Commission’s securitisation proposal is out

Today, the European Commission published its proposals on securitisation within the Capital Markets Union project.

Based on an earlier draft leaked by the Financial Times, there was much to commend the Commission’s approach, some items to keep an eye on and some issues which were serious enough to have the potential to derail the chances of market recovery altogether.

First, the Commission should be commended for a number of very positive aspects: (a) there is a definition of simple, transparent and standardised (STS) securitisation to be used to bifurcate the regulatory outcomes for this financing channel as a whole; (b) the STS definition focuses on elements of structural integrity rather than on the credit quality of the securitisation or the underlying assets; (c) the STS definition is intended to be used across the regulatory framework so that all types of investors and issuers will be able to work on a single definition and (d) the definition, based on the EBA’s work, is complex (57 criteria by our count) but fundamentally correct and workable.  For all this, we must be grateful for the Commission’s work.

The items that will need an eye kept on them are: (a) many of the 57 criteria remain extremely vague and will need substantial clarification – a process that could either improve or damage the ultimate workability of the scheme; (b) no new calibrations for Solvency II are currently being proposed and whether the proposal can revive the market remains dependent in large measure on where those numbers finally come out and (c) how the scheme would work for third country issuers remains unclear.

Finally there are five items that could endanger the workability of the whole project and call into question its capacity to revive European securitisation

First, the nature of the required attestation could be very problematic for many issuers.  The principle of issuer attestation and the fact that failures in attestation should be actionable is good and uncontested; however, we can see issuers being willing to attest to what they know or control, in other words, the individual 57 components of the STS definition.  But the leaked proposal required the issuers to attest to the conformity of their issuance with the STS rule.  The complexity of the definition means it must be subject to regulatory interpretation.  We anticipate that many issuers will have difficulty attesting to what they are not and cannot be privy to, namely the future interpretation of regulators.

Secondly, the rejection of a formal role for independent third party certification agents in favour of self-attestation and individual investor due diligence.  This was a solution rejected in the consultation response unanimously by every investor and investor association, most banking federations and many public sector bodies.  The absence of a “common language” provided by a real master list and the requirement of repetitive, costly and inefficient mechanical due diligence – as distinguished from credit due diligence which will be performed by investors – is very likely to stop most potential new investors from coming to the market and drive many of the remaining ones out.

Thirdly, the choice to leave the administration of the scheme with a multiplicity of national regulators is problematic.  That national regulators remain in charge of administering the scheme is not problematic but, if they are responsible for interpreting the 57 criteria, then the likelihood that a single STS definition survives across the European Union is very low indeed.  As interpretations drift, it will leave a nationally fragmented market – which is precisely what CMU was seeking to overcome.

Fourthly, the maturity limitations and the unnecessary public disclosure requirements set out of ABCP conduits are likely to close down most of that market.

Fifthly, the EBA proposals for bank calibrations in the CRR context – and particularly the vast non-neutrality factor left in the proposals – are difficult to justify and will drive a key investor class away from securiitisation.

These are the five key issues which we will be paying attention to when reading the just released paper.