Europe’s ABS Market Boost Hinges on Inducing Insurers to BuyJohn Glover and Alastair Marsh
Europe’s push to promote asset-backed securities hinges on persuading insurers to buy the debt by easing capital requirements, investors and analysts said.
European Union and global regulators recently proposed criteria for identifying simple and transparent securitizations that could qualify for preferential regulatory treatment. While the EU insurance law known as Solvency II already offers capital relief for “high-quality” securitizations, investors say it’s not enough.
It’s now up to Jonathan Hill, the EU’s financial-services policy chief, to decide how far to lower capital charges on simple and transparent asset-backed debt. He has promised an “action plan” for next month, followed by “a comprehensive package on securitization with updated calibrations for Solvency II” and bank-capital rules.
Until Solvency II capital requirements are addressed, “I doubt whether we will ever see a revival of the ABS market, as ABS will be off-limits to a large portion of the investor base,” said Ruben Van Leeuwen, an analyst at Rabobank Nederland in Utrecht. “That will be the game changer.”
A lot is riding on the attempt to breathe life into Europe’s market for asset-backed debt. Hill’s goal is to free up capital and encourage banks to boost lending, especially to small companies, as part of a drive to spur economic growth.
Insurers, directly and though asset managers, make up about a third of the investor base, with the rest split about evenly between banks and asset managers, said Gareth Davies, head of asset-backed securities research at JPMorgan Chase & Co. in London. So attracting them into the market is crucial.
“Solvency II is a major hurdle given the larger role played by insurers in the investor base than a quick read of the stats often suggests,” Davies said. “It’s very conservative in terms of capital charges and that’s holding back a lot of potential investors.”
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 European Central Bank began purchasing the securities last year.
Issuance was 216 billion euros ($237 billion) last year, down from a peak of 819 billion euros in 2008, according to Association for Financial Markets in Europe data, which include bonds sold to investors as well as those retained by banks to use a collateral for central bank funding.
The market is currently shrinking as banks have access to cheap funds from the ECB and redemptions outpace new deals. Net issuance in the first half was negative 28 billion euros, taking the total outstanding in the market to 528 billion euros, according to Morgan Stanley.
“The authorities mustn’t forget you can’t rebuild an investor base if there are no issues to buy,” said Rob Ford at TwentyFour Asset Management in London. “And if they keep capital charges where they are, yields aren’t going to fall to a place where it’s economic to issue.”
The Basel Committee on Banking Supervision set tougher capital rules on asset-backed debt in December. In advice issued last month, the European Banking Authority said the capital charges foreseen by Basel, scheduled to take effect in January 2018, should be lowered for less risky products.
The EBA recommended cutting the capital charge lenders face on securitizations that qualify as simple, standard and transparent by an average of 25 percent.
The Basel group, which brings together regulators from nations including the U.S., U.K. and China, followed with its own criteria for simple ABS and held out the possibility of lower capital requirements.
“The softening of capital rules that’s proposed doesn’t go far enough,” said Srikanth Sankaran, head of European credit and asset-backed securities strategy at Morgan Stanley in London.
The charges proposed for senior bonds of U.K. and Dutch residential mortgage-backed securities, “among the most risk-remote ABS out there, are still too high,” he said. “They will in fact be double what they are now.”
Solvency II divides securitizations into two types with differing capital charges.
Capital requirements on the senior portion of a “high-quality” product that meets simplicity, transparency and credit-quality criteria are capped at the level they would be for an insurer holding the collateral directly.
Charges on riskier deals can be an “order of magnitude” higher than on the underlying assets, a result Rob Marshall, head of ABS and financials credit research at M&G Investments in London, calls “perverse.”
The list of approved underlying assets excludes commercial mortgages, those secured by loans for the factories, offices and shops used by small and medium-sized companies -- the same companies for which the commission is trying to help ease funding.
Hill is aware of the need to bring insurers into the market. It remains to be seen if the high-quality criteria will help him achieve his goal.
“Capital rules have been one of the biggest hindrances for the ABS market, so while the latest signals from regulators point in the right direction, a lot of investors are still very cautious,” said Annemieke Coldeweijer, head of securitized investments at NN Investment Partners in The Hague, Netherlands. “If capital charges are lowered that will change activity for some investors and will see others look at the market again having previously pulled away.”