10th November 2015

STS securitisation – a way ahead

Written by Simon Hills, Executive Director, Prudential Regulation and Risk

At a meeting yesterday in Amsterdam I spoke with banking colleagues from around Europe about the European Commission’s proposals on simple, transparent, standardised securitisations (STS). These are a key part of its Capital Markets Union package designed to rebalance the funding of EU corporates and SMEs, making them less reliant on banking funding which may turn down in a future period of economic stress as well as underpinning infrastructure finance.

Banks are keen to get their teeth into a revived securitisation market so that they can play their part in helping corporate Europe in its drive to support jobs and growth.

The Commission’s parallel initiative to reasses the capital weighting of insurance companies and investment funds’ holdings of STS securitisations is welcome too as it will widen the potential investor base. But our discussions in the Netherlands also reminded me that securitisations were a couple of years ago accepted as High Quality Liquid assets (HQLA) which can contribute to their meeting the required Liquidity Coverage Ratio (LCR).

The BBA has been a strong supporter of widening the range of HQLAs to include other assets such as covered bonds and securitisations. This has benefits for the banking system as a whole in that most banks have the bulk of their HQLA requirement invested in sovereign bonds issued by their own country’s government, creating a significant concentration risk which could impede the operation of any future Europe-wide Deposit Guarantee scheme. Greater appetite from banks as investors for HQLA purposes will in term deepen the market in Europe for securitisations.

But there are a number of impediments to greater holdings by banks of securitisations in their HQLA buffer.

The first is the capital calculation methodology. Assets held to satisfy LCR requirements properly have to have capital held against them to guard against the risk of unexpected loss. But the current risk weighting methodology finalised by the Basel Committee on Banking Supervision (BCBS)  in December last year, requires banks to use the external rating based approach (SEC-ERBA) in preference to the standardised approach (SEC-SA) for risk weighting purposes.

As I suggested in my 18 February blog, this needs to be reexamined to reverse the hierarchy so that banks can use the SEC-SA in preference to the SEC-ERBA. However today’s consultation by the Basel Committee on revisions to its methodology for calculating risk weightings including a possible recalibration of the SEC-ERBA curve may provide a solution that would avoid Europe having to go it alone. Both the Commission and BBA members prefer alignment with agreed international national standards. The efficacy of this recalibration will not be fully understood until a quantitative impact study has been undertaken and the results analysed.

What if the results of the BCBS’s deliberation don’t sufficiently incentivise STS securitisations? As an alternative for capital calculation purposes, I would like banks to be allowed a degree of flexibility permitting them to apply the SEC-SA for their HQLA holdings where the capital requirements of applying the SEC-ERBA would be substantially higher and the bank’s supervisor agreed with this assessment. This could be further constrained by applying it only to STS securitisations.

A second issue relates to the proportion of securitisations that can be held in the LCR buffer. At present only 15% of the total LCR requirement can be held in securitisations, yet covered bonds – somewhat analogous to securitisation structures – can comprise a much higher proportion of HQLAs. Is it time to allow a greater proportion of securitisation to be included in the HQLA to encourage greater diversification, particularly if they are STS compliant?

And a final issue relates to the treatment of securitisations which makes it very difficult for banks to deconsolidate them for accounting purposes – which has a knock on impact on leverage ratio calculation.

So my discussions in Amsterdam yesterday were strangely prescient of today’s BCBS consultation on recalibrating securitisation risk weighting methodologies. This hopefully will redress the imbalance between SEC-ERBA and SEC-SA making STS a more attractive HQLA instrument, thus broadening and deepening the pool of potential investors. This can only support the Capital Union objective of reviving the European market for securitisations for the good of jobs and growth in the EU.

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