Friday, September 14, 2012

How to save securitization

The sell-side continues to roll-out its solution for saving securitization.  The solution involves putting a new label on opaque securities.

Fortunately, as regular readers know, the NAIC White Paper has already set the global standard for disclosure that securitizations are going to have to meet.  The White Paper links both frequency and completeness of disclosure to how much capital has to be held.  

The more frequent and complete the disclosure the lower the capital requirements that has to be held by the insurance company.  The less frequent and incomplete the disclosure, the higher the capital requirements, up to 100%, has to be held.  This removes insurance companies as direct or indirect buyers of these securities.

Covered bonds and structured finance securities the provide observable event based reporting on the activities like payments and defaults on the underlying collateral by the beginning of the next business day require much less capital than covered bonds and structured finance securities that provide once per month or less frequent reporting.

By linking frequency and completeness of disclosure to capital requirements, a standard is set for the entire buy-side.

Securities that provide disclosure equivalent to valuing the contents of a clear plastic bag are deemed less risky as buyers can know what they own.  Securities that provide disclosure equivalent to valuing the contents of a brown paper bag are deemed more risky as buyers are blindly betting.

In an ILFR interview, the global head of BNP Paribas securitization area, Fabrice Sussini, tries to make the case for why slapping a label on an opaque security should save securitization.
The first European Prime Collateralised Securities (PCS) labelled securitisation is expected imminently. 
The PCS initiative was launched by the Association for Financial Markets in Europe (AFME) and the European Financial Services Round Table in June. It aims to revive the region’s depressed securitisation market by developing a label for high quality securitisations.
Please note, an initiative run by and for the sell-side.
With securitisation offering a sure-fire way of increasing lending to the real economy, recession-ridden Europe cannot afford to dismiss the scheme....
Actually, Europe can afford to dismiss the scheme because it is only a scheme and not a real solution to the problem with covered bonds and structured finance securities.
Why is the PCS project necessary? 
The PCS initiative was borne out of a mixture of frustration and bemusement at European policymakers’ response to the global financial crisis. 
With no European subprime equivalent, and no obvious wrongdoing having occurred in Europe’s securitisation market, it seemed strange to market participants that the pendulum swung back so heavily in the region. Moreover, that many regulatory measures promoted even by European regulators, excluding some justified proposals, seemed disconnected from market realities.  
The issues that prompted the crisis were not only primarily localised to the US subprime market but were also far more linked to how credit origination was regulated than to the supposed lack of regulation of securitisation itself. Credit business was much more controlled than in the US.
Regular readers will recall how hard the sell-side has been fighting against Article 122a of the European Capital Requirement Directive.

Under this article, the standard of knowing what you own was placed on the buy-side by the European Parliament.

The sell-side lobbied the Committee of European Bank Supervisors to get them to agree that opaque, toxic subprime securities provide adequate disclosure so that the buy-side can know what it owns.

Of course, the buy-side knows that is not true.

Not only the buy-side, but the regulator for some of the largest direct and indirect buyers of covered bonds and structured finance securities.  The reason for the regulator publishing the White Paper was to remind everyone that the standard for knowing what you own includes observable event based reporting.
So it was evidently a bit frustrating to see European regulators and policymakers letting securitisation come to a halt while overlooking the actual performance of the product ,as well as its necessary contribution to the funding of the economy....
The question for this small working group centred on “how to get it started, how to restore the confidence lost, what are the lessons we should factor in and the messages from investors and regulators we should listen to?”
The reason securitization came to a halt is there is a buyers' strike and it is only with observable event based reporting and complete disclosure that the buyers are coming back.

Of course, the sell-side doesn't want to listen to that message.
Ultimately, the various initiatives taken at different levels in different countries converged and, under the leadership of AFME and EFR, the work continued and resulted in the PCS initiative. 
Its purpose is to provide the market with a label, not as a rating or a substitute to the credit analysis investors must keep performing, but as a reference for European best practice in terms of transparency, simplicity and quality of processes....
What is the value of the label if the European best practice doesn't include observable event based reporting so that investors can keep performing credit analysis?


Without observable event based reporting, a PCS label is nothing more than putting lipstick on a pig.
Has investor risk appetite returned? 
There is some volatility in the US market, but risk appetite and liquidity remain with a focus on some products such as collateralised loan obligations (CLO) or commercial mortgage-backed securities (CMBS). 
The European market, in contrast, has developed into a very limited playing field. The investor profile changed significantly in Europe post-crisis, with many market participants disappearing. Today’s transactions can gather between 40 and 50 investors - substantially less than pre-crisis days – but more importantly, tickets are much smaller. What’s more, a number of these investors are actually European arms of US institutions....
As a practical matter, the US regulator's standard will cover these US institutions and their European arms.

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