An invitation for feedback from the FSB (...no, not that one)
Europe’s Financial Stability Board published, on August 30th, an invitation for feedback on the effects of G20 financial regulatory reforms on securitisation . This is a precursor to a report the FSB intends to write on the topic by mid-2024 and on the draft of which they have committed to consult.
With a tight deadline for submission of 22nd September, it is not clear what European securitisation stakeholders will be able to provide. The three week deadline leaves no time for the gathering of meaningful data beyond what is already on stakeholders’ shelves or the articulation of complex argumentation additional to what has already been communicated to policymakers.
The FSB has not provided any specific questions and has stated that this is not in preparation for any technical policy or regulatory proposals. So it is a very open canvas on which respondents will need to decide what they want to paint. Some may wonder whether there is much, if any, point in responding.
This invitation should not be ignored though, in PCS’ opinion. Next year will see a new European Parliament and a new European Commission. These will require a sense of priorities and a direction of travel across the policy spectrum. Reports such as the one the FSB intends to publish are part of the creation of the agenda for the 2024-2029 term. Even if it does not put forward specific policy recommendations, it will contribute to setting the "mood music" on securitisation in the European Union for the coming years.
ESMA publishes an updated securitisation Q&A
It would appear policy makers and regulators are clearing their decks before departing for their summer holidays and the welcoming beach. After the publication on Monday of the retention RTS by the Commission and the publication of the near final draft of the UK securitisation statutory instrument by HMT on Wednesday, it is now the turn of ESMA. The European securities regulator has just published an updated set of securitisation Q&As.
Unsurprisingly, in view of their remit, these deal primarily with disclosure and templates. Helpfully, ESMA has highlighted additions and amendments. Market participants can now add this to their beach reading as they while away the pre-cocktail hours.
PCS responds to the EBA consultation on STS synthetic guidelines and the Commission issues final RTS on retention
Two for one on news today.
First, PCS filed its response to the EBA's consultation on the draft guidelines for synthetic/on-balance-sheet STS securitisations. As we approach the final implementation of the Basel III rules, the issue of capital management has loomed ever larger for many European banks. The increase in synthetic/on-balance-sheet securitisations reflects this trend. Going forward, the creation of a large and successful STS synthetic securitisation segment is likely to be a key element of the future development of the European banking system. This is why this seemingly exceedingly technical and dry consultation is, in reality, of great importance. The stark binary nature of STS - you either fully meet all the criteria or you fail - gives disproportionate importance to every nuance of the rules. Globally, the EBA proposals are sensible but we do point out some aspects of the proposal that we think could benefit from some fine tuning.
Secondly, the European Commission, yesterday, published the RTS on retention. This does not quite make it law, as the European Parliament and Council have three months to object, should they wish to do so. However, taking into account the technical natured of this RTS, this does not appear likely. If no objections are raised, the RTS will become law twenty days after it is published in the Official Journal, in the weeks following the end of the three months.
EBA publishes the RTS on “synthetic excess spread” achieving a sensible and balanced approach
Following their consultation last August the EBA has just published the final draft regulatory technical standard (“RTS”) on the capital treatment of synthetic excess spread.
Although a seemingly exceedingly dry and technical subject, the impact of this paper on the European banking industry should not be underestimated. In the last few years, synthetic securitisations have become a key capital management tool for an increasing number of European banks. Without such a tool, the risk of the exiguity of bank capital, in the near future, constraining the credit available to European borrowers was substantial. The regulatory treatment of synthetic excess spread was likely to play a key part in the availability of this tool, especially for asset classes with higher default rates but higher yields.
PCS has yet to read with care the entire RTS, but our preliminary take is that the EBA has allowed a derogation from capitalisation for synthetic excess spread that is the lesser of the actual cash excess spread generated from the securitised assets and one-year expected loss.
