EBA publishes consultation on synthetic excess spread

The European Banking Authority has just launched a consultation on the treatment of "synthetic excess spread" or "SES".

The issue of the capital treatment of synthetic excess spread in the context of synthetic STS securitisation is a topic that is as arcane as it is important.

We will not review here the arguments and possible approaches as this would take way more space that is appropriate for a news item.  To summarise, though, in a synthetic securitisation the originator and the investor can agree to an amount which will be deducted from any losses suffered on the securitised pool before the investor is required to make a protection payment.  This is designed to replicate synthetically the effect of "excess spread" in a cash deal, where a lender does not suffer real cash losses if the interest paid on performing assets is sufficient to compensate for losses on the defaulting assets.  Since this amount is just an agreed number (rather than, as in a cash deal, the actual cash received from borrowers) it is called "synthetic excess spread".

Synthetic excess spread is controversial and viewed with suspicion by regulators as it can, in theory, be used to generate regulatory arbitrage.

During the passage of the amendment to the Securitisation Regulation that ushered in synthetic STS, some voices were raised advocating the banning of any use of SES in STS synthetic transactions.  Many, including PCS, argued that this was unnecessary and illogical since the device, properly deployed, only replicated synthetically a totally uncontroversial aspect of true sale securitisation.  The compromise chosen by the legislators was to allow it but impose a capital cost on its use.  We expressed the view at the time that this was the wrong answer and that a perfectly good answer had been suggested by the EBA itself in its original report which we were happy to endorse.  But there we are.

Having chosen the solution of a capital cost for the SES, the legislators then left it to the EBA to come up with an amount.  This consultation, deadline 14 October, solicits the market's views on the proposed EBA approach to calculating that amount.  PCS will, of course, be responding.

EBA publishes consultation on updated homogeneity

The European Banking Authority has just launched a consultation on the homogeneity of the underlying exposures in STS securitisation.

The consultation is addressing the issue of the homogeneity in the context of synthetic STS securitisation. Although the scope is extended to also cover on-balance-sheet (synthetic) securitisations, at the same time it establishes the same criteria for the assessment of homogeneity for all securitisations.

More specifically, given the relevance of corporate and SME loans in the context of synthetic securitisations, adjustments have been made to the type of obligor to reflect the current market practices and the credit risk assessment approaches applied to those asset types.

At the same time the in the proposal, we see that similar changes are made to the respective homogeneity factor for all relevant asset types. The proposal further specifies the asset type for credit facilities provided to enterprises, where similar underwriting standards are applied as for individuals.

This consultation, deadline 28 October, solicits the market's views on the proposed EBA approach.  PCS will, of course, be responding.

PCS files its response to EIOPA’s consultation

PCS filed its response to EIOPA’s disappointing consultation on a possible reform of the capital requirements for insurance companies investing in securitisations.

The response may be found here.

The consultation was, in our view, a major disappointment. EIOPA’s preliminary conclusions – underlined by their statements at a public roundtable attended by PCS – were that the current framework was “fit for purpose”.

For all the reasons set out in our response, PCS feels that this is not borne out by the facts and that the assertion itself as set out in EIOPA’s consultation document feels more like an “act of faith” than a genuinely reasoned conclusion.

We hope that the responses provided by stakeholders will lead EIOPA to reconsider the importance of fixing a framework that is unfair, inaccurate, and deeply damaging to the prospects of the European economy as well as a source of potentially destabilising regulatory arbitrage.

PCS Responds to the Joint-Committee's Consultation on Sustainable Disclosure for STS

PCS has responded to the Joint-Committee of the European Supervisory Authorities on its consultation regarding the optional disclosure relating to sustainability of the assets securitised through an STS transaction.

Our response can be read here.

Acknowledging the very narrow mandate that had been given the Joint-Committee and the challenges this posed, PCS nevertheless believes that this was the wrong mandate, at the wrong time for far too narrow a sub-set of capital market instruments.  Through no fault of the committee, this feels like another siloed regulatory endeavour that risks again punishing unnecessarily securitisation and tilting yet further an already unlevel playing field away from allowing securitisation to recover and play a full role in financing the transition to a sustainable economy.

To understand our approach, we invite you to read only the General Considerations section of our response.  It covers merely three pages.  (Although hard core players are welcome to read the full thirteen page document, of course.)

The Cinderella Regulation - EIOPA launches a consultation on Solvency II capital

We have previously referred to the issue of capital calibration for securitisations purchased by insurance undertaking as the "Cinderella issue".  Of all the issues on which the European Commission  has asked the ESA's to provide advice, it is both the least noticed and yet, in our view, the most important of the unfinished reforms begun with the passing of the Securitisation Regulation.

Today, insurance companies are holding a minuscule percentage of securitisations in their books - just above 2%.  Their holdings of high quality STS securitisations are in homeopathic amounts at around 0.05%.  Yet, if we are to see a revival of a securitisation market in Europe that mobilises non-bank savings to fund the economy, the return of insurance companies is essential.

Yesterday, EIOPA, as part of gathering evidence for its report to the commission, issued a consultation (here)

PCS welcomes this consultation and urges all concerned stakeholders to participate.  We note though with some disappointment the very short period in which the market is asked to respond .  The deadline for responses is 13 July. Less than four weeks in the summer months for a consultation likely to be heavy on data that needs to be gathered and marshalled seems unnecessarily challenging.

EBA publishes excellent report of "Green Securitisation"

Today the European Banking Authority released its Report on Developing a Framework for Sustainable Securitisation.  This report was requested by the co-legislators who asked the EBA to outline how they would envisage a regime for green securitisation.

Although PCS still has to review the report in detail, a first look suggests that the EBA should be commended for the logical, coherent and fair approach it has brought to bear of this subject.

