- Greg Medcraft – Chairman, Australian Securities and Investments Com- mission and Chairman, International Organization of Securities Commissions (IOSCO)
- Michel Heijdra – Deputy Director Financial Markets Directorate, Ministry of Finance, the Netherlands
- Sébastien Raspiller – Deputy Director, Financial Markets and Corporate Financing, French Treasury, Ministry of Economy and Finance, France
- Carlos Montalvo Rebuelta – Executive Director, European Insurance and Occupational Pensions Authority (EIOPA)
- Almorò Rubin de Cervin – Head of Unit, DG Financial Stability, Financial Services and Capital Markets Union, European Commission dans les Public authorities
- Peter Simon – MEP and Vice-Chair, Committee on Economic and Monetary Affairs, European Parliament DG Financial Stability,Financial Services and Capital Markets Union, European Commission (tbd)
- Katherine Frey – Managing Director – EMEA Structured Finance, Moody’s Investors Service Ltd.
- Alexander Batchvarov – Head of International Structured Finance Research, Bank of America Merrill Lynch Global Research
- Edoardo Reviglio – Chief Economist, Cassa Depositi e Prestiti (CDP)
- Emmanuel Lefort – Global Head of Structured Credit Solutions, Natixis
- Giles Williams – Partner, Financial Services Regulatory Centre of Excellence, EMA region, KPMG
1. Key political objectives:
Securitisation enables better funding of economic growth
Structuring an effective securitisation market in the EU is a critical project since such a market can play a very important role in funding economic growth, as European economies are less funded by financial markets than the US economy. By bridging banking and financial markets, securitisation can unlock additional sources of funding for the EU economy. This would in turn increase the EU economy's ability to accumulate capital, which is a prerequisite for the economy’s development.
Securitisation is an additional tool, which supports normal bank financing
Tools are needed in the EU to make the Juncker Plan work and to be able to attract private money, notably the huge EU and global long-term savings - over €100 billion - which need other financial products to invest in. However, many doubt that SME financing, which many Member States have problems with, will effectively be improved. In addition, some stress that securitisation should not threaten the successful work accomplished by many banks in the countries that appropriately finance SMEs, notably by triggering unfair competition with the unhealthy “originate and distribute” model. Lastly, there will be greater acceptance on the political side only if there is a prospect of securitisation money going back into the real economy.
Securitisation is also a way to broadly distribute and manage risk without endangering financial stability
Securitisation is a valuable funding tool, since it offers a way to not only diversify bank funding, but also to broadly distribute and manage risk, it can liberate and redeploy capital. Furthermore, securitisation brings together issuers and diverse investors seeking various specific risk profiles.
In particular, securitisation can reduce contagion and financial instability since it can withstand the originating bank going bankrupt as no-one can claim the underlying assets except its liability holders. Similarly, the many other service providers involved can go bankrupt since they can be replaced. In addition, securitisation reduces the size of the problem related to a bank defaulting. Conversely, when a bank issues covered bonds and then defaults, its defaults impact everyone in the market, even covered-bond holders.
2. Key challenges
While the US securitisation markets are functioning almost at pre-crisis levels, EU issuance levels are a mere fraction of them
Today, the US securitisation markets have recovered and the CLO, CMBS (Collateralised loan obligation, Commercial Mortgage-Backed Securities) and many of the ABS consumer markets in the US are functioning almost at pre-crisis levels.
In Europe, the market is not totally dormant; there are large segments of the market – RMBS (Residential Mortgage-Backed Securities - UK and Dutch), ABS consumer – where investors are actually investing. However, EU issuance levels are a fraction of what they were pre-crisis. Moreover, many deals are now structured for central bank funding purposes.
The political challenge is to ensure that investors have enough trust and confidence to participate in a securitisation market
Problems of trust in securitisation are currently on the political side, mainly because voters have to be shown that securitisation is not as bad as they were told in the context of the financial crisis. They are now surprised to discover that securitisations issued in the EU suffered very few losses in that period of time and ratings have performed as expected.
The stigma came from instruments that investors should not have invested in, given that some banks offered wrong investments that investors did not really understand. It should also be stressed that in the EU, Spanish banks in particular directly funded the unfortunate expansion of the real estate bubble.
However, there are valuable precedents in Europe, in Australia, etc. to be used as a basis for proving that securitisation contributes to the economy. Last but not least, one specific feature of the EU is that the securitisation market will always be a lend-to-distribute model, as opposed to an originate-to-distribute model.
3. Progress still to be made with regulation
To restore confidence, clear-cut criteria should unequivocally clarify the reliability of securitisation products
The US has come up with a solution that uses public guarantees to restart the market. Europe should not go in that direction, as this is an unsustainable solution in the long run.
The market should be rebuilt on a self-standing basis, although the Juncker Plan can help. Indeed, it is clear that some countries presenting higher economic risk would find it difficult to securitise their loans to SMEs and guarantee schemes should therefore enable investors to erase that part of bond risk, which is linked to specific sovereign economic features.
In such a context, Europe’s approach to rebuilding the market, to overcome this stigma and build trust in these products, is based on the differentiation of simplicity and transparency.
The ECB, the Bank of England, EIOPA, EBA and IOSCO have all worked to construct a market that works and generates trust. However, the challenge at this particular time is to find the right set of criteria. It is not only about calibration, although this is a factor.
