Shaping Tomorrow’s Securitisation Market in Europe

A series of regulatory discussion papers has sought input towards forging the future path of Europe’s securitisation market. However, the debate has omitted the types of transaction used most directly by non-financial corporates – or excluded them from the most revered regulatory capital status.

That was the general consensus from market participants responding to a consultative document entitled ‘Criteria for identifying simply, transparent and comparable securitisations’. Jointly issued by the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO), the consultation period for its proposals recently concluded.

Those canvassed pointed out that asset-backed securities (ABS) can play an important role in financing companies and supporting regulators’ overarching goal of spurring European economic growth – but not as envisioned in the current document. One proposal is to hold off dealing with asset-backed commercial paper (ABCP), a source of short-term funding principally used by corporates, until a separate future project can address it.

“We think it’s important that ABCP conduit funding should not be excluded from consideration in the overall ABS framework,” says Richard Hopkin, head of fixed-income and managing director in the securitisation division of the Association of Financial Markets in Europe (AFME). “It’s very important for the corporate issuer base – for trade receivables and other short term funding loans such as dealer floor plans.”

The current proposals, if enacted, could also prohibit synthetic securitisations backed by trade receivables and potentially other corporate assets and managed collateralised loan obligations (CLOs) that help fund banks’ commercial lending, from attaining the most optimal status from a regulatory-capital perspective – thus making them more costly to borrowers.

Yet as shown below in figure 1, the default rate from mid-2007 to mid-2014 for European residential mortgage-backed securities (RMBS) – by far the largest securitisation asset class in Europe -averaged only 0.14%, and for other consumer ABS excluding credit cards was 0.18%, according to Standard & Poor’s (S&P) data. Default rates have also been low-to-zero for securitisations of asset classes such as credit card loans, leveraged loans, and small- and mid-size enterprise (SME) loans, although collateralised debt obligations (CDOs) and commercial mortgage-backed securities (CMBS) saw default rates well into single and even double digits.

 

Figure 1: AFME – Historical Default Rates for Securitisation, mid-2007 to mid-2014:AFME Default Rates for Securitisation

Source: Standard & Poor’s

Despite so many strongly-performing securitisations, ABS volume has plummeted and has yet to revive – even as many European economies struggle. AFME shows 2014 European ABS issuance at €216.0bn, up from €180.3bn in 2013 but still well below 2008’s record total of €819.2bn.

A Wide Debate

The BIS/IOSCO consultation paper is regarded as the fourth in a series of publications with ideas for reversing the decline. It proposes creating a framework for securitisations that achieve a high level of standardisation, and are simple, transparent and comparable (STC). Regulators and market participants mostly support the plan; in part to attract new investors, as factors such as new capital requirements make ABS less attractive for banks, traditionally the primary buyers of the securities.

The European Insurance and Occupational Pensions Authority (EIOPA) issued a draft paper in late 2013, introducing the concept of high-quality type-1 securitisations that meet certain requirements and thus achieve more attractive regulatory capital requirements. Hopkin says the market views those requirements as still too high to encourage investors to return.

The European Central Bank (ECB) and Bank of England (BoE) subsequently issued a joint paper, expressing concern that the notion of “high quality” could imply a credit judgment, and proposing the more neutral “qualifying securitisation.”

“At AFME we like that, because it’s very important that people don’t mistake this designation as a credit rating,” says Hopkin. “It’s not a substitute for due diligence – simply an indication that in a securitisation the information is there for you to make your own judgments.”

The European Banking Authority (EBA) then issued a consultation along similar lines, outlining a “simple, standard and transparent” (SST) securitisations framework, for which comments were due in January. On February18, as a part of its green paper on capital markets union (CMU), the European Commission (EC) issued a separate consultation paper. Feedback on ‘An EU framework for simple, transparent and standardised securitisation’ is due by May.

“In Europe, this whole concept of qualifying securitisations is much more advanced than anywhere else,” says Kevin Hawken, a London-based partner of law firm Mayer Brown. As he notes, the concept has already been incorporated into rules that became final late last year. EIOPA has incorporated type 1 securitisations into Solvency II regulations that, when introduced in 2016, will significantly lower insurance companies’ capital requirements for investing in qualifying ABS, giving them more in common with corporate bonds than non-qualifying ABS.

The EBA has likewise favorably treated certain liquid ABS by allowing them to be included in the liquidity coverage ratio (LCR), a provision of Basel III that takes effect from October and requires banks to hold highly liquid assets equal to their stressed net cash outflows for the next 30 days.