First, the EBA has concluded that there is no need or rationale for having a conceptually different approach to the definition and regulation of green securitisations from that of capital market instruments generally.   PCS had expressed a concern over the asynchronicity of the work on green securitisation and the work of green capital market instruments in general in the context of the legislative passage of the EU Green Bond Standard.  Specifically the accidental request that the EBA define “green securitisations” as a sub-category of capital market instruments before the EU had settled on a definiton of “green capital market instruments” as a whole.  The EBA wisely concluded that this made little sense and that securitisations should be regulated under the same conceptual umbrella as all other capital market instruments.

Secondly, flowing from the first point, the EBA has agreed that a green securitisation should be defined, like any other green bond, by the use made of the proceeds of the issuance rather than by the green nature of the securitised assets.  PCS strongly approves of this approach as we have pointed out publicly that any other would lead to deeply illogical consequences and reduce the amount of financing to the green transition.

The EBA also suggests that this proceeds based approach might be a transitional one until we have greened the European economy. There is a lot to be said for this view.

Finally, the EBA has pointed out that there is a technical amendment required to the current draft of the EU Green Bond Standard legislative text to ensure that the proceeds the use of which defines a green securitisation are the proceeds in the hands of the originator and not the special purpose vehicle.  The same point had been made by the ECB and a number of market participants (including PCS).  This appears not to be a political issue but merely (if crucially) a matter of getting the drafting right.

On synthetic green securitisation and social securitisation (the "S" in "ESG"), the EBA suggests more work needs to be done.   This seems reasonable to us at PCS.

This is a well thought through and excellent report that deserved to be a building block on the path to mobilising the securitisation market in financing the desperately needed ecological transition

Green securitisation - ECB adds its voice in support of the "green proceeds" approach

The European Central Bank has just published its opinion on the draft EU Green Bond Standard legislation.  Overall an excellent piece, it is notable when it comes to securitisation for its support for a definition of green that encompasses issuance where the proceeds are used by the originator to finance sustainable projects.  This can be found in article 3.1.5 of their opinion.

As our readers will recall, a debate arose as to whether the legal EU definition of sustainable securitisation should be limited solely to securitisations of green assets (eg mortgages of green housing or auto loans for electric vehicles) or could also cover - as is the case for all other capital market instruments - bonds whose proceeds are used to finance the transition to a sustainable economy.  PCS has argued forcefully that the latter is both logically compelling and far better helps achieve Europe's sustainability goals.

In the context of the draft EU Green Bond Standard legislation, the intervention of the ECB is welcome not only for its support for the broader definition but also at a technical drafting level by suggesting a clarification of the text.  As currently drafted, the law may not allow a real "use of proceeds" approach because of the ambiguity of the definition of proceeds for securitisations.  The ECB has rightly suggested the ambiguity be lifted to clarify that proceeds of a securitisation in the hands of the originator may be used for green purposes and not, if one followed a technical narrow reading, only the proceeds in the hands of the special purpose vehicle.

Commission's Call for Evidence on Securitisation - progress...but ever so slow

In the securitisation consultation  which closed last month, the Commission wrote that it would issue a call for evidence to the Joint Committee of the ESAs on the key unfinished parts of the STS reform - namely capital calibrations and LCR treatment.

True to its word, the Commission has now issued this call for evidence (found here).

The good news is that it seems to cover all the items needing to be covered including the capital calibrations for both bank and insurance investors and the treatment of securitisations for the liquidity coverage ratio.  It also name checks the excellent report from the High Level Forum on Capital Markets' Union containing most (if not all) the recommendations that we, at PCS, and many market participants have called for.

The bad news is that the ESAs (ie the EBA, EIOPA and ESMA) do not have to report before September 2022.  This means that the very earliest we could expect these reforms to be introduced is at the end of next year.  When one considers the continued decline of the STS securitisation market, the need to revitalise this market to assist banks faced with capital constraints and the financing of Europe's green transition, this extended timetable is unfortunate to say the least.  We should not lose sight of the fact that the High Level Forum's recommendations were issued in June 2020.

PCS would therefore implore the European Union, at the very least, to keep to this most elongated timetable and not to allow it to slip further if it wants to have any securitisation market to revive.

European Commission consults on securitisation

In line with the traditional review process, the European Commission has issued a consultation on the functioning of the EU’s securitisation framework.

The deadline for the consultation is 17 September 2021.  PCS will be responding, of course, and strongly encourages all market stakeholders to express their views.

This is potentially an important milestone in completing the reforms started in 2019 but left unfinished.

Repairing the issues that remained a problem would greatly help revitalising a key financing tool for the European economy.

The Joint Committee of the ESAs’ report on securitisation is published

Today, the Joint Committee of the European Supervisory Authorities (EBA, ESMA and EIOPA) issued their long-awaited report on the regulation of European securitisation.  This report was mandated in the 2017 Securitisation Regulation and was supposed to provide a “tour d’horizon” of how the regulation was functioning and whether it was achieving its stated objective of reviving a safe and sound securitisation market.

An initial review of the report would suggest that it appears to be a significant missed opportunity to address the shortcomings of the current regulatory framework and consequent failure to revive the market, and that it has not drawn the firm conclusions needed. Retreating behind the narrow mandate provided by the regulation, the ESAs have chosen not to address the recommendations of the independent High Level Forum on the Capital Markets  Union set up by the Commission and endorsed by almost all market participants (including PCS) and have instead opted to call for yet more investigations of the key recommended prudential changes.

PCS hopes to bring a more thorough analysis of this report in a forthcoming Newsletter, but it is unlikely that its conclusions will change our view that this report is a major disappointment.