Richard Hopkin, AFME's Head of Fixed Income, highlights that barriers to STS securitisation will serve only to weaken Europe’s capital markets.
Today (13 June 2016) sees securitisation debated in the European Parliament for the first time since 2009, during the aftermath of the financial crisis. On the agenda are the European Commission’s proposals to implement “simple transparent and standardised” – or "STS" – securitisation, which aim to make securitisation an effective funding channel for the European economy.
Securitisation has certainly received a bad rap over the years. A recent letter to the European Parliament from a group of academics goes to show just how poorly understood asset-backed securities continue to be and that the memory of the financial crash pervades in the institutional memory.
Yet, in its simplest form, securitisation is no more than a financing and capital management tool, with the positive potential to boost both credit and growth. Unlike in the US sub-prime market, securitisation in Europe has performed well, and now the new STS proposals provide investors with even greater protections against the mistakes of the past.
Disappointingly, it now looks like some legislators and commentators continue to fight old battles which will add further delay in passing STS into law. This is despite EU national governments quickly agreeing on the proposals late last year. While it is understandable that some MEPs may be cautious, given securitisation’s association with US sub-prime mortgages, are such distractions justified?
Lessons learned almost a decade on from the crisis
Europe today already has the toughest regime in the world for regulating securitisation. Since 2011 we have had strong regulations which have implemented the lessons of the financial crisis: the risk retention “skin in the game” rules, as well as requirements for transparency and disclosure to enable investors to better undertake due diligence. No other forms of fixed income investment – many much riskier than AAA-rated securitisations – are subject to these special requirements.
European securitisation has also performed extremely well through and since the crisis. Unlike US residential mortgage-backed securities (“RMBS”) which suffered a 25.8% default rate from 2007 to the end of 2015, most European asset classes experienced only tiny levels of defaults: only 0.16% over the same period for European RMBS. This is acknowledged by many regulators and policymakers, and even by many opponents of securitisation’s revival.
Securitisation needs to be restored to health not for its own sake, but as a means to an end: Europe is crying out for growth and the longer the delay the longer it will be before securitisation can play its part by providing incremental funding to the real economy, risk transfer out of our banking system and wider and deeper capital markets creating high quality and yield-rich investment opportunities.
Europe stands to benefit most
The benefits of reviving securitisation in Europe are clear. Securitisation acts as a bridge from balance sheets to the capital markets and helps to transform illiquid assets into liquid, transferable securities.
For SMEs, securitisation can help provide finance at all stages of the supply chain. Not only direct loans to SMEs but also leases, trade receivables and sales finance lending all support the SME sector. Also, by helping banks transfer risk, securitisation frees up space on bank balance sheets for further lending, including to SMEs. Securitisation of all asset types therefore supports economic activity, both directly and indirectly.
But the longer it takes to adopt the STS framework, the worse the problem will become. European securitisation issuance has already fallen from €400bn in 2007 to just over €80bn in 2015. High capital charges and harsh treatment under liquidity rules are at the root of this bleak picture – with costs for holding securitisation paper several times higher than other similarly-rated products. As a result, new issuance levels continue to be low, participants are exiting the market and each month brings news of further losses of institutional, human and intellectual capital.
As the market shrinks, it is harder and harder for market participants, and especially underwriters and investors, to justify the investment they need to maintain to play a full and prudent role in the securitisation market – especially when bank structural reform and other regulatory changes are also hitting the bottom line of banks.
Postponing STS will only intensify these problems. As Commissioner Jonathan Hill said, “Every extra day that this proposal takes to pass into law is one more day of a missed opportunity for growth.”
The road ahead
Our task in the coming months will be to continue to challenge the remaining negative perceptions surrounding securitisation, and continue to explain, as clearly as we can, the benefits it provides to Europe’s real economy: incremental funding, risk transfer to support and strengthen our banks and a bridge to wider and deeper capital markets.
We are making good progress. Most European policymakers and regulators strongly agree that securitisation should be a key component of the Capital Markets Union initiative. For those who remain cautious, we urge them to take reassurance from the strong performance of European securitisation through and since the crisis, and the robust framework of regulation already in place for many years. The Commission’s proposals for STS securitisation provide yet more protection, and while issues of detail need to be worked through there is simply no evidence to justify not moving forward in a positive spirit. Unjustified distractions which create new barriers to STS securitisation will serve only to weaken Europe’s capital markets and restrict their ability to help restore growth throughout the continent. For the sake of Europe, now is the time for action, not delay.