[London] The European Banking Authority (EBA) has dispatched the first formal definition of top-tier or"qualifying" securitisation, calling on regulators to consider aligning its treatment more closely to other classes bearing similar risks.
Coming just a few days after the European Commission published its highly debated rules on banks' liquidity buffers and insurers' capital charges, the EBA report underpins the fact that the rules still rely on criteria - such as ratings - that penalise the asset class compared with products such as covered bonds and whole loan portfolios.
The paper in fact goes further than drawing up theoretical criteria, and calls for a cross-sector revision of current regulation. "The risk exists that the extent of some of the differences in the regulatory treatment between securitisation and other investment instruments may not be fully justified," the EBA said. "Major differences in regulatory treatment clearly have an impact on the respective incentives to issue or invest in one instrument or the other and can lead to unintentional effects that could destabilise the financial system as a whole," it warned.
The authority proposed a two-stage approach to identify sound and simple assets that could qualify for better capital and liquidity treatment in the future.
A one-size-fits-all regulatory approach "appears to be no longer appropriate," the paper says, "as it may result in a too lenient treatment of transactions that are structurally risky and in an unduly conservative treatment" of less risky ones.
An ABS deal would first be assessed in terms of transparency and simplicity to capture and mitigate risks unrelated to the underlying collateral pools, and secondly by credit quality.
This assessment builds on criteria similar to those put forward by the industry-led Prime Collateralised Securities and the European Central Bank alongside the Bank of England in June.
The EBA said this criteria could limit the inconsistency of"non-neutrality" of capital charges based on external ratings, which for ABS deals are sometimes high multiples of the charge applicable to the underlying portfolio.
The proposal could, for example, allow charges to be reduced for the more junior tranches and increased for more senior ones, other than the most senior tranche of a deal, the EBA said.
The second level, taking into consideration the pure credit risk of collateral pools, would set up minimum credit quality criteria for the exposures, such as maximum risk weights, granularity levels and sound underwriting standards.
The EBA said that if an ABS product met requirements on both levels, it should be granted lower capital charges, regardless of where it lies in the seniority spectrum, which would reliance on external rating.
The EBA builds its criteria on three pillars: simplicity, standardisation and transparency.
Criteria under the first pillar include meeting the definition of securitisation in the Capital Requirements Regulation, for securitisations to be traditional (imply legal and economic transfer) and to exclude re-securitisations.
It also wants to rule out deals with active portfolio management on a discretionary basis, wants deals to be characterised by legal true sale without clawback, be backed by homogenous assets, exclude deals with disputes between the originator and borrower (also exclude defaults and credit-impaired borrowers) and be backed by assets where at least one payment has been made.
The second pillar of standard securitisation requires compliance with risk retention rules, full mitigation of currency and interest rate risks and that payments be referenced to commonly used market interest rates.
In addition, deals with revolving periods should include early amortisation or termination triggers and, in the event of a performance-related trigger or an event of default/acceleration, the securitisation should be repaid sequentially with no provisions for immediate liquidation.
The documents must also clearly specify contractual obligations, have provisions for an 'identified person' with fiduciary responsibilities and require the management of the servicer to demonstrate expertise in this field.
As for transparency, the third pillar, the EBA says the securitisation should comply with the Prospectus Directive, meet disclosure requirements and provide investors with access to all documents where legally possible. It also calls for clear and consistent definitions of remedies and actions relating to delinquencies, and to be independently verifiable.
The EBA also wants investors to have loan-level data and be given access to historical default data for similar exposures to those being securitised. It also calls for reporting at least quarterly. IFR