Securitisation: upgrade essential, but ‘moribund’





April 6, 2017

Is the EU’s policy to bring into effect legislation on securitisation central to the EU’s slow moving economic growth? Few would fail to support the EU’s new Securitisation Regulation in principle, but abrasively polarised positions on how it should pan out have already delayed its expected implementation. And the deadlock is in danger of dragging on.

By Jeremy Woolfe

In summary, there are three contrasting viewpoints on the procedure which is intended to boost credit and growth at a time when bank lending is constrained. The three start with the Commission’s determined priority to kick development into the EU’s economy, for obvious social and political motives. Then, there is the argument that any new legislation has to be disaster-proof, even at the cost of delay. And, finally, as the financial sector argues just as justifiably, that over-tight rules which actually put a brake on the intended investment are untenable.

Overall, the evident head-on clashes of positions have emerged at the time when the Commission’s proposal for its regulation inches through “trialogue“. These meetings bring the European Parliament and national governments together with the Commission.

They started in January, but at a pace, according to one critic, that is “glacial”. One highly qualified bystander even tells GRR that the planned set of rules is a “dead duck on a train to nowhere”.

Currently, confrontation is centring on whether to accept most of the European Commission’s proposal, as done back in autumn 2015, or rather to favour a range of what some would think of as aggressive amendments since brought in by the European Parliament.

Tang defends stance

Here, one of the most striking commentaries comes from Paul Tang MEP himself, the European Parliament’s relevant ‘rapporteur’ in its Economic and Monetary Control Committee (ECON). He is the member responsible for nursing into implementation a final version of the EU’s new Securitisation Regulation, as proposed by the European Commission.

While clearly a supporter of the basic theme, the centre-leftist Dutch MEP also defends a stiffening of the rules ranging over risk retention, transparency and others. He also pours derision on the criticism of not proceeding with urgency against claims of consequential hindrance to unblocking a massive flow of investments into the EU’s economy.

Stark disagreement is clearly reflected in comments from the side of the European People’s Party (EPP) centre-right political party in Parliament.  Othmar Karas, the ‘shadow’ rapporteur, tells GRR: « We want to restore trust in the European market for securitisation and ensure that this financial instrument becomes a secure vehicle for the financing of our real economy.

« However, if you were to build a car that has seven safety belts, eight airbags and can only drive a maximum of five kilometres per hour, nobody would buy it. During the ongoing legislative process, we have to ensure that this does not happen to securitisation. We need more security, transparency and an instrument that remains attractive and applicable at the same time. »

Challenged on the atmosphere of rancour, the Commission remains calm. It repeats that its proposal (of one and a half years ago) was designed to turbo-charge simple, transparent and standardised securitisation (STS) securitisations in the EU. “We believe that our proposal is balanced and based on solid analysis and consultation, » it adds.

In fact, the Commission also lauds the development of the rules as « key part of the [Capital Markets Union] project » in order to promote « a real effect on investment, jobs and growth ».

In its recent public consultation on its CMU mid-term review, it writes that: « Soundly structured, securitisation is an important channel for diversifying funding sources and enabling a broader distribution of risk by allowing banks to transfer the risk of some exposures to other banks or long-term investors such as insurance companies and asset managers. »

Emphasising the vital nature of its position, it describes the need on the grounds that existing securitisation markets are “seriously impaired”. It calls for a “rapid implementation” of the securitisation package to pave the way for a revival of the market.

« We look forward to these discussions wrapping up as rapidly as possible, » it writes. It argues for swift implementation of the package, as this « has the potential of freeing up €100bn of additional funding to the real economy ».

Similarly, Commission vice-president Valdis Dombrovskis, responsible for the CMU, has warned against delay, because “every month there is news of issuers reducing their presence in this market. This means less funding for European companies — just when we need it to strengthen Europe’s recovery.”

Here, precise figures from the Association for Financial Markets in Europe (AFME), reveal issuance in Europe to be “low”. Full year figures for 2016 that show that out of a total of €237.6bn issued, only €96.4bn was actually placed with third party investors. The remainder was retained for use in repo schemes at central banks, namely the European Central Bank (ECB).

AFME describes the European securitisation market as remaining “moribund”. It blames “regulatory costs for holding securitisation paper as several times higher than other similarly-rated products”. This is leading to participants continuing to leave the market.

