When Yves Mersch, member of the executive board of the ECB, sat down after delivering a speech to an industry gathering in the City of London on Monday, one of his final comments still hung in the air: “If the ECB and the Bank of England (BoE) were to put forward a joint statement on this issue [securitization] at the forthcoming IMF spring meetings, it would underline the European determination to decisively move forward.”
After a swift query from the audience as to whether this meant the ECB and the BoE actually were going to make such a statement, he added: “I would not be surprised if we have such a statement at the spring meeting. Our analysis is quite similar and we believe that there are important elements where we have to work together.”
Euromoney understands that the ECB and BoE will recommend that the capital treatment for high-quality securitizations should be at Basel II levels. They released a paper outlining the thinking behind their joint approach on April 11.
This revelation was just the latest example of the regulatory thaw in which securitization is now basking.
“The last five months we have seen a sea change in the attitude of policymakers across the board when it comes to securitization,” says Ian Bell, head of the PCS Secretariat – an independent organization that seeks to define and promote standards of best practice in the asset-backed market – in London.
“By the end of last year there was a new consensus that you can do securitization well, you can do it without risk and that securitization is essential in avoiding a Japan-like slide in Europe.”
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| Yves Mersch, member of the executive board of the European Central Bank |
He says the significance of Mersch’s comments is that they refer to the IMF. “Yves Mersch has gone one step beyond what was said before,” Bell tells Euromoney. “He is signifying the globalization of this position by taking it to the IMF. He is now putting the Basel Committee on notice that Europe cares about securitization.” The ECB has long been a champion of ABS in general and its recent reincarnation as a font of liquidity for SME companies in Europe.
It has argued forcefully against the capital charges applied to ABS instruments. “ABS come in many shades and colours, and can have many different risk profiles,” Mersch said in his Monday speech. “It is clear to everyone that the ECB feels that EU ABS are being treated inappropriately by present regulations and proposals.
“The securitization capital framework is currently being overhauled at the international level, with proposals being calibrated largely on a single pool of data that does not reflect differences in standards across the world, does not reflect the structural differences across ABS deals and does not reflect the vastly different default performance of SME ABS at the European and global level.”
In late March the EC announced two measures to promote securitization as part of its long-term financing action plan: the identification of high-quality securitization, which would attract preferential regulatory treatment, and the development of global standards on risk retention, high-quality securitization and transparency.
This follows on from the European Insurance and Occupational Pensions Authority’s (EIOPA) December announcement on the design and calibration of long-term investments, which advised different risk charges for higher- and lower-risk securitizations: 4.3% for low risk – a widely circulated private paper now recommends lowering this to 2.1% – and 12.5% for riskier ABS.
Mersch argues that central bank ABS eligibility criteria would form a useful starting point in identifying high-quality ABS that are determined using a common risk tolerance threshold, are widely accepted by market participants and are set without conflicts of interest.
“The approach recently developed by EIOPA, and partly inspired by the Eurosystem eligibility framework, has many merits, not least being relatively simple, while managing to exclude many particularly risky ABSs,” he says.
The PCS Secretariat has long argued that the bifurcation of the market into “good” and “bad” deals is the means by which its reputation can be restored and splitting high-quality assets from the rest of the market is a means by which the regulators can be persuaded to afford them preferential treatment, particularly as liquidity eligible assets.
“We have been in discussions with the ECB and we would hope that the regulatory line would be drawn at PCS-minus,” says the PCS Secretariat’s Bell.
This would mean that any investor buying a security with the PCS kitemark would know that it was automatically eligible to be treated as a high-quality asset for regulatory purposes.
“The emphasis on ‘high-quality’ securitizations represents a path to more rational ABS capital treatment across investor types, as opposed to just insurers,” says David Covey, head of European ABS strategy at Nomura in London, adding: “The EC’s focus on securitization seems broader than just SME ABS, which was the focus of the 2013 green paper. We see both as positive developments.”
There certainly seems to have been a gear shift in the past year away from encouraging securitization purely as a means by which finance can be targeted to SME corporates to the realization that this market can only really be revitalized if it is encouraged within the asset class for which it is most suited: mortgages.
“Securitization offers the opportunity to find a way out of the massive bank deleveraging needed in Europe,” says Bell. “We need to lighten the capital load.
“The debate around SME ABS is changing. Recent statements by the Banque de France have been very interesting in their encouragement of RMBS issuance for capital relief purposes in order to create headroom for banks to lend. This has given legitimacy to the argument that securitization should be encouraged in the mortgage market too.”
While all these developments are clearly positive for the industry, there is still a long way to go before ABS can be the engine of credit that the regulators finally realize that it can be.
“It is important to make any definition of ‘high quality’ flexible enough to include a range of securitization types, but firm enough to have teeth,” Nomura’s Covey points out, warning: “The European securitization revival the EC, ECB and investors would like to see is far from imminent.”
