Sunday, August 24, 2014

Securitization in Europe – Overcome current impediments to boost the economy?

Roughly six years ago, the whole world learned about securitization and how it had destroyed the world economy. It will not be a surprise for you that securitization markets have, since the financial crisis, shrunk substantially. This is especially true in Europe.

Today, the European Central Bank and the Bank of England want to change this situation. They have taken a joint initiative to explain why securitization is important and how we can revitalize it in Europe.

The securitization market in the EU continues to be impaired.”

The European asset backed securities (ABS) market remains small, shrinks, and is mostly concentrated in a few jurisdictions. Two figures underline this statement:

  • Today, ABS of around 1,500 BEUR are outstanding in the EU. The absolute figure doesn't matter here. Just keep in mind that this is 67 % of the ABS peak in Europe (2,250 BEUR) and roughly 25 % of today's U.S. ABS market.
  • New issues of ABS in Europe are constantly declining since 2008: In 2013, less than 200 BEUR were issued which is roughly 25 % of Europe's 2008 peak.

Why should Europe care about securitization?

Europe should care because securitization

  • is ,despite all we have heard about it, a good financial instrument: As a matter of fact, most European structured finance products performed well throughout the financial crisis. Default rates between Q3 2007 and Q3 2013 were only about 0.05 %.
  • , if appropriately structured and regulated, can complement other long-term wholesale funding sources for the real economy, including for small and medium-sized enterprises (SMEs). The buzzword here is “diversification of funding base”.
  • can tansfrom relatively illiquid assets into more liquid securities and, thus, make them more attractive to investors.
  • can customize cash flows and risk exposures, creating different asset pools and investment tranches.
  • can support both monetary and financial stability.
  • disciplines the issuer willing to operate a securitization as he must collect and disseminate substantial amounts of information for the deal.
  • is a good compromise between capital-markets based lending and bank lending. This is especially true for SMEs and residential and commercial real estate borrowers.
  • allows banks to transfer risk.

How can Europe develop securitization?


Why is securitization not more successful today? The reason is eightfold:

  • Investing in securitized assets comes with a stigma, because it has an adverse reputation among investors and because regulators and standard-setters are conservative.
  • In addition, investors are more risk-averse than before the 2008 financial crisis and question sponsor support in securitization structures.
  • ABS and securitization lack transparency and harmonization across European jurisdictions.
  • Due to regulation (namely Solvency II insurance standards), investors may be deterred from holding ABS on their balance sheet. The same is true, on the other end of the investment chain, for banks, which are unsure about capital relief which securitization may or may not grant.
  • Some pools of assets are difficult to securitize, because historical data on significant asset pools fall short.
  • Historically, trading volume in ABS has been low, leading to low liquidity of ABS investments.
  • The need for securitization is less important in Europe than in the U.S., given Europe's deep covered bond markets.
  • Structuring securitization deals requires costly IT systems; smaller banks and non-bank companies may shun such fixed costs.


The European and U.K. central banks suggest six principal ways to develop securitization in Europe:

  • Risk retention rules have already been introduced to ensure that originators of securitizations maintain skin in the game.
  • Transparency is key to address information asymmetry between originator and investor in securitizations. Namely, credit registers for all asset classes would allow investors to better compare the performance of underlying financial instruments.
  • Rating agencies should act more transparently and be held accountable for their ratings.
  • Regulators across Europe should treat securitized assets consistently. What's more, holding ABS on a bank's balance sheet should not have negative consequences for the bank's liquidity ratios.
  • Securitization structures must become simple, with well-identified and transparent underlying asset pools with predictable performance. Investors must be capable “to model and understand with confidence the risks incurred”; for example through reading standardized prospectuses and investor reports.
  • Every securitization should be backed by a real economy asset. This, by definition, bans re-securitizations.

Some quotes

The ideas of the reports are interesting, even though they remain a bit vague. Let's wait and see if and how they will be put in practice.


Friday, August 15, 2014

Economic Sanctions III – When can the UN impose economic sanctions?

As we have seen in the last two posts, economic sanctions can be taken by sovereigns against one-another. In addition, the UN can also impose sanctions on a single country.

This type of sanction is not only the most effective (“All UN countries against one country.”) but also the most difficult to obtain. The reason is that a UN sanction requires a Security Council resolution, decided either unanimously or by some UN member states.

UN sanctions intend protecting international peace and security. They can take the form of interruptions of economic relations, arms embargoes, travel restrictions, aviation bans, communication restrictions, and financial restrictions.