The Commission’s initiative to develop an STS framework is fully supported, since every investor must be advised with very clear-cut criteria that provide them with unequivocal understanding of the risk. Yet, when defining high-quality securitisation with STS, there is the risk specific to any “labelling” of financial products, and policymakers should avoid the STS becoming securitised products that replace the former misleading securitisation products from 2006/07.
Lastly, there is a trade-off with precision since if the criteria are too prescriptive, then they are too narrow. The main aspects that must be clarified are the appropriate element of interest, the crucial role of sound underwriting standards, the risk-taking associated with complex structures and the imperfect transfers of risk. The market must be based on criteria that originators and investors are comfortable with.
One challenge is building trust on bank data
The ECB asset quality review highlighted that bank data needed improvements in the EU. There is a challenge everywhere in terms of whether data is accurate and presented in a consistent manner, to feed the process of completing the credit risk assessment of underlying assets. This issue is related to the trust in due diligence and it must be resolved.
Many aspects of financial regulation across assets and financial institutions must be made consistent globally
The relative regulatory treatment of securitisation versus underlying corporate loans would be consistent if the securitisation process doubled or tripled the credit risk involved. Another element is that it is much easier to use a covered bond or to issue senior unsecured bonds, as the results of securitisation for the bank regulatory ratios, such as SCR or leverage, remain the same.
Lastly, the fact that pension funds and insurers are actually taking up 30% of the mortgage market and corporate loans by directly issuing such mortgages and loans does not make sense. It would be more logical if institutional investors simply bought securitisation. Therefore, consistency between financial regulations is an issue.
In this respect, one problem before the crisis was a market that was largely funded by banks, either directly or indirectly. Some were of the opinion that it would be better if the investors in securitisation were not banks. However, this cannot be achieved at the expense of insurance sector inconsistency, since everything should be calibrated at the same explicit confidence level under Solvency II.
The Commission’s proposals must be thoroughly reviewed regarding these aspects. There must be an alignment between risk and capital requirements, whereas capital requirements must by no means be an obstacle preventing this market from working.
Appropriately calibrating financial regulation is challenging
Making the calibration of capital charges proportional to actual risk is crucial.
In this respect, banks and investors regard the current regulatory outcome as disappointing, lamenting different prudential treatments for products with similar risk profiles in the EU and the US.
Policymakers point out that the Commission's STS proposal deals specifically with this issue, aiming to introduce a more risk-sensitive prudential treatment for securitisations. Furthermore, policymakers object that for normal EU populations and politicians, learning from the Americans often means taking risks and warn that to systematically compare markets to each other creates problems, as this triggers a race to the bottom.
Lastly, the priority is to overcome the stigma in order to capture a sufficiently safe market where trust can be rebuilt. This raises many questions regarding appropriate incentives. Does it require rebuilding on a narrower but safer base? Banks and insurers could be offered incentives, but would this be sufficient? Will such a market work?
4. Assessing the probable success of the securitisation market’s relaunch 10 years from now
Since the US and EU economies are very different, the danger is trying to change in a short timeframe. In this context, the success of the political initiative will be signalled by the fact that issuance levels will have increased substantially. Part of the challenge is therefore for the STS criteria to work and to make the market succeed. Success in 10 years’ time would also mean managing to get this money into the real economy and into SMEs.
In addition, there should be no conflict in EU countries, particularly between large banks and smaller ones whenever they finance SMEs. Banks should remain the most important link because they are so close to the SMEs and they are the best rating agencies for rating SMEs.
An obvious success indicator for the securitisation market would also be that more insurance companies are buying securitisation, understanding the risk, the return and the conditions, bearing in mind that this is a market for professional investors. Therefore, in 10 years’ time, securitisation should be used merely as a technique for bundling assets so that the senior tranche, which is supposed to be almost risk-free, should go to the people who know the least about these assets (though it does not exempt people from due diligence), and to long-term money carriers, while the mezzanine should perhaps go to hedge funds or people who appreciate risk and volatility.
A successful development of the securitisation market 10 years from now would also be that the reason why people issue an instrument is no longer its regulatory treatment, but its properties. Second, the next crisis, which inevitably will happen, will have been resolved by the Market Union and the different channels, including securitisation, would have lessened the effects of the crisis.
Lastly, one participant wondered if people would eventually be able to leapfrog and in particular if digitalisation would help develop securitisation, since Alibaba is originating online and then securitising money market funds, while PayPal is doing the same in the United States. Similarly, it is necessary to think about how block-chaining could help make securitisation simpler to trade and how to embed it in the value chain. The issue of digital investors, of whom there are not many, but they constitute a minority, will also need to be dealt with.
5. The regulatory adjustments, which accompany the definition of STS, might not be sufficient to relaunch the moribund EU securitisation market
A representative from a bank stressed that the market is moribund and this is the result of many years of neglect, negative headlines and regulations. The recent new regulation with Basel III also raises a number of questions.
The main concern is about the calibration of capital, based on the principle of non-neutrality. According to this principle, the regulatory capital after securitisation can be many times over the regulatory capital before securitisation. Yet he stressed that these kinds of modelling and agency risks exist in other parts of the regulatory framework where multipliers or other forms of adjustment have been defined. This has to be controlled. The second concern is the maturity adjustment of calibration under Basel III; yet there is no reason to introduce it in the liability side, provided that this adjustment is actually already included on the asset side. The third concern is that capital charges are not risk-sensitive enough, although the EBA has done an enormous amount of work.
