Securitisation - Prudence not paralysis
- Securitisation helps diversify the funding base of an economy, enabling banks to raise further financing, reduce borrowing costs for consumers or support more lending.
- Since 2008 regulation has been a key driver in incentivising market participants to use securitised assets as a structural tool - enabling a sustainable recovery of this market.
- Outside US sub-prime mortgages, collateralised debt obligations and leveraged vehicles, securitised assets have caused limited actual credit losses in respect of their level of seniority.
With the help of securitisation, the systemic risk of an economy is distributed beyond bank balance sheets to other capital market participants (institutional investors), diversifying the funding base of the economy, and while doing so freeing up bank capital – which helps enable banks to raise further financing, reduce borrowing costs for consumers or support more lending. Beyond the direct impact on financial markets and at a more practical level, examples of benefits of securitisation include: a car manufacturer using the process of securitisation to sell their claim on a stream of loan payments (i.e. convert the stream into one lump sum) to finance research and development to remain competitive or a department store with an in-house store card selling its claim on the card repayments to support product development1.
Given the above, it was not surprising to see that the IMF and OECD encourage regulators and policy makers to enable a sustainable recovery of the securitisation markets2 after the global financial crisis. It was evident that the main central banks took note - the Fed backed Fannie Mae and Freddie Mac in purchasing US mortgages post the global financial crisis while the ECB’s asset purchase programme also included the purchase of securitised assets. In fact the EU came forward with several proposals, one of them being the creation of Simple, Transparent and Standardised (STS) Securitisations in a bid to make risk analysis easier and empower investors.
Given the importance of securitisation for the economy; its use as a liquidity and risk management tool for banks and its ability to allow investors to diversify into otherwise granular, inaccessible and illiquid instruments, in this paper we turn our attention to helping investors understand securitisation better by:
- identifying the prominent regulatory measures taken across major markets to restore investor confidence in securitised assets
- dispelling the blanket negative perception of securitised assets and hence attempt to show the differentiation between them
- outlining the importance of good deal structures.
What has changed since 2008?
It is interesting to see that despite the troubles of the financial crisis, regulators did not determine that securitisation as a concept needed to be eradicated. Instead, regulation has been a key driver in incentivising various market participants to use securitisation as a structural tool.
In the United States, the major regulatory reform impacting securitisation transactions has been the Dodd-Frank Act. In the European Union, this has come from various regulatory reforms3.
1 Remarks of Commissioner Jonathan Hill at the European Parliament’s Public Hearing on Securitisation, European Commission Speech, Brussels, 13 June 2016.
2 https://www.imf.org/External/Pubs/FT/GFSR/2009/02/pdf/chap2.pdf and http://www.oecd.org/finance/public-debt/48620405.pdf.
3 Examples of regulation affecting securitisation in the EU: The Basel II and III, the Capital Requirements Directive and Capital Requirements, the Credit Agency Regulation, the Alternative Investment Fund Managers Directive and the Solvency II Directive, amongst others.
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