BARCELONA--(BUSINESS WIRE)--Macro volatility continued into the early part of this week, as the new Italian government laid out its euro-skeptic policy agenda and a new Spanish government, controlled by the Socialist Party, took power over the weekend. Against this backdrop of elevated political uncertainty across the Eurozone, the Global ABS Conference kicked off on Tuesday with a post-crisis record of around 3,700 attendees in Barcelona.
Regulation and policy took center stage on day 1, with eight out of 17 panels devoted to topics ranging from the Simple, Transparent, Standardised (STS) securitisation framework to the impact of less accommodative central bank policy on the structured finance market (Figure 1). Unlike in the U.S., where the implementation of Dodd-Frank era rules has mostly been completed and are now being rolled back under the Trump administration; a number of regulations affecting the securitisation market are just starting to be rolled out in Europe, putting it at the front of most conference goer’s minds.
Below we give a quick recap of some of today’s panel topics.
A Brief History of Recent Regulatory Developments
The conference kicked off with a panel discussion of the various regulatory developments effecting the structured finance market. The STS regulation took up the majority of the panel’s time, as its implementation appears to be front of mind for most European investors. It was noted that there are around 80 individual requirements that must me complied with for a securitisation to be STS eligible, but many of the requirements are vague and up to interpretation, particularly a requirement that all assets in a securitisation must be homogeneous. It was also noted by the panel that for a securitisation to be STS compliant, it cannot contain non-EU assets. As a result, most U.S. issuers and investors aren’t paying much attention to this new regulation.
The STS framework is not the only regulatory development that market participants should pay attention to, according to panelists. The U.S. Appeal Court’s ruling exempting CLOs from the risk-retention rule, and what this could mean for other securitised asset classes, was also discussed. It was generally agreed by the panelists that it remains to be seen whether the court’s ruling can be applied to other structured asset classes and if it can, whether investors will be willing to buy bonds from issuers that don’t retain any of the risk.
The panel concluded by discussing what impact the phase out of LIBOR will have on the market for ﬂoating-rate debt. The panelists believed that regulators and industry trade associations are highly focused on facilitating an orderly transition away from LIBOR to an alternative rate by 2021. However, until the market agrees on a suitable replacement for LIBOR, issuers should incorporate provisions that provide flexibility in switching to an alternative benchmark (see LIBOR No More, published November 2017).
Esoteric Investment Overview
The panel began with a seemingly simple question: what is an esoteric asset? The answer depends on whom is asked, but there was broad agreement among the panelists that esoteric assets are generally assets that are less familiar to investors. Some examples included transportation assets, marketplace lending, and renewable energy receivables. Next, the panelists compared deals backed by esoteric assets in both the European and U.S. markets, and it was noted that there has been less breadth of deals in Europe, with those that have come to market generally anchored by familiar asset classes with slight structural tweaks. The panelists then discussed regulatory matters, particularly the jurisdictional aspect in Europe that can make aggregating assets more complicated. However, it was noted that the European Union is seeking to unify standards across jurisdictions. The panel ended with a discussion on where investors can find yield and what new asset classes and structures investors can expect to see in the future, with renewable assets and the whole loan market mentioned, respectively.
An Introduction to STS/The STS User Manual for Investors and Issuers
During the two panels , panelists provided an overview the STS regulatory framework, as well as its potential impact on the structured finance market. The panelists walked through how the European Council adopted the STS securitisation regulation in late 2017. Under the new regulation, a securitisation will qualify as STS if certain conditions are met, at which point lower capital requirements would apply for banks under the Capital Requirements Regulation (CRR). However, the panelists noted that the European Council has been slow to adopt similar capital relief measures for insurance companies holding STS compliant debt under the Solvency II capital regime, creating uncertainty for insurance investors.
Although there remains a lack of clarity on the exact criteria for an STS securitisation ahead of its January 2019 implementation, the European Banking Authority (EBA) and European Securities and Market Authority (ESMA) are currently drafting Regulatory Technical Standards with more details to come later this year. In general, the panelists viewed the STS framework as a positive for the European structured finance market, mainly because it signals an official policy and regulatory “buy-in” and should bring securitisation capital charges somewhat more in line with those applied to covered and corporate bonds.
Fundamentals of Residential Mortgage Finance
As part of the conference’s introductory “101 Series,” the panel began with a conversation regarding the two primary RMBS structures: static and revolving, with the former being the dominant structure in Europe. Next, the panelists discussed the emergence of specialty lenders since the Financial Crisis, noting the increased presence of private equity shops, which are incentivized to enter the market by the prospect of higher returns, particularly in the non-performing market. The conversation then turned to the five fundaments of residential mortgage finance from KBRA’s rating agency perspective. The panelists then discussed the benefits of RMBS versus covered bonds, with RMBS generally seen as a more efficient vehicle, despite being more heavily regulated. The panel concluded with a discussion comparing and contrasting RMBS in the U.S. and Europe, with the former still heavily reliant on Agency RMBS, and the latter experiencing strong volume of buy-to-let issuance.
Comparative regulations (U.S., EU, UK, Australia) and Their Impact on Investors and Issuers
The panel kicked off with a discussion regarding the differences in risk retention regulations in the U.S. and the EU, centering on how horizontal risk retention is treated in the two geographies. Of note, the “L-shaped” structure seen in some U.S. transactions is not allowed under EU regulation. The panelists moved on to discuss risk retention specific to CLOs, noting the recently relaxed U.S. regulations and discussing the need for dual-compliant CLOs if the intent is to market the associated securities in both geographies. Of interest, Australia has no explicit risk retention legislation, in part due to other regulations that seek to ensure alignment of interest between issuers and investors. The STS regulation was discussed at length, with the panelists agreeing that the regulation’s homogeneity requirement, as well as several others, has several issues that need to be resolved. Recent changes to the U.S. Volcker Rule were also discussed, noting the expected “lighter regulatory touch” under the current U.S. administration. The panel concluded with a discussion on capital treatment under Solvency II in the EU, with the panelists agreeing that, overall, the regulatory environment in the EU towards securitisation is hostile compared to the U.S. and Australia.
The End of Quantitative Easing: Weaning the Patient off the Methadone
The day concluded with a discussion on how the less accommodative central bank policy will impact the European structured finance market moving forward. The panel noted that the phasing out of the ECB’s Targeted Long-Term Refinancing Operations and Asset Purchase Programmes over the next 24 months, as well as the end of the BoE’s Funding for Lending Scheme (FLS) and Term Funding Scheme (TFS) earlier this year, signals an end to an unprecedented era of expansionary monetary policy in Europe.
Panelists pointed out that with the ECB and BoE providing cheap, medium-term funding to the banking sector, activity in the European structured finance market has been subdued for a number of years. The economics of issuing residential mortgage-backed securities, historically the largest European securitised asset class, simply haven’t made sense for banks, given their ability to borrow from central banks at or near the base rate. However, as these cheap sources of capital become less readily available over the next few years, the panel generally thought that banks would gradually return to the securitisation market for their funding needs.
For more specific panel coverage, check out KBRA’s live tweets from the conference!