According to the bank's representative, the adjustment proposed by the EBA is insufficient for several reasons. It does not factor in that the STS approach has already imposed heavy criteria on underlying assets that effectively eliminate the loss tail of the risk distribution and reduce its volatility. Secondly, STS has established disclosure and enforced retention requirements, which realign interests between investors and issuers. He argued that the bank liquidity ratio eligibility criteria also need to be adjusted for STS securitisations, which should be considered as a useful additional funding tool.
Lastly, he argued that there is a need to restore the level playing field between the various financial instruments, notably regarding the operating requirements for singling out high-quality securitisation. There are also concerns about how STS will be assessed, how self-certification will work, and also whether there will be third-party certification.
However, another participant pointed out that the current regulatory support for securitisation is very positive since people agree on the concept of simple transparent standardised structures, although it is not the full answer.
1. Key political objectives: ensuring that investors have trust and confidence to participate in a securitisation market which funds economic growth.
A public decision maker set the scene by reminding the audience that structuring an effective securitisation market in the EU is a debate that continues to be a critical project. He insisted that an active, vibrant and sustainable securitisation market can have a very important role in funding economic growth.
He stressed in particular that compared with the European economies the US economy is funded significantly, up to almost two-thirds or more, by the markets. He emphasised that there is often some correlation between the ability to accumulate capital and the development of the economy, and that large benefits can be seen in this respect in the US essentially from enlarging the financial market space.
Then he explained that securitisation is therefore at the heart of the market regulators’ work in order to ensure that investors and issuers have enough trust and confidence to participate in a market and fund economic growth.
IOSCO and the BCBS he said, recently published the criteria for simple, transparent and comparable securitisation and are now starting work on the next phase, which is looking at asset-backed commercial paper. They are working with the industry, most importantly, on both but also on standardising documentation for securitisation. Much important work has been done in the official sector in Europe over the last year, he added, in terms of facilitating the way forward. Solvency II requirements have been finalised. The Commission has issued proposals concerning the Capital Markets Union, and the EBA has published its technical advice on qualifying securitisations.
2. The regulatory adjustments, which accompany the definition of STS, might not be sufficient to re launch the moribund EU securitisation market.
By contrast a representative from a bank stressed that investors and broker/dealers are withdrawing and the actual European placed volume is extremely small: in 2015 at best probably 40 billion a year to date and maybe 70 billion for last year. This is a fraction of what this market was prior to the crisis: not 2006/07, when the market went into excess, but 2004/05 when the market actually experienced very sustainable growth.
He explained that the current situation in the European securitisation market is the result of many years of neglect, negative headlines and negative regulations. In this respect he stressed that recently the Basel III’s new regulation has raised a number of questions. The main concern is about the calibration of capital, based on the principle of non-neutrality, which suggests that the regulatory capital after securitisation can be many times over the regulatory capital before securitisation. The reality of the non-neutrality produced by securitising assets has to be controlled because of the risk of having regulatory capital after securitisation four or five times that before securitisation. This kind of modelling risk, an agency risk, exists in other parts of the regulatory framework, and multipliers or other forms of adjustment have been addressed.
The second concern is the maturity adjustment of calibration under Basel III; yet there seems to be no reason to introduce it in the liability side provided that this adjustment is actually already included in the asset side. The end result is very extreme regulatory capital.
capital charges are not risk-sensitive enough
The third concern is that capital charges are not risk-sensitive enough and this needs to be addressed in the context of Europe. EBA did an enormous amount of work, but it did not deviate sufficiently from the Basel approach. Consequently, there was only a small adjustment to the reduction of capital charges devoted to the Simple Transparent and Standard (STS) securitisations.
The adjustment proposed by the EBA is insufficient for several reasons and finally, the regulatory outcome is not where it should be. First, the STS approach has already imposed heavy criteria on underlying assets that effectively eliminate the loss tail of the risk distribution and reduce its potential volatility. Secondly, it established disclosure and enforced retention requirements, which realign the interest between investors and issuers the lack of which had led to some of the excesses in the sub-prime lending and securitisation in the US that have been rightfully denounced by the regulators.
the necessity to restore the level playing field between the various financial instruments
The representative of the private sector concluded by listing the various drivers for effectively restarting the securitisation market.
Firstly, he reminded the audience of the necessity to restore the level playing field between the various financial instruments. In this respect he insisted on the operating requirements for singling out high quality securitisation, which are being proposed in terms of due diligence. He stressed in this respect that investors can invest in private equity or non-rated B-loans from a commercial property funding, without using any due diligence or without proof of due diligence, whereas due diligence for Triple-A securitisation with an effectively zero risk of loss has to be proven. There are issues he said, regarding how STS will be proven and how self-certification will work, also regarding whether there will be third-party certification and finally there is the fact that post-issuance raises the risk of investors being punished eventually for non-compliance for which they are not responsible.
Secondly, he stressed the fact that in a context where capital requirements continue to be very high, a significant effort has still to be made on the occasion of the possible revision of securitisation capital requirement for insurance companies - Solvency II – he insisted there on the fact that what has been proposed by the EBA for banks would not be inappropriate. Regarding bank prudential requirements, he mentioned the bank liquidity ratio eligibility criteria that still need to be adjusted to STS securitisations. He explained that securitisations even short-term ABS papers are currently included in the 2B category i.e. just considered as a useful additional funding tool. He concluded by stressing the fact that beside the requirements for capital, liquidity and due diligence, there are concerns about grandfathering. Many bonds may not meet the new requirements; investors concerned about being captured on the wrong side of the regulation are already selling.
