The European Commission (EC) is confident a solution around the Simple, Transparent and Standardised (STS) proposals around securitisations can be agreed with the European Parliament despite the latter refusing to fast-track the rules.
STS forms a core component of the EU’s Capital Markets Union (CMU) initiative, which hopes to streamline rules governing European capital markets. However, STS is being held up in the European Parliament amid concerns about the perceived risks of loosening the rules governing securitisations. Securitisations still have an image problem and are commonly associated all too often with the financial crisis.
STS seeks to harmonise securitisation rules. Existing rules vary across national regulators meaning different financial institutions are subject to fragmented due diligence and risk retention provisions related to securitisations.
“The first steps of the CMU initiative – on a whole – have gotten off to a good start. The STS proposal has been well received in the European Council, but over time, we are confident an agreement will be found with the European Parliament,” said Martin Merlin, director, DG Financial Stability, Financial Services and Capital Markets Union at the European Commission, speaking at the European Capital Markets Union conference in London.
The proposed STS rules, for example, will require EU originators, sponsors and original lenders to retain a 5% net economic interest in securitisation issues. Investors into these securitisations under the STS provisions would also be required to undertake due diligence and confirm that the originator, sponsor or original lender has retained its interest in the securitisation in line with the rules.
The second component of the proposals is contained within the Capital Requirements Regulation (CRR) which will recalibrate regulatory capital treatment for financial institutions in regards to STS securitisation. In other words, entities subject to capital requirements under Basel III and Solvency II can recalibrate their capital requirements if they have exposures to STS securitisations. “The components of STS will be achieved step by step and will require a combined effort of member states and market participants,” said Mark Boleat, chairman of the Policy & Resources Committee at the City of London Corporation.
Regulators in Europe have already eased Solvency II capital requirements for insurance companies looking to invest in European Long Term Investment Funds (ELTIFs). ELTIFS are infrastructure funds structured as alternative investment fund managers (AIFMs) but open to retail investors. Insurers with ELTIF exposure will now be subject to a capital charge of 30% instead of the 49% capital charge prescribed to hedge funds and other equity. It is obviously hoped a similar conclusion will be reached for STS securitisations.
However, there are likely to be challenges, particularly for US institutions looking to invest in STS securitisations. US institutions will not reap the same capital charge benefits as their EU counterparts if they invest in STS securitisations. This is because capital charges around securitisations for US investors must adhere to US rules and not EU requirements. This could discourage external investment although EU policymakers point out most STS securitisation investors will be European anyway.
Proponents of securitisation highlight the European securitisation market fared far better than the US space. However, the US securitisation market appears to have made a much stronger comeback than Europe with Dealogic data indicating covered bond issuance dwarfed asset backed securities in Europe. As such, European securitisations have yet to reach their pre-crisis levels.
International regulators have an increasingly favourable disposition towards securitised products. A paper produced by the European Central Bank (ECB) and Bank of England (BoE) said increasing issuances of asset backed securities would bring about a diversified source of funding for banks. It would also enable them to transfer credit risk to other financial institutions such as fund managers and institutional investors. This would help banks boost their balance sheet capital requirements as mandated under Basel III. It would also enable banks to lend more out into the real economy.
The CMU has been welcomed broadly by financial institutions. There are hopes among fund managers that marketing and distribution rules under UCITS and the Alternative Investment Fund Managers Directive (AIFMD) could be harmonised amid concerns some national regulators have been gold-plating the rules and introducing additional requirements and obligations.
European regulators have also been asking industry participants for comment on a number of issues around CMU. “A number of financial institutions have complained about reporting requirements insofar as there is a lot of duplication. Many firms complain they are disclosing the same information in different ways to comply. This is something we are looking at,” said Merlin.
However, the CMU debate appears to be stifled somewhat by the ongoing BREXIT drama. The referendum, which is due to take place on June 23, is certainly causing widespread concern in financial markets. “London forges excellent EU initiatives and the CMU is an example of one such initiative. It is an initiative the whole of the EU will benefit from and CMU will enable financial services to thrive again which is key to economic growth,” said Boleat.
European Commission confident CMU proposals will be pushed through
The European Commission is confident a solution around the Simple, Transparent and Standardised proposals around securitisations can be agreed with the European Parliament despite the latter refusing to fast-track the rules.