17th Oct 2019

Markets wait for EU rules on securitised financial products

  • The stock exchange in Madrid. The EU wants to revitalise a financial product called securitisation, which involves cutting up and repackaging loans, and selling off the risks (Photo: European Parliament)

A new EU 'stamp of approval' to kickstart the use of a controversial financial tool was given for the first time last week - but the market has mostly been in a waiting mode as the adoption of technical rules for the new EU system has faced delays.

The controversial financial tool is called securitisation, and it involves cutting up loans, mortgages or other debts in multiple pieces and then selling off the risk.

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  • Anti-capitalist protesters in London in 2011. The EU has tweaked the rules on securitisation, which in the US helped spark the 2008 financial crisis (Photo: Seun Ismail)

Securitisation of subprime mortgages in the United States caused the 2007-2008 crisis, leaving the method to be tainted with a bad reputation.

While the European financial services industry issued some €813bn in securitisation at its peak in 2008, this dropped to its lowest point in a decade in 2013, at €177bn.

In 2015 the European Commission announced that it wanted to remove the "stigma" attached to securitisation and to revive Europe's securitisation market by creating a framework for trusted securitisation.

This resulted in legislation that laid down the framework for "simple, transparent and standardised" (STS) securitisation.

The commission thinks that if there was an increase in repackaging contractual loans and selling off the risk in a certificated manner, this would free up balance sheets.

It estimated that between €100bn and €150bn of additional credit would become available to the private sector - and that in particular small and medium-sized companies would benefit.

The STS regulation has applied since 1 January 2019, but it was only last Friday (22 March) that the European Securities and Markets Authority (Esma) received its first notification of a securitisation product which met the STS criteria.

This raises the question: has the commission overestimated the market demand for STS securitisation?

According to a commission source, who spoke on condition of anonymity, the demand is there.

"There is a lot of demand in the market from potential issuers, but the market is waiting from some key implementing rules to be adopted by the European Commission," he said.

It is very common in EU law that the European Parliament and the Council of the EU - representing national governments - adopt a general regulation, but that these co-legislators leave technical details to be adopted by the commission, through a law-making procedure called comitology.

While the STS regulation was approved by EU institutions in December 2017, the work on the technical standards proved to be more work than foreseen.

"The commission received a lot of comments through the consultation that we wanted to address," said the source.

"That is why it has taken a bit longer to produce these technical standards. We are working very hard to address all the comments," he stressed.

In hindsight it is easy to say that the entry into force of 1 January was perhaps too optimistic.

But according to the commission source comitology was the only way to establish the very detailed standards.

"We could not have had this level of detail in the regulation," he said.

"Some of these reporting templates are 300 pages long. It would have taken the co-legislators ten years to go through all the detailed templates. You need technical expertise," he added.

The contact stressed that there is nothing in the law that prevents the market to issue STS securities, but that most market parties prefer not to do so until the key rules are in place.

Under comitology, there is also a period of one, two, or three months during which MEPs are given a chance to veto the detailed rules. With EU elections scheduled for May 2019, it seems unlikely that the final detailed legislation is in place before autumn.

The party which had the honour of being the first to have a securitisation adopted in the Esma register has remained anonymous.

The London-based Association for Financial Markets in Europe (Afme) said in its quarterly report earlier this month that while more securitised products were being issued, they were often not being placed on the market.

"The delay in approval by the EU public authorities of key elements of the new securitisation framework is clearly a factor," it said.

Nevertheless, Afme reported that in 2018 European financial services issued €269bn - the highest volume since 2012.

Unclear goal

The commission said when presenting its proposal in 2015, that if "EU securitisation issuance was built up again to pre-crisis average, it would generate between €100-150bn in additional funding for the economy" - although not everyone believed the additional funding to be this high.

The commission had not defined what "pre-crisis average" meant - which makes the target vague because the average will change depending on which years you include.

When defining the "pre-crisis" years as the period 1996-2006, the average issuance of securities in Europe was €168bn. For 1996-2007, it was €203bn, and for 1996-2008 the average was €251bn.

One could therefore argue that the goal of reaching the pre-crisis average has already been achieved - the 2018 issuance figure was €269bn - even before the STS regulation had applied.

But securitisation had been increasing almost every year since 1996, so the average would be much higher if those early years were excluded - defining the pre-crisis years as 2004-2007, the target would be much higher: €475bn.

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