Another participant on the panel expressed the fact that the current regulatory support for securitisation is very positive. Indeed, he said, people agree on the concept of simple transparent standardised structures. Although External Credit Assessment Institutions (ECAIs) might assign Triple-A to structures that might not qualify for that label, it is a way forward. However, he concluded, the devil is in the detail. Many aspects are not yet where they need to be and may still impose obstacles and constraints. Investors’ due diligence remains critical but they cannot be expected to have the responsibility of ensuring compliance with risk retention. That would make products unappealing to many investors. Expanding the STS is helpful but not the full answer and it is important for all to work together to ensure the healthy development of the regulation.
3. The multiple benefits expected from a securitisation market and its specificities in the EU
A representative of a public bank explained that for the Juncker Plan to harvest the huge EU and global long-term savings - over €100 billion - which need other financial products to invest in, the securitisation of project finance and bank loans should be looked at.
A representative of the private sector also depicted the various benefits expected from the re launching of the EU securitisation market. Securitisation is a valuable funding tool, he said, it offers a way to diversify bank funding but also to broadly distribute and manage risk – it can liberate up and redeploy capital. Securitisation brings together issuers and investors seeking specific risk profiles: two very important constituents of the market.
A representative of a public bank stressed however that whereas the corporate bond market in Europe is working very well, what SMEs need most is equity, more than loans, so that this has to be further worked on in Europe.
Another panellist stressed that there are valuable precedents in Europe to be used as a basis for proving that securitisation contributes to the economy. Then, on that basis, its value can be restored and the stigma removed, which came from investing in instruments in which many people should not have invested. Indeed, the EU provides positive examples, which include how securitisation helped German automakers, how KFW provided funding for SMEs, and how the Dutch market operated both with and without guarantees, as did the French market. He finally stressed that in the EU we also know how Spanish banks directly funded the unfortunate expansion of the real estate bubble.
the CLO, CMBS and many of the ABS consumer markets in the US are functioning almost at pre-crisis levels
Another panellist pointed to the fact that now the US securitisation markets have returned and the CLO, CMBS and many of the ABS consumer markets in the US are functioning almost at pre-crisis levels. In Europe the market is not totally dormant; there are large segments of the market – RMBS (UK and Dutch), ABS consumer and recently the CLO market – where investors are actually investing and the markets are functioning almost normally. However, he said issuance levels are a fraction of what they were in a healthy pre-crisis situation, and of what they could and should be. Many deals are just being made for central bank funding purposes.
A specificity of the EU is that the securitisation markets fundamentally will always be a lend-to-distribute model, as opposed to an originate-to-distribute one
A specificity of the EU that he stressed is that the securitisation markets fundamentally will always be a lend-to-distribute model, as opposed to an originate-to-distribute one. In the EU indeed, securitisations have functioned very well he stressed. Even during the economic disturbance that was endured during the crisis, deals were resilient. Ratings have performed as expected and even those that would not have qualified for STS or QS have performed well.
Another bank representative insisted on the importance of the calibration of capital charges and their proportionality to actual risk. He asked: has anyone ever gone to their MEP and said: “We need to have Triple-A CLOs at 62.5% regulatory capital.” People only said: “make the market safe.” There he took the example of Germany where they have one of the most positive securitisation markets. However, it is very difficult to find an outgoing German who presents a balanced view and this is a challenge to face, not as an industry but as a policy maker. He emphasised that it is very strange that the US can have 1% capital for a product that in Europe requires 62% capital. The US can have 0.7% capital for covered bonds, which in Europe in RMBS requires 10.5%.
For EU normal populations and politicians, learning from the Americans, means taking risks
Yet an EU policy maker objected that perhaps in the US they do not need the capital requirements we have here in Europe and perhaps the Americans are right. But he said, in recent years Europe has been learning from them about light capital requirements and insufficient caution, and that they do not always bring the best results. For EU normal populations and politicians, learning from the Americans, means taking risks, which is not allowed in the EU where one must be responsible. Is the American way not too risky? Why is it a more appropriate way to go? Conversely what could Europe tell the people, or the markets? He concluded by warning that it is an issue to systematically compare markets to each other, as this triggers a race to the bottom and the industry does not want this anymore.
4. Two valuable features of securitisation, which positively impact financial stability and should be factored in investor and issuer solvency regulations
Securitisation is merely a technique that has two unique features stemming from the fact that securitisation is like a life capsule.
The first consequence is that a securitisation is totally autonomous and bankruptcy-remote, meaning that no one can claim the assets except its liability holders. It can withstand the originating bank that sold the assets going bankrupt and even many other service providers connected to it can go bankrupt, as they can be replaced.
The second is that investors in the securitisation SPV have no recourse except to its assets, meaning that once the bank has sold and securitised these assets it no longer has any liability for them, unless such assets do not conform to the contracts, representative agreements (reps) or warranties.
These two features foster financial stability. He illustrated this by comparing two banks: one uses only securitisation, the other only covered bonds, both based on exactly the same pool of assets. If the latter bank issues one trillion covered bonds and then defaults, its defaults impact everyone in the market, even covered-bond holders. If the bank using securitisation defaults, nothing will happen to the securitisation holders. Securitisation guarantees additional stability in the financial market, however these features are not taken into account in prudential regulations.
it is securitisation that reduces the size of the problem related to a bank defaulting
Indeed, he insisted that financial markets currently lack supply in the ABS segment because banks have no incentive to use securitisation. It is much easier to use a covered bond or to issue senior unsecured bonds, as the results for the bank regulatory ratios, such as SCR or leverage, remain the same. Yet the risk related to the use of securitisation is very different for investors in the financial industry, or for financial stability. Indeed, through the various bank regulatory proposals such as the Core Tier I ratio, regulators are mainly addressing issues related to the size of banks. But what is the size of the problem if the bank defaults? Rather it is securitisation that reduces the size of the problem related to a bank defaulting. Consequently, the solvency and liquidity ratios of the insurers and treasurers investing in securitisation, or the Banks issuing securitisation should be positively impacted.
