David Rule: Simple, transparent and comparable securitisation
Speech by Mr David Rule, Executive Director for Prudential Policy of the Bank of England, at
Global ABS, Barcelona, 17 June 2015.
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Thank you for inviting me to speak at Global ABS 2015. For the past couple of years the
Bank of England has been working with the ECB to consider what can be done to foster the
development of robust and well-functioning securitisation markets in the EU. Last year we
published a joint discussion paper1 and received helpful feedback from a wide range of
commentators. One theme was support for defining the characteristics of simple, transparent
and comparable securitisation - more on that in a moment. More recently, we published a
joint response2 in support of the European Commission's consultation on securitisation and
look forward to the Commission's forthcoming legislative proposals.
A key objective of the Capital Markets Union in Europe is a financial system in which stable
market-based funding complements bank lending as a source of finance for the economy.
Securitisation can be an important part of that stable, market-based funding, alongside other
markets such as equities, bonds and private placements. Banks can use securitisation to
diversify their funding and transfer risk on underlying loans. Importantly, non-banks can also
finance lending through securitisation.
Banks and non-banks can use securitisation to help match the maturity of their liabilities to
their assets. This is particularly important in the context of housing finance. Residential
mortgage-backed securitisation (RMBS) was the largest part of the EU market before the
financial crisis and the subsequent decline in the overall market is primarily explained by the
fall in RMBS issuance. A large part of that decline may be explained by fundamentals -
banks have cheaper ways to finance themselves at present. But, in the long run, I think we
will need robust RMBS markets so that at least part of the risk on long-term housing lending
is financed from long-term savings rather than short-term bank deposits.
I prefer to focus on the long-term goal of building sustainable securitisation markets rather
than reviving securitisation in the short run. Comparing current issuance with pre-crisis levels
misses the point that the pre-crisis market was fragile, based on investment by leveraged
funds and bank treasuries. Building a stable market will require a broader, real money
investor base.
The market also needs to be based on genuine risk transfer not regulatory arbitrage, such as
synthetic sales of thin mezzanine tranches intended to maximise the reduction in regulatory
capital at minimum cost. I hope the future will be transactions in which banks look to sell
down the capital structure, subject to meeting risk retention requirements. Transferring the
entire risk on a portfolio will be the only way to achieve a reduction in the exposure measure
used for the leverage ratio. And the new Basel risk-weighted capital requirements announced
in December also move in the direction of incentivising transfer of senior as well as
mezzanine tranches of portfolios.
I said I would come back to Simple, Transparent and Comparable (STC) securitisation.
Unfortunately, we have done our best to confuse people by using a bewildering range of
acronyms and terms for this project - STC, SST, STS, qualifying, high quality etc. Today I
am using the STC term developed by the taskforce of global banking and securities
regulators that I co-chair. But I can reassure you that these will be brought together into a
single set of criteria in European legislation. I believe the intention is that they will then be
applied consistently across different sectors - for example, banks, insurers and funds - and
different regulations - for example capital and liquidity.
I see the aims of the STC criteria as threefold. First, to help investors. An STC securitisation
should meet the "What You See Is What You Get" principle. The structure should not have
hidden traps or complications, allowing investors to focus on analysing the credit quality of
the underlying assets. But, importantly, the STC criteria are not a credit opinion on those
assets and STC will certainly not mean "risk free". Second, to help issuers. As well as
potentially helping to broaden the range of investors, the STC criteria should make risk
transfer more robust. And third, to help regulators. Setting risk sensitive capital requirements
for securitisation tranches is challenging. One solution is to use credit ratings but the
shortcomings of that approach were exposed during the crisis. Another is to use a regulatory
formula capturing dimensions of risk such as the credit quality of the underlying pool, tranche
seniority and maturity. In our view, including a differentiation based on STC in that capital
calculation helps to capture other important dimensions of risk related to structure,
transparency and governance.
Because one of our objectives is to broaden the investor base, it is important that the STC
designation makes things simpler for investors, particularly non-banks. For example, they
should be able to place greater reliance on it when conducting their own due diligence on
matters covered by the STC criteria, such as risk retention. Investors would thus be in a
position to concentrate with more confidence on other, existing due diligence requirements,
such as in relation to the creditworthiness of the underlying assets and cash flows
characteristics.
The implementation process for the STC designation is therefore important. In our view, the
primary obligation should be on the originator to attest compliance with the criteria. But this
needs to be in the context of a regulatory regime with effective supervisory oversight and
sanctions.
We must also be careful not to label all non-STC transactions as "bad". There should be a
continuing place in the market for many transactions that do not qualify for the STC
designation, including synthetic transactions, managed portfolios and pools that do not meet
the granularity requirements.
Turning to capital requirements, looking at historical losses on securitisation tranches, we
think the calibration of bank capital requirements that the Basel Committee published in
December is broadly right. But there is a case for some lowering of capital requirements for
STC transactions on the grounds of lower structure risk.
A stronger argument can be made that Solvency 2 standardised capital requirements for EU
insurers are still too high, especially at longer maturities - although it should be noted that
these will not apply to insurers using internal models. For banks and insurers, part of the
issue with securitisation capital requirements is the comparison with covered bonds, which
tend to be treated favourably in EU regulation. Issuers looking to raise secured funding may
therefore see covered bonds as a more cost effective alternative to securitisation. Covered
bonds have a legitimate role in the market as a source of stable long-term funding. But
securitisation has the advantages of risk transfer and lower encumbrance of underlying
assets. We would support moves to put securitisation and covered bonds on a more level
playing field.
To conclude, we support the European Commission's current work on an EU framework for
securitisation as part of the longer-term objective of growth in stable, market-based financing
markets alongside bank lending. A uniform set of criteria for STC securitisation can play an
essential role in de-stigmatising European securitisation, helping the market to develop on a
sustainable track and attracting a broader investor base.