When elaborating sanctions, the UN Security Council must

  • duly consider the feasibility and the implications of targeted sanctions;
  • be clear about the behavior it intends to change;
  • clearly define the scope of the sanctions and how they can be eased or lifted;
  • put up a credible mechanism to monitor the sanctions regime.


Tuesday, August 12, 2014

Western / Russian Sanctions – A story about national security, political stability, and retaliation

Last time, I promised to compensate for my rather academic post on sanctions. So how do current Ukraine-related sanctions fit the scheme I described a few days ago?

Who has imposed which sanctions so far?

Since March 5, 2014, the Council of the European Union adopted several conclusions, freezing funds of Russian citizens identified as responsible for misappropriation of Ukrainian state funds. The Council also imposed travel restrictions. On July 29, 2014, the EU expanded the sanctions. It now limits access to EU capital markets for some Russian financial institutions and corporations, imposes embargoes on trade in arms, and limits transfer of technologies.

Since March 10, 2014, the U.S. Government blocks U.S. assets of persons involved in undermining democracy in the Ukraine and prohibits these persons entering the U.S.

On August 7, 2014, the Russian Government responded by banning imports of agricultural produce, raw materials, and food products from the U.S., the EU, Canada, Australia, and Norway.

Why have sanctions been taken and what do they intend to achieve?

On the U.S. side, the Government sees a national emergency:

“The actions and policies of persons, including persons who have asserted governmental authority in the Crimean region without the authorization of the Government of Ukraine, that undermine democratic processes and institutions in Ukraine, threaten its peace, security, stability, sovereignty, and territorial integrity, and contribute to the misappropriation of its assets, constitute an unusual and extraordinary threat to the national security and foreign policy of the United States.”

What a fabulous sentence! You have to read it at least ten times to know what it means! So let's look at it step by step: The U.S. perceives a threat to its national security and foreign policy. Why? Because foreign (especially Russian) people undermine democratic institutions in Ukraine. At this stage, you can agree with this statement or not; but, at least you have understood it now.

The EU targets maintaining political stability in the region:

“The European Union has important relations with Ukraine and the Russian Federation and stands ready to engage in a frank and open dialogue with them. It has a special responsibility for peace, stability and prosperity in Europe. We will pursue these objectives using all available channels and ask the EU representatives to take all necessary initiatives.”


“The EU again encourages the Ukrainian authorities to implement an inclusive process, to pursue their efforts to ensure free and fair elections and to advance constitutional reform. All human rights violations and acts of violence need to be properly investigated and measures need to be stepped up to combat impunity.”


“The European Union remains committed to uphold the sovereignty and territorial integrity of Ukraine. […] The European Council firmly believes that there is no place for the use of force and coercion to change borders in Europe in the 21st century.”

Russia, in turn, has taken its “special economic measures to ensure the security of the Russian Federation.” Its Prime Minister, Dmitry Medvedev, sees them as retaliatory acts:

“I have repeatedly stated that there is nothing productive about sanctions. We had a hard time deciding on retaliatory measures, and we were forced to make this decision.”


“For a long time, Russia has not responded to the so-called sanctions declared against it by certain countries. Until the last moment, we hoped that our foreign colleagues would realize that sanctions lead to a blind alley, and that no one benefits from them. But they didn’t realize this, and now we have been forced to respond.”

In addition, Russia's Prime Minister says that economic sanctions can stimulate the local economy:

“The retaliatory measures that we are introducing will essentially open up shop shelves for domestic producers. Of course, Russian farmers will have to accomplish a lot and work hard, but this opportunity to launch and expand import substituting production facilities should not be missed. […] I am sure that our market will be filled with fresh quality Russian products, which anyway many Russians prefer to the imported ones.”

Have sanctions been effective?

It is obviously too early to give a clear answer to that question.

Economists of the Institute of International Finance say the direct financial impact of sanctions on Russia is likely to be manageable. In fact, most Russian companies don’t depend specifically on foreign financing in the near term. In the long run, however, this might be different as Western lenders could follow economic sanctions beyond their precise scope of application to avoid any legal risk or stigma attached to financing the Russian economy.

Even in the long run, the Russian central bank might compensate for absent foreign financing. It has already started increasing bank refinancing and broadening the scope of securities and loans acceptable as collateral.

Beyond the issue of foreign financing, the Russian economy might suffer from significant capital outflows (see chart below). This could trigger a further recession of the Russian economy, especially if not compensated for by rising oil prices.

