Securitisation crisis is far from over, EC expert tells bankers

Jun 05 2008 Peter Elstob

A European Union expert on securitisation has told European and US investment bankers, lawyers and accountants operating in the asset-backed finance market that the seriousness of the securitisation crisis should not be underestimated. Giuseppe Siani, seconded to the commission's internal market directorate general, and a commission observer on the Basel Committee on Banking Supervision, added that it would be a concern if people thought nothing had happened.

"Something has happened, something very serious," Siani told a session at the Global ABS conference held in Cannes this week. He believed that "the end of the beginning" of the crisis was probably still to come. "I really believe that supervisors, regulators, and industry need to try to understand what went wrong, while respecting one another's roles," he said.

Siani told the bankers that Europe's financial regulators and finance ministers, together with the Financial Stability Forum, were in agreement that the originate-to-distribute model of asset-backed securitisation had four weaknesses. All of these weaknesses were linked intrinsically to the three pillars of Basel II:

Incentive structures for both originators of asset-backed securities and investors in the instruments.

Unexpected risk factors, such as reputational risks for originators, and the need for both originators and investors to have a firm-wide risk management function.

Shortcomings in the risk calibration of the OTD framework, which had "perhaps not been in line with the actual risk profile".

Insufficient transparency of complex instruments.

The EU still believes the Basel II framework is a good one, according to Siani. Despite this, it is having a fresh look at its three pillars — minimum capital requirements, risk management, and transparency — in relation to securitisation. The industry can expect some changes to be included in the upcoming amending legislation to the Capital Requirements Directive. Within pillar three, for example, the commission plans to begin work in October after it has heard the European Securitisation Forum's proposals on improving transparency in both the primary and secondary markets.

On compensation, a central element of incentive structures, Siani said the commission was already speaking to the industry but had not yet arrived at its final position. He noted that some individual member states had already approved national regulations introducing the principle of longer compensation periods.

Proposed changes

Two sets of proposed changes to the CRD relate specifically to securitisation, according to Siani.

The first set of amendments, which are linked to certain EU specificities, attempt to do two things:

Clarify the underlying criteria for assessing whether a significant risk transfer has really been achieved by a particular securitisation.

Introduce the principle that investors need to conduct proper due diligence before investing in any securitisation. Investors should also have a "hook" on the underlying assets of the portfolio that has been securitised, Siani added.

The commission has also proposed the temporary removal of the treatment for general market disruption liquidity facilities. Siani said: "We believe it is not worth having such preferential treatment for liquidity facilities which have proved not to be so risk-free."

These proposals represent work in progress, Siani stressed, and the commission would welcome industry feedback, as it would on its proposal to apply a single set of credit conversion factors equal to 50 per cent, which would be a significant increase from the current level of 20 per cent.

European dimension

The commission is looking at the possibility of introducing a "European dimension" into the mandates of national regulators and supervisors, which would oblige them to consider the EU perspective of their supervisory role, including crisis management. It is also looking at the possibility of giving a degree of legal force to the three level three committees — the Committee of European Banking Supervisors, Committee of European Securities Regulators, and Committee of European Insurance and Occupational Pensions Supervisors — and improving the supervision of all cross-border banking groups. This would extend beyond the 45 so-called "systematically important" groups. This could involve making colleges of supervisors mandatory, although Siani noted that a number of colleges were already in operation, some including US as well as EU supervisors.

The second set of initiatives are linked to the work going on in the Basel Committee, and include the signing of a formal multilateral memorandum of understanding among Europe's regulators, central banks and finance ministries, setting out the principles for handling a future cross-border crisis. In the spring of next year there will be an EU-wide simulation exercise of such a crisis.

The industry has expressed concern that, in the words of one market participant on the same panel as Siani, "while the regulators are under control, some of the EU politicians are less under control". Asked whether the European Parliament might take a different approach to that of the regulators and finance ministers towards regulation securitisation, Siani said the commission did not expect, "at this stage", wide differences in approach. "We have a really strong, robust, technical proposal to submit, by September, both to the European Parliament and the council. I believe that it is critical," he said.

Siani added that in some respects the present exercise was similar to the review of the trading book undertaken at the time of the initial drafting of the CRD four years ago. "I remember myself drafting 212 amendments in order to incorporate the trading book review that had been agreed upon by the Basel committee. And I don't remember a single amendment proposed by the parliament," he said.

"We believe that the [securitisation] model is good. It's not perfect, maybe it can be refined, so let's do that, together."