This is a sensible result for which the EBA should be commended. First, PCS has always accepted that synthetic excess spread can be abused to provide disguised credit support. Therefore, capitalisation of excess spread at some level has always been a legitimate prudential requirement. But if the excess spread contracted in the synthetic securitisation is less than or equal to the excess cash generated by the assets, there can be no disguised credit support since the issuer is only providing the investor with the benefit of cash it actually receives. It is an uncontroversial fact that banks need not allocate capital against revenue.
The RTS also provides for a cap on the amount of synthetic excess spread that can benefit from the derogation equal to one-year's expected loss. This reflects the STS criterion and thus avoids what could otherwise have been a perverse result of tilting the field in favour of non-STS securitisations.
Finally, the RTS allows grandfathering of existing trades, avoiding an unnecessary dislocation in the banking sector's capital management.
So, by exempting synthetic excess spread below actual cash received from capitalisation (up to one year expected loss) but capitalising anything above, the EBA has provided, in our opinion, the right balance between meeting legitimate prudential principles and not unduly punishing equally legitimate uses of actual excess spread. In our estimation this sophisticated and grounded approach should allow synthetic issuance to grow whilst avoiding the possibility of abuse.
EBA publishes consultation paper on Guidelines on the STS criteria for on-balance-sheet (synthetic) securitisation
EU Green Bond Standard getting close
This week the European Parliament, European Council and European Commission reached an agreement on a text for the European Union Green Bond Standard. This much anticipated piece of legislation will create a statutory standard for EU green bonds.
As those in the securitisation community following these issues know, there was some controversy early on as to how to define "green securitisations" - particularly around whether a green securitisation ought to be a securitisation of green assets or, like other green bonds, a securitisation whose proceeds would be used for EU taxonomy compliant financings. There was also a subsidiary, if connected, discussion as to whether securitisations even had a place in the EU GBS or should have their own separate regime.
Although the text of the EU GBS compromise is not public, indications are that the final agreement may well incorporate securitisation within the new standard and do so on the basis of proceeds rather than assets. Should this be the case, it would mark a very positive step towards allowing securitisation fully to play its role in the transition of the European economy to a sustainable basis.
One that we suspect passed most of you by is a call for papers by CEBRA, the Central Bank Research Association, to be discussed at their annual meeting in New York this July. As many as 37 topics will be discussed, but we spotted this one, organised by Europe’s Financial Stability Board:
19*. “Effects of Financial Reforms on Securitisation Markets”
With a deadline of March 10th 2023 (!) for submission of papers, it is unlikely that CEBRA will be deluged. But the fact that the FSB chose to organise this session is not uninteresting, taking into account all the discussions that have taken place in Brussels and around Europe’s capitals on the role of regulation in suppressing the European securitisation market.
Busy Week for the EBA - Homogeneity(Final draft) RTS and Green Lending
Last week was a busy week for the EBA when it comes to items of importance to securitisations.
First, the EBA published a final draft RTS on homogeneity for synthetic securitisations.
In PCS’ view, this is a thoughtful and altogether excellent proposal.
First, it leaves unchanged the division for corporate loans between SMEs and larger corporates but without an artificial line being drawn between the two. On the contrary, the EBA makes it clear that the dividing line should lie where it is drawn by the bank’s own underwriting procedures (and therefore as approved by their prudential regulator. as part of the latter’s overall oversight functions). This approach is to be commended as it preserves the legislative intent by avoiding artificial and arbitrary definitions of homogeneity. It therefore favours true homogeneity over simplistic binary formulas.
Secondly, and in line with an approach prioritising true homogeneity over artificial definitions, the EBA has taken the opportunity of recognising in auto loans and credit cards that some loans to micro-SMEs are really identical in underwriting and servicing to loans to individuals and can therefore be treated as a single category.
Finally, the draft RTS provides fair grandfathering provisions for all types of STS securitisations (including synthetic transactions) that avoid punishing unfairly transactions which meet the spirit of the homogeneity rules but might otherwise have been caught out by the technical details of the new text.
All in all, the EBA’s proposal balances the spirit of the legislation and a practical real world approach to the matter of homogeneity.
The RTS now goes for approval by the European Commission.
