Friday, November 9, 2012

UK Business Secretary Vince Cable looks to restart securitization market

The Telegraph reports that UK Business Secretary Vince Cable is looking to restart the securitization market as it is needed as a source of funding for loans to small and medium size enterprises.

Mr. Cable observed that a number of ways have been tried to restart the securitization market and none of them has been successful.

Regular readers know that the only way to restart the securitization market where investors assume the credit risk on the underlying collateral is to require these securities to provide observable event based reporting.  All activities like a payment or delinquency involving the underlying collateral must be reported before the beginning of the next business day.

It is only with observable event based reporting that investors have the current information they need to satisfy the "know what you own" standard in Article 122a of the European Capital Requirement Directive.

It is only with observable event based reporting that potential investors have the current information they need to independently assess the risk of each security and 'know what they are buying'.

Providing observable event based reporting restarts the securitization market as potential buyers are no longer blindly betting on the contents of a brown paper bag, but instead are making investment decisions on the contents of a clear plastic bag.

Mr. Cable suggested that maybe the way to restart the market is for the UK government to guarantee the debt.  While the government guarantee effectively eliminates the need to know the contents of the brown paper bag, the question is why should the UK taxpayer take on the credit risk for the underlying collateral when by providing observable event based reporting they do not have to?

Business Secretary Vince Cable says that the Government’s £1bn Business Bank will include an agency that parcels up small business debt and sells it on to investors. 
Mr Cable said an agency for business lending is being planned which would package loans into various types of bonds, backed by a state guarantee, which could bring a new source of money into the SME debt market. 
The plan would involve a renaissance for called “securitisation”, which is associated with the kind of financial engineering that led to the economic crisis. 
Mr Cable told The Daily Telegraph that the Government would have to be "very careful" about the design of the agency given the risks associated with securitisation. 
“An agency is part of the current thinking. We’d need to think it through very carefully and decide exactly what role government guarantees and financial support would play. 
“A new version of securitisation does have a future. Various attempts have been made to relaunch it since the financial crisis and none have quite worked. But it’s one of the ways to get money into small businesses and we’ve got to try everything because there is a serious problem of supply of finance, not just demand.”
The primary role for the government is to require that all structured finance securities, broadly defined, must provide observable event based reporting.

This is consistent with the global standard set for the buy-side by the US National Association of Insurance Commissioners in its white paper on the Future of Mortgage Finance.
A Business Bank was announced by Mr Cable in September. It is designed to provide small and medium-sized businesses with an alternative source of finance. 
The £1bn of taxpayers' money will be supported by private partners to provide "£10bn of lending capacity", Mr Cable said. 
"The target market is medium-sized companies that want to borrow for longer than five years. We want to create a facility for companies to access what we call patient capital." 
The bank is expected to support loans on terms of between five and 25 years, with the focus on funding growth....
One of the benefits of observable event based reporting is that it pays for itself.  It pays for itself because it assures there is a secondary market for the securities.

As shown by the current structured finance securities, if there is not observable event based reporting, the secondary market for these securities freezes.  As a result, investors have to charge a premium for this illiquidity.  This premium substantially drives up the cost of the financing.

With observable event based reporting, this illiquidity premium disappears as investors know that other buyers can independently assess and value these securities and as a result, there will always be a buyer should they want to sell.

The savings from eliminating the illiquidity premium pays for the cost of observable event based reporting several times over.
The Business Secretary added that an advisory group is being established which will create a detailed business plan for the bank at the "beginning of 2013".
Your humble blogger would expect to be added to this advisory group.
A feasibility study on the securitisation scheme has been conducted by the Association for Financial Markets in Europe. 
The idea would see existing lenders make loans to small businesses, then sell the debt on to the agency, which would in turn package loans in to bonds which could be sold on to the market. However, banks would have to keep a slice of each loan to avoid them simply passing the poorest quality debt on to the state-backed scheme.
No surprise that with the AFME's involvement the solution is to stick the UK taxpayer with the risk rather than simply provide transparency.

No comments: