Europe might be feeling great uncertainty over how to resolve its sovereign debt crisis, but its securitization market has still managed to restart.
Key to the European market's resiliency are more "user-friendly" regulatory changes - an example that U.S. regulators must draw from, according to panelists at the Information Management Network (IMN) ABS East 2011 conference held in October.
For the U.S. market, the lessons of European regulatory simplicity could be key to reviving other sectors of securitization outside the consumer ABS asset classes.
"A lot of what is inhibiting investors from putting money to work and issuers from tapping the market areas are issues on the regulatory side, like sorting out risk retention," said Adam Siegel, managing director and co-head of ANS/MBS/CMBS trading at the Royal Bank of Scotland, speaking at the event.
Stephen Kudenholdt, IMN speaker and co-chair of the capital markets practice at SNR Denton, said the issue of risk retention has been complicated by Congress. The legislature has exacerbated the issue by including in the risk retention proposal the definition of a qualified residential mortgage (QRM) and the premium capture cash reserve provision. By contrast, an across-the-board 5% risk retention requirement for European jurisdictions became effective on Jan. 1.
"The U.S. can learn from what has already happened in Europe, where the capital requirements directive has been implemented," said speaker Jason Kravitt, senior partner at Mayer Brown.
In theory, Europe should probably take longer because of all the different jurisdictions it must take into account, yet it is the U.S. that is years behind on the issue of risk retention. The reason behind Europe's quicker turnaround is that the regulators dealt with the risk retention provision through article 122a in the capital requirements directive via a short 20-page proposal.
Because the U.S. plan was much longer and more complicated, it has resulted in hundreds of comment letters containing objections to the proposal.
Instead of a simple 5% rule, the U.S. version requires the securitization sponsor to retain the risk, but companies could decide if their piece was 5% of the whole securitization or 5% of each tranche. It also outlined criteria for the QRM, a special class coined by the Dodd-Frank Act to exempt these mortgages from risk retention, limiting the exception to loans with a 20% down payment and low debt-to-income ratio. The U.S. rules have also exempted loans other than mortgages, such as car loans, from the 5% retention requirement.
The QRM criteria have caused the most controversy, with various stakeholders protesting that the strict criteria will limit credit availability.
Several industry groups have said that the QRM does not need a down-payment requirement and that other loan characteristics are better predictors of performance. Other commentators have just called for a lower down-payment requirement.
Industry commentators have also warned about the proposed creation of "premium capture" reserve funds, which are meant to prevent securitization issuers from using bond sales to avoid the negative effects of risk retention.
A premium capture fund will hold proceeds from such bond sales but will also expose the issuer to potential losses on the underlying assets. Yet critics have said that requiring such funds, as proposed, could turn investors away from the market.
"How can issuers make money off of a deal when assets with higher coupons would no longer be readily securitized because of the costs involved with the premium capture fund? That could pose a real danger to the industry," said speaker John Arnholz, a partner at Bingham McCutchen.
Kravitt, along with other market players, believes that the industry could get a second bite at the apple on the issue of risk retention.
But even in Europe, where the simplicity of article 122a has been applauded by U.S. market observers, problems can still occur.
"You have to look at areas of the market where deals have come back," said Vishwanath Tirupattur, head of structured product research at Morgan Stanley.
An example in the U.S. are CLOs. This is one area where issuance has come back in the country. There has been more than $10 billion issues year-to-date versus Europe, where there has been no new issuance.
"It's because of the difference in risk retention requirements," Tirupattur said. "One set of rules can deter the emergence or reemergence of a securitization asset class."
When applied to actively managed arbitrage CLOs, risk retention is problematic because none of the deal parties can strictly fall within the definition of "originator," or "original lender," a note published by law firm Ashurst explained. Meanwhile, the definition in the Central Registration Depository of "sponsor" requires that this entity be a credit institution.
Regulating Ratings
Kris Kraus, executive vice president of advisory marketing at PIMCO, pointed to the added uncertainty created by the Franken Amendment. This change proposed that the Securities Exchange Commission (SEC) establish a board that would assign which rating agency or nationally recognized statistical rating organization (NRSRO) can rate certain structured finance transactions. "It's issues like risk retention as well as other outstanding issues that create loan-level uncertainty," he said.
The Franken Amendment requires the SEC to conduct a study on the ratings process and to look at the feasibility of establishing the board. The SEC must complete the study and come up with a recommendation by July 2012.
Specifically, the amendment would require that the board be established and comprise investors, an issuer, a rating agency representative and an independent member.
The board must first qualify an NRSRO to be eligible to participate in the rating of certain types of transactions. Once the board determines who is qualified, it would select from the selected agencies as to who would be assigning the rating on a given transaction. On an annual basis, the board would conduct a performance review on the NRSROs and determine their future eligibility.
Volker Rule
Speakers at the event also discussed the newly minted 300-page notice of proposed rulemaking under the Volker Rule.
While the rule does not deal specifically with securitization (see related story on page 6), it prevents banks from using the industry as a way out of restrictions.
Debbie Toennies, managing director at JPMorgan who spoke at the IMN event, said that the rule prohibits banks from adding credit enhancement to ABCP conduits. "That market can't function without liquidity and credit enhancement provided by the sponsor bank," she said. "The rule creates some potential pitfalls with the way banks do securitization."
Even with bipartisan support for U.S. covered bond legislation, its passage has been pushed to 2012. IMN event speakers said that U.S. issuance in this sector has been primarily held up because of the Federal Deposit Insurance Corp.'s desire to treat covered bonds the same as other secured obligations on banks' balance sheets.
The IMN panelists warned that an unintended consequence of overregulation in the U.S. is less securitization activity. This means slow economic growth with less credit available to the broader economy.
"It's important that regulators write rules that affect the capital markets, but they have written too many, and unless they rewrite some of these rules the market won't unfreeze," Arnholz said. - NC
