Yves Mersch: Next steps for European securitisation markets
Speech by Mr Yves Mersch, Member of the Executive Board of the European Central Bank,
at the Information Management Network (IMN) Global ABS Conference, Barcelona, 11 June
2014.
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Ladies and gentlemen,
It is a pleasure to be here with you at the 2014 Global ABS Conference.
Over the last year ABS have become a major focus of discussion within European
policymaking circles. There is a growing consensus that an instrument once seen as part of
the problem could in fact be part of the solution. I am therefore happy to see that the
conference agenda contains many sessions touching on the key issues we are thinking
about, such as regulation and economic growth. I am sure there will be several useful
insights we can draw on.
In my remarks today I would like to provide you with the ECB's perspective on securitisation
markets and how they fit within our overarching objectives. I also want to offer some further
proposals and thoughts on how to stimulate European ABS markets, which I hope will
provide some food for thought over the remainder of the conference.
The Eurosystem's interest in securitisation markets
Let me start with the ECB's perspective. As you may know, in recent months the ECB has
put a great deal of public focus on reviving the European ABS market. Why are we so
interested in this particular market segment?
There are three parts to the answer: price stability, financial stability, and the stability of our
balance sheet.
First, and most importantly, we see ABS as a means to an end, and that end is achieving our
primary objective of price stability. ABS provide a channel for the funds of liquidity-rich bank
or non-bank investors to reach the real economy, in particular its more opaque segments. By
stimulating further credit creation, which in turn feeds into consumer prices, this supports the
transmission of monetary policy and the fulfilment of our mandate. This mechanism is useful
at any stage of the cycle, but especially in an environment of low interest rates and low
inflation as we see today.
It is in this context that the Governing Council decided last week to intensify preparatory work
related to outright purchases in the ABS market. Under this initiative, the Eurosystem might
consider purchasing simple and transparent ABS with underlying assets consisting of claims
against the euro area non-financial private sector. Moreover, we see longer-term monetary
policy benefits to a stronger ABS market: firms that are less reliant on bank finance in future
downturns, and banks that are less constrained in their lending decisions by their capacity to
hold credit risk.
The second reason for our interest in ABS is their potential financial stability role. Of course,
we know that overly-complex and opaque ABS, particularly in the US, contributed to the
financial instability witnessed in 2007 and 2008. But as I have long argued, alongside other
policymakers, simple and transparent instruments can spread well-understood risk across
different financial actors and hence play a stabilising role. As ABS can be customised, for
example in terms of asset exposure, geography, and maturity, they can satisfy the needs of
most non-bank investors, whether a pension fund, an insurer, or an asset manager. And
sharing credit risk among the non-bank sector is important because, in a severe market
disruption, the correlation between banks and non-banks' financial health is likely to be lower
than the within-banking industry correlation.
Finally, the ECB takes a close interest in ABS because they are an important component of
the Eurosystem's own balance sheet. As of the end of March this year, 307 billion of ABS
collateral was pledged, amounting to 15% of the total pledged collateral for Eurosystem
operations. If a counterparty were to default on its obligations, the Eurosystem would gain
ownership of this ABS collateral and would then seek to liquidate it in secondary ABS
markets without incurring a loss. Thus, we have a strong interest in ensuring that ABS is a
safe and transparent asset class traded in well-functioning, liquid markets.
So these are the reasons why the ECB sees ABS as deserving specific attention. Let me
add, however, that the ECB does not believe that ABS should warrant special treatment
where it is not justified from a theoretical, empirical and practical perspective. The ECB is
interested in ABS insofar as they can help us achieve our policy objectives in compliance
with our legal obligations, while ensuring risk equivalence in our collateral framework. In
other words, supporting the ABS market is not an end itself. If the ABS market benefits along
the way to securing our objectives, so much the better, but we do not a priori favour any one
type of financial instrument over another.
Still, it is no secret that, broadly speaking, European securitisation markets are not doing too
well. Market-placed issuance is low, trading is thin in some segments, the size of the investor
base has not recovered and various conservative regulations are under discussion. What
can be done to revitalise securitisation markets in this context?
