European securitization dancing slow as ‘mood music’ turns upbeat

After years spent in what many market participants consider something close to regulatory purgatory, the European securitization market is showing signs of a growing sense of optimism.

For a start, securitization may be an inadvertent beneficiary of Brexit. No longer tied to the European Union, the UK is now drafting its own securitization rules, and senior figures in the UK government have called for a “bonfire” of EU laws.

If anything, this appears to have spurred on EU rule makers. The bloc appears to be showing a newfound willingness to unleash a more competitive securitization market, with French finance minister Bruno Le Maire and German finance minister Christian Lindner having publicly called for securitization to help close the EU’s capital markets “gap” versus the US and China. Moreover, the EU is also seeking an additional €500bn of financing per year for the green and digital transitions of its economy, all while having to wean capital markets off cheap central bank funding. Securitization could serve as a partial replacement at the very least.

These factors are driving a sense of optimism that encouraging regulatory changes may finally be around the corner. According to Ian Bell, CEO of securitization verification agent PCS, there is a glass half full analysis to be made. “[The] mood music has changed enormously,” he says.

There is almost unanimous consensus that this is required. Post-global financial crisis reforms spawned certain developments that have benefited the industry, such as the rise of private credit and significant risk transfer (SRT) securitizations. Yet ultimately, according to those that witnessed the rise of securitization and then lived through its shrinking relevance on the continent, European securitization has served a 15 year sentence in being far more tightly regulated than comparable asset classes such as covered bonds.

This has led to years of subdued activity, with investors — insurers and bank treasuries, in particular — discouraged from entering the market because of the way securitizations are treated in capital requirements regulations. Indeed, research by the Association for Financial Markets in Europe (Afme) in 2022 found that the European market had shrunk from being 75% of the size of the market in the US in 2008 to 6% by 2020.

Alex Batchvarov, head of structured finance research at Bank of America, points to deal execution timelines as an example of the problem. “Why does it take one hour to announce, price and close mortgage covered bonds, when it takes days if not weeks to place an RMBS?” he asks.

Lengthy due diligence and compliance regulations mean it is normal for European securitization transactions to take about a week between announcement and pricing.

The mood began to change in December 2022, when the UK government explicitly mentioned securitization as a sector that needed changes as part of its Edinburgh Reforms, a set of changes designed to drive growth and competitiveness in the country’s financial services.

Then, in June, came the Financial Services and Markets Act 2023. According to this, the UK would be taking a principles-based approach to regulation, with stripped back primary legislation. The finer details were to be left to the Financial Conduct Authority (FCA) and the Bank of England’s Prudential Regulation Authority (PRA).

In this respect, it is a crucial departure from the EU, where potential regulatory tweaks that could fit niche markets such as securitization have not been possible without passing EU law through the European Parliament, slowing any change.

“Broadly, the UK is heading in the right direction in relation to regulation,” says Shaun Baddeley, Afme’s managing director for securitization. “In the EU, regulation has been predominantly prescriptive.”

While the UK’s strategy might be correct, the regulators still have a lot to deliver before the optimists are vindicated.

Although Janet Oram, head of ABS at UK pension fund USS, says that the FCA “has always understood where the industry is coming from”, she insists that what will happen is not deregulation but “reregulation”.

“Regulators are looking at what is going on and saying ‘how can we make this better?’,” she says. “[It’s] not for banks and investors necessarily, but for a market that functions.”

As the FCA and PRA contemplate how to use their new powers, they have received a hint from the top. As of 2023, they have been granted a secondary statutory objective: to support the long-term growth and competitiveness of the UK economy.

Yet not everyone is convinced that this will be enough to galvanise the duo into taking the big steps that the market would like to see.

“I question whether there isn’t a disconnect between the ambitions of this government and the tool that it has given itself,” Bell says.

He adds that, so far, “neither the PRA or the FCA have signed up for a bonfire of regulations”.

Both institutions have held initial consultations on securitization rules, which will be finalised with reports in the second quarter of 2024. In addition, the PRA is consulting on a set of rules for securitization under the Capital Requirements Regulation (CRR), which is scheduled for completion in the second half of 2024. More publications from both regulators are likely to follow.

Although not finalised, the consultation papers published already offer hints as to where the UK’s regulations are heading. The approach by regulators does appear more proportionate than existing rules, “which makes sense”, according to Afme’s Baddeley. Yet it doesn’t yet amount to radical reform.

“[The PRA and FCA] have taken positive steps,” says Batchvarov at Bank of America. “But [it’s] nothing that I would call game changing.”

Gordon Kerr, head of European research at KBRA, says — similarly to Batchvarov — that the initial FCA and PRA’s papers were “somewhat of a missed opportunity”, though he acknowledges that regulators are not that fast moving”.

“It’s a first step and an opportunity to consider further changes,” Kerr says. “Putting decisions in the hands of the regulators will allow them to change their approach in future.”

