The European Union’s biggest banks and insurers said regulators must deliver big on lowering capital rules if their effort to revive the bloc’s battered asset-backed debt market is to succeed.
“The punitive requirements simply make securitization uneconomical for banks and insurers versus alternatives,” said David Covey, head of European ABS strategy at Nomura Holdings Inc. in London. “It’s the case for both securitization investors and issuers.”
The Basel Committee on Banking Supervision adopted tougher capital rules on bundled securities in December that must be implemented by nations to take effect. In the EU, this falls to the European Commission, which said Basel’s rules would raise capital charges for even the highest-rated securities and needed work.
As part of Europe’s push to stimulate the asset-backed debt market, led by the European Central Bank, the commission has drafted plans to lighten regulation of products that meet planned standards of transparency and simplicity. The industry has until May 13 to respond to the commission’s consultation paper.
The European market for ABS was brought close to extinction in the financial crisis of 2008, which was fueled in part by banks taking heavy losses on securitized subprime mortgage debt. It has been slow to recover, even after the ECB began purchasing the securities last year.
While first-quarter European ABS issuance was the highest in almost four years at 23.5 billion euros ($25 billion), the market still contracted, according to JPMorgan Chase & Co. The volume of outstanding notes held with investors fell to 420.8 billion euros at the end of March, down from 433.2 billion euros in the fourth quarter and 496.9 billion in the first three months of 2014.
“The markets for high-quality securitization should play a key role” in Europe’s efforts to boost market financing of businesses, according to Andreas Dombret, a board member of Germany’s Bundesbank.
“As it is relatively difficult for small enterprises to place issues in capital markets, securitizing loans may provide one alternative way to diversify their funding,” Dombret said in an article prepared for a conference in Riga, Latvia.
Also, banks could use ABS to “partly offload SME credit risks and transfer them to investors who are willing and able to bear those risks,” he said.
When the Basel committee, which brings together regulators from 30 countries, published its updated rules late last year, it said they “significantly increased” capital requirements compared with pre-crisis standards. The measures include a floor that limits how low banks’ assessments of the risks they’re running -- and thus their capital requirements -- can go.
“The capital requirements for banks and insurance companies are not right,” said Richard Hopkin, head of fixed income at the Association for Financial Markets in Europe, which represents the region’s largest lenders. “If this market is to recover, then those capital requirements do desperately need to be adjusted.”
The Basel committee said it may adapt its rules for ABS that are deemed to be “simple, transparent and comparable,” criteria it is developing in tandem with the International Organization of Securities Commissions.
Similarly, many of the ideas in the commission’s consultation paper, published in February, center on identifying a class of “simple, transparent and standardized” products that would have reduced capital requirements. The EU has been the main driver of efforts to establish such criteria at the global level.
“We’re looking at how we could set up a framework for an EU market that singles out a category of hyper-transparent, simple, and standardized products with an appropriate regulatory treatment,” Jonathan Hill, the member of the European Commission responsible for financial services policy, said in a speech in London on April 17.
The “drive for a high-quality ABS label is a positive development and is helping, along with the support from the ECB and Bank of England, to reduce the stigma associated with the products,” Felix Blomenkamp, the head of Pacific Investment Management Co.’s European ABS team, said in an interview.
EU regulators already took steps last year to ease treatment of asset-backed debt as part of legislation known as Solvency II, trimming planned capital standards for insurers, key investors in the market. Yet much more must be done to have an appreciable impact, according to the industry.
Industry complaints include that the rules for issuers and investors are set too high both in relation to the credit risk of the underlying assets, and in relation to the treatment of covered bonds, another type of asset-backed debt.
“Insurers face capital charges on senior AAA mortgage-backed securities that are often three times the capital charges on the loans themselves, even though the loans are far more risky,” Covey said. “Banks face capital charges on AAA securitizations that are twice as high as those of similarly-rated covered bonds.”
Financial firms say that the combined effect of the bank and insurance capital rules is to clog up the creation and sale of new asset-backed debt.
The capital requirements matter for banks because they hold on to parts of the ABS they originate. This arises through a combination of legal risk-retention requirements and practical considerations around securing a high credit rating for senior ABS tranches.
On top of this, issuing banks face the further challenge that investors’ capital requirements lead them to demand higher returns.
“Higher returns for investors mean higher costs for issuers,” Covey said. “Right now there is a significant gap between the spread level at which investors wish to buy and issuers wish to sell.”
As regulators work on the criteria for determining which ABS should benefit from preferential treatment, the financial industry is warning that a significant part of the market needs to qualify if the step is to have any impact.
“If policy makers get this wrong, the revitalization of the ABS market will take much longer and it will be a marginalized product,” said Tracy Chen, a money manager at Brandywine Global Investment Management in Philadelphia, who manages a fund that invests in European asset-backed debt.