Assessing the Impact of STS Securitization and Regulatory Framework on European and UK Markets

Assessing the Impact of STS Securitization and Regulatory Framework on European and UK Markets: A Comprehensive Analysis Presented by: Marke Raines Date: 14 February 2022 Standardizations 1. New category of 'simple, transparent and standardized' ('STS') securitization if it meets 100+ requirements and notified to regulator - Reg (EU) 2017/2402 (Securitization Regulation), as amended, Arts 18-24 and 27-30 2. STS is now a condition of LCR eligibility -Reg (EU) 575/2013, as amended, Art 13 3. STS gives somewhat more favorable regulatory capital treatment for institutions than non-STS and a reduced (but still high) spread risk requirement for insurance and reinsurance companies -EU Reg 575/2013 (CRR), as amended, Arts 242-3, 260, 262 and 264; Delegated Reg (EU) No 2015/35, as amended, Art 178 'Special Treatment Of Securitization Exposures 1. Non-STS AAA/Aaa-rated ABS are not eligible for LCR -Reg (EU) 575/2013, as amended, Art 13 2. Non-STS AAA/Aaa-rated ABS and A-rated non-senior STS ABS both cost more capital for an insurer/reinsurer than BB-rated (junk) corporate bond or loan -Securitization as a key pillar of the UK Future Regulatory Framework, AFME, September 2021, p. 64 3. AAA/Aaa-rated non-STS, non-senior RMBS costs a bank twice the risk-weighted capital of a book of residential mortgage loans -Securitization as a key pillar of the UK Future Regulatory Framework, AFME, September 2021, p. 64 The European And UK Securitization Markets Remain Moribund  European securitization placed issuance was €119.2bn in 2019, €81.4bn in 2020 and €56.2bn in H1 2021 -Securitization as a key pillar of the UK Future Regulatory Framework, AFME, September 2021, p. 50  So, EU placed issuance hovers around 20-25% of 2006 level, nearly 15 years after the onset of the GFC  UK placed issuance was approximately €31bn in 2019, €20bn in 2020 and €15bn in H1 2021 -Securitization as a key pillar of the UK Future Regulatory Framework, AFME, September 2021, p. 52 STS Is Not Getting Off The Ground  More than twice as much non-STS as STS securitization has been issued in the EU and in the UK in 2019, 2020 and H1 2021 -Securitization as a key pillar of the UK Future Regulatory Framework, AFME, September 2021, p. 52  Sophisticated investors do not need STS -Securitization as a key pillar of the UK Future Regulatory Framework, AFME, September 2021, p. 53  Less sophisticated investors will do the same due diligence and credit analysis for higher-yielding non-STS transactions -Securitization as a key pillar of the UK Future Regulatory Framework, AFME, September 2021, p. 53 The Effect Of EU And UK Securitization Regulation 1. It is much more difficult, time-consuming and costly for originators to securitise than it was prior to the EU regulatory project 2. Securitization paper is much less attractive to institutional investors by reason of compliance constraints, prohibitions and penalty risk weightings 3. The continuing 'process' of regulation some 14 years after it began - results continuing market uncertainty Industry views at September 2021 Global ABS Conference, London  an "avalanche of regulation"  regulation is “moving all over the place"  investors prefer non-STS so they "don't have to read all this guff"  we need to "roll back the regulation" Review of the Securitization Regulation: Call for evidence  HM Treasury was required by Art 46 of the Securitization Regulation to report to Parliament by 1 January 2022 on, among other things, the effects of the Securitization Regulation on the functioning of the securitization market  HM Treasury called for evidence in June 2021 and reported in December 2021. Response To The Call For Evidence  HM Treasury said they received 21 responses from range of industry participants and from academics -Review of the Securitization Regulation: Report and call for evidence response, December 2021, HM Treasury, p. 5  One response was from Marke Raines  One response was submitted jointly by the Association of Financial Markets in Europe ('AFME') and UK Finance, on behalf their members (together with an 88-page Appendix of explanation and evidence)  AFME has 45 members, including Clifford Chance, Allen & Overy, Barclays, HSBC, Banco Santander, Citi, S&P, Moody's, Deloitte, BNY Mellon, BlackRock, PwC and more  UK Finance represents around 300 firms providing finance, banking, markets and payments-related services in or from the UK Highlights of the Raines Response - The evidence shows two things: 1. During the GFC there were no credit losses on rated UK term securitization (even though there was virtually no EU-level regulation of securitization at the onset of the GFC and little UK regulation of any consequence); and 2. The UK securitization market, in terms of placed securitization issuance backed by UK collateral, has remained moribund since 2007. Highlights of the AFME/UK Finance Response  The impact of the STS framework has been “disappointing, though not entirely surprising..." -2 September 2021 Response of AFME and UK Finance to HM Treasury's Review of the Securitization: Call for evidence, p. 2  The "very harsh risk factors" applied under Solvency II for mezzanine and subordinated risk “discourage any meaningful engagement by insurers" -2 September 2021 Response of AFME and UK Finance to HM Treasury's Review of the Securitization: Call for evidence, p. 6  LCR treatment has “significantly harmed secondary market liquidity for [securitization] instruments and bank treasuries' demand for this issuance." -2 September 2021 Response of AFME and UK Finance to HM Treasury's Review of the Securitization: Call for evidence, p. 8  The benefits of the Securitization Regulation "...are outweighed by higher compliance requirements and costs, especially for issuers." -2 September 2021 Response of AFME and UK Finance to HM Treasury's Review of the Securitization: Call for evidence, p. 9  The Securitization Regulation, “...although intended to encourage new investors into the market, has had the opposite effect by increasing the barriers to entry fo investors." -2 September 2021 Response of AFME and UK Finance to HM Treasury's Review of the Securitization: Call for evidence, p. 9  The cumulative effect of the Securitization Regulation appears to have been "...to make securitization markets shallower and less liquid than they otherwise would be." -2 September 2021 Response of AFME and UK Finance to HM Treasury's Review of the Securitization: Call for evidence, p. 10  The Securitization Regulation diligence and disclosure rules "...have not in fact created meaningful market safety, nor have they done much to develop the market or increase financing of the real economy at a scale that reflects the potential of the product." -2 September 2021 Response of AFME and UK Finance to HM Treasury's Review of the Securitization: Call for evidence, p. 13 HM Treasury's Report And Call For Evidence Response - HM Treasury counted 21 responses and appeared to accord them equal weigh including that of AFME/UK Finance: 1. "16 respondents answered questions on the overall effects of the Sec Reg." -Review of the Securitization Regulation: Report and call for evidence response, HM Treasury, December 2021, para. 2.5 2. "...the vast majority of respondents conveyed their general support for the Sec Reg." -Review of the Securitization Regulation: Report and call for evidence response, HM Treasury, December 2021, para. 2.6 3. "...HM Treasury assesses that the Sec Reg remains an important element to the functioning regulation of securitization in the UK. We remain committed to the ongoing and effective implementation of the Sec Reg..." -Review of the Securitization Regulation: Report and call for evidence response, HM Treasury, December 2021, para. 2.51 4. "...HM Treasury does not currently see sufficient evidence to support significant changes to the capital treatment of securitization, which is consistent with the Basel standards." -Review of the Securitization Regulation: Report and call for evidence response, HM Treasury, December 2021, para. 11.13 Where Does That Leave Us?  All the evidence in the world will not move HM Treasury to revisit the regulatory treatment of securitization  The UK securitization market, in this regulatory environment, will not recover  "It is what it is." -S. Quinn, Royal Canadian Navy (RET'D)