Events of 2008 all but destroyed public confidence in the securitization market. However, used properly, securitization is an effective tool, and its disappearance has given rise to market inefficiencies. The European regulator has now intervened to inject fresh life into securitization as a way to boost credit in the EU, improve market liquidity and transferability of credit risk.
A new framework, in force since January 1 2019, aims to revive investors’ trust. Akin to the much-revered “Made in Germany” originating from the German industrial powerhouse of Europe, the framework introduces a new “Made in EU” quality label with three key requirements – Simple, Transparent and Standardized – for investments in securitization by EU institutional investors and issuance of shares in securitization by EU regulated entities.
The label gives investors the assurance that, wherever the assets originate, the whole framework surrounding their securitization shall remain within the scope of EU-regulated actors. Asset servicing is ensured by a regulated asset manager under the stringent European framework, and records of the securitized assets are kept by a repository that has to respect European duties in terms of electronic capabilities to ensure long term availability of asset performance information.
Although most of the requirements are standard practice for soundly managed players, the framework introduces some new restrictions aimed at preventing securitization from ever again becoming the vector of a wider financial market collapse triggering a general downturn at a global level.
- A ban on setting up new activities that rely solely on securitization. This aims to ensure that originators always have expertise in risk management and a solid track record in their ability to generate exposures with a positive asset performance.
- Re-securitization that triggers exponential complexity to understand risk & repayment profiles shall be the exception (it used to be common market practice), and requires express agreement from regulators.
- The STS label shall be granted only to transactions relying on true sale of assets without severe clawback provisions, so that the investors’ pledge is real and easily actionable.
- As the regulator noted that strong reliance of the repayment of securitization positions on the sale of collateral pledged as guarantee of the securitized assets creates market-wide weaknesses, especially on the Commercial Mortgage Backed Securities, transactions where repayment of investors relies heavily on the activation of such guarantees shall be excluded from the STS framework.
The reputations of the major Investment banks are at stake. If a single transaction fails to obtain (or loses) the STS label, it could trigger a more general loss of market confidence in the ability of the concerned bank to structure sound securitization deals.
Flight to quality from January 1
As a step to renewing confidence in securitization, the regulation will likely trigger a “flight to quality”. Investors will favor safe operations where risk is soundly monitored and thus likely to obtain the STS label, or ask an even higher return on excluded transactions, particularly as STS securitizations are likely to receive preferential capital and liquidity requirement treatment from regulators.