The European Commission published new rules on Friday to encourage more securitisation of assets such as car and consumer loans and small business loans as part of a drive to channel more funds into the flagging European economy. The new rules form part of laws designed to make banks better able to withstand shocks, and to keep insurers solvent.
Reviving securitisation - where loans are pooled to underpin a security which pays out money from repayments of the loans - is part of the EU's new flagship capital markets union project to encourage fledgling companies to turn to markets for funding rather relying too much on banks. Banks have long dominated funding for companies but lenders have become more cautious as they must comply with new rules to increase their capital levels so that taxpayers won't have to bail them out again in another crisis.
The European Commission, the EU's executive body has included the new rules as part of two so-called delegated acts, one on insurance solvency and the other on bank liquidity. Combined they represent the EU's first regulatory action to revive and restructure asset-backed securities (ABS), a sector tainted by ABS linked to poor quality US home loans turning toxic in 2007, sowing the seeds of the global financial crisis.
"They show that Europe is serious about creating a framework to support investment in the economy, particularly through promoting safe and transparent securitisation and encouraging insurers to invest for the long term," EU financial services chief Michel Barnier said in a statement. The European Central Bank (ECB) is also planning to buy chunks of ABS in coming months as a way of injecting money into the weak euro zone economy and giving the ABS market a confidence boost.
The EU, along with the ECB and the Bank of England, also wants to promote a high quality market segment that would benefit from lower capital charges for banks that originate the security, and for insurers and others that buy it. Banks have cautioned that the demarcation line between top quality ABS and the rest must be handled sensitively to avoid a sizeable chunk of the market being sidelined. The delegated act on insurer solvency comes into force in January 2016 to allow a lighter capital treatment for top rated ABS bought by insurers.
The European Commission said it would incentivise insurers, acting as investors, to channel more funds into safe, simple and transparent securitisation markets in Europe, contributing to their development and liquidity. "This is the first attempt in the European Union to define high quality securitisation," said Cristina Mihai, a policy adviser at Insurance Europe, which represents the bloc's insurance companies.
Top quality securitisation includes only the most senior tranches of simple, top rated ABS and excludes complex varieties such as collateralised debt obligations. The second delegated act details the assets banks can hold in new mandatory buffers by January 2018 to withstand rocky markets unaided for up to month.
It aims to encourage issuance by endorsing a wide range of ABS that can be included in a bank's liquidity buffer. Allowing pooled debt based on car and consumer loans, and loans to small and medium sized companies, will breach globally agreed rules known as Basel III which limit ABS to residential mortgage backed securities in a bank's liquidity buffer. As expected, a much larger chunk of a bank's liquidity buffer can also be in the form of covered bonds - an asset similar to ABS but seen as safer - than allowed under Basel III.
Denmark, which has a large covered bond market, had pressed Brussels hard for this concession. The Commission said Basel failed to give adequate recognition to certain specific assets which have demonstrated high liquidity in the EU, such as auto loan-backed ABS.
A broader pool of securitised assets will reduce the risk of excessive concentration on one type of ABS, the Commission said. There is no global law to make Basel legally binding. "It is imperative that Europe gets a high quality liquid securitisation framework working. This will free up more lending capacity and will be essential when central banks exit from quantitative easing," said Patricia Jackson, head of financial regulatory advice at consultancy EY.
The Commission also published a third delegated act that details how banks must comply with a new leverage ratio, a measure of a bank's assets in relation to all of its assets. A decision on whether or not to introduce a binding leverage ratio will only be made in 2016, the EU executive said.
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