Financial Markets

Can Europe finance its recovery with one hand tied behind its back? Europe’s securitisation market has the potential to help address some of the long-term economic damage caused by the Covid-19 pandemic and support the transition to a sustainable economy, but it is being held back by an outdated post-GFC regulatory framework. By Richard Hopkin, head of fixed income at the Association for Financial Markets in Europe.

Following the global financial crisis (GFC), new regulation was imposed to constrain the misuse of risky securitised products such as US sub-prime mortgages. However, these products were largely confined to the US, and today, with the benefit of the years that have passed, the evidence shows that European securitisation has performed strongly through and since the GFC. 

As a result of new regulation, today the world of European securitisation is much safer. However, it is increasingly recognised that the regulatory pendulum has swung too far, and while many features of the new regulation should remain (for example, risk retention) a fresh calibration which better recognises the high quality and strong track record of European securitisation is now sorely needed.

This is not least because over the coming months and years Europe needs a thriving securitisation market to help meet the growing need for bank lending. Despite the early positive signs of economic recovery in Europe, volumes of non-performing loans are likely to increase as government and central bank support is withdrawn. This means, to keep more businesses afloat, bank lending will need to increase.

Securitisation enables banks to package loans into a tradeable product for investors, which frees up their balance sheets for further lending. Today, this process is a far cry from risky US sub-prime mortgages; securitised products are now thoroughly regulated and closely supervised, safe for investors and key to enabling the funding of businesses.

A vibrant securitisation market is also key for the health of the financial system. Securitisation is unique in that it is the only financing technique that enables banks to transfer risk while still continuing to lend to, and keep the relationship with, their customers – whether they be individuals, small businesses or multinationals. In this way it can help banks use their capital more efficiently by ‘recycling’ it to support further lending. It also helps banks reduce concentration risks and diversify exposures efficiently to non-bank investors. With the appropriate risk parameters in place, this not only increases the opportunities for fund managers to improve their returns but also enhances monetary and financial stability.

Sustainable transition

Crucially, securitisation can also support Europe in its sustainable transition. By freeing up bank balance sheets there will be greater capacity to lend to sustainable projects, such as mortgages for energy-efficient houses. Moreover, the securitisation market itself will enable investors to contribute directly to specific sustainable projects.

However, despite a buoyant securitisation market having the potential to aid economic recovery, its current market is disproportionately small for an economy the size of Europe. Over the past 13 years, securitisation placed issuance has struggled to exceed much more than around €100bn a year. In contrast, last year the US exceeded €600bn in issuance.

Europe’s securitisation market is lagging behind because many potential issuers and investors simply cannot make the economics work. Compliance requirements are still overly complex, implementation has created higher hurdles, and there has not been enough recognition of the ‘gold standard’ EU (and now UK) securitisation framework in capital and liquidity rules. This makes securitisation less attractive for both issuers and investors than other fixed-income products, especially more generously treated covered bonds.

While the simple, transparent and standardised (STS) securitisation framework, introduced by the EU, aimed to help attract new issuers and investors into the market, it has not been transformative. The upcoming revision of the STS framework is therefore vital to address these concerns. 

The Securitisation Capital Markets Recovery Package implemented in March proposed targeted changes which were a step in the right direction, but its benefits for market participants were materially reduced during the legislative process. 

For example, while the introduction of a framework for STS securitisation for on-balance-sheet securitisations was very welcome, tough new requirements for cash collateral, and for capital to be held against synthetic excess spread, increased the cost of on-balance-sheet securitisations for originators, acting as a brake on, rather than an incentive for, issuance. 

Part of the solution

From a sustainability point of view there is also a lot of room for progress. While Europe’s sustainable economy is showing positive early signs, it is still nascent and requires support. In 2020, only €603m of green securitisation was issued. By developing proportionate common standards for ESG securitisation, considering incentives and accommodating transitioning assets as collateral, sustainable securitisation has the potential to have a very material impact on Europe’s sustainable transition.

As Europe emerges from the shadow of the pandemic, it needs to embrace the potential of its securitisation market. A vibrant market can free up banks’ balance sheets to support further lending and fund sustainable projects that will make a real difference to Europe’s recovery. After more than a decade since the GFC it is time to recognise in the EU regulatory framework that securitisation is no longer part of the problem for Europe; it is part of the solution.

Speaker’s Corner: A Speakers’ Corner is an area where open-air public speaking, debate and discussion are allowed. The original and most noted is in the north-east of Hyde Park in London.

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