5. Improving the contribution of securitisations to the Juncker Plan, requires also defining guarantee mechanisms smoothing underlying sovereign risk discrepancies
Securitisation is an important part of the capital market union. François Villeroy de Galhau has said that it is an important part of the Juncker Plan. Jacques de Larosière stated that SMEs and infrastructures are probably two of the weakest points in the growth strategy of the European Union and that consequently it may be appropriate to give a calibration shock for a couple of years to the capital charges related to those two asset classes.
In such a context a representative from a public bank stressed that one issue that should be addressed is that Member States are very diverse in their financial structure. In bank-oriented countries like Germany, the banks properly finance the SMEs, so there is no need there to change using securitisation. France and the UK are more interested in financing their SMEs through the capital market and Italy falls somewhere in between. That has to be considered when building a Pan-European financial market for SMEs and infrastructure including securitisation.
In particular, European countries show different economic risk profiles. When making a proposal for high quality ABS for SMEs, it is clear that some countries posing higher economic risk would find it difficult to securitise their loans to SMEs, so they would need a specific credit enhancement. Following 2014, in the context of unconventional monetary measures notably involving ABS, Draghi suggested national guarantees to address the variability of sovereign risks.
dedicated guarantee schemes for SMEs and Infrastructure financing, in order to dampen the negative impacts of the economic risk specific to each EU member state
Now a discussion regarding the EU’s competition policy is needed to allow dedicated guarantee schemes for SMEs and Infrastructure financing, in order to dampen the negative impacts of the economic risk specific to each EU member state. Such an approach would enable insurance companies to erase that part of the risk of bonds financing SMEs, which is linked to the sovereign economic specificities, while benefiting however from attractive spreads. In Italy this proposal has been materialised through bonds financing SMEs with a risk equivalent to the Italian sovereign risk - a kind of synthetic BTP (Buoni del Tesoro Poliennali) or Multi Year Bond issued by the Italian Treasury -. It is an interesting proposal which however still needs work, though it is not the most appropriate time to complete it because of the current low level of interest rates and the liquidity poured into the markets. However, an appropriate framework needs to be built by addressing both regulatory and information issues, according to the different jurisdictions so as to get it ready for the take-off of this market.
guarantees are not necessarily a bad thing, if they are well priced
He concluded by stressing the fact that guarantees are not necessarily a bad thing, if they are well priced - they must be market priced - and as long as they do not impact the quality of the information provided by the pipe-lines of projects i.e. the transparency on risk and its pricing.
6. One challenge is to appropriately complete due diligence and restore confidence on the outcome of the assessment of the risk related to securitisation techniques and underlying assets
Investors in Europe have had quite an informative experience with these instruments, so the question that arises is why has trust not come back here as it has in the United States? One of the big learning points from the asset quality review was that bank data is probably not good enough.
No trust in information is a fundamental problem as is the challenge for investors to complete due diligence against very variable data, issue by issue.
During the Eurofi Forum there was an extremely valuable debate on how to create new markets for new instruments and whether those instruments would be marketable securities. The Capital Markets Union debate touched on this first in terms of market liquidity. The second issue was the debate on data; the speaker was of the opinion that currently there is experience coming out of the asset quality review of poor data, and insisted on the fact that there is a challenge everywhere in terms of whether data is accurate and presented in a consistent manner, to feed the process of completing the credit risk assessment of underlying assets.
this is not a market for retail investors, but for professional investors
Another panellist stressed that indeed there are reams of data for the US home equity loan market, which reduce the risk of bank portfolios and through all the eligibility criteria for STS, reduce the risks of the bonds associated with those portfolios. However, he was of the opinion that on the issue of transparency, this is not a market for retail investors, but for professional investors.
In particular, a panellist emphasised that there were few things technically wrong with the structures that went awry in the United States; but it was mainly the underlying credits that misfired. He explained that consequently the issue related to the trust in due diligence must be resolved; there must be debates on capital and how it is treated, the costs of due diligence and how much of the margin that consumes, the responsibility of individuals on the side of both the issuer and the investor.
However, he reminded the audience that addressing these issues may create a divide between investors and issuers. So he proposed they should be productive and narrow that gap, for it to work – which is what the Capital Market Union is about – it should not be about profitability purely for banks, but about matching companies that need money with investors that need opportunities. In the long run it will be good for the wider economy and Europe, which is in a difficult situation.
7. The regulation regarding securitisation must be consistent with the prudential regulations regarding the other assets held by banks and institutional investors
A representative of the public sector stressed the paradoxical situation of the EU securitisation market. He explained that the global securitisation market is the market where financial problems started, where losses were the biggest, and it is also the market that has recovered the most notably in the US. Conversely in Europe, where securitisation was extremely resilient despite the negative news and the regulatory uncertainty, the market is not recovering.
Consequently, he wondered: do American banks have better data quality than European banks? That could be part of the answer, but he was of the opinion that other differences can help to explain the situation.
Relative prudential treatments make a difference, he said.
