Tuesday

4th Oct 2022

EU endorses controversial finance tool

  • Securitisations - packaged loans traded as securities - have become "stigmatised". (Photo: Bankenverband - Bundesverband deutscher Banken / Jochen Zick, Action Press)

The European Commission announced on Wednesday (30 September) it wants to revive the securitisation market, embracing a financial practice which in the United States led to the 2008 financial crisis.

Capital markets commissioner Jonathan Hill told journalists in Brussels on Wednesday afternoon that the European economy needs more securitisation, which is the process of packaging loans, mortgages, or other contractual debts, and then selling them as securities.

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  • Hill: "We are acting in a sensible and proportionate way" (Photo: European Commission)

The British official noted that the financial engineering tool "has been contaminated, stigmatized" because of the US experience, where securitisation of sub-prime mortgages led eventually to a global financial and economic crisis.

According to their ratings, the US securitisations should only have had a 0.1 percent probability of defaulting, but actually defaulted in 16 percent of cases.

But in Europe, default rates "were very low", said Hill.

"If you look at the record of European securitisation during the crisis, after the crisis, actually it was much stronger and much better than it was the case in the United States", he added.

In a legislative plan the Commission sent for approval to the European parliament and member states on Wednesday, the EU executive proposed the creation of a new type of securitisation, called simple, transparent and standardised securitisation (STS securitisation).

Earlier on Wednesday, a Commission official said the EU is "not going to drop any of the important protections that are in place to deal with the sub-prime issue", but that "fundamentally we're trying to restart what is a good market".

The Commission hopes that if banks can sell the risks for mortgage loans and other assets, it will free up cash to lend to small- and medium-sized (SME) businesses.

"Who asked us to do it? The European Central Bank, the Bank of England, the European Banking Authority, comprised of regulators from all around Europe, so I think there is a consensus that this is needed", the source noted.

Commissioner Hill noted the proposal is based on "very detailed, careful work done by highly conservative and regulatory-minded organisations".

"That gives me a lot of confidence that we are acting in a sensible and proportionate way", the UK commissioner said.

According to figures from the International Monetary Fund and the European Banking Authority, the value of securitisation issuance in the EU has already increased in 2014 compared to the year before, but Hill noted that an EU intervention is necessary.

"It is recovering, but I think we feel that to give that a further boost is sensible and desirable, not least because of the beneficial effect it would have on the banks, freeing up their balance sheets, encouraging them to lend", he said.

The securitisation proposal is part of a much broader package of measures laid out in the Commission's "Action Plan on Building a Capital Markets Union", also published on Wednesday.

The paper notes that compared to the United States, the EU's capital markets are "underdeveloped and fragmented".

What is the Union in the capital market?

While Jean-Claude Juncker's Commission promises it will "build a Capital Markets Union", it emerged Wednesday that it is unclear when its construction will be finished. There is no deadline or objective criteria to be met to mark a new stage in European integration, unlike with the introduction of the eurozone.

"If you're a business somewhere in, like, Latvia or Lithuania, and you wake up one day and suddenly you can get some finance that you wouldn't have been able to get the year before, then that would be for you I guess, Capital Markets Union. But there won't be a single thing that kind of encapsulates that", a Commission source told this website.

A Commission spokesperson gave further clarification: "A more useful way to think about it, is a single market for capital. 'Union' spurs all sorts of thoughts about the fact that you might have sort of structures and frameworks, et cetera, in place – it's a single market for capital which is not yet in place because we see huge discrepancies between 28 member states, there are lots of barriers to cross-border investments."

When asked why the Commission uses the word 'union', which for many will have federalist connotations, Hill noted that the process is more important than the end-goal.

"For me, the most important thing is to concentrate on what the elements are of the package and to make steps that allow you to make progress towards it, rather than what's in the name", he said.

"We are better to be honest and realistic on what we're trying to achieve, rather than to set ourselves huge figures, huge goals, that actually when time passes by, we're nowhere near hitting."

Business: "excellent" proposals

Industry lobby groups welcomed the publication of the strategy paper, which BusinessEurope head Markus Beyrer said contained "excellent" proposals.

"The action plan is realistic in recognising EU companies' heavy reliance on bank lending, but at the same time rightly seeks to make equity financing a more viable option, even for small businesses with limited domestic market investment opportunities", noted the association of European chambers of commerce and industry.

"The Commission's plans will tackle major barriers to cross-border investment arising from tax, insolvency law and fragmented market structures", said the Association for Financial Markets in Europe in a statement.

NGO Finance Watch was more sceptical, especially about the securitisation proposal, which it said "goes in the right direction but does not truly learn the lessons from the crisis". The non-profit group fears "the main beneficiaries are likely to be the 'too-big-to-fail' banks that manufacture securitisations".

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Interview

MEPs wary of small print in EU securitisation bill

Paul Tang, the Dutch economist and MEP shepherding through the EU's securitisation bill, casts doubt on claims the risky sector can bring EU states an extra €100 billion.

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