EU’s ABS Market Revamp Must Tackle Moral Hazard, Lawmaker Says

The European Union’s plan to revive the asset-backed securities market must contain “crystal-clear” disclosure rules to prevent investors from taking on excessive risk and avoid moral hazard, according to Paul Tang, a Dutch lawmaker in the European Parliament.

“Sharing risks should normally contribute to financial stability as long as the risk-taker understands the risks and there is prudential supervision to avoid excessive concentration of risk,” Tang, the assembly’s lead lawmaker on the ABS initiative, wrote in a May 19 report.

Tang proposed a public register for “essential information of securitizations and which investor holds which position,” providing an “important safeguard whenever the market would come under stress in the future,” he wrote.

Jonathan Hill, the EU’s financial-services chief, presented the asset-backed debt plan in September in a bid to deliver as much as 150 billion euros ($168 billion) of new lending and diversify funding sources for companies traditionally reliant on banks. By bundling assets and selling them on as securities, banks can free up balance-sheet capacity to offer new loans to companies, according to the plan.

EU member states reached a negotiating position late last year on the bill, which would create a new class of “simple, transparent and standardized” products qualifying for preferential capital treatment. Once the European Parliament settles on its own stance, talks will begin on a final draft of the legislation.

To gain the benefits of securitization, “important lessons from the financial crisis have to be learnt, important lessons concerning asymmetry of information and moral hazard,” Tang wrote. “These problems will not be solved by the market on itself and need to be dealt with in the STS framework.”

Asymmetric information can occur when issuers know “much more about the security itself,” the “credit quality of the underlying loans, the profile of the credit receivers and the relative quality of the different tranches,” Tang wrote. This can then lead to problems of moral hazard.

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