Richard Hopkin, AFME’s head of fixed income, states: « While no silver bullet, securitisation can undoubtedly help fuel economic growth thereby benefiting SMEs… [It ] also meets the needs of important institutional investors, such as insurance companies and pension funds. »

Quality over speed

However, in response to the Commission’s cries for urgency, Mr Tang calls for prioritising quality of legislation over haste. This is typical of many-a-parliamentary-rapporteur, when, over the years, he/she finds him/herself in similar circumstances.

In an interview with GRR, Mr Tang sets out his case that there are “good reasons for any delays” in what is an “important, but technical topic”.

« At present the need is to find a balance between effective market securitisation products… We need a deep and good market that [will survive not only] in good times but also in bad times. » Summing up, he describes the regulation as merely something that the banks would like to see at some time in the future.

In addition, he goes on to bolster his view on any need to hurry. “Even if [the Regulation] came into implementation immediately the effect on investment would be very little.” His justification? “Because there is plenty of cheap money available.”

Also, during the interview, he disputes that in the real world, « Finance is not the issue [for economic growth as long as] the current ECB policy [remains] effective. Provided that it does not taper off, I do not think that delay to the securitisation regulation is an issue ».

On another question, which implies that the €100bn of investment into European Fund for Strategic Investments (EFSI) was being held back until implementation of the legislation, he describes the estimate from the Commission as something that « they just make up. I don’t take it seriously. »  It is merely “the usual story line on finance and its link with jobs and growth”.

So why is large-scale investment funding still not moving? « That diverts from the theme of securitisation, » claims Mr Tang.

Apart from delay, hot topic in the cross-hairs of contention, is the subject of risk ‘retention’, or ‘skin-in-the-game’. This safety factor sets the rate for how much an issuer of a securitised package has to hold on to, as a guarantee of propriety. And with risk retention, comes ‘tranching’.

The latter defines the repackaging of loans in a securitised package divided into different categories of risk. As stated in a text from the Council of the EU, each category can be tailored to the risk/reward appetite of investors.

On retention, the draft report adopted by the ECON Committee makes a distinction between the horizontal first loss retention (5%) and the vertical retention modalities (10%).

An information document from the committee has added that the European Systemic Risk Board (ESRB) or the European Banking Authority (EBA) should be mandated to be able to increase the rate to 20% « in light of market circumstances ».

Still on the retention subject, Mr Tang argues that not differentiating different risk categories is « not a good thing ». He says here should be a differentiation between risk retention modalities, because they have different skin-in-the game-effects. He stresses the need for legislation that will prove itself « in bad times as well as good ».

He is clearly commenting on the Commission’s original version of its legislation, which stuck at the simple and preceding rate of 5%, as banks would prefer. « You get some oddities. Do you think that the European Parliament should not discuss this?…That is why the European Parliament is looking at the matter much more deeply [than the Commission did]. »

Transparency issues

The MEP also brings up another field of dispute. It is that both the Parliament and the Commission are targeting the importance of transparency. He advocates European Securities and Markets Authority (ESMA) authorising and supervising data repositories, which could also be done via the existing initiatives like the European Data Warehouse. In contrast, the Council of the EU, representing member state governments, would like supervision to be done on a national basis. With due logic, Mr Tang disagrees.

Answering his previously given statement that, despite ECB’s support, investment in the EU remains low, comes in an explanation from the AFME. Perhaps significantly, the association identifies barriers to investment and job creation as problems faced by « risk finance providers ». Examples here would be business angels and venture capital funds, feeding into high-growth businesses.

AFME’s capital markets manager, Cédric Pacheco, also infers that the trans-border hurdles faced by risk funds could also be behind the EU’s low R&D spend, currently around 2% of EU GDP. The fault here, he finds, could be due to various factors, such as differences in national standards or language barriers, but also, notably, to fragmented legislation, including national tax incentives.

Mr Pacheco cites the fact that the average venture capital investment into a company in the EU is only €1.3m. This compares with a €6.4m equivalent in the US.

There is some good news on the venture capital scene. The ECON committee has recently cleared a proposal made by the Commission last summer. That was for amendments to the European Venture Capital Funds (EuVECA) and the European Social Entrepreneurship Funds (EuSEF) regulations.

Returning to the Securitisation Regulation itself, the aim remains the elusive squaring of the circle. That means the achievement of a practical compromise between the different parties. Mr Tang forecasts that there will be several more trialogue meetings to come.

To clear through the Brussels legislative machinery, the Regulation will require a « qualified majority » vote by the Council, that is, with 16 out of the 28 member states in approval. Target date for completion of that process is “mid-year” 2017. To follow will be publication in the Official Journal, and implementation, hoped for by Q3.