The immediate reaction of financial markets has been mixed so far:

Even though Russia's stock market (here measured by the RTS index) has declined heavily after both announcements of recent sanctions, it is not clear whether this is a sustainable trend.

The same holds true for Russian CDS spreads and government bond yields; they have increased significantly after the announcements of the sanctions.

Russian CDS Spreads

Russia - Government Bond Yields

Finally, the Ruble has experienced a sharp devaluation since the beginning of 2014. However, it seems that only the second announcement of sanctions (in July 2014) has had a significant impact on the currency.


A final thought on the importance of sanctions   
Here is a final chart on the importance Russia plays in today's world economy. I find that interesting to keep in mind when following the current debate of economic consequences of sanctions.


Sunday, August 10, 2014

Economic Sanctions I – What they are, who can impose them, what they can achieve, why they are taken, and when they are effective

Nowadays, you can read, hear, and see about economic sanctions everywhere. But do we always understand what we are talking about? Here are the questions that you probably don’t dare to ask when discussing economic sanctions.

What are economic sanctions?

Economic sanctions are coercive measures taken against one or more countries to force a change in policies or, at least, to demonstrate a country’s opinion about another’s policies. On a continuum of relations among states, they are in the middle between full cooperation and war.

Economic sanctions can take the form of

  • trade embargoes, i.e. restrictions on particular exports or imports (commodities etc.);
  • limitation of foreign assistance, loans, and investments;
  • control or freeze of foreign assets;
  • cancellation of government procurement contracts;
  • negative votes in international institutions;
  • abrogation of trade agreements and other bilateral accords;
  • limitation of aviation, maritime, or surface access.

Who can impose economic sanctions?

One country (unilateral sanctions), several countries (multilateral sanctions), or the United Nations (universal sanctions) can impose economic sanctions. Obviously, the more countries impose a sanction the better are its chances of success.

What can economic sanctions achieve?

By inflicting economic sanctions, a country can

  • condemn a certain behavior,
  • coerce a change in a specific behavior,
  • punish, and
  • dissuade third countries to adopt the same behavior.

Why do states set up economic sanctions?

First of all, economic sanctions can be motivated by defense interests, i.e. the protection of the home country and its citizens against a threat of physical violence.

A state can also pursue economic interests, for example enhancing the home country’s economic well-being.

Likewise, world order interests, for instance maintaining a secure and peaceful international political and economic system, can motivate economic sanctions.

Finally, ideological interests, such as protecting a set of values that the citizens of a nation-state share and believe being universally good, can drive economic sanctions.

(When) are economic sanctions effective?

Notably, many commentators agree on the following statement:

“The effectiveness of sanctions is very difficult to assess because the cost of benefit cannot be considered in vacuum.”

What this means is that international relations are so complex that you cannot reasonably assess what the impact of sanctions is.

However, it seems clear that sanctions can only be effective when credible armed forces are available and ready to be used if required.

“Coercion in the economic realm can force compliance in the political realm.”

In addition,

  • compliance with economic sanctions should not be too difficult to obtain,
  • the objectives should be clear and not shift over time, and
  • the target state must be vulnerable.

This was a bit stodgy, I know. Next time, we will bring these concepts to life by looking at the current relationship between Russia and the West.


Sunday, August 3, 2014

Support business vs. free enterprise – Should the U.S. Export Import Bank disappear?

On February 2, 1934, Franklin D. Roosevelt signed an executive order forging the U.S. Export Import Bank (Ex-Im). At that time, the U.S. faced “emergency by reason of widespread unemployment and disorganization of industry” (quote from the executive order). Ex-Im should help tackling this problem.

Today, 80 years after its birth, Ex-Im might disappear. Its current charter lapses on September 30, 2014 and some U.S. congressmen advocate not expanding it.

Even though its abolishment would come as a big surprise, it is still worthwhile to follow the debate as it provides compelling insights into why export credit agencies exist or, if you take the opposite view, should disappear.


Ex-Im had, since its origin, the mission “to aid in financing and to facilitate exports and imports and the exchange of commodities between the United States and other nations” (extract from the executive order).

Today, it serves four product types:

  • The bank grants direct loans to foreign buyers of U.S. products.
  • Ex-Im issues working capital guarantees to U.S. exporters to ensure that the latter can finance raw material, labor, etc. to produce goods.
  • It delivers loan guarantees, ensuring foreign buyers’ debt obligations incurred for the purchase of U.S. exports.
  • Finally, Ex-Im offers export credit insurance, covering a credit to a foreign buyer of U.S. merchandise.

