Schizophrenic regulators killing securitization
Regulators must speed up their efforts to rehabilitate the securitization market – one of the best routes to revive lending activity in Europe – or risk killing it. But, at best, regulators are sending mixed signals.
The regulatory search for financial stability will have gone too far if it chokes the securitization market, which exists in an inhospitable environment, warns Richard Hopkin, who leads the securitization division at the Association for Financial Markets in Europe.
It is not only poorly calibrated regulation that is stifling the market, but exceptionally loose monetary policy, which encourages banks to finance themselves cheaply elsewhere, he says.
The debate surrounding the regulation of securitization has come a long way in the past 12 months. “There has been a sea-change in the rhetoric at the higher, policymaker level,” says Ian Bell, head of the PCS Secretariat. “It feels like we have broadly won the battle for hearts and minds at the highest levels.”
In Europe, for example, a green paper by the European Commission explicitly acknowledges the role securitization has to play in boosting economic growth. It states that the market can “help unlock additional sources of long-term finance,” where it is “subject to appropriate oversight and data transparency”.
Yet the rhetoric disguises a disconnect between senior policymakers and the technocrats they tasked with revising the rules for securitization some years ago. The rules being proposed seem to correspond with the instructions they were given some years ago, when policymakers were blaming securitization for causing the crisis, says Bell.
If the technical regulatory rules continue down the proposed lines, demand might disappear altogether and kill the market, he warns. Banks are discouraged from investing via Basel capital charges and the liquidity coverage ratio (LCR), and insurance companies cannot invest because of Solvency II. The market could be left so thin it is no longer viable, says Bell.
Adding to a lack of vertical coherence in regulatory thinking is horizontal inconsistency – between different policymakers at a global, regional and national level – regarding rules for securitization, says Hopkin. The net effect is to create uncertainty about what rules the industry in Europe will ultimately be governed by.
Part of the problem is that, in their efforts to reverse engineer the new rules away from the reliance on the rating agencies that was embedded in Basel II, the proposals have become excessively complicated, says Neil Hamilton, partner at law firm Paul Hastings.
“It doesn’t help the market,” he adds. “Every time they remove an anomaly they end up replacing it with another one.”
“The real lesson of the crisis is that securitization cannot be analyzed only, or even primarily, on a quantitative basis, there has to be a qualitative assessment as well, factoring in things like transparency and simplicity,” says Bell. “But most of the Basel proposals seem to ignore this lesson completely.”
The communication on capital was especially disappointing. Its calculations took a seemingly random set of assumptions that do not properly reflect the reality of the business, says Bell.
For example, it assumes all securitized products are composed of pools of B assets, instead of the higher-quality assets the vast majority of securitizations contain. Consequently, rather than reducing the capital requirement to be set against high-quality securitizations, in line with actual performance, it raised it.
“It sometimes looks like the authors had a preconceived idea of the conclusions they wanted to draw, and chose their assumptions to ensure they arrived there,” says Bell.
On the LCR, liquid assets that must be held by a bank to fund itself for a month if for some reason they had no access to the markets, there was some better news.
Residential mortgage-backed securities (RMBS) are eligible to be held as a highly liquid asset, with caveats: the loan-to-value ratio must be under 80%, which disqualifies most Dutch RMBS. It must be at least AA, which disqualifies southern European issues. And it must be full recourse, which means US paper is typically ineligible.
That leaves only UK and Australian RMBS of the large markets – a limited pool of assets from which to choose.
“This does not look like a principled approach – this looks like a bad case of horse trading,” says Bell. “Why would you exclude Dutch RMBS when it has performed so well throughout the crisis? Why would you only consider mortgages and not car loans, for example, which is also a very liquid asset class? And why would you allow AA- issues for covered bonds, but only AA for RMBS?”
The different treatment of securitization versus covered bonds is particularly instructive, suggesting regulators are driven not by the underlying economics of a product but by reputation and politics.
“There is no economic justification for the regulation of the two to be as different as it is,” says Paul Hastings’ Hamilton.
Officially, this is the Basel Committee’s final word on the LCR, although the market is hopeful the strength of feeling on the matter will force it to revisit the issue in due course.
These are not the only ways in which Basel is undermining high-quality securitization. Proposed rules for initial and variation margin for non-centrally cleared derivatives also create problems for SPVs, which do not have the spare cash to post collateral. If that is not resolved, it could make it impossible for SPVs to operate, says Hopkin.
The securitization market is now on life support, adds Hopkin, with placed issuance last year at €72.2 billion in Europe, down from €88.3 billion the previous year. “The market is fragile.”
Yet the industry remains confident. “Basel is like a tanker,” says Hamilton. “It takes a long time to turn it around.” But investors will be resilient. He concludes: “We will see demand increase gradually, even if regulation is not making it easy to invest right now.”