On the face of it, there is less reason for cheer in the EU. Going into the end of 2023, discussions over primary legislation have paused, as the European Parliament comes to the end of its term. The election for the next five years will be in June.

That just leaves the possibility of reinterpreting or adding guidance to existing rules. As well intentioned as that might be, it can overcomplicate things.

“It worries me tremendously that they are layering detail over detail, instead of reining back and simplifying things,” Batchvarov says.

What’s more, in the past five years, advocates for securitization have achieved very little, compared with the major reforms that many in the market were after, Bell says. “Capital Requirements Regulation, Liquidity Coverage Ratio, Solvency II, better disclosure, and a better deal for private securitizations,” he says. “If you look at that sheet of desiderata, we got pretty much nothing.”

Yet, for the longer term, optimism is growing and actions from politicians are backing up the hope. MEPs from Germany, France and the Netherlands, representing the biggest factions in the EU Parliament, have all tabled amendments that would, at least indirectly, benefit the securitization market.

Politicians proposing these changes might not particularly see themselves as bastions of the industry, but their actions are important, Bell says. Apart from anything else, they highlight the contrast with the attitude of politicians over the previous 15 years.

“We have three big political families, all of them doing positive things, whereas five years ago we were told ‘you don’t want to get anywhere near the European Parliament’,” he says.

“Now you have people coming out both in the Commission and in various member states saying that not only is securitization important, and not only is it a good thing, but it is actually essential for the CMU [Capital Markets Union].”

Interventions from Le Maire, Lindner and various MEPs suggest that discussions over securitization are finally moving away from the margins and towards centre stage.

So far, market participants have engaged in various hand-wringing arguments around specific rules on investing in non-EU originating securitizations because of due diligence requirements. Today, however, bigger topics such as capital requirements calculations could be on the menu.

High level political interventions also suggest a larger concern at play. This goes beyond an effort to spur on securitization and is part of an attempt to make the EU’s financial ecosystem capable of competing with larger economies around the world, such as the US and China.

“The needs are so great,” Baddeley says. “Politically, the EU needs to unlock any channels of capital they can, as they need between €500bn and €700bn a year to finance the [green and digital] transition in one form or another.”

Baddeley adds that the historical “stigma” attached to the securitization market is starting to fade, at least from policymakers.

“Policymakers fully recognise the importance and the role of securitization in this transition as well,” he says. “Politically, the will and understanding are there, but it does need to be prioritised by the supervisory authorities if political aspirations are to be met.”

However, for the EU’s securitization market to become competitive, the catching-up is about more than loosening the rules. There is a particular shortage of investors.

“It certainly feels like the investor base in Europe is not big enough to support the material growth needed if central banks want to transition away from cheap central bank funding and let capital markets take up the slack,” says Matt Jones, head of EMEA specialised finance at S&P.

Bringing more investors on board, and potentially making the securitization market look much more like the covered bond market, is key to development. The fact that securitization assets have proved their solidity should help.

“We have had 15 years to observe how securitizations have performed since the global financial crisis,” Jones adds. “And European securitization has performed very well. It’s not that regulators need to take more risk; regulations need to be more balanced for the observed risks.”

Kerr points to the stark contrast between the EU and US securitization markets, highlighting how the non-agency market has grown dramatically in the past 15 years in the US. “[Meanwhile] the European [non-agency market] sits idle,” Kerr says. “If the EU really wants to take the CMU seriously and develop a pan-European market, then something needs to change.”

That the need for a better functioning EU securitization market comes from the highest levels of government in Europe is a source of hope, but Batchvarov warns that there remains little detail and potentially years of waiting. “I’m optimistic in the sense that the attitude is more positive, but I’m neutral on the market effect because we won’t know what is changing for another two to three years,” he says.

And, even then, as Oram points out, it can take some time for new investors to start enhancing liquidity in the market.

“[For a new investor] it is difficult to do all the regulatory stuff from scratch,” she says. “You probably have to hire in experience. As for all investors, you have to demonstrate that — before you have bought anything — you have done your credit write-up. You then have a ramp period, where the whole secondary market is stuff you didn’t look at in primary.”

In GlobalCapital’s survey of market participants, less than 10% of respondents predicted that more than two new investors would emerge in the European market in 2024.

Even if the noises are getting louder around regulatory reform, detail is light. In the UK, some have put their hope in a more principles-based approach being a strong starting point. In the EU, politicians slowly falling on the side of the market, particularly in Germany and France, suggest there is a powerful impetus.

Inevitably, divergence between the two jurisdictions makes a workable solution more complicated. On top of this, the EU regulating securitization through primary legislation will make adapting to problems as they occur harder still.

Securitization reform in the UK is a more likely reality in 2024 than it is in the EU. But when it comes to competing in a meaningful way with major economies, only the EU bloc has the scale to make an impact.

Perhaps the UK can take credit for changing the music, but it is the EU’s next steps that everyone will be watching.