Why should Ex-Im disappear?

  • Ex-Im lends if the private market doesn’t do so. The bank, therefore, distorts competition and interferes with free markets. Ex-Im’s opponents say that competition should be based “on quality and price of products rather than quality of any officially-supported financing”.

  • A similar argument is that Ex-Im should not make loans taxpayer-backed that the private sector is unwilling to make. This leads to a form of corporate welfare that involves significant costs for Americans.

“To support business does not necessarily support free enterprise.”

“Washington loves to use the tax code to pick winners and losers.”

  • Ex-Im should retreat because the bank helps competitors of U.S. companies: It may be true that U.S. exporters benefit from Ex-Im’s products; however, foreign importers may benefit even more so and ultimately beat their U.S. competitors through Ex-Im’s support.

“The Main Street competitive economy relies upon hard work, creativity, perseverance and “can do” optimism to create wealth. The Washington insider economy, in contrast, relies on earmarks, regulatory barriers to entry, subsidies, tax preferences and political influence.”

  • Ex-Im lends U.S. taxpayer money to countries such as China, Russia, Saudi Arabia, United Arab Emirates, and Congo which do not respect U.S. economic and human rights principles and sometimes even threaten the security of the country.

  • Ex-Im claims to support U.S. SMEs. However, these companies are no significant part of U.S. Ex-Im’s lending activity, since more than 60 % of the bank’s funds benefit big corporations such as GE, Ford, Caterpillar, and Boeing.

  • Instead of generating jobs, Ex-Im only shifts production from one sector of the economy to another: “At best, Ex-Im Bank creates jobs in export industries by destroying jobs in non-export industries.”

“History teaches us that, sooner or later, every government insurance and guarantee program – almost without fail – will fail.”

  • Ex-Im’s antagonists say there is simply no financing gap that the bank could fill: As a matter of fact, 98 % of American exports are financed without public support.

“Only free enterprise is fair. Only free enterprise is moral.”

Why is Ex-Im important for the U.S. economy?

To a great extend, the arguments in favor of U.S. Ex-Im mirror those against the bank:

  • Ex-Im is a self-sustaining bank and doesn’t cost any taxpayer money. For example, its loans incur low default rates.

  • The bank boosts U.S. exports and helps the U.S. economy recovering. Especially small businesses benefit from Ex-Im’s products.

  • Ex-Im creates jobs in the U.S.

  • Since all developed economies operate ECAs, Ex-Im is necessary to create a level-playing field for American companies operating in the global economy.

“Credit insurance is part of running a responsible business, just like fire or theft insurance.”
Fred Hochberg / U.S. Ex-Im – June 25, 2014

“In this global economy, buyers will make procurement decisions based on the availability and attractiveness of financing.”
Fred Hochberg / U.S. Ex-Im – June 25, 2014

  • Ex-Im implements American development policy in emerging markets.

  • Ex-Im fills private sector lending gaps; it gets only involved where the private sector is unable or unwilling to finance.

How much cost Ex-Im’s credit programs?

In the political debate, the U.S. Congressional Budget Office has produced an interesting estimation of the cost of Ex-Im’s credit programs, based on the bank’s cash flow projections. The study opposes two valuation approaches:

  • The FCRA (Federal Credit Reform Act) approach discounts expected cash flows using U.S. treasury rates with similar terms of maturity. This means, implicitly, that Ex-Im’s credit assistance incurs no market risk or cost for the government.
  • The fair market value approach discounts expected cash flows at rates that private financial institutions would use. Here, you take into account the cost of market risk that Ex-Im’s business is exposed to. As a consequence, the approach measures the costs of federal credit programs more comprehensively.

As you can see above, the FCRA approach shows a profit for the U.S. Government (The costs are actually negative.) whereas the fair value approach results in a cost for the American taxpayer.

Current proposals

Today, the U.S. Congress discusses two main legislative proposals:

  • A 2013 draft law intends to abolish Ex-Im in three years time. The drafts of May 5, 2013 and June 6, 2013 also describe how Ex-Im’s assets and personnel will be transferred and how Ex-Im shall operate until its shutdown.

  • Recent drafts propose to extend Ex-Im’s activities until September 30, 2017 (Proposal dated April 2, 2014) or September 30, 2021 (Proposal dated June 24, 2014) respectively. In addition, they want to increase Ex-Im’s budget as follows:

As I wrote above, nobody really believes U.S. Ex-Im to be shut down. The discussion still remains interesting to follow.