The European Commission has posted its proposal for revisions to the capital requirements directive.
This proposal aims to ensure the financial soundness of banks and investment firms in the European Union and contains a wide range of changes.
The proposal includes new rules for securitization that would come into effect beginning January 2011, contained mostly in the new article 122a.
Originators and sponsors of securitization instruments will be required to retain for their own account and on an on-going basis no less than 5% of the overall risk that is being transferred to investors.
This retention requirement makes securitization less attractive than previously and perhaps also compared to other funding instruments, such as covered bonds, said Barclays Capital analysts in a research note published today. It also raises the question whether vertical tranche securitization is going to be feasible under this new requirement. If the sponsor needs to retain 5% of each individual investors' risk position, it would limit any of the investors to sell any part of their position in the secondary market. Since if they did so, it would be nearly impossible for the sponsor to guarantee that has retained exactly 5% of that investors' new position.
Under the new proposal, only vertical tranching of the risk is allowed which is, Barclays said, is contrary to the fundamental reason for securitization. Sponsors might be driven to reduce the level of funding through securitizations.
The new rules also call for investors to be able to demonstrate a comprehensive and complete understanding of each securitization position and to implement formal policies and procedures covering both initial analysis and ongoing monitoring through regular and independent stress testing as well as the need for adequate information on the individual underlying exposures being provided by the originator.
In our view, most of these requirements are sensible, but will require a significant investment on behalf of investors in both systems and staff training, Barclays analysts said. Third-party model and consulting providers should be able to assist investors in this process. However, the net effect might still be that many investors will not be in a position to meet these requirements.
They added that this could potentially further reduce the investor base, which has already shrunk dramatically as a result of the significant losses and mark-to-market write-downs.
This is still a proposal as it still needs to be approved by the European parliament, analysts said. The commissioner has already stated that it will not put EU-based banks at a competitive disadvantage compared to other global banks, highlighting the need for global regulatory coordination. The proposal leaves room for interpretation of the new rules, which we expect will allow for some issuance by sponsors over time. In the end, we do not believe that the Commission is trying to eliminate the European securitization market.