Top of the Blog #5: Securitisation: A Necessary Revival of the European Market

The Draghi report on European competitiveness* is clear: “To enhance the financing capacity of the banking sector, the EU must revive securitisation.” In response