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.