Also of note, the EBA has launched an industry survey to receive input from credit institutions on their green loans and mortgages as well as market practices related to these loans. Responses are due by April 7th. Although not technically a securitisation matter, the outcome of this survey will, in due course, feed into the framework for green securitisations issued under the forthcoming EU Green Bond Standard legislation and the securitisation community should therefore not stay on the sidelines of this discussion.
Joint-Committee of the ESAs response to the Commission is published - expected disappointment has materialised
Today, the Joint-Committee of the ESAs (grouping the EBA, EIOPA and ESMA) has published the long awaited response to the European Commission's Call for Advice on a possible reform of the securitisation capital calibrations under CRR and Solvency II. The response comes in two reports: one for banking and one for insurance. These can be found here and here.
As they have just been published, we have yet to read the full conclusions. But the EBA announcement page gives some indication as to the proposals (or lack thereof) contained in the documents.
For the CRR, the EBA has proposed to lower the floor for senior tranches of some STS securitisations from 10% to 7%. Crucially, they do not appear to have taken the opportunity to propose any changes to the infamous p factor. The p factor is the number used in the CRR to account for "agency risk" in securitisations. As PCS has pointed out numerous times, the entire STS regime is designed to eliminate agency risk in securitisations. PCS is not aware of a single securitisation specific agency risk that is not accounted for in the STS criteria.
Unfortunately, the rejection of any amendment to the p factor is not only a missed opportunity to align STS securitisation's capital requirement to the actual risks. It also negates, in the medium term, any value to the proposed lowering of the floor. From January 2025, the introduction of output floors in the final implementation of the Basel III rules will, without change to the p factor, wipe out any benefit from the lower floor.
The EBA also did not take the opportunity to make meaningful changes to the Liquidity Coverage Ratio eligibility criteria. This is notwithstanding the increasing amount of evidence as to the liquidity of high quality securitisations such as this quantitative analysis by Risk Control. (It does seem to propose fixing a problem with ratings limits though, although PCS needs to read the proposal with care to gauge its import).
As for Solvency II, EIOPA proposes nothing. Based on the announcement - but without having read the full report - EIOPA assets that, since the original introduction of STS in Solvency II did not lead insurance companies to buy STS securitisations there is no value to the regime. We would suggest an alternative conclusion: since the introduction of the STS regime in Solvency II was accompanied by grossly excessive capital requirements, it gave no incentive whatsoever for insurance companies to purchase high quality securitisations. It was not the introduction of the STS regime that led to the absence of insurance investors but the failure to see through the STS reform to its logical conclusion by the introduction of the correct and appropriate capital requirements.
PCS continues to be puzzled by the assertion that the Solvency II calibrations are fit for purpose when the capital requirements for an illiquid pool of whole mortgages remains lower than the capital required to purchase a highly liquid AAA rated senior tranche of a securitisation benefiting from substantive credit enhancement of the same pool of mortgages.
PCS hopes that careful reading of the two reports may yield better news but we are not optimistic.
Stakeholders' letter to European policy makers: "Securitisation cannot play its vital role for the European economy without reform"
PCS has added its name to a securitisation market stakeholders' letter to European policy makers.
In addition to PCS, the letter is co-signed by AFME representing wholesale markets, the European Banking Federation representing the banking sector, Leaseurope representing the leasing sector, Eurofinas representing consumer lenders, IACPM representing credit portfolio managers as well as the DSA, Europlace and TSI respectively representing market participants based in The Netherlands, France and Germany.
The letter comes back to themes that those who follow PCS have often seen us write about. The importance of a safe but deep securitisation market for the health and growth of the European real economy, the increased urgency of fixing that market in the face of the green challenge and the need to complete the welcome reforms started with the passage of the Securitisation Regulation especially in respect of the CRR calibrations, the Solvency II calibrations and the disclosure regime.
Considering the breadth of representation encompassed by the signatories - in addition to PCS' own independent voice - we hope the letter will be taken to heart by policy makers.