The European Central Bank has pushed back on a sweeping package of proposals aimed at overhauling Europe’s securitisation regulation.

In a 23-page report published on 11 November, the ECB said it broadly supported the mooted package of reforms, but opposed what many in the market say would be the most impactful prudential changes.

“The ECB says it agrees with the reforms, but it disagrees with all of the specific points that matter,” said Véronique Ormezzano, chair of the Paris Europlace European Financial Regulation Committee and former head of regulatory affairs at BNP Paribas.

While the ECB supported several operational reforms, it raised concerns over the proposed risk-weight floor change, arguing that this could allow “excessively low” risk weights on senior tranches that would not account for the idiosyncratic risks of securitisations. It also took issue with plans to allow insurers to more easily participate in synthetic securitisations.

However, market participants spoken to by Debtwire said that the report overstates or misinterprets risks posed by securitisation – particularly synthetic transactions – and that the report could fuel opposition to the reforms.

“It’s ammunition to those in Parliament that are always going to look askance at amending the capital rules,” said Neil Hamilton, partner at Mayer Brown.  “I’m hoping that it doesn’t change the fundamental direction of travel.”

The report was following a request from the European Council and Parliament, and will inform policymakers as the proposals move towards the next stage of the legislative process.

Published by the European Commission in June, the proposals aim to remove operational and prudential barriers to securitisation, with the aim of boosting lending to the real economy.

The report’s “broadly constructive” tone is helpful but the ECB’s “over-conservatism” when it comes to prudential reforms are concerning, said Remi Kireche, director of advocacy at trade association Association for Financial Markets in Europe. “A more balanced approach would help unlock much-needed capacity without compromising the safety or resilience of the European banking system.”

Fixed floors

Risk weight floors are a big area of contention. The floor effectively set a minimum capital charge on securitised positions. A higher risk-weight floor makes it trickier to securitise low risk assets, like mortgages.

In its original proposals, the Commission argued for introducing a risk-sensitive risk weight floor that would be based on the underlying assets rather than simply relying on fixed limits.

In practice, this could lower the floor below levels seen in securitisations before the financial crisis, the ECB said, and may not account for agency and model risk. It instead proposes a fixed 7% floor for transactions deemed both ‘resilient’ and Simple, Transparent and Standardised.

It’s a view that Georges Duponcheele, senior credit portfolio manager at Great Lakes Insurance, a wholly owned subsidiary of Munich Re, describes as “disheartening.”

“If one implements as a sole reduction a fixed floor at 7% only for originators and resilient STS transactions then the increase in financing the Commission hopes will be marginal,” said Duponcheele, who co-chairs the Paris Europlace Securitisation Committee Experts Subgroup on Prudential Regulation.

Under the microscope

Synthetic securitisations faced particular scrutiny in the ECB’s report.

In a synthetic SRT, banks secure capital relief by shifting the credit risk of a portfolio to third-party investors.

The report warned that synthetic deals involve higher refinancing risk, can increase bank leverage, and may fail to deliver capital relief in stress conditions if collateral is weak. The ECB instead favours true-sale securitisations, which also supply funding.

However, the rollover risk cited by the ECB is overstated said Ormezzano, who previously worked as head of regulatory affairs at BNP Paribas. Annual outstanding SRT rollovers represent just 0.4% of overall EU bank lending books, according to data from the International Association of Credit Portfolio Managers. Many investors in the market are specialised managers, pension funds and insurers, who will continue to take risk regardless of broader financial conditions, Ormezzano said.

Rising SRT issuance is also cause for concern, the ECB said. As reported, the market has grown quickly from a low base over the past few years, with industry participants estimating an approximate 20% growth in issuance year-on-year over the past five years.

That the ECB takes issue with the growth of the market, when it manually approves or rejects every SRT transaction, has raised eyebrows from some in the industry.

