Investors are urging Europe’s politicians to make sweeping reforms to its moribund market for debt securitisation, in a move the industry claims could attract hundreds of billions of euros in financing for the region’s economy.
Asset managers including bond giant Pimco and insurers such as Italy’s Generali have called for a shake-up during a consultation on EU rules governing the market, where the likes of risky corporate loans, car finance and mortgage borrowing are packaged up into debt securities that can then be sold by banks to investors.
Executives and investors say layers of regulation — designed to prevent a repeat of the 2008 global financial crisis — have strangled the market, while the US has boomed. They hope that potential reforms in the EU and UK could finally revamp the sector after years of false starts.
Brussels launched a consultation in October investigating ways to revive the market and attract more financing for businesses and households, while freeing up the region’s banks to lend more.
A key catalyst for change was an influential report last September by former Italian premier Mario Draghi on transforming Europe’s economy, in which he argued a bigger market for securitised lending could even “act as a substitute for lack of capital market integration”.
“Over the past decade, the impact of Europe’s unique approach to gold-plating of global standards has become clear and action is overdue,” said Shaun Baddeley, head of securitisation at AFME, a trade group. Some rules were “not fit for purpose and are ultimately hindering economic growth”, he added.
Some €245bn in debt securitisation was created in Europe last year, including the UK, with about half passed on to big investors such as asset managers and insurers.
Although it was one of the biggest totals in recent years, according to industry body AFME, it pales in comparison with the US where the equivalent of €1.5tn was issued. That yearly US number was bigger than the total outstanding market across the EU and UK, on AFME’s figures.
In spite of the market consultation, many executives privately argue that European policymakers’ conservative attitudes to securitised debt are still moulded by the subprime mortgage-backed collateralised debt obligations that hit the US economy hard during the financial crisis.
“Every finance ministry wants the issue addressed,” said a senior executive at one insurer, speaking privately. “They all want a more effective debt market.”
The biggest chunk of placed European securitisation comes from collateralised loan obligations, which group together dozens of loans to typically risky companies, slice them into tranches with different credit ratings and parcel those off to investors. Others include securities backed by portfolios of mortgages or car loans.
But critics of the EU’s securitisation rules say they are tighter than common global standards in a few key areas. EU rules have tried to force many products into a “simple, transparent, standardised” (STS) framework, with the offer of lower capital charges as an incentive.
Market participants argue the STS definitions are too narrow and so exclude unorthodox assets that are difficult to standardise. In contrast, US markets are flush with inventive products, or “esoteric ABS”, including securitised aviation loans and music royalties.
Exclusions are compounded by generally tough capital requirements for products such as CLOs, the industry argues.
Insurance Europe, an industry body, said the bloc’s “capital charges imposed on securitisation investments . . . are disproportionately high compared to other financial instruments with similar credit risk and asset quality, notably corporate bonds”.
Industry executives also complain that due diligence requirements are more onerous than in other jurisdictions.
As a result of these various barriers, esoteric products in Europe, such as securitised football transfer fees, are more often found in the private market, traders say.
In Brussels, the European Commission is consulting with the market about potential changes, including whether a broader group of debt securities should come under the STS, and also on capital charges for those investing in securitised debt and due diligence requirements.
The UK is also working to foster a bigger securitisation market, making changes last year to rules on due diligence. It is also consulting on making related capital charges more “proportionate”.
Among the responses to the EU consultation, Pimco said the bloc’s securitisation market had “unequivocally failed as an alternative credit channel to the broader economy”.
The US group argues that permitting EU funds to acquire a greater proportion of the debt securities issued by a single issuing body could boost the market by an additional €100bn-to-€150bn.
Private capital group Apollo estimates that addressing a range of issues, including reducing capital charges to increase demand from life insurers, could unlock more than €1tn in financing for the EU economy.
It pointed to regulatory data showing that the European life insurance industry held less than 1 per cent of investment assets in securitisations while counterparts in the US held 17 per cent, even though the industries were of similar size.
Though gross European investment in CLOs totalled €49bn last year, the net figure, when taking account of maturing CLOs, was considerably less at €23bn, according to Bank of America.
“One of the biggest confusions about CLOs [comes from] people looking at the value of issuance and assuming the market is booming,” said Alex Batchvarov, an international structured finance strategist at BofA. Changes are “long overdue”, he added.
Regulators have long focused on insurers’ ability to liquidate assets in a crisis, which could be challenged if their long-term securitised debt is held in hard-to-sell securities. Part of the Commission’s consultation asks about risks to financial stability from proposed changes.
But Generali, Italy’s biggest insurer, said the industry’s buy-and-hold strategy for securitised debt means they do not have to sell in volatile markets.
“Nobody is advocating for a return to the pre-global financial crisis era of regulation,” said AFME’s Baddeley. “What is required is making the rules risk-sensitive, proportionate and relevant.”
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