Welcome to this special end-of-year edition of the STS Newsletter by PCS, keeping stakeholders up to date about market and regulatory developments in the world of STS.
In this edition we do not follow the usual pattern of our Newsletter but will instead look back at the year 2020, assess the current state of play and look towards 2021.
As ever, we very much welcome any feedback on this Newsletter.
There can be no doubt that 2020 was the year of COVID-19 and the pandemic weighed, directly and indirectly, on all aspects of our lives. STS securitisation was no exception. We look at STS numbers generally and by asset-class and jurisdiction and attempt to draw out the big picture and emerging trends. We also look at our predictions for 2021.
Please note that, differently from most year-end commentaries, we have focused on number of deals rather than volume of issuance. The reason for this is not that numbers have a greater explanatory power than volume but rather that they have a different and complementary explanatory power. Many research firms and other commentators provide the volume numbers and it seemed of limited value to just do the same. But by focusing on numbers PCS hopes to shed not a better light but a different light on 2020. An example of this difference in perspective would be Dutch RMBS, where the volume decreases were driven by the (temporary?) withdrawal from the market of the largest issuers by volume. However, when one looks at the numbers, one sees an increase in smaller transactions by smaller platform players. That is the type of development that can be missed if one solely looks at the volumes. Also, a small number of very large transactions can distort the picture. A week ago, for example, ING issued a € 14bn retained RMBS out of its Spanish branch. This alone will add massively to the 2020 issuance.
(All numbers are as of 6th December 2020 and so comparisons with 2019 are not exactly on the same basis. PCS only expects 4 to 5 additional STS deals by year end though).
|ESMA listed STS transaction||143||273||416||90%|
The sample of figures above confirms the overall picture. In both the UK and the Netherlands, a large part of the issuance is usually from traditional banks and most often in RMBS. In 2020, one of the two largest Dutch issuers (Obvion) stayed away from the markets post-COVID and the other (Aegon) stayed away in 2020 altogether. (Also, some smaller regular issuers like Argenta and EDML were missing in the public market.) Similarly, in the UK there was almost no post-COVID issuance from traditional bank and building society RMBS issuers. In Germany though, where auto-captives play a larger role and have built their business models around securitisation, declines were more modest. In the Netherlands though, the volume decline is more stark than the numbers since the large deals from traditional banks have been replaced in part by smaller deals from new platform entrants such as MeDirect.
Predicting markets at the best of times is somewhat of a foolish endeavour. Today, with uncertainty over a global pandemic hanging over everything, it is truly quixotic. Yet, predictions are a traditional part of the holiday season, like Christmas trees, presents and over-eating. So here we go …
PCS continues to believe that the most important driver of subdued issuance remains the competition from central bank free money. Without any special knowledge, we assume that the current consensus view that the vaccines will be rolled out to a sufficient level to put restrictions on economic activity behind us by April/May is correct. However, central bank – and particularly the ECB still bearing the scars of its premature tightening in 2011 – are exceedingly unlikely to change monetary policy before well into 2022. A research house we recently spoke to, believed that no central bank tightening will occur until 2024.
So, based on our conversations with market participants and our own transaction pipeline, we see current ongoing volumes of issuance remaining steady for the first half of 2021. Once economic activity returns post-vaccine an acceleration of lending to consumers will, on the one hand, fill up warehouse facilities faster and, on the other hand, lead traditional lenders to want to dip their toes back in the water. But the free central bank money will still cast its baneful influence on issuance volumes. So, we expect some growth in the second half of 2021 but nothing spectacular.
One aspect that could add to issuance though is the growing interest by banks in deconsolidating securitisations. These are securitisations that allow the originator to free regulatory capital under the Capital Requirements Regulation. After their almost complete disappearance in the last two decades, such transactions are starting to re-appear with the looming threat of Basel III. Free money from central banks does nothing for your capital requirements and so this type of STS transaction should not suffer from it.
Taking capital relief deals and greater funding needs in 2H21 together, PCS expects the STS term market to grow a little over 2020, by about 15%.
The trajectory of ABCP STS notifications is harder to ascertain, since, as we have indicated above, most of these new STS notifications are not new deals and so the decision to amend them to STS or not involves more complex and also more private considerations over which it is harder to obtain visibility. PCS suspects that ABCP notifications might run at roughly the same rate as in 2020 before dipping in 2022 when all the existing low hanging fruit have been picked and STS ABCP will have come mostly from new transactions.
None of this takes any account of any possible STS synthetic market, as to which, we invite you to read our synthetics article below.
In the STS Regulation passed in 2017, European legislators explicitly closed the door to STS synthetic securitisations. Yet, they also signaled that if the door was closed, it was not locked and instructed the European Commission to bring to the Parliament a project for incorporating such securitisations into the STS regime. Following a report commissioned by them from the EBA and published in May of this year, the Commission prepared some draft legislation which was presented to the European Parliament and European Council for expedited treatment. As this Newsletter is published, the draft legislation that would allow synthetic securitisations to become STS is being negotiated between the Commission, the Parliament and the Council and there is a decent chance that a political agreement could be reached before year end. In turn this would see synthetics become eligible for STS status already in Q1.