In the US, a 5-6% leverage ratio gives an incentive for banks to offload securitisations. Having a Basel floor, as the US has, gives higher risk weights to assets and mortgages; then it is easier to offload them from the balance sheet.
the key problem for restarting the European securitisation market, apart from monetary stimulus, is that banks cannot refinance cheaply
Yet the key problem for restarting the European securitisation market, apart from monetary stimulus, is that banks cannot refinance cheaply. The relative regulatory treatment of securitisation versus the one for underlying corporate loans suggests that the process of securitisation is doubling or tripling the risk.
Another element is the existence of the covered bond market by which banks are not decreasing their exposure, and the fact pension funds and insurers are actually taking up 30% of the mortgage market and corporate loans, by directly issuing such mortgages and loans. It does not seem to make sense. It would be more logical if institutional investors simply bought securitisation, as then they would not have to do the underwriting.
The first consultation proposals by the Commission must be thoroughly reviewed regarding the relative regulatory treatment of the securitisation instrument versus corporate loans and versus covered bonds. Creating a sustainable market for the long run requires finding the right calibration that fits the overall framework. The markets hopefully will then recover.
8. Securitisation is an additional financial tool to support normal bank financing
A public decision maker explained that slowly, everywhere in Europe and in the European Parliament, it is becoming clear that tools are needed to make the Juncker Plan work and be able to trigger private money. Consequently, he said that the Capital Markets Union must be combined with the question of how to deal with securitisation in the future, as the main aim of the Juncker Plan is to restore investments in the economy.
people - the voters - are surprised to discover that the securitisation issued in the EU suffered very few losses during the crisis
He stressed however that there are more problems on the political side than on the technical side. Why? First, people – the voters – have to be told that securitisation is not as bad as they were taught within the last decade. They learned during the crisis that securitisation exists and is a very bad thing. Now they are surprised to discover that the securitisation issued in the EU suffered very few losses during the crisis. The political debate has to start three steps beyond that point, he concluded. Politicians will not be courageous enough, or perhaps not informed enough, without the support from the industry to give trustworthy information about what happened in the past, under the securitisation issued in the EU and what might happen and which form it might take in the future.
The Juncker Plan and securitisation will work and be accepted if it is well put together.
He added that many doubt that SMEs will also be included. A lot of member states have problems financing SMEs, but if they are offered a perspective that with securitisation money will go back into the real economy, even in the SME-sized economy, there will be greater acceptance on the political side.
all these things cannot replace the successful work done by the many banks
However, he insisted on the fact that all these things cannot replace the successful work done by the many banks. SMEs in Germany, for example, are mainly financed by the seven public banks and by the co-operative banks. This works quite well, so it is important for these countries to ensure that additional offers also discussed, are not just things that replace normal business. It is important for countries like Germany to have acceptance not only from the banks but also the politicians.
9. To restore confidence clear-cut criteria should enlighten unequivocally the reliability of securitisation products
A public decision maker stressed that it had not been easy for ministers two years ago when they first heard that securitisation could be the first crucial milestone of a Capital Markets Union. Yet they did it because they already thought it was crucial for finding a way to finance SMEs in particular. It is an important part of the Capital Markets Union initiative; it will probably be the first thing to be delivered so it has to be a success, and it is also important for the Juncker Plan.
Every investor must be advised by very clear-cut criteria that provide them with unequivocal understandings
In such a context the Commission’s initiative to develop an STS framework is fully supported, it makes the industry responsible but it could also bring considerable value to the financing of the real economy, as well as for investors, who for example might be offered some returns better than sovereign bonds. First, there needs to be very clear and effective criteria for the STS certification. The main aspects that must be addressed are the appropriate element of interest, the crucial role of sound underwriting standards, the risk-taking associated with complex structures and the imperfect transfers of risk. Every investor must be advised by very clear-cut criteria that provide them with unequivocal understandings: so that they understand it in different interpretations what will not work. For simplicity and transparency, there does not need to be a very long list of criteria and each criterion should be defined in a sentence, or a maximum of say 10 lines.
Second, one reason why the market in Europe has always been very small, except maybe for MBS in the Netherlands, is trust: for politicians, and also for investors. For the market to be successful, raising people’s interest in originating and investing needs to be encouraged. Investors need a compliance mechanism that is sufficiently strong and credible, not only to answer political demands but also to rebuild their trust in such a market. That is important to make it work. The credibility of such a mechanism will be very important. It is well known that France is not in favour of a self-attestation mechanism, not just for political reasons but because it can see that originators and investors are not in favour of it. Even underpinned by a well-written regulation, any market that is based on criteria that no originator and investor is comfortable with will not work. It is very important to address the question of trust. It is not only about calibration, though this is a factor. The industry must help and agreements with the Council, the Parliament and the Commission can be found.
the US came up with a solution that used public guarantees to restart the market. Europe does not have that and should not go in that direction
Another public decision maker insisted on the challenges posed by the necessity to remove the stigma of securitisation products and building a securitisation market on a self-standing basis. The real problem of securitisation products he said is what the impact assessment called the stigma. The stigma came because a number of banks failed because of their investment in securitisation. Depositors and taxpayers remember this very well. Second, they offered the wrong investment, the wrong products; investors did not really understand them. Part of the current effort here is to make both the issuers and the investors bear responsibility again. There has to be a balance between responsibility and making sounder investments. The crisis generated a stigma because uncertainty over the securitisation product itself generates stigma.
