By Paul Wilden | Head of Capital Markets Services
Change is coming to the European securitization market. Some of the changes and new regulations are clear and relatively easily implemented, while others remain vague and will probably have a high impact on business process.
It’s no secret that securitization products played a big role in the US subprime mortgage crisis of 2007 – complex, opaque and lightly differentiated securitization led to a market meltdown. The effects of the crisis are still being felt in the European securitization market; its slow recovery is limiting the capital being freed-up to support economic growth in the region.
With this in mind the European Commission, as part of its capital markets union action plan, introduced two legislative measures to promote a safe and liquid market for securitization:
- The first will apply to all securitization products, and includes due diligence, risk retention and transparency rules together with a clear set of criteria to identify Simple, Transparent and Standardised (STS) securitizations. We’ll look at this in more detail below.
- The second is an amendment of the regulation on capital requirements to make the capital treatment of securitizations for banks and investment firms more risk-sensitive and able to properly reflect the specific features of STS securitizations.
STS compliance: a review of deals qualified to date
No current securitization deal would be compliant with STS, concluded a panel discussing STS at the 22nd Annual Global ABS in Barcelona, Spain, in June. The event is the largest annual European structured finance gathering, attended by nearly 4,000 leaders in the global ABS market; STS was one of the hot topics on the agenda this year.
The STS regulation covers roughly 80 very technical and crucial deal criteria that must be complied with. According to the panellists, a deal considered “really good” being put into the current market would comply with around half of these criteria – but to be STS compliant, the deal would have to comply with all of them.
There is no leeway; the criteria is black and white. Currently a securitization deal that’s underperforming in one area can be offset by over-performing in another, resulting in an overall “good” rating. This however, would not be STS compliant. If one of the STS criteria is to wear a blue hat, one cannot offset this by showing you have a red hat or a blue umbrella to cover your head – it needs to be a blue hat, end of story.
The interesting part is not that current deals fail to meet the criteria; it’s seeing in which areas they fail to meet the STS criteria. This ranges from relatively easy-to-fix areas like expanding the information in the prospectus or changing the reporting cycle from every four months to quarterly, to more difficult areas affecting the actual operations.
Data is an obvious issue, and seems to be the most crucial area in the STS regulation – according to the regulation, there is a need to have static and dynamic data on the securitised assets. But this is easier said than done. One must ask: do I have the data required, and do I have the data in the required format? Often this will not be the case; some but not all of the data may be available in current systems, and likely not in the STS-required format. So we’re left a messy situation: data is already difficult to get your hands on; it needs to be manually manipulated to fit the STS format; and this obviously increases the chance of mistakes and therefore liability issues.
To tackle this business issue, players need to invest in new software and business processes – and that is obviously more difficult than expanding the prospectus.
There is a silver lining
Change is coming to the European securitization market. Next to these rules and regulations around STS, the European securitization market will face additional regulatory changes around risk retention, credit, capital requirements and transparency disclosure standards. Some of the changes and new regulations are clear and relatively easily implemented, and some are still very vague and will probably have a high impact on business process.
The new regulation does have a silver lining: it solidifies what a lot of players in the securitization space have already implemented on their own accord. As always, the devil is in the detail, so aligning what has already been implemented to adhere to the new rules will be the biggest challenge.
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