Penalising securitisation market 'will hit real economy'
by Rick Watson
14 August 2012
The securitisation industry has launched a new label for high quality asset-backed securities, but its effectiveness in helping to solve Europe's funding gap is likely to depend on more positive signals from policy-makers
Europe's future economic prospects lie delicately balanced in the face of the long-running eurozone crisis, yet there is another growing area of concern in need of urgent action – a funding gap.
Recent estimates by Bloomberg and Bank of America Merrill Lynch show that some €650bn of senior unsecured and covered bond funding will mature in 2012 for European banks. For sovereigns, funding of over €900bn will be needed, comprising debt roll-over and the next year's deficit. As the sharp fall in bond issuance seen throughout last year further deepens this funding hole for European banks, it becomes increasingly clear that a healthy securitisation market is critical to plug this funding gap.
However, despite the numerous advantages of securitisation, the European market remains depressed, with issuance placed with third party investors – rather than the European Central Bank or Bank of England – at approximately €90bn each year for 2010 and 2011, as compared with €450bn prior to the crisis.
There are two main reasons for Europe's stagnant securitisation market. Firstly, since the financial crisis, many investors as well as policy-makers perceive all securitisation products to be 'toxic', even though European asset-backed securities have performed very well from a credit standpoint.
For issuances outstanding in mid-2007, the credit performance of securitised European residential mortgages, auto loans, credit cards, consumer loans and small- and medium-sized business loans asset classes was excellent, with a 0.09 per cent cumulative default rate. Moreover, last year, European residential mortgage-backed securities also performed very well from a price standpoint – outperforming all European Union sovereign debt, senior bank debt and most covered bonds.
Secondly, investors have seen a continual stream of new European regulations in recent years and the cumulative effect could easily give the impression that policy-makers are discouraging investment in all securitisations, of any type. These include Basel III, CRA 3, CRD 2, CRD 3, CRD 4, Solvency II and new reporting obligations and national implementing regulations.
Securitisations have been noticeably absent from ECB purchase programmes, and based on current proposals will not be eligible in the Basel III nor CRD 4 liquidity buffers. Unless the European Commission changes its views soon, Solvency II is looking to propose capital charges for European insurers that will make securitisations prohibitively expensive for them to invest in.
Another example of regulatory bias against the securitisation market can be seen with the commission's Solvency II directive which imposes severe capital charges on insurance companies to hold asset-backed securities on their balance sheet. The proposed charges will mean that insurers will be charged approximately 10 times more to hold asset-backed securities than to hold covered bonds or corporate bonds.
Yet the rationale used by the commission to reach these figures is seriously flawed – the methodology focuses mainly on United States subprime mortgages, is not consistently applied across all asset classes and, furthermore, does not differentiate between different types and levels of risk. If the securitisation market continues to be penalised, it is the real economy that will feel the negative effects.
In June 2012, the industry launched the Prime Collateralised Securities initiative, focusing on developing a label for qualifying securitisations, to be granted and maintained by an independent third party. Developed by Association for Financial Markets in Europe and the European Financial Services Round Table, the label aims to revitalise the market by meeting industry best practices in terms of quality, transparency, simplicity, and standardisation, all of which are preconditions to restore secondary market liquidity.
The independent, not-for-profit PCS label is not intended to replace investor due diligence, nor is it a credit rating. It will only be awarded to securitised products that are backed by asset classes that performed well through the financial crisis and which are also of direct relevance to the real economy. Investors and regulators need clear reference points, setting out best practices around which to build investment guidelines and regulations, which in turn, will encourage issuance and investment and ultimately support Europe's recovery.
It is essential for the industry to have the support of Europe's policy-makers as capital markets undergo regulatory reform at unprecedented levels. It is time that the highest quality forms of securitisation be considered to also receive the same benefits as other types of capital market investments.
This means a more accurate calibration is needed for Solvency II – one which reflects price volatility for high quality securitisation, not US subprime and collateralised debt obligation squared, and takes account of reform of EU and US regulation as well as new and better market practices.
The actual experience of European securitisation demonstrates that a properly regulated and transparent securitisation market is a critical component in a stable, competitive and responsive banking system, which in turn, fuels the real economy. Europe needs this market to get back on its feet, now more than ever.