Another panellist explained that conversely in Australia, the securitisation market is regarded as fabulous because it brought competition and consumers accredit securitisation as having brought that. It has reduced the spread on mortgages and its availability. It is interesting because Australia had obviously felt the impact but not the stigma because of the country’s reduced level of investment in CDOs before the crisis, etc. The securitisation market performed very well. The record of Australia was based on what it could bring to the consumer. Now, post-crisis, it is a lend-to-distribute model.
Another public decision maker reminded the audience that stigma is why the US came up with a solution that used public guarantees to restart the market. Europe does not have that and should not go in that direction, because it would be stuck with an unsatisfactory solution for a long period. Though the Juncker Plan can help, the market should be rebuilt on a self-standing basis. It is important also to target reviving both short-term and long-term securitisations, as both are needed to help SME financing.
In such a context Europe’s approach to rebuilding the market, to overcome this stigma and build trust in these products, is based on the differentiation of simplicity and transparency. The ECB, the Bank of England, EIOPA, EBA and IOSCO have all worked to construct a market that works and generates trust. That is a basic condition to attract investors. The differentiation requires defining a number of criteria in the process. There are many ways to design it and it is a challenge at this particular time to find the right set of criteria. The criteria themselves must be clear, simple and with sufficient detail to be operational and understandable, but not too general. That is the trade-off with precision; if the criteria are too prescriptive then they are too narrow. One of the difficulties in the negotiations will be providing clear definitions without narrowing the scope too much.
10. Incentivising financial institutions moving away from the stigma on securitisation, may require rebuilding a securitisation market on a narrower but safer base
When it comes to reviving a market there is also the question of possible incentives? Should investors be proposed a number of incentives in order to move away from the stigma even if it requires rebuilding on a narrower but safer base? Banks and insurers could be offered incentives, but would that be sufficient? Will such a market work? The proposals are at the final stage, where the trade-offs and the package should work. It is important to keep in mind that the first element is to overcome the stigma in order to capture a sufficiently safe market where trust can be rebuilt. Then the incentives can be set.
11. Risk must be understood and appropriately priced
A public decision maker explained the specificities of the insurance sector perspective, which impose that the risk is understood and appropriately priced.
The speaker explained that though a number of features and characteristics of certain securitisation products have merits, they raise also a number of concerns and revive stigmas. He explained that for this market to succeed and function smoothly, insurers need to understand the risk. This involves due diligence and the STS definition that was in use two years ago, of the so-called high quality securitisation. He explained notably that securitisation has a number of features that may pose a legal risk, which has to be factored in.
He also insisted on the fact that not only does the risk need to be understood, but also the return on that risk has to be aligned accordingly. One aspect is trust; the other one is appropriate risk reward. Finally, he acknowledged that there must also be an alignment between the risk and the capital requirements, but capital requirements must by no means be an obstacle for this market to work, moreover there should not be artificial regulatory incentives.
The public sector speaker also stressed that in defining high quality securitisation, STS, there is the risk specific to any “labelling” of financial products. Whereas many think that to make sure that the economy grows again the current proportion of something like 20% HQS or STS versus 80% falling outside the category, should be reversed, policy makers should avoid however t STS being the securitised products that will replace the former misleading triple-A of 2006/07 securitisation ones. He then quoted Oscar Wilde who said: “Experience is the name we give to our mistakes.”
The second important thing to get right is the element of cross-sector consistency on which the European Commission is working. It is difficult. Does it come at the cost of insurance sector inconsistency? Under Solvency II, everything is calibrated at the same confidence level, but the banking system does not follow that approach. How can one be aligned with the other without disrupting sectoral consistency?
12. Banks should not be specifically incentivised to invest in the securitisation market
A representative of the public sector examined the fact that pre-crisis, an issue was a market that was largely funded by banks either directly or indirectly, which raises the question of the neutrality of whether it is banks buying securitisation or real money investors. He was of the opinion that it would be better if the investors in securitisation were not banks, as banks would be the least transparent. It would be more significant for a bank-denominated system such as the EU’s, as it would also help the bank itself and it is important for banks because of their regulatory ratios. However, bank investments can help, so there should not be talk of right incentives or proportional calibration.
13. BCBS and IOSCO criteria correspond to what investors need to assess the key risk they face when looking at securitisation
A public decision maker clarified the nature and the source of the criteria, which enable the producing and labelling of STS securitisation products. He explained that according to the criteria of simple, transparent and comparable securitisation, the objective for BCBS and IOSCO has been to develop 14 criteria, based on evidence, that contribute to facilitating investors’ confidence, in particular real money investors. Investors globally were surveyed; one of the biggest issues they want is what Europe is asking for. He said that in a McKinsey study, which was made back in 2007, the answers were the same then. Some 150-200 investors around the world said they wanted simplicity, transparency and comparability.
He explained that the criteria were organised around the key risks that investors face when they are looking at securitisation, based on the experience of market professionals, who know their asset risk, the structural risk, the fiduciary and the service risk which is absolutely key in a securitisation. However, the credit risk of underlying assets was not touched on, he said.
He also mentioned that the BCBS and IOSCO’s approach to date has been modular, and that their thinking has been for industry and for the official sector to decide how the work could be carried forward.
BCBS and IOSCO are looking at how to encourage the standardisation of securitisation documentation
He concluded by explaining that BCBS and IOSCO are now focusing on extending the criteria to asset-backed CP, which has just been approved. He also said that BCBS and IOSCO are also looking at how to encourage the standardisation of securitisation documentation.
Indeed, there has been much talk about standardisation in asset management, he said as to make the markets work it is all about standardisation, whether that is about documentation or data. It is critical to work with industry on these projects.