Proposals to unblock European ABS markets
Much has already been written on this topic and I will not attempt to repeat all the arguments
in the limited time we have today. I would like instead to offer three proposals that I see as
important to keep moving the debate forward. These relate to the regulatory treatment of
ABS, transparency and standardisation requirements and the treatment of ABS by credit
rating agencies. The proposals should be seen as complementary to the suggestions made
elsewhere, including the recent joint discussion paper from the ECB and the Bank of
England.
Regulatory treatment
My first proposal to revive EU ABS markets is to find a more holistic approach to their
regulatory treatment. There has been a lot of discussion about various individual issues
related to ABS: for example, excessive securitisation capital charges, transparency and risk
retention improvements, higher credit enhancement requirements, as well as the current
liquidity rule proposals, which I see as overly constraining. And regulators have responded
by making efforts to overhaul the securitisation capital framework, categorise ABS in liquidity
categories, finalise securitisation capital requirements for insurers, and reform transparency
and disclosure requirements for these instruments.
In my view, however, this focus on discrete issues is causing us to miss their continuous
dimension. There is still a sense that the regulatory agenda is proceeding in an
uncoordinated manner.
One example concerns "high quality" treatment across regulations. The BCBS' efforts to
finalise the securitisation capital framework before end-2014 will not consider "high quality"
preferential treatment. In a few weeks, however, the European Commission must identify
which ABS are "high quality and liquid" in the Liquidity Coverage Ratio.
Another example concerns transparency requirements across asset classes. Substantial
efforts are underway to further improve the transparency and disclosure requirements of ABS
in a pan-EU manner, building on the improvements to ABS transparency brought in by the
ECB's ABS loan-level data templates. Yet, while so much effort is being devoted to
improving transparency over an asset class where substantial progress has already been
made, covered bonds continue to have no common transparency framework and indeed no
common supervisory framework. Nonetheless, they benefit from preferential risk weights in
the Capital Requirements Regulation - which, by the way, deviate from the Basel capital
framework.
Still another example concerns capital requirements across different investors. The proposed
insurer securitisation capital requirements have been set using a spread risk approach
calibrated to 99.5% Value at Risk. By contrast, the bank frameworks are based on a credit
risk approach calibrated to 99.9% Value at Risk. Finally, closer to home, the ECB, Bank of
England, and ESMA are all involved in loan-level data reporting requirements for ABS, where
there appears to be significant but not perfect overlap.
One might reasonably respond that coordinating such an approach would be challenging,
that deadlines are fixed by legislation, and that it is difficult to coordinate simultaneously at
the global, EU, and national levels - especially given the different mandates and scope of the
various parties involved in regulation. However, I believe all of the actors are present and
pieces in place to go down this route.
Indeed, the European Commission, the ECB, the Bank of England, the three European
Supervisory Agencies, and the European Systemic Risk Board, cover the near totality of EU
ABS considerations under discussion at the moment. They also possess many legal powers
to reframe the regulatory debate in a more holistic and sequentially-sensible manner. Would
it be too challenging to regularly align views at least at the EU level, and to speak with a
common voice in global fora? This is already beginning, but much more could be done in my
view.
Transparency and standardisation requirements
My second proposal concerns transparency and standardisation requirements for ABS
products. I wholeheartedly support disclosure for ABS. This is because ABS will always have
the potential to be highly complex, which implies much more room for opacity than other
standard financial products.
As I mentioned, much has already been achieved or envisaged in the area of ABS
transparency: the loan-level data requirements, the proposals by ESMA to have minimum
common information for ABS in a single portal, and reforms mandated in the Prospectus
Directive. Yet we could still streamline the reporting requirements: for example, ABS investor
reports could be standardised to allow a consistent set of information to be provided across
transactions and across time. These same investor reports could also be aligned, in terms of
data cut-off dates, with loan-level data submissions. This would provide greater means for
market participants to verify the accuracy of data provided by issuers and exert market
discipline.
Another interesting area for exploration is the provision of standardised ABS prospectus
templates, including common diagrams, which would allow non-specialised investors greater
ability to make comparisons across products. ABS are of course highly diverse instruments
and so I would not propose to shoe-horn all types into a single form. Rather, the idea is to
provide a common starting template for describing ABS transactions that could then be
departed from as needed.
My concern here is that prospectuses and broader transaction documentation must inform
both legal and financial specialists. Some creative thinking on how to present the information
in an accessible manner may help preserve legal precision while avoiding information
overload. This would build on what I believe are the very helpful ESMA proposals for a
transaction summary.
