Tuesday, May 3, 2011

ECB paves the way for loan-level utility

In a recent International Asset-Backed Strategy report, an RBS analyst discusses the ECB and the ABS Data Warehouse it is seeking to create.

This report reaffirms why the ABS Data Warehouse with its monopoly on loan-level information has to be free of conflicts of interest with existing structured finance market participants.
Following its decision to enforce loan-by-loan level reporting requirements on the European securitisation market as announced in December 2010, last week the ECB announced its intent to utilise a central data repository for these purposes, with provisional plans for this “Data Warehouse” to process, verify and ultimately distribute standardised ABS loan level data to market users. 
The ECB’s Eurosystem will be one such user, verifying the info against its loan-level requirements (see below for detail) in order for ABS assets to be repo-eligible, although the statement makes the point that its subscriber role in this respect is intended to be non-exclusive. 
The ECB’s letter of intent published last week cites that an independent, external party will be charged with building the ABS data warehouse, selected following an open tender process. 
The concept of a central bank taking the lead in such an initiative is certainly novel, if not alien to us, indeed the norm (at least in the case of the US SEC and Bank of England’s data reporting requirements) is for securitisation issuers to absorb the cost of compliance and make their collateral data publicly and freely available, subject to regulator’s loan fields criteria. How that data is aggregated and distributed is then usually left to the market. 
Our read of the ECB’s letter of intent is that the central bank aims to be a “catalyst” to what it hopes will be a market-led initiative to create a central ABS data warehouse (and this has indeed happened – see below), yet the ECB’s spearheading role in this regard still confounds us considering the many private sector data vendors that exist and compete in the European securitisation credit market today.  
In any case, we would see an ECB-endorsed (even if “non-exclusive”) data provider as an effective market monopoly in the ABS data aggregation business, presumably leaving current vendors to compete on higher value-add analytics following its creation. 
I agree that the ECB-endorsement makes the ABS Data Warehouse an effective monopoly first in Europe and subsequently globally.
The ECB’s letter of intent states that “To the extent possible, market participants will have the opportunity to use and invest in the Data Warehouse subject to entering into appropriate legal arrangements” – while this statement appears to encourage a ‘market-owned’ data provider, we think the difficult practicalities of creating such a socialised venture will mean that the project likely ends up going to a private firm(s). 
This was in fact directly indicated by a press release issued on April 28th from a group of market participants (originators and investors) stating that they will oversee and manage the selection process for the construction and administration of the Data Warehouse, which according to the press release will allow ABS issuers to submit loan-level data electronically, which will then be verified and audited for compliance with the ECB’s criteria requirements for repo eligibility. (The invitation to tender kicks off on 6th May according to the group’s press release). 
It is precisely because the ECB-endorsement effectively makes the ABS Data Warehouse a monopoly that there is no doubt that the European Commission's concerns over conflicts of interest with Markit would apply to any investor in the ABS Data Warehouse.  This would also be true of any party, like the Market Group, that could influence the day-to-day operation of the ABS Data Warehouse through activities like selecting the constructor of the ABS Data Warehouse.
The ECB’s letter of intent suggests that technical specifications and other performance obligations will form part of the tender process and requirements of the data administrator, and that the scope of the tender is intended to ensure competitive pricing that will be ultimately passed through to end-users via a fee-based data information service. 
As mentioned in an earlier blog, the ECB should instead specify two criteria.

First, that the firm that constructs and operates the ABS Data Warehouse be verifiably free of conflicts of interest with existing structured finance market participants.  This requires that any firm that is involved in either the day-to-day operation of the ABS Data Warehouse or the Coordinator role should be required to make a full disclosure of all competitive and financial interests in the design of the database, the presentation of the data, the analysis of the data, and the use of the data, including:

  • Is the firm engaged in a related business that could gain a competitive advantage from its role? Examples of such related businesses include data distribution, pricing services, trustee services, monitoring, analytic solutions, loan servicing, collection services, consulting, ratings services, investment as a principal or agent or portfolio manager, and underwriting.
  • Does the firm have investments that could benefit from its role, such as long or short positions in ABS transactions?
Second, that the firm that constructs and operates the ABS Data Warehouse have demonstrated domain expertise in designing the necessary information system for collecting, verifying, standardizing and disseminating loan-level data for structure finance securities.
To us at least, it would appear that – unlike the private vendor market currently – the ECB is looking to create an almost regulated or utility-like pricing service that is accessible to all market users, including itself. 
This utility is exactly what the market needs.  All of the existing vendors focus on the higher value-added analytics.  The utility would focus on the necessary, but not very exciting task of collecting, verifying, standardizing and disseminating the loan-level performance data and terms of the deals.
... As we have remarked on many occasions, a more transparent and analysable market is certainly a welcome development, however with the issuer constituency in Europe dominated by banks who often enjoy alternative funding channels, the risk is clearly to the continuity of primary issuance as bank borrowers balance the increased costs, administrative burdens and competitive considerations of data transparency compliance against such alternatives.
It is the existence of alternative funding channels that ensures that, even though the ABS Data Warehouse has a monopoly, pricing for its service remains competitive.  If pricing gets too high, banks will move away from structured finance. 
In this respect, we would also remark that, unlike most other jurisdictions, the ECB has clearly singled-out securitisation for such enhanced transparency (as mentioned covered bonds and other instruments are largely exempt from similar requirements), which would of course mean that securitisation will ultimately provide far greater insight into bank asset profile and quality than anything provided on a statutory basis. 
Yet another important reason for the constructor of the ABS Data Warehouse to be free of all conflicts of interest.

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