14. Regulatory consistency is required at both regional and global levels
There must be alignment going forward within Europe, to ensure that paths do not diverge. Consistency, both regionally and globally, is important because a globally consistent market builds more, greater, long-term global liquidity. The EBA’s work on ABCPs will be a very important input into the work on ABCPs. Getting a more standard consistent securitisation market is a great expectation, but one that has never been achieved. Hopefully the industry can get it right this time.
15. Assessing the success of the re launch of the securitisation market
A representative of the public sector explained that in his opinion the success of the securitisation political initiative would be signalled by the fact that issuance increases to a much more significant level, in particular issuance in bottom segments as some segments are already working. He went on however to say that the question is to what extent pre-crisis levels were the right benchmark?
He explained that securitisation is not a single unified market, but in fact composed of many segments. Part of the challenge he said is therefore finding a way to start it, for the STS criteria to work for all and to make the market work. It might work on its own, with disclosure and transparency elements, if it is sufficiently standardised. But to what extent should it be standardised or not? In a fairly diverse market, will reform work?
An EU policy maker explained that success in 10 years’ time would mean managing to get this money into the real economy, via securitisation, and into the SMEs. There would be no conflict regarding this financial process in countries whenever they finance SMEs, no conflict in particular between the large banks on the one side and the small or medium-sized banks on the other which could be the most important links in this game because they are so close to the SMEs. They know them well. They are the best rating agencies for rating SMEs. To bring these two worlds together would be a good thing, and would find proper solutions he said.
He said that solutions must also be found for working with asset-backed commercial paper securitising loans with remaining maturity exceeding the maturity of the ABCP for often more than one year.
A public decision maker insisted on the fact that ten years from now, the obvious success indicator of the securitisation market would be that more insurance companies are buying securitisation, understanding the risk, the return and the conditions. This is a market for professional investors and the stigma comes from investing in products that perhaps they should not have invested in. But it is not the small insurance company that said, “I’m going to buy structure products”, it is that someone came and sold them knowing, in some cases, that the customer was probably not up to the level of the product. That is a good lesson.
The senior tranche that is supposed to be almost risk-free should go to the people who know the least about these assets
A representative of a bank tempered such ambitions saying that in 10 years’ time things would not be upside down. Today insurance companies are buying corporate loans directly; banks are selling first loss capital to insurance companies not for arbitrage purpose but for optimising. This is the financial world turned upside down. In 10 years’ time, securitisation should be used as merely a technique for bundling assets. The senior tranche that is supposed to be almost risk-free should go to the people who know the least about these assets. It does not exempt people from due diligence but it means they do not have to know as much as the person buying the most junior piece. Triple-A should go to the long-term money carriers, who are the insurance companies and pension funds. The mezzanine should perhaps go to hedge funds or people who appreciate risk and volatility. The junior piece should go to people who know the assets well, these are the banks. Indeed, the banks originate those assets, they know the pre-payment, they provide their customers with bank accounts. The bank that holds the current account in which the customer’s salary is paid every month is best placed to know someone’s credit score. The insurance company buying the mortgage loans does not have that view. This why today you have a wrong calibration as you have less capital charge when you buy mortgages than when you buy a Triple-A tranche of the same securitised mortgage: this does not make any sense. Securitisation is merely transformation.
US and EU economies are very different consequently the danger is trying to change in a short time
Another panellist commented on the appropriate pace for changing financing mechanisms in the EU. He stressed in this respect that US and EU economies are very different and that consequently the danger is trying to change in a short time. In the US, after the crisis they securitised most of their SMEs loans very quickly, with guarantees of course. They have a large capital market plus about 5,000 community banks that have been having their loans repaid. It worked well. This is not necessarily the same for all European member states. Similarly research from Standard and Poor’s shows that loans to projects have a better recovery and default rate in the EU than corporate bonds.
A public decision maker was of the opinion that three things will be illustrative of a successful development of the securitisation market 10 years from now. First, the regulatory treatment is not the reason why people issue a covered bond or securitisation, but it is the properties of the instrument. Second, the next crisis, which inevitably will happen, will have been solved by the market union and the different channels, among them securitisation, which have lessened the effects of the crisis. Third, securitisation has a new name.
digitalisation would help develop securitisation
Finally, a public decision maker wondered if people would eventually be able to leapfrog and in this respect if digitalisation would help develop securitisation. Indeed, he said that Alibaba is originating online and then securitising money market funds while Paypal is doing the same in the States, originating online securitising. He also stressed the need to think about how block chaining could help to make securitisation simpler to trade and how to embed it in the value chain. He concluded by stressing the issue of digital investors, of whom there are not many, but they constitute a minority that needs to be dealt with.
By E. Reviglio - Chief Economist, Cassa Depositi e Prestiti (CDP)
By G. Medcraft – Chairman, Australian Securities and Investments Commission and Chairman, International Organization of Securities Commissions (IOSCO)
By E. Lefort - Global Head of Structured Credit Solutions, Natixis
By G. Williams - Partner, Financial Services Regulatory Centre of Excellence, EMA region, KPMG
By P. Simon - MEP & Vice-Chair, Committee on Economic and Monetary Affairs, European Parliament
By M. Heijdra - Deputy Director Financial Markets Directorate, Ministry of Finance, the Netherlands
By K. Frey - Managing Director – EMEA Structured Finance, Moody's Investors Service Ltd.
By C. Montalvo - Executive Director, European Insurance and Occupational Pensions Authority (EIOPA)