Looking forward, I believe that greater standardisation of ABS products is a key goal to
stimulate greater market activity. SME ABS, for instance, are widely acknowledged to be
extremely heterogeneous across EU countries, in part reflecting both the type of business
and banking relationships that prevail in each jurisdiction. Any efforts that could be made to
enhance the transparency and consistency of ABS structures could, I believe, provide
greater comfort to investors reluctant to take the plunge into these instruments.
Treatment of ABS by credit rating agencies
My third proposal relates to the treatment of European ABS by credit ratings agencies.
Currently many ABS in stressed economies are constrained by the rating of the
corresponding sovereign. The rationale put forward by rating agencies is that there are
immitigable risks that affect all issuers and assets in a particular country, above all the
sovereign. As regards calibration, some quantitative and many qualitative factors are taken
into account by the agencies when setting this ceiling. Yet, I question whether this ceiling is
appropriate.
For example, I am not aware of any defaults on Greek RMBS or ABS transactions, despite
the partial sovereign debt exchange in 2012. Or, in Italy, the vast majority of RMBSs appear
to be constrained by the sovereign ceiling despite an average of 25% current credit
enhancement. And, from my latest check, the ECB's Composite Index of Systemic Stress for
the euro area is around the 5th percentile of the distribution since January 1999 and six
times lower than the median from 2010 to 2012. This suggests that many of the systemic
risks used to justify the country ceiling approach seem far off.
From all these examples, and others, I find it hard to believe that the redenomination risk that
is driving so many sovereign ceilings still justifies such stringent caps. Moreover, I am not
fully reassured that there is no double counting taking place in these calculations: in other
words, that country credit risk is not already being captured in the credit risk assessment of
the pool and third parties to an ABS transaction.
Be that as it may, I recognise that it is the rating agencies' prerogative to decide on the best
methodologies to assess risks and that these methodologies will not change overnight. I do
believe nonetheless that providing more transparency on how ratings are derived and, in
particular, disclosing ratings absent the sovereign ceiling to investors could certainly help, as
suggested in our recent paper with the Bank of England.
This proposal is underpinned by my conviction that it is investors who should decide whether
to apply the sovereign cap or not when assessing a transaction. In fact, I would argue that
rating agencies should publish the ratings absent any cap - whether for a sovereign, swap
counterparty, account provider, or other entity - and then add on the caps in a building block
approach, all for the sake of clarity. And, in my view, it behoves the rating agencies to
provide more transparency on the precise methodologies for determining and applying
sovereign ceilings, given the impact of these measures on the structured finance market.
This points to the important role that market participants themselves have to play in reviving
European ABS. It is one thing for regulators to improve transparency or credit ratings
agencies to provide more granular information; it is another for market participants to analyse
it and trade on it.
For example, I recommend that market participants look closely at what the ECB is doing
with our loan-level data initiative. We are providing much higher quality information on which
they can make informed credit risk assessments of ABS, either on the basis of the individual
underlying loans, or on the basis of the summary information made available in the
respective data repositories.
I realise that there is no free lunch, and that there are financial and resource implications to
such detailed scrutiny. But I am convinced that the more market participants "get their hands'
dirty", the more the ABS market as a whole will benefit. This is because more informed
market participants means greater discipline for data providers, less automatic reliance on
others' opinions, and greater awareness of gaps in the transparency requirements across
financial products.
Conclusion
Let me conclude.
The Eurosystem places great importance on the health of European ABS markets. ABS are
an important means to achieve our policy objectives in a prudent manner, which could be
achieved either by ensuring the applicable haircuts or by outright purchases in this market.
Our decision to intensify the preparations could help to catalyse new securitisation activity.
But for a virtuous circle to take hold, the regulatory and market barriers that are preventing
the revitalisation of European ABS markets need to come down in tandem.
Much work is already on-going to improve the environment for ABS issuance. What I have
tried to outline today is several practical steps that can be taken to take this work forward. I
believe that a holistic and coordinated approach among EU policy-makers, as well as greater
standardisation and more methodological transparency by rating agencies, could help
encourage the revival of the ABS market that we all want to see.
Thank you for your attention.