There is nothing “simple” about the European Commission’s securitisation proposal

On May 23, 2016, 83 scholars from Europe wrote to the European Parliament to call for a careful consideration of the European Commission’s proposals for a new market for STS securitisations, part of the Capital Markets Union agenda. Members of the ECON Committee of the European Parliament are currently working on this proposal. Read the full letter here  – Open letter to MEPs – STS securitisation.

 

 

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One comment

  1. First: I am absolutely in favour of banks being funded with much more (a lot more!) equity capital. Second: I do agree the STS securitization initiative won’t have a significant impact on European SME – as correctly pointed out, the SME securitization market has always been very small.

    However, this open letter has some serious flaws:

    1) “The buyers of these securitisations are already heavily interconnected with banks through repo markets and will be even more so through the securitisation channel.” Sorry, it’s quite the opposite. Once banks securitize their assets, their role in the securitization is minimal. Check among investors of bonds issued by Northern Rock and Lehman Brothers against investors of their ABS to see who suffered the biggest losses.

    2) “Tranching is fully allowed, as are credit enhancements such as credit default swaps, while interest rate swaps are even obliged. All three suggest not simplicity but the same kind of complexity that caught investors as well as regulators off guard before the crisis.” Interest rate swaps complex? Banks, investors and corporations continuously enter in swaps: it’s one of the most liquid, used and understood derivatives. Additionally in ABS it is used only for hedging purposes: loans may pay fixed or floating interest linked to different reference rates, which can be converted to the desired coupon thanks to swaps. Credit default swaps as credit enhancement? CDS can be used to create synthetic securitization (that with some restrictions might be included in the STS label), but as a credit enhancement method… how? Where is it discussed in the proposal? Regarding tranching: how do you protect investors from losses? Besides, check the capital structure of a corporation: equity, preferred equity and hybrid debt, senior unsecured debt, senior secured debt. Isn’t it the same as tranching?

    3) Skin in the game: the 5% rule is relevant only for a small amount of transactions (mainly CLO). If you look at the placement to investors of ABS you will see that the senior tranches are placed, the mezzanine tranches sometimes, while the most junior tranches are always fully retained by the originator: nobody wants to buy them (not even before the crisis). Skin in the game has always been there. Finally the statement “banks can pick the tranches they want” is too vague: they keep 5% of the whole deal by owning either all tranches in pro-rata amounts or only the most junior tranche.

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