On October 10, the European Commission published its report on the functioning of the EU Securitization Regulation (EUSR). In this article, we will summarize the main takeaways from the report and what it means for actors inside the securitization space.
The role of EU Securitization Regulation
Securitizations have a pivotal role in “well-functioning financial markets” (quote from Securitization Regulation 2017/2402), and regulators put a huge effort into creating a solid framework that increases transparency and solidity of the market, although taking some time.
The European Commission’s report on EU Securitization Regulation starts with a reminder that most financial practitioners have been hearing for the past 15 years: “loosely regulated securitization contributed in a significant way to the US subprime mortgage market crisis, which rapidly spread through the global financial system with far-reaching consequences for taxpayers and companies in the EU and beyond.”
In other words, the commission deems the lack of regulation as one of the main factors causing the great financial market crisis. Since then, the European securitization space has still not recovered the annual volumes from 2007/2008 (the current volume for the EU is still a quarter of 2008’s peak and a third of 2007’s).
While the European market has never been able to fully recover from the crisis, the United States got back on track quite quickly.
The growth potential of European’s Securitization Market
Currently, the European market represents only 6% of the total outstanding volume, which is highly dominated by the US at 87%. This gap can by no means be explained by the difference in the two economic areas: the US has a share of the global GDP of 42.4% against 30.7% of Europe, although with a smaller population (329 million vs 444 million in 2019).
However, the European securitization market has the potential to grow significantly. The EC has stated that “If EU securitizations could be revived – safely – to pre-crisis average issuance levels, banks would be able to provide an additional amount of credit to the private sector of more than EUR 100 billion” (Action Plan on Building a Capital Markets Union).
The importance of securitization has been restated even in the context of the COVID-19 Pandemic when measures to expand the market were included in the Capital Markets Recovery Package. The package removed regulatory barriers as a means of supporting financial markets in providing credit to the real economy.
Main Findings from the EC’s report
The European Commission carried out a targeted public consultation that received 56 replies from a broad range of market participants (both on the buy side and the sell side) and from public authorities and academics.
Respondents regarded in a negative light the existing legal framework (i.e. Securitisation Regulation). The only positive note was about the regulation’s ability to provide investor protection through risk retention and information availability. But even there, respondents pointed out the costs related to complying with those standards and the limited impact on risk monitoring, somehow suggesting that individual and independent tools are still required.
Sharper stances against the Securitisation Regulation framework were instead expressed about how it had been able to deploy its effect on the real economy. Almost 80% of the respondents indicated that there has not been an improvement in access to credit for the real economy, in particular for SMEs. With a similar percentage, industry respondents did not witness an increase in either the investor or issuer base.
Overall, in the absence of a tangible increase in market volume, there has been no concrete benefit to the real economy and SME lending.
The surprising conclusion of the EC’s report
Given these findings, it is surprising how the Commission does not anticipate any real action on improving the regulation.
Given these findings, what is the Commission planning to change to improve the situation?
After eight pages of discussion on its own survey’s results involving market actors, the Commission declared that given the lack of a “comprehensive data source that captures all segments of the market, it is not possible to confidently determine the situation for the entire market.”
And that’s not all. The EC concludes that “Securitisation Regulation seems overall to be fit for purpose and does not see the need for major legislative change”.
These conclusions are surprisingly contradictory: both market evidence and the consultation results would have called for some sort of action to realize the securitization market’s full potential.
Some reporters even suspect that regulators, despite what they state, somehow plan to prevent the growth of the European securitization market.
It is hard to believe that the Commission is actually conspiring against an instrument indicated by many regulators (including the EC itself) as critical for a healthy financial system.
Nevertheless, such a weak conclusion casts many doubts, especially regarding the ability (or at least the confidence) of the regulator to effectively monitor the market and therefore take proper measures where necessary.
On one side the commission has set up an extensive regulatory framework aimed at providing transparency and information to investors, on the other hand, market participants struggle to keep up with all the requirements.
Let’s now take a look at three other important topics of the report: Due Diligence, Transparency, and Private Securitizations.
Due diligence and Transparency
“The Securitisation Regulation requires that institutional investors conduct thorough due diligence before holding a securitization position. A prudent and diligent analysis of the risks involved in a securitization critically depends on access to information.”
When asked about the proportionality of disclosure and due diligence requirements most respondents, in particular, those representing the industry, consider due diligence and transparency requirements as disproportionate. Just a small section highlights the benefit of standardized disclosure in analyzing complex transactions. Complaining about an excess of transparency sounds a bit odd.
Also, it is a surprise to read that some respondents consider that the information provided under Article 7 of the Securitisation Regulation is “actually excessive” and that investors might not use it, relying on due diligence arrangements in place instead.
Some of the observations, such as the proliferation of fields with similar information or lack of clarity on how to fill specific fields (which meaning could vary from jurisdiction to jurisdiction), are without a doubt fair. On the other hand, “complaining” about the availability of loan-by-loan information in case the “portfolio is composed of a large number of exposures is counterintuitive.
The result of all this is a statement by the regulator about the opportunity to simplify the disclosure regime and to “consider whether information on a loan-by-loan basis is useful and proportionate to investors’ needs for all types of securitizations”.
Private transactions have no dedicated templates and need to report under the same standard as public transactions. Industry respondents recognized the benefit of standardized templates. However, they also argued that “supervisors and investors have enough information to, respectively, monitor market developments and perform thorough due diligence.”
Since there are some “national competent authorities that request basic information on private deals via individual forms”, the Commission invites ESMA to draw up a dedicated template for private securitization transactions, tailored to supervisors’ needs and that could replace the existing templates for all private securitizations.
Instead of increasing the standardization and level the playing field, the Commission wants to add unnecessary complexity.
There is no single word explaining how, or why, templates dedicated to regulators should differ between private and public transactions and how the regulators can effectively exercise their control duty over the data provided to private transactions investors, if each one has a different template.
In our opinion, market participants and regulators involved in the report have no intention to significantly impact and revive the Europan securitization market by promoting higher transparency and data standardization.
Is there a reason?
One of the possible explanations is linked to the recurring requests to somehow scale down reporting requirements, in particular when it comes to large amounts of information and large amounts of data to process. Instead of craving access to a wide and detailed pool of data that could be used not only to monitor a specific transaction but even to drive better decisions on a wider scale to realize what we called “data leverage”, investors and regulators complain about the difficulties to produce and manage such information.
Is that data really complicated to manage, or is it just a lack of tools (and desire to invest in them) that pushes market participants to ask for simplifications?
Both banks and asset managers still lag behind in terms of technology adoption that allows them to fully leverage the power of data.
CARDO AI’s insight
We believe market participants should become more active in setting appropriate market standards for transparency and information sharing. Loan-by-loan data tapes should become part of any transactions not just to satisfy an overwhelming regulation but to allow any investor (or potential ones) to run in-depth analysis and monitoring.
If you want to know more about how we help private debt market actors to efficiently manage their data and automate reporting, request a demo today.