Rekindling Europe's repackaged debt market will take years

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(Tues 02/09/14 19:49:14)

LONDON (Sept 02): Reviving Europe's repackaged debt market to fund economic recovery will take years and hinge on a re-invention of the sector, rather than quick regulatory tweaks, bankers and regulators say.

The securitised debt, also known as asset-backed securities or ABS, is created by banks pooling mortgages, and corporate, auto or credit card loans and selling them to insurers, pension funds and even the European Central Bank (ECB). This could help wean the banks off cheap ECB money and provide funds that can be lent to other businesses, helping economies to grow.

But the European market for this debt has dwindled since the market based on subprime U.S. home loans froze in 2007, sowing the seeds of a three-year global financial crisis and instilling a lasting distrust of the sector.

European officials will meet this month to discuss the market, which the ECB desperately wants back on its feet to help raise money for companies in the euro zone's flagging economy at a time when banks, traditionally the main source of funds, cut back on loans after the financial crisis.

The ECB has fuelled market expectations that it could buy securitised debt within months and one of its executive board members, Benoit Coeure, stunned bankers last week by saying the state may need to provide some kind of guarantee to the market.

Since the financial crisis, banks that create securitised debt and its buyers have had to pay higher charges to insure against default, and this is partly to blame for the subdued market, the ECB and the Bank of England have argued.

But there is no global agreement on what constitutes top quality securitised debt, something that could help reassure key investors such as insurance companies that there will not be a repeat of the subprime crisis. This could also bring down capital charges.

ABS makes up only about 1 percent of insurer holdings and capital charges planned by European insurance regulators remain enormous compared with historical default rates for the products, industry lobby Insurance Europe said.

"Reviving the securitisation market will take time," said Cristina Mihai, Insurance Europe policy advisor for investments. "At the moment we don't have stability in the outlook for capital charges to incentivise them or clear calibration of what constitutes high quality ABS."

Others say economic recovery is needed in the first place to generate the demand for more loans that can be securitised.

European Union finance ministers meet Sept. 13 in Milan to discuss rekindling securitisation after issuance in Europe sank to 181 billion euros in 2013 from 711 billion euros in 2008. In contrast, the U.S. market has sprung back from 934 billion euros in 2008 to 1.5 trillion euros last year.

But bankers and regulators are not expecting the European market to snap back even with ECB backing as investors still opt for safer types of debt such as covered bonds which are treated more leniently by regulators.

Reuters reported in August that a document for the EU ministers' meeting this month sets out a "roadmap" to revive securitisation that stretches well into 2015 as 19 EU and global initiatives are underway, raising concerns over coordination.

It recommends assessing the state of play by late 2015 to see if legislation, which could take years to approve and implement, is needed.

Greg Medcraft, chairman of the International Organisation of Securities Commissions (IOSCO), a global body of regulators, said scaling back capital charges is not a silver bullet for a lasting revival that will take time to put in place.

"We have got to think a bit more holistically than that," Medcraft told Reuters. "A focus on capital charges is probably the old world. The new world needs to be focused more on how do we build a sustainable market."

The old world was about banks creating securitised debt and shovelling it into off-balance sheet vehicles, while the new world will be about non-bank originators and real economy investors, such as big asset managers, Medcraft said.

New world briefing

Medcraft will brief leaders of the Group of 20 economies (G20) in November on joint work by IOSCO and the global Basel Committee of banking supervisors to identify blockages in the securitisation market. Their recommendations will be put to a public consultation early in 2015.

Medcraft said a revived market would be based on simple, transparent and consistent products, a goal that has proved elusive in the past due to the lack of common approach to how the quality of assets underpinning ABS are assessed.

Anna Bak, securitisation manager at the Association for Financial Markets in Europe (AFME), a banking trade body, said a comeback in Europe won't happen overnight despite the ECB push.

Industry efforts to introduce a "quality label" on ABS has floundered with lawyers saying this was because regulators did not agree to cut capital charges on this segment.

"We think the market will be healthier three to four years from now. It will be different, the investors will change and people will go for simpler products," Bak said.

"The signals from senior officials are very helpful but there are still many institutions involved and there needs to be a consistent message and implementation, which takes time," Bak said.

Cheap funding for banks from the ECB dulls the incentive to offer ABS, and the central bank could offer even more as soon as this month and going into next year.

"As long as central banks offer cheaper liquidity to banks, it's going to suppress securitisation," Bak said.

And while there is well over a trillion euros of European securitisation in issue, over half is "retained" or tied up as collateral, such as by banks to back cheap loans from the ECB.

Nomura bank expects the ECB to buy 50-100 billion euros of ABS over a year and with the ultimate amount depending on its confidence in how much new issuance will be developed.

AFME wants regulators to work together and avoid differences in capital charges that unilateral European action could create.

The bloc is already poised to bend global rules on new buffers of top quality bonds at banks to favour more use of ABS - and also of competing covered bonds.

But the region's sense of urgency is not shared by the United States or Asia, making it hard to engineer rapid reform on a global basis to avoid fragmenting the market.

The Basel Committee is set to ease its planned bank capital charges on securitised debt later this year but is not expected to push them even lower for top quality ABS as Europe wants.

"The market said they did not want us necessarily to reduce capital charges. What they said is that they want neutrality, a level playing field that does not necessarily discriminate against or favour securitisation," said Medcraft, who also chairs Australian market watchdog ASIC.

Another regulatory source said that even bankers admit that complexity of issuance and a thin pipeline of assets to securitise were more of an impediment to reviving the market than concerns over capital charges.