A harder line on securitization rules by EU would make US softening more difficult.
With so many European banks left holding the bag on asset-backed securities sourced from the US (principally, US home mortgages), it is hardly surprising that EU bank regulators would like to see stricter retention and disclosure requirements for issuers than seems likely in the US.
Under Article 122a, an amendment to the European Capital Requirements Directive proposed by the Committee of European Banking Supervisors, European banks would be subjected to new requirements, including an ongoing 5 percent minimum retention requirement in order to be involved securitization transactions as an originator, sponsor, original lender, an investor, or otherwise.
What’s more, credit institutions that are even exposed to asset-backed securities as hedge counterparties or liquidity providers would have to show proper due diligence and risk management decision making, including retention of the underlying net economic risk. The penalty for failing to do so will be higher capital requirements, 250 percent to 1250 percent above the normal risk weight and up to 100 percent of the offending position.
The aim in casting such a wide net is to incentivize all regulated ABS-market participants to enforce the all-important disclosure requirements that are also part of the proposed ABS regulation.
Per Paragraph 7 of Article 122a:
Sponsor and originator credit institutions shall disclose to investors the level of their commitment under paragraph 1 to maintain a net economic interest in the securitisation. Sponsor and originator credit institutions shall ensure that prospective investors have readily available access to all materially relevant data on the credit quality and performance of the individual underlying exposures, cash flows and collateral supporting a securitisation exposure as well as such information that is necessary to conduct comprehensive and well informed stress tests on the cash flows and collateral values supporting the underlying exposures. For that purpose, materially relevant data shall be determined as at the date of the securitisation and where appropriate due to the nature of the securitisation thereafter.
While the disclosure elements are consistent with what the US SEC is proposing with Reg AB and elsewhere, the sticks to incentivize the market to provide the disclosures regulators desire is much more extensive. This has caused several market commentators, including Yves Smith on her blog Nakedcapitalism.com, to suggest that the EU effort will force US regulators not to cave in as much as anticipated on their own securitization reform proposals, including those being worked out in post-passage, Dodd-Frank rulemaking. Further, US institutions would have to comply with Article 122a if they wanted to sell ABS to European institutions in any event.
According to Richard Field, founder of the portfolio strategy firm TYI LLC, writing for The Institutional Risk Analyst, “For example, if an EU or US auto ABS issuer wants to sell auto loan ABS tranches to a European credit institution, it will need to comply with the EU retention requirements and also provide sufficient information for EU investor due diligence.”
If a harder EU line on securitization rules is indeed in the offing, comments on the proposal are due by October 1, this would set an interesting precedent for other elements for financial reform, including derivatives. Treasurers following regulatory impacts on their activities thus should be wary of how EU proposals could force the hand of US (and perhaps other major-market) rulemakers to limit the scope of exceptions and otherwise push back on efforts to soften the blows of reform.