A new era for securitization in Europe?
In the last months the European securitization market has been at the center of public attention due to talks within EU institutions about an upcoming proposal to seek a substantial overhaul of the current regulation involving the European securitization industry. The proposed reform of the asset-backed securities (ABS) market is part of a broader “capital markets union” plan, whose objective is to increase the spectrum of market financing options for businesses who operate within the European Union.
The EU’s top financial services official, Lord Jonathan Hill, British member of the European Commission and supported in its action by the European Banking Authority, is set to propose a substantial reduction in capital charges for the securitization industry in an effort to jump-start and encourage a market seen as one of the main avenues for boosting lending across the 28-country bloc.
ABS provide a stream of income through their underlying assets, such as mortgages, car loans or credit card debt. MBSs (i.e. securities backed by a pool of mortgages, including the infamous “subprime”) played a central role in the recent financial crisis. The devastation caused by packaged US subprime mortgage loans (for this reason defined as “toxic assets”) scarred the entire industry, deterred investors and prompted a stricter regulatory approach across the US and the EU.
Total securitisation issuance in Europe declined to about €217bn in 2014 from €815bn in 2008, according to the Association for Financial Markets in Europe. In the US, a market now almost five times bigger than across the Atlantic, the fall was smaller, from €1.1tn to €935bn in 2014.
Active participants in the securitization industry, such as banks, securities firms and insurance companies, have repeatedly stated that the current restrictive capital charges imposed during the financial crisis have so far prevented them from reviving the weak European ABS market.
Financial institutions, including large multinational banks, have long argued that regulation on the ABS market has been far too aggressive and thus dramatically undermined the economic incentive for banks to engage in any type of securitization program, while having a severe impact on the availability of affordable credit in the whole economy.
Under the new plan, banks would be eligible for an average reduction of 25 per cent on the capital requirements they must meet on holdings of securitized debt that satisfy specific criteria of transparency, simplicity and standardization. The presence of that criteria clearly aims to prevent any future possible financial meltdown due to the excessive exploitation of credit derivatives by financial institutions.
The European Union identifies securitization activity as “an important element of well-functioning capital markets”, which fits well into the “capital markets union” objective set by the EU officials to be reach within the next few months. The EU’s goal is to “restart markets on a more sustainable basis” by favoring those asset-backed securities that meet a criteria of simplicity and transparency.
The reform should also be helped by the fact that, since early 2015, as part of its quantitative easing (QE) program, the ECB has been purchasing large amounts of ABS, directly supporting the market’s liquidity. The QE program is also expected to indirectly reduce the price risk associated with ABSs by increasing the demand for such securitized products, which should further encourage investors’ demand and issuers’ supply.
The European Union and the ECB see the proposed reform as a mean of increasing the flow of credit without necessarily triggering overleveraging, which was also one of the reasons of the collapse of the financial system.
Investors and the whole European economy could benefit from a more dynamic ABS market thanks to capital market-driven growth. Increased issuance and higher investor demand for securitized products would boost the profitability of global banks’ securitization programs, while lower capital requirements would eventually improve the returns on such activities.
Reviving high-quality securitization in Europe is also seen as the opportunity for the whole financial services industry to prove how financial innovation can still spur stronger economic growth and wider access to financing though responsible, forward-looking financial engineering.
WRITTEN BY EMANUELE ERBA FOR BESA
PLEASE DIRECT ANY INQUIRY TO AS.BESA@UNIBOCCONI.IT