One of the key projects that European institutions wish to promote this year is the Capital Markets Union. This project takes in several initiatives, such as promoting investment in insurance company infrastructures and simplifying the brochures that companies publish in order to be financed in the capital market. However, the proposal most talked about is that of making changes to legislation in order to relaunch the high-quality securitization market in Europe.
What is securitization and what is proposed by Brussels?
Let us start by imagining a credits package. A securitization involves transforming a series of illiquid financial assets (e.g. these credits) into bonds, obligations or similar instruments which often can be traded on the market. The mechanism of a traditional securitization is based on transferring an assets portfolio from a financial institution or company to a vehicle without equity which issues covered bonds for this portfolio. Several tranches of securities are normally issued in each securitization, with different levels of risk to satisfy the demand of different types of investments and minimize the cost of the issue.
The objectives sought by entities through the use of securitization include capturing liquidity, balance-sheet management and reduction of regulatory capital needs, which will permit additional credit to be provided. This last objective is typical in the case of financial institutions, as it permits them to remove risk assets from their balance sheet that require high levels of capital.
The European Commission wishes to distinguish securitizations of high quality and transparency in order to promote robust, sustainable markets. Specifically, it proposes to create labels to identify those that are “Simple, Transparent and Standardized” (STS), which will receive laxer regulatory treatment in accordance with the lower risk entailed.
What is Europe seeking by this? Basically, to increase – by promoting this market – the funding available to companies and families by between 100,000 and 150,000 million euros.
Securitization: what has happened in recent years?
Securitization has been one of the big victims of the subprime mortgage crisis originating in the USA. Mistrust toward complex products spread rapidly from 2008 to all securitization, which, coupled with increased financial regulation, brought this market to a halt. In Europe, the market went from having 594,000 million euros circulating in 2007 to 216,000 million in 2014, with investor appetite being negatively affected by contagion from the USA, despite relatively good performance by European products, according to data from the Association for Financial Markets in Europe (AFME).
It took until 2015 for something of a revival to be seen. AFME calculates that the second quarter of 2015 saw 46,600 million euros put into circulation in securitization in Europe, 33.6% more than the 34,900 million in the first quarter of the same year.
Behind this revival there is a wealth of documents containing recommendations and requests by several international bodies; these have become regulatory initiatives in Europe, and have led to other actions in support of securitization. The first body to take action was the European Central Bank. In 2014, the ECB launched a purchase program for asset-backed securities which met certain quality criteria. This initiative aimed to encourage financial institutions to issue this type of debt again and, as a consequence, rekindle credit.
Also, the European Banking Authority (EBA) launched a public consultation in 2014 (through to January 2015) to help the European Commission define the regulatory reform areas in relation to this market. The resulting recommendations (published in June 2015) propose stricter regulatory treatment of complex and opaque securitization, and laxer treatment of securitization transactions in compliance with specific standards. And this was precisely the approach of the draft regulation published by Brussels at a later date.
In January and May 2015, the IMF published two reports which showed its support of regulatory changes to securitization, whereby the role of rating agencies would be reduced and these instruments would be standardized by risk factors. The IMF believes that a securitization market which works well is a suitable source for banks to increase their ability to grant credit, and for SMEs to obtain funding. The IMF also suggests introducing a different treatment for high quality securitization.
In line with this view, in 2015 Spain approved a bill on fostering business funding. This bill updates the legal framework of securitization transactions and removes the requirement whereby funding of asset-backed securities must have at least one rating, among other elements.
BBVA has been one of the most openly vocal institutions in defending its view on securitization regulations. In its answer to EBA's consultation in January 2015, BBVA supported the idea of creating a label for all simple and transparent securitization transactions. Promoting this type of transaction is essential to revitalize robust, high-quality securitization markets. Just as the IMF, BBVA defended that the importance of ratings in securitization regulation should be reduced.