Since the beginning of the solvency crisis on August 9, 2007 when BNP Paribas said it could not value sub-prime mortgage backed securities, the City and its lobbyists have run circles around the financial regulators on everything related to structured finance.
For example, the European Parliament adopted Article 122a of the Capital Requirements Directive, otherwise known as the 'know what you own' requirement. The Committee of European Bank Supervisors, now called the European Banking Authority, was given responsibility for translating this requirement into a regulation.
By the time the City and its lobbyists were done with the individuals at CEBS who were writing this regulation, these individuals had agreed that the disclosure provided by sub-prime mortgage backed securities was adequate to know what you own.
What is adequate for regulators to know what they own is not adequate for private investors to be able to value the securities.
Naturally, having been burned by the securities they bought prior to the start of the solvency crisis, the private investors are staying on strike.
Replacing the private investors are the European Central Bank and the Bank of England. Both of these central banks allow structured finance securities to be pledged as collateral. Collateral that apparently violates Bagehot's rule that central banks should only lend against good collateral.
Since the start of the crisis, your humble blogger has been offerring to help ECB, BoE and other European policymakers get the structured finance market restarted with on-going disclosure of the current performance of the underlying assets.
A Reuter's article provides more on the European actions to restart structured finance.
After nearly four years in the doghouse, regulatory bias against securitisation could finally be easing, if recent progress in market-led initiatives and policy statements continues.
The ECB has relaxed ABS repo rules, progress is being made with the Prime Collateralised Securities (PCS) initiative and in the UK the FSA has more closely aligned covered bond reporting and disclosure rules with RMBS.
By lowering the requirement on the second-best rating to Single A from Triple A, the ECB is making it easier for Portuguese banks to repo bonds, confirms Italian issuers' eligibility (a downgrade to A minus of the sovereign, for instance, will cost all Italian ABS their Triple A rating due to the rating caps) and also assist Irish originators.
Nevertheless, the ECB's shift is unlikely to stimulate public market activity, because the countries that stand to gain the most (the peripherals) are the least likely to be able to bring publicly-marketed deals.
But the decision should help ease the stress on liquidity-starved banks - many of which have faced progressively higher haircuts on ABS repo and more stringent rating rules. Furthermore, banks can now also pledge raw mortgage or SME loan portfolios.
And the UK's FSA has introduced new rules that will equalize the pressures on covered bonds and RMBS, such as through loan-level requirements.
JP Morgan analysts said the changes are "in line with those already adopted by the BoE relating to ABS, and leverage the work of the ECB ABS loan level data technical working groups."
They hope that these initiatives are indeed "the start of the process of leveling the regulatory playing field for Europe's secured debt market."
The Association for Financial Markets in Europe (AFME) and the European Financial Services Roundtable (EFR) have been pushing the PCS. This market-led initiative aims to produce a high quality label for European securitisation, with the hope that regulators will agree, and ease what ABS practitioners view as unfavourable treatment of the product.
Covered bonds, for instance, are eligible for liquidity buffers under the Capital Requirements Directive IV (CRD IV) but securitisation is not. This dissuades some investors from buying the assets, while Solvency II rules also make it expensive for insurance companies to buy ABS because of the capital they have to hold against it....
But there are doubters. At Global ABS conference in June various market contacts questioned whether this project could succeed due to variations in underlying markets across Europe, for example between high LTVs. But AFME and EFR are confident PCS will work.
"One thing unique about Europe is that assets are different across countries, but we still feel that a consistent labelling process is do-able. Investors who have invested in this product in the past do understand that even though the underlying products are different the securities that come out the other end have a lot of similarities to them," said Watson.
To do this, it has to be tagged clearly. The pool will be verified by the PCS Secretariat, which checks for basic agreed eligibility criteria.
"Those would be consistent across European countries, for example certain types of underwriting criteria and documentation requirements. They wouldn't have to be the same, we're not saying the underwriting is exactly the same across different countries, but there would be agreed underwriting criteria which are achievable," explained Watson.
But simply giving deals a new moniker will not solve all problems.
"Generally investors as well as issuers concluded that a label by itself doesn't achieve all that much because the investors can always create their own internal labels if they want to, however they do recognise that if the label is combined with some type of regulatory changes over time, it could be a potentially significant benefit to the entire market," said Watson...
Pricing differentiation is one side-effect of PCS/non-PCS structures that could be felt sooner than regulatory changes with "high quality" eligible deals printing tighter than non-qualifying issues. And market players do appear to be willing to take the risk.
"The decision to do something with the label does involve a risk that it does split into a PCS and non-PCS market but investors do recognise there will non-label deals that are also still good securitisations but may not have the label for various reasons," added Watson.
The PCS strategy is also an attempt to focus the minds of policy-makers, as well as boards of investors who have not seen the same level of support for securitisation as other assets.
If ratified by the regulators, the PCS' allure could spread beyond typical investor types such as banks and funds, with Bank of America Merrill Lynch analysts suggesting in their 2012 outlook that retail clients could also feature.
"The aim is to create a pan-European market. It will help investors in the future to make decisions, to look at investor reporting and documentation in a more consistent way - that is one of the potential benefits of PCS," summarised Sebastian Fairhurst, secretary general of the EFR.