EC lending plans could resurrect securitisation market
EC economic investment plans could revive securitisation
The European Commission has introduced new rules designed to encourage investment and trigger liquidity – including the use of “high quality” securitisation. The move has been welcomed cautiously by experts, despite the controversial role of securitisation in the financial crisis.
Under the Solvency II Directive and the Liquidity Coverage Ratio delegated acts it has just adopted, the Commission argues “securitisation can constitute an important funding instrument for the economy” and adds that securitisations positions will be eligible for “more proportionate” and “risk sensitive” prudential treatment for banks, as long as they meet certain criteria set out in the acts. At the same time, it acknowledges that the practice was closely linked to the financial crisis, as complex and poorly understood low-quality assets fuelled the crash.
In response, some observers have warned that history should not be allowed to repeat itself, and have put forward ideas to the Commission on how best to rebuild the European securitisation market. “In the years after 2004 there was a deterioration in the quality of assets,” said Patricia Jackson, head of financial regulatory advice at EY (formerly Ernst & Young). “Participants offset the falling quality by using multiple tranches and passing them on, in a system that concealed the true nature of these subprime assets. If we are going to rebuild trust, we must ensure that this does not happen again.”
Jackson added that in the period in the run up to the crisis, the assets in question were becoming less scrutinised, leading to an increase in the risk of fraud. “We need to get the market going again for lending, but I feel the lessons of the crisis haven’t been learned,” she said. “Nobody has really taken a look at what we need to do to fix it. I recommended there should be a minimum level of tranches – perhaps two or three at most – to control the quality of assets going into the pool. I also think they should be traded on-exchange, so that the liquidity can be seen clearly.”
The Commission has not yet defined high quality securitisation, but it is expected to bring out its final proposals next year. The EC also emphasised that its proposals would be “differentiated” – a phrase that appears to be aimed at quenching fears among European investors that the two trillion dollar securitisation market that collapsed in the US might simply be revived.
“Look at the attention the regulators have placed on derivatives,” said Jackson. “There has been huge attention on that market, and yet derivatives were not the root cause of the crisis in the way that securitisation was. A quarter to a third of bank losses during the crisis were linked to securitisation, so the market and the regulators really need to go back and learn the lessons.”
Back in November, the International Organisation of Securities Commissions set out 10 recommendations on securitisation, to restore confidence in the practice as a useful alternative source of funding for the banking sector. The IOSCO recommendations include aligning incentives of investors and securitisers, including mandating retention of risk in securitisation products where appropriate; clarity over the party on which obligations are imposed and risk retention; greater transparency and standardisation; standardised asset level templates and more disclosure to assist investors in making decisions.
Lack of transparency over securitised instruments was a key element in the financial crisis. Securitised products were often based on of high-risk, poor-quality mortgages that were issued to consumers who lacked the means to pay back their debts. The securitised products were passed around between market participants and investors, who were often unaware of the high risk due to the complicated and non-transparent nature of the products.
