Sell-side of European ABS industry looks to rebrand a skunk

According to a Financial Times article, the sell-side of the European securitization industry is trying to rebrand structured finance deals in the hopes that calling these deals a new name will fool the muppets and end the buyers' strike.

As your humble blogger has pointed out repeatedly, current disclosure practices for structured finance deals do not allow an investor to 'know what you own'.  This fact is recognized by buyers and is the reason they are on a buyers' strike.

Labels do absolutely nothing to change this fact.

The only way for buyers to know what they own is if structured finance securities provide observable event based reporting.  Under observable event based reporting, every time there is an activity like a payment, delinquency, default, modification or borrower bankruptcy involving the underlying collateral it is reported before the start of the next business day.

With observable event based reporting, investors always have current information about the performance of the underlying collateral.  Investors can use this data to independently assess the risk and value of the security and make buy, hold and sell decisions.

Without observable event based reporting, buyers of structured finance securities are not investing, but rather blindly betting.  A lesson the buy-side learn as it absorbed hundreds of billions of dollars in losses on structured finance securities that did not have observable event based reporting at the start of the financial crisis.

Europe’s securitisation industry has officially launched a new labelling system that aims to revive the fortunes of a financial product that some dubbed as toxic during the US subprime crisis. 

The Prime Collateralised Securities project will award a stamp of approval to high quality European asset backed securities that meet a set of criteria in terms of quality, transparency, simplicity and standardisation. 

The new labelling system aims to counter negative sentiment towards European securitisation products by championing well structured deals backed by assets focused on the real economy such as auto loans, consumer loans, credit cards, residential mortgages or loans to small and medium-sized companies....

Essentially they are trying to rebrand a skunk.

Ian Bell, the newly appointed head of the PCS Secretariat that will manage the day-to-day running of the scheme, said the initiative would create a new benchmark and reassure investors who had previously been put off by ABS to reassess the product. 

Translation:  the buy-side is composed of muppets who are easy to dupe.  After all, the muppets bought portions of these securities based on a AAA-rating label.  Therefore, the muppets should be gullible and buy a new 'Prime' rating label.

The initiative will combine asset screening, structured screening and forced compliance with more detailed reporting requirements used currently only for European Central Bank and Bank of England repo transactions, he said.

Sounds like a replacement for the rating agencies.

Analysts say the scheme could also encourage European regulators to reassess the role of securitisation as another vital part of the funding tools available for banks. Proponents want to encourage regulators to allow ABS to be included in a bank’s liquidity buffers.

At a minimum, if an asset should qualify for inclusion in a bank's liquidity buffer, there should be a deep, liquid secondary market for the asset.

Clearly, the secondary market for structured finance securities is illiquid.  Some might even say that it borders on being frozen like a block of ice.

It appears that structured finance securities without observable event based reporting are the exact opposite of what should be included in a bank's liquidity buffer.

With observable event based reporting, there is a reason for a deep, liquid secondary market to develop.  Investors will be able to assess the current performance of the underlying collateral and value the deal.

The two trade bodies leading the scheme – the Association for Financial Markets in Europe and the European Financial Services Round Table – have raised more than €3.6m to initially fund the PCS initiative and set up two bodies to govern the scheme. The not-for-profit project will then be funded by fees paid by issuers.

Both of these trade bodies are actually sell-side controlled lobbying organizations.  They do not represent the buy-side.  An important point when it comes to reporting who is sponsoring an initiative.

The PCS initiative is yet another effort by the sell-side to retain opacity in structured finance deals.

In fact, the 3.6 million euros that were provide to initially fund the initiative gives an indication of just how valuable the sell-side thinks maintaining the current level of opacity is in structured finance.  Nobody spends this type of money on a speculative bet unless they expect to receive multiples on their investments in return (which by the way, lobbying delivers).

Until these deals offer observable event based reporting, anyone who buys them is showing they learned nothing from the opaque, toxic mortgage-backed securities and is asking for the losses they are likely to experience.

Rick Watson, head of capital markets at AFME, said PCS has received broad support from issuers and investors around Europe. The Bank of England, European Investment Bank and ECB have also been “observing” the initiative. 

I wonder if they ever get tired of observing the fact that the sell-side initiative is not ending the buyers' strike.

Mario Draghi, ECB president, said he “welcomed the initiative, which aims at increasing the attractiveness of asset-backed securities among investors and originating banks”.

Of course the ECB is supporting the sell-side initiative.  The ECB's balance sheet has a significant exposure to structured finance deals and it is hoping to sell them.

Critics, however, argue that the pan-European scheme is unlikely to have any meaningful effect on promoting ABS by itself and could even just confuse investors.

The critics are wrong as the scheme has already had a meaningful effect.  It has delayed the financial regulators and central bankers from requiring observable event based reporting for structured finance transactions.