Rick Watson is head of capital markets at the Association for Financial Markets in Europe
Europe's future economic prospects lie delicately balanced in the face of the long-running eurozone crisis, yet there is another growing area of concern in need of urgent action – a funding gap.
Recent estimates by Bloomberg and Bank of America Merrill Lynch show that some €650bn of senior unsecured and covered bond funding will mature in 2012 for European banks. For sovereigns, funding of over €900bn will be needed, comprising debt roll-over and the next year's deficit. As the sharp fall in bond issuance seen throughout last year further deepens this funding hole for European banks, it becomes increasingly clear that a healthy securitisation market is critical to plug this funding gap.
However, despite the numerous advantages of securitisation, the European market remains depressed, with issuance placed with third party investors – rather than the European Central Bank or Bank of England – at approximately €90bn each year for 2010 and 2011, as compared with €450bn prior to the crisis.
There are two main reasons for Europe's stagnant securitisation market. Firstly, since the financial crisis, many investors as well as policy-makers perceive all securitisation products to be 'toxic', even though European asset-backed securities have performed very well from a credit standpoint.
For issuances outstanding in mid-2007, the credit performance of securitised European residential mortgages, auto loans, credit cards, consumer loans and small- and medium-sized business loans asset classes was excellent, with a 0.09 per cent cumulative default rate. Moreover, last year, European residential mortgage-backed securities also performed very well from a price standpoint – outperforming all European Union sovereign debt, senior bank debt and most covered bonds.
Secondly, investors have seen a continual stream of new European regulations in recent years and the cumulative effect could easily give the impression that policy-makers are discouraging investment in all securitisations, of any type. These include Basel III, CRA 3, CRD 2, CRD 3, CRD 4, Solvency II and new reporting obligations and national implementing regulations.
Securitisations have been noticeably absent from ECB purchase programmes, and based on current proposals will not be eligible in the Basel III nor CRD 4 liquidity buffers. Unless the European Commission changes its views soon, Solvency II is looking to propose capital charges for European insurers that will make securitisations prohibitively expensive for them to invest in.
Another example of regulatory bias against the securitisation market can be seen with the commission's Solvency II directive which imposes severe capital charges on insurance companies to hold asset-backed securities on their balance sheet. The proposed charges will mean that insurers will be charged approximately 10 times more to hold asset-backed securities than to hold covered bonds or corporate bonds.
Yet the rationale used by the commission to reach these figures is seriously flawed – the methodology focuses mainly on United States subprime mortgages, is not consistently applied across all asset classes and, furthermore, does not differentiate between different types and levels of risk. If the securitisation market continues to be penalised, it is the real economy that will feel the negative effects.
In June 2012, the industry launched the Prime Collateralised Securities initiative, focusing on developing a label for qualifying securitisations, to be granted and maintained by an independent third party. Developed by Association for Financial Markets in Europe and the European Financial Services Round Table, the label aims to revitalise the market by meeting industry best practices in terms of quality, transparency, simplicity, and standardisation, all of which are preconditions to restore secondary market liquidity.
The independent, not-for-profit PCS label is not intended to replace investor due diligence, nor is it a credit rating. It will only be awarded to securitised products that are backed by asset classes that performed well through the financial crisis and which are also of direct relevance to the real economy. Investors and regulators need clear reference points, setting out best practices around which to build investment guidelines and regulations, which in turn, will encourage issuance and investment and ultimately support Europe's recovery.
It is essential for the industry to have the support of Europe's policy-makers as capital markets undergo regulatory reform at unprecedented levels. It is time that the highest quality forms of securitisation be considered to also receive the same benefits as other types of capital market investments.
This means a more accurate calibration is needed for Solvency II – one which reflects price volatility for high quality securitisation, not US subprime and collateralised debt obligation squared, and takes account of reform of EU and US regulation as well as new and better market practices.
The actual experience of European securitisation demonstrates that a properly regulated and transparent securitisation market is a critical component in a stable, competitive and responsive banking system, which in turn, fuels the real economy. Europe needs this market to get back on its feet, now more than ever.
Rick Watson is head of capital markets at the Association for Financial Markets in Europe
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