Last week, the securitization industry was hit by another regulatory broadside. As a way of tying together the different disclosure and due diligence obligations related to the product, the three European super-regulators — the European Banking Authority, the Securities and Markets Authority and the Insurance and Occupational Pensions Authority — proposed a harsh new set of disclosure rules.
Salient points include ensuring that cashflow models are verified by an independent third party, and providing financial reports not just for the collateral and its originator but for all major transaction counterparties.
Putting a deal together already involves an originator, a servicer, a backup servicer, an account bank, a swap counterparty, a trustee, rating agencies, data agencies and arranging banks, all with their legal counsels.
Adding another layer of box-ticking, and another few hundred pages in every prospectus, isn’t fatal to the industry. Securitizations are already long and expensive to put together, with plenty of mouths to feed at every stage. What’s another week on a deal that has already taken three months?
But the move doesn’t match the latest round of positive rhetoric from policymakers or the performance of the asset class, and it certainly doesn’t acknowledge that securitizations are already the most transparent instruments in the debt capital markets.
Tiny losses
Fitch’s analysis of pre-crisis securitizations in Europe found realised losses of just 0.4%. That covers the whole rated universe, including commercial real estate, CDOs of ABS and the most junior tranches of deals.
In the senior tranches of consumer deals, such as ABS or RMBS, Fitch found no losses at all, even on deals where the originator had defaulted.
This isn’t just a European thing, either.
In the rightly reviled pre-crisis US subprime market, an international byword for terrible underwriting, senior tranches in securitizations that were explicitly part of a lawsuit over lying about disclosure suffered losses of 1.25%.
In contrast to any other direct obligation, securitizations already disclose precisely what assets back liabilities. Bank debt might or might not be bailed in and is backed by a huge and extraordinarily opaque set of assets.
Try finding out, say, how much a big German bank is exposed to loans to Austrian widget makers, and it will be impossible, by design. The German regulator might know, but an investor in the bank’s senior debt, or even its equity, will not.
However, almost any securitization issued post-crisis (and most pre-crisis subprime) will have a detailed set of information about every loan backing the deal, updated monthly and available to any investor.
Market risk, not credit risk
This isn’t an attempt to rewrite history — there is no doubt that investors across the world suffered heavily from their exposure to securitizations in 2007 and 2008.
But the new disclosure rules do not distinguish between these problems, which were caused by the abrupt crash in mark-to-market values of securitizations, and the latters' credit risk.
This mark-to-market crash was caused by the same combination of leveraged short term investment that has caused market crashes across products for time immemorial. The vehicles packaging the leverage had new, acronym-based names, but the economic issue was as old as the hills.
But regulation of securitization, including the latest disclosure and due diligence proposals, can only be about credit risk — the assessment of whether or not an investment is, fundamentally, money good.
However good the disclosure, it says nothing about whether the investors in securitizations are funding their positions with overnight wholesale money or long term patient capital. The past seven years of securitization regulation has strained every nerve, and almost killed a market, to solve a problem that never existed.