Reviving Securitisation in Europe

European authorities (European Commission, UK HM Treasury) have recently launched consultations (UK Call for evidence (June 2021), EC Targeted Cosultation (July 2021)) concerning the state of the securitisation markets and the economic impact of the Basel regulatory framework for securitisations. Securitisation is viewed by European authorities as having the potential to finance economic growth in Europe, due to its four roles 1) as a funding tool for banks, 2) as a capital management tool, 3) as a portfolio-based de-risking tool (warehousing) and in the case of the EU, 4) as a rare enabler of cross-border activities.

The main reason why the securitisation market has been shrinking in the last decade in almost all European countries, is because the current prudential rules for securitisation exposures have developed with multiple inconsistencies. Regulatory rules should be designed to be consistent with the relative riskiness and liquidity of different financial instruments. Not doing so leads either to partial or complete elimination of financial activities or to regulatory arbitrage by the industry unacceptable to regulators.

We highlighted some of those at the May 2022 AFME & Paris EUROPLACE conference and mentioned that to solve those issues, European policymakers should make sensible interventions to reduce distortions and inconsistency with actual risk. For securitisation prudential rules, this includes:
• Reconsidering the basic calibration rectifying the major incoherence that exists between actual risk and capital charges in the mezzanine range.
• Scaling total pool regulatory capital (KIRB/KA) before inserting them into the Simplified Supervisory Formula Approach (SSFA) which is the basic equation of the SEC-IRBA and SEC-SA.
• Making the senior tranche floor in the SEC-IRBA and SEC-SA proportional to pool risk weights (RWs), not a constant.

In this short note, we highlight a simple solution for the SEC-SA.

Note available here.

Authors: Georges Duponcheele and William Perraudin