Monday, May 7, 2012

Refusing to end buyers' strike by giving up its informational advantage, the sell-side continues to block return of ABS

As predicted (see here and here) by your humble blogger, the refusal by the sell-side to give up its informational advantage is preventing the securitization industry from restarting.  Having lost trillions, the buy-side is on strike until it has access to the information on each structured finance security it needs to know what it owns.

A Financial News article looks at the current sell-side efforts to restart securitization in the EU while protecting their information monopoly.
Some might prefer to let ABS rest in peace, were it not for the fact that the market is considered crucial to the funding capabilities and survival of banks. It is even being hailed as the solution to the problem of reduced mortgage lending.... 
[The] European Central Bank announced its ABS loan-level initiative in December 2010 in a bid to kickstart the market. 
The aim is to improve transparency and investor confidence in the European ABS markets by compelling issuers to provide data on the underlying loans that are backing securities.  It is not compulsory. But any institution that wants to borrow from the ECB and post ABS as collateral will need to reveal the relevant data....
The key here is that the data is relevant for purposes of valuing the structured finance securities and knowing what you own.

Under the current data warehouse proposal, the data is not relevant.  It will be both out of date (it is being updated once per quarter) and incomplete (it includes data fields carefully selected by the sell-side and the industry trade group it controls).
Investors, by and large, are only confident buying the most senior tranche of a securitisation, leaving the bank with the junior tranche, against which they still have to hold capital....
A direct reflection of the opacity of the product and the inability to access all the useful, relevant data in an appropriate timely manner for use in valuing the lower tranches.
[The] market may be tentatively welcoming the idea of a data warehouse but there is still the thorny issue of who will pay for it. 
It is a well established principle that the issuer pays.  Payment for transparency should be built into each deal.

The fact that the current ECB endorsed data warehouse has adopted a business model that abandons this principale and makes the buy-side pay for data confirms the data warehouse is a sell-side initiative.

A source close to the project said that the data warehouse was keen to attract investment and was preparing to float but admitted it was not a “money-making machine” and was relying on banks to provide the investment. 

The source said: “The plan is to issue shares that will be bought by rating agencies, vendors and those that have a stake in the ABS market, namely banks. The incentive to create such a platform comes from banks because they have to sell securities and need to provide investors with transparency.” 
Why exactly would the buy-side end its strike when the proposed ABS data warehouse is designed to protect existing sell-side business models and would be controlled by investors with significant conflicts of interest with the buy-side?

For example, the reason for a rating agency to buy a stake is to protect its access to proprietary data (say data that is updated more frequently than quarterly).  After all, what value does a rating agency offer if investors and the rating agencies have access to the same data?

For example, why would anyone on the buy-side think that they had access to all the useful, relevant information in an appropriate, timely manner when the data warehouse is owned and controlled by the banks.  The same banks that exploited their informational advantages prior to the financial crisis.

In short, the current data warehouse proposal doesn't work even with the ECB's prominent endorsement.

On the other hand, I proposed a viable data warehouse alternative prior to the beginning of the financial crisis.

It features current and complete information on the underlying loans backing the securities.  It complies with borrower privacy laws.  It doesn't have any conflicts of interest with the buy-side.  It has a business model that works.

It is time for the ECB to stop endorsing a sell-side initiative that will not end the buyers' strike and endorse my solution so that ABS can be restarted and the buyers' strike ended.

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