Hawken says the two rules largely parallel each other in terms of criteria for qualifying ABS, showing that European regulators are talking to each other in a bid for consistency. The EBA’s proposal is aimed at bank capital treatment of ABS and builds upon the insurance capital and bank liquidity regulations. The BCBS/IOSCO proposal, he adds, is more principles-based since its guidelines would need to be implemented internationally.

The Basel Committee and IOSCO haven’t proposed to change rules based on their discussion paper, beyond developing the concept of STC securitisations for market participants’ use. “They’re leaving that open, but the Basel Committee has said it will consider whether and how to build the criteria into bank capital requirements,” says Hawken.

The EBA’s discussion paper, on the other hand, will help it advise the European Commission (EC), which intends to introduce a package to change the approach to securitisation for the European Parliament (EP) to consider, probably before the year-end.

“This could be a big game changer in Europe,” says Ian Bell, head of the Prime Collateralised Securities (PCS) secretariat. “We assume at the very least it will change Solvency II and LCR rules, and Basel capital requirements. It may also change forthcoming money market fund regulations as well as rules impacting alternative funds.”

PCS is essentially an industry utility set up by stakeholders in the securitisation market in the wake of the 2008 financial crisis. Operating independently, it labels ABS transactions meeting criteria that indicate a high level of transparency, but doesn’t label ABCP, CDOs, CMBS, synthetic securitisations or managed CLOs.

Asking Too Much?

ABCP is, by far, the securitisation product most relevant to European corporates. Its volume, too, has fallen significantly since 2008, roughly tracking the overall ABS market.

Teaming up with several international trade organisations, AFME’s comment letter on BCBS/IOSCO’s discussion paper echoes its earlier feedback to the EBA. It notes that ABCP is the principal way that certain asset classes, such as trade receivables, are securitised, making it a significant contributor to corporates’ working capital and in supporting trade and business. AFME acknowledges that ABCP securitisation is structured differently from term securitisations, and so criteria for one might be inappropriate for the other. Nevertheless, the letter says, similar frameworks should be set up for both markets.

In addition, trade and auto receivables are the main assets in ABCP conduits and tend to provide granular and predictable performance, the letter says, adding that current regulatory capital requirements for such transactions are therefore excessive, especially given their conservative levels of credit enhancement.

“Mainly for those reasons, the [joint associations] would submit that [the] level of regulatory capital required to be held against investments in these transactions already exceeds that warranted by their level of risk,” it adds.

“We are therefore deeply concerned by any STC regime that does not cater for ABCP and might therefore worsen an already onerous regulatory capital burden associated with these highly beneficial transactions.”

Commenting on the EBA’s discussion paper, the Association of German Chambers of Commerce and Industry (Deutscher Industrie- und Handelskammertag, aka DIHK) voiced similar concerns, noting that the focus of the EBA’s proposed framework is in making securitisation a more effective means for banks to refinance.

“However, refinancing through securitisation is not limited to banks, but also of considerable importance to many corporates via the use of [ABCP],” said the DIHK. “ABCP provides an important channel to refinance e.g. trade and leasing receivables and should be included in the EBA framework.”

Bell suggests though there are pragmatic reasons for keeping term ABS and ABCP on separate tracks, given ABCP criteria are significantly different and little debate regarding the latter has taken place so far.

“If you insist on having ABS and ABCP rules in the same framework, you will ultimately just delay the ABS rules,” he adds. “Work should start on ABCP rules as soon as possible, because it’s a very good product, but keep it separate.” The same holds true for securitisation products, such as synthetic securitisations.

AFME and the other financial-services associations expressed more urgency in their letter to BSCS/IOSCO about including at least some of those products in the framework being considered, including certain synthetic securitisations – despite that deal type’s poor performance during the crisis.

“It should further be noted that allowing certain types of synthetic securitizations to qualify as STC will help to contribute funding to the real economy,” the letter states. “They would ease the execution of securitisations of more challenging asset classes such as SME loans and trade credit by transferring risk, freeing up bank capital to make additional loans.”

The DIHK also supports a more inclusive framework that includes criteria for true-sale term transactions such as SME loans and auto finance, and also for synthetic securitisations – especially those including SME loans – as well as the securitisation of trade and leasing receivables. Moreover, it recommends designing the framework as an “open structure,” so that criteria for CMBS and infrastructure financing can be added later.

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