“There is not one SRT transaction in the Euro area that doesn’t require the greenlight from the ECB,” said Ormezzano, “It’s really surprising that they seem to be uncomfortable with things they are approving on a day-to-day basis.”

At the heart of the ECB’s preference for conventional securitisations is its belief that synthetic SRT does not stimulate lending to the real economy – a criticism that many in the industry have pushed back against.

In the German market, for example, banks have typically used true sale securitisations for consumer exposures, while synthetic SRT has been the go-to for corporate exposures.

“If they want to transfer more risks out of the banking system, and to distribute them appropriately, then of course we also need to look at synthetics,” said Barbara Lauer, partner at Linklaters.

To say that synthetic securitisation does not finance the European economy is “very wrong”, said Ormezzano. “It assumes that the financing of the European economy is a question of access to liquidity. But it is not just a question of liquidity – it’s mainly a question of capital, which synthetic SRT provides.”

The ECB also voiced scepticism about allowing insurers to play a bigger role in the SRT market.

Under current rules, non-life insurers cannot write credit protection on SRT transactions that are both Simplified, Transparent, and Standardised (STS) and unfunded – meaning that the insurer does not have to stump up collateral to the issuing bank.

Insurers argue that this narrows the potential range of SRT counterparties. Banks gain more capital relief on STS-labelled deals, and insurers find it trickier to engage in unfunded deals altogether because they write credit protection from the liability side of their balance sheet.

But the ECB has thrown a spanner in the works for insurers keen to write more credit protection by opposing unfunded STS SRT altogether. Concentration risks would increase under the Commission’s proposal, the report said, as (re)insurers could become a dominant counterparty to banks issuing SRT transactions.

Those fears appear greatly overstated given banks’ internal risk appetite and management, said Jo Goulbourne Ranero, consultant at A&O Shearman. In contrast to the ECB, insurer participation in STS deals would strengthen financial stability by broadening the range of counterparties beyond a universe of specialist funded providers.

“Ultimately, if the EU wants the benefit of insurer funds to facilitate increased bank lending to the EU real economy, there is a need to accept the unfunded nature of insurers’ participation,” said Ranero.

“You cannot be worried about refinancing risk and financial stability, as well as potential market concentration, and at the same time not welcome the participation of the most resilient, most diversified, through the cycle, counterparties – non-life insurance companies,” said Ormezzano.

One section of the report repeats an error previously included in a European Systemic Risk Board paper published earlier this years. It warns of a ‘rating cliff’ for insurers participating in SRT deals. If an insurance counterparty to an SRT transaction is downgraded below Credit Quality Step 3 – roughly equivalent to a low investment grade rating – then the capital relief the bank gains through the SRT would disappear.

But the ‘rating cliff’ effect discussed in the ESRB report was a feature of the Capital Requirements Regulation II – and was removed when CRR III came into force at the beginning of this year.

More concerning, Duponcheele argues, is that one of the ECB’s proposed amendments would reintroduce this ‘rating cliff’ risk.

“This is a toxic amendment, because it is trying to reintroduce a risk that has disappeared: the cancellation of capital relief for banks upon the downgrade of an insurer below CQS3,” he said.  “I hope that policymakers understand that this would risk regulation-induced instability; that risk should absolutely not be reintroduced.”

Low hanging fruit

Where the ECB finds the most common ground with the Commission’s proposals is on operational reforms. Many of these are “easy wins,” said Lauer: aspects of the proposal that industry had pushed back on.

A mooted of ‘public’ and ‘private’ securitisations, that could have forced CLOs and CMBS to report as public deals, was dismissed by the ECB.

Similarly, it backs the removal of a ‘cliff edge’ effect for resilient securitisations. Under the initial proposal, securitisations labelled ‘resilient’ would be tested on an ongoing basis. If a securitisation failed to meet the resilient criteria, then it would be stripped of the label and all its capital benefits – creating a so-called cliff edge risk. Instead, the ECB backed a ‘day one’ test checks whether securitisations are ‘resilient’-eligible when they are issued.