Upcoming reforms in the calculations for mandatory regulatory capital for banks (Basel III and additional European elements) and the impact of the leverage ratio is likely to put great pressure on European financial institutions to raise substantial new capital in, what were even before COVID-19, difficult conditions.
Therefore, tools that allow banks to manage their capital requirements by legitimately removing risk from their balance sheet have become a key element of the future of banking in Europe. Synthetic securitisations are one such tool.
But they suffer from a problem resulting from the anomalous and often logically inconsistent regulatory treatment of securitisations. A bank has a pool of assets. Those assets require capital to be allocated against them. To reduce that capital, the bank will “insure”, via a synthetic securitisation, some of the risk of that pool. This transferred risk may well be the risk for which 100% of the regulatory capital is required. But, after transferring some of the risk, the senior part of the risk that is not transferred is now treated as a securitisation AND the same risk in securitised form is treated much more severely than in its raw state. The result is that the capital usually required by that senior part of the risk AFTER all the real risk has been insured is often no less (and in some cases even greater) than the capital required before the bank removed that risk.
Allowing synthetic securitisations to be STS is a way to mitigate this absurdity. It will do this by allowing senior risk in retained synthetic STS form to attract the lower STS capital required by the CRR.
Will it work ?
Although the Commission could have done this by creating a new synthetic standard with benefits similar to those that exist for true sale securitisations for investors, they chose to follow the EBA’s lead and limit any benefits solely to the originator holding the senior tranche for capital reasons. In other words, the proposed law can only benefit banks seeking to manage their capital requirements.
PCS sees two problems with this approach. First, it is a missed opportunity to create a new investor standard that could have been the seed of a new class of tradeable securities. This would have improved the prospects of the European Capital Markets Union (“CMU”). Policy makers focused more on fixing the mistakes of the past than on building the future.
Secondly, although policy makers opted to limit the scope of the legislation solely to originators holding the senior piece, they then added provisions which, in fact, go against the interests of the same originators and make it more difficult to execute this type of securitisations. This would have made sense if they were creating an investor standard but they chose not to do this. A good example of this are the discussions around cash collateral and how it should be taken away from the originator in yet to be settled circumstances. In this, the proposed law seems to be working at cross-purposes.
Another potential problem is the issue of synthetic excess spread, where sensible EBA proposals appear to have become somewhat of a political football and where we cannot exclude a fairly bad result.
It seems probable that some political deal will be struck this year or early next year. This would, in theory, see STS synthetics become available early in 2021. A question mark though will be how the synthetic excess spread and cash collateral debates end up. In particular, and especially for the former, it is possible that the can will be kicked down the road by devolving the final decision to an EBA drafted regulatory technical standard. Depending on when that standard is passed and the level of uncertainty as to where the EBA will come out, it is possible that some or many banks will postpone doing STS transactions. This is hard to predict though. The delay in the passing of the “homogeneity” RTS for true sale securitisations did not thwart issuance in early 2019. But that was also because the market had a fair sense of where the EBA would come out on the issue.
PCS did a lengthy piece on this which can be found here.
Summary: there will be no synthetic STS securisations in the UK unless the UK government passes legislation to that effect. The chances of this are fairly small at this juncture.
Barring extraordinary developments – which in 2020 can never be entirely discounted – the UK will truly exit the European Union on 31st December 2020, at midnight Brussels time.
So where has the tortuous exit process, at times pure slapstick comedy, at times horrifying road to Golgotha, left securitisation and STS in particular?
First, one must recognize that whatever final deal is struck over fish and chocolate, for the finance industry, Brexit was always going to be a “hard Brexit”. Many clear-eyed observers have long considered that the UK’s request to protect the City of London by covering broad swathes of the financial industry with “equivalence regimes” was not so much optimistic as what American sports aficionados call a “Hail Mary”. For reasons unconnected to Brexit, EU policy makers have, over the last few years, become very wary of “equivalences” in financial regulation. For them to grant extensive equivalences to the City of London would have required them to overcome that skepticism. Such a reversal, in turn, would have called on an immense amount of political goodwill. The type of political goodwill that the UK government, seemingly wedded to triumphalist declarations, not so much squandered as drenched in kerosene and set alight.
Securitisation was no different. Despite some concessions from the UK, the STS regime will basically suffer a total fracture running down the Channel.
This article summarises the position of STS securitisation in the new year. For those wanting to delve deeper in the arcana, we also provide the links to the relevant texts – in red highlights.
On the UK side, the legislative rules that regulate Brexit are set out in a UK Act of Parliament: the European Union (Withdrawal Agreement) Act 2020. Under this act, Her Majesty’s Government can pass statutory instruments to regulate diverse parts of the UK legislative landscape in the implementation of Brexit. Such an instrument was passed to amend the EU securitisation regulation: the Securitisation (Amendment) (EU Exit) Regulations 2019. This is our key document and will be referred to as the “UK REG”.
The main purpose of the UK REG is to onshore the STS Regulation. In other words, the UK REG makes all the logically necessary changes to jurisdictional clauses.
So, “EU” in the STS Regulation is replaced by “UK”, “ESMA” by “FCA”, “EBA” by either “FCA” or “PRA”, references to specific EU legislation by their new UK replacements and so on.
In this Newsletter, we will not highlight one of the members of the PCS team as usual but mention some things you probably did not know about the Outreach and Analytical team at PCS :