximately a third from its peak in 2009 to 1.5 trillion ($2 trillion) outstanding, and is one-quarter the size of the U.S. securitization market, according to figures from the Association for Financial Markets in Europe (AFME).
Even those figures overstate the market, since many securities issued today are retained by issuers to use as collateral for central bank borrowing, rather than placed with private investors.
What makes the BoE-ECB paper all the more timely and important is that it addresses the global regulatory work being done by the Basel Committee and IOSCO, according to Ian Bell, head of the Prime Collateralized Securities (PCS), a European securitization trade group. PCS puts its imprimatur on European securitizations that comply with certain criteria of simplicity, asset quality and transparency and reflect what the organization sees as best practices.
“Until now, most of the contributions to the high quality securitization debate had taken place within Europe and concentrated on European approaches (for example, Solvency II),” Bell said in a report published by the PCS in April. “[The ECB-BoE paper] globalizes the issue and puts this European approach squarely on the international regulatory agenda.”
The change in tack from regulators reflects arguments the PCS trade group has been putting forward since its inception.
The hope has always been that the PCS label could eventually be a criterion of high quality ABS. The PCS label focuses on securitizations that fund the real economy. It has awarded 47 labels to high quality securitizations, totaling over 83.5 billion ($115 billion) in issuance.
“By supporting the crafting of a definition of high quality’ securitization and its harmonized use across all the relevant regulations in a way that reflects the very good performance of these financing instruments in the crisis, the [European] Commission is leading the way in providing the conditions for a strong and safe securitization market able to fund the growth of the European economy, and particularly its small and medium business sectors,” said Bell.
It appears that regulators are ready to do more than pledge support for the high quality label.
In March the Commission proposed to halve the capital charges outlined by the European Insurance and Occupational Pensions Authority (EIOPA) in a December proposal regarding insurers’ securitization holdings under the Solvency II regulatory framework.
Under the proposals, EIOPA defined high quality “type A” securitization category, which would be subject to lower capital requirements. Other deals are “type B.”
Among other criteria, Solvency II outlines asset-level requirements for a deal to be type A. The underlying assets must not include any credit-linked notes, swaps, synthetic securities, or derivatives other than those used to hedge foreign exchange and interest rate risk.
Only residential mortgage loans, loans to small and midsize enterprises, auto loans, leases, consumer finance, or credit card receivables are type A material.
None of the loans can be more than 90 days past due prior to being acquired as collateral.
Sources said the Commission has proposed a capital charge of 2.1% for type A securitizations.
“We had already seen a significant reduction in the capital charges proposed by EIOPA in its December 2013 draft proposal for Solvency II regulation and have since learned that these could been halved again, according to a new draft,” Barclays stated in a report published in April.
“It is unusual to see such a shift in policy only three months since previous guidance and we believe that this is due to pressure from key policy makers and market authorities. This latest paper reinforces the stance of the ECB and BoE and applies further pressure to regulators.”
The concern was that EIPOA’s proposed capital charges for type A securitization — while sharply lower than those detailed in the prior draft technical specifications from December 2012 — would nevertheless “remain high compared with other fixed-income investments and may still deter insurers from investing in the securitization market,” according to a report published by Standard & Poor’s in February.