As the securitization industry enters the final leg of discussions before the 2007 implementation of the new Basel accord, there are still a number of issues to be worked out.
The new Basel Accord will be implemented in the European Union via the Capital Requirements Directive (CRD), which is slated to take effect on January 1, 2007.On Feb 28, the U.K.'s Financial Services Authority (FSA) issued its consultation paper on the proposed plans for the U.K. implementation of the CRD.
The FSA consultation paper CP 06/3 is a handbook of amendments that were made to implement the new directive. Chapter 16 of this paper is dedicated to a number of areas concerning the securitization framework. Deadline for comments is April 28 and the FSA expects to produce its final handbook of rules and guidance by October 2006.
On March 24, ahead of the FSA's April deadline, U.K. industry players plan to have a preliminary meeting discussing remaining concerns about the amendments. On a preliminary read, sources say there are still many issues that need to be resolved.
The biggest one is consistency. Mark Nicolaides, a partner at Mayer Brown Rowe & Maw and a member of the legal and regulatory committee at the European Securitization Forum, said that, at the moment, there are at least 200 areas where the regulations are left to national discretion. It also remains unclear if a national implementation of the regulation will get rid of this discretion, and if it will create a more uniform playing field from country to country.
"Banks that are regulated in different places will hold different capital against the same bond," said Nicolaides. "Some banks will have a competitive advantage and some will have a disadvantage." Nicolaides said that, in certain cases, a risk weighting based on the rating of a credit could vary from bank to bank, ranging between 20% and 150% risk weighting.
The committee for European banking regulations, CEBS, said it wanted to retain discretion, according to Nicolaides. "The EU capital directive [also] maintains this discretion and doesn't seem to offer any guaranty that there will be a level playing field," he said.
Industry players are also looking to get more clarity on the rules on collecting data.
Under the new Basel II accord, banks applying the advanced Internal Ratings Based (IRB) approach are permitted to design their own formulas that calculate exposure. Foundation IRB banks come up with probability of default formulas. Nicolaides said that the accord does not clearly detail how much data is sufficient to accurately plug in these formulas.
"There is great variability in the data and it was that detail that caused U.S. regulators to be afraid to implement Basel II," he said. "In some instances, for the same retail credit, depending on what formula was applied and what amount of data was used, could come out at 5% risk and in other instances 80% risk weighted."
The FSA is looking at several of these issues and Nicolaides said that the German regulating body, BaFin, has also publicly made efforts to resolve the outstanding issues. He believed the French regulators had a draft in circulation, although this is only used in France.
"National regulators are operating this machinery without instructions and, as a result, they will require banks to hold abnormal high amounts of capital for securitization," said Nicolaides. "There is a lot of work that is being done at the national level to clear up these outstanding points and its not entirely clear whether they will get it done in time."
Hans Vrensen at Barclays Capital said that many investors remain concerned about the impact of Basel II due to the uncertainties over implementation from jurisdiction to jurisdiction. "Given that many existing ABS issues have specific call options relating to Basel II, the key question is whether these issuers will in fact exercise these call options," he said.
The FSA is looking to set a limit on when the decision to exercise a regulatory call due to CRD implementation can be taken. It has proposed setting a January 1, 2008 deadline for firms using the standardized approach and January 1, 2009 for firms using the IRB approach. "We think a decision to exercise such a call after these dates is unlikely to be linked to a CRD-related regulatory event," wrote the FSA in its consultation paper.
Vrensen said that certain issuers have also been deleting the Basel II call option language from newer deals.
The good news is that, in the run-up to Basel II, the primary pipeline continues to thrive. Vrensen said that the impact of the new accord on issuance volumes and spreads is likely to be less than previously expected. Not all originators and investors are subject to the new regulations and the European ABS investor base is increasingly moving away from banks.
It's also important to remember that ABS issuance is not entirely driven by regulatory capital arbitrage. Vrensen said that factors such as funding costs, diversity of funding and rating agency constraints should continue to encourage issuers to come to market.
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