The Basel committee securitization group released its second working paper on securitization last month, inviting industry comments on the proposed changes until the cut-off date of Dec. 20, 2002. The full consultative paper should be ready for public market comment sometime next spring.

According to analysts at Morgan Stanley, the changes included on this second tour represent a significant step forward for the treatment of securitizations in the Basel 2 proposals. In particular, analysts pointed to refinements in the treatment of transactions with early amortization triggers and of liquidity facilities provided to conduits.

The original working paper prompted concerns among market participants that banks providing liquidity might also be providing credit support to their transactions. In the current working paper, the committee distinguishes between facilities that offer credit enhancement and those that solely provide liquidity in periods of financial market turbulence. "It appears that under the standardized approach, traditional liquidity facilities are likely to be assigned a 20% risk weighting under these rules, and banks providing liquidity facilities to conduits that they advise or manage may be able to use a 0% risk weighting provided that the facility can only be drawn in the event that they cannot roll over CP issuance," explained analysts at Morgan Stanley.

In respect to the early amortization feature, the first working paper stressed that there was a risk of the originator - while benefiting from regulatory capital relief from the assets - being exposed to the economic risk as well. Now, two different credit conversion factors will apply to deals with controlled and non-controlled amortization features. For the non-controlled amortizations, a 100% credit conversion factor will be applied; for deals with controlled features, an 80% credit conversion factor will be used. This proposed treatment applies only to the securitization of revolving credit facilities and transactions where replenishment occurs, analysts reported.

Regulator's ongoing role

As it stands, the new working paper outlines a draft of the supervisory treatment of securitization. It proposes that regulators must assess the true risk transfer in a securitization in order to judge the fairness and adequacy of the bank's assessment. Regulators ultimately have the authority to deny the bank capital relief from a transaction or to require it to hold more capital, explained analysts.

The regulator is also charged with the responsibility to determine potential issues that are not covered by the capital requirements. The working paper also stipulates that the regulator may formulate a supervisory response addressing any market innovations by either issuing operational requirements or dictating a specific capital treatment.

But, analysts warned, the rapidly evolving European market is likely to change within the next few years. They expressed concern that by the time the new guidelines are implemented in 2006, they might already be outdated. "We suggest that the introduction of regular, fixed meetings of the regulators to consider policy and implementation issues might be one way to reduce this risk."

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