The European Union set out its plan for overhauling the securitized debt market, laying down criteria for a class of notes that will merit lower capital charges on holders as part of a broader effort to expand financing sources for companies and spark growth.
The proposed regulations, which amend existing laws governing banks and insurers, cover all aspects of asset-backed debt, from origination to capital charges, supervision and risk retention. The centerpiece is a new class of “simple, transparent and standardized” products eligible for preferential regulatory treatment.
The European ABS market has shrunk almost 50 percent since 2010 amid stiffer capital requirements for holders and investors’ reluctance to buy the securities blamed for the financial crisis. While sales have rallied to 67 billion euros ($75 billion) so far this year from 58 billion euros in the year-earlier period, they remain far short of the 308 billion euros raised by this point in 2006, the busiest year for issuance, according to data compiled by JPMorganChase & Co.
Issuance “is recovering, but I think we feel that in order to give that a further boost is sensible and desirable, not least because of the beneficial effect that it would have on the banks -- freeing up their balance sheets, encouraging them to lend,” Jonathan Hill, the EU’s financial-services chief, told reporters in Brussels. “In many countries, for many businesses, bank financing is going to be the main source of financing for SMEs.”
The commission’s plan says that if Europe’s securitization market returned to pre-crisis average issuance levels, and new issuance was used by banks to provide new loans, this would provide an “additional amount of credit to the private sector ranging between 100 billion euros and 150 billion euros.”
While losses from securitized U.S. subprime debt that banks racked up during the financial crisis gave securitization a bad name, the performance of European transactions was far better, with default rates on top-rated portions of residential mortgage-backed bonds of less than 0.1 percent, according to the commission. In the U.S., the default rate was 16 percent on subprime, 3 percent on prime for the best-rated bonds and as much as 62 percent for weaker credits.
Under the commission’s proposed rules, the originator, sponsor or original lender of a securitization must retain at least 5 percent of the debt, a measure to limit risk-taking by ensuring the interests of buyers and sellers are aligned. While the commission said it considered criticism from the European Banking Authority of deal structures that meet the legal requirements for risk retention without complying with the spirit of the rules, the securitization industry scored a win in the final version.
A previous draft of the rules said originators would be deemed non-compliant if their “primary purpose” was securitization, a factor that deterred investors and stalled sales in the market for collateralized loan obligations. The final document says deals from originators whose “sole purpose” is to securitize assets will not comply.
National authorities will have to submit to binding arbitration if they can’t decide whether to apply the bloc’s new rules for preferential capital treatment to a deal. The aim is to ensure the simplicity criteria retain credibility and to avoid regulatory arbitrage.
While not ruling out admitting securitizations backed by derivatives, known as synthetics, to the new category, the commission said that for the moment the door will remain closed.
The commission renewed its promise to amend the EU insurance-industry law known as Solvency II to align it with the new rules. It also committed to come up with an adapted capital charge for insurers holding the non-senior portions of simple, transparent ABS deals, offering “significant reduction of the capital charge.” It also promised “technical improvements” to calculations of charges on senior tranches.
“The recalibration of regulatory capital charges relating to STS securitizations for banks under the CRR and insurers under Solvency II will also be welcomed, although only time will tell if the new risk weights are sufficient to attract a deep enough pool of investors from these two constituencies,” said George Gooderham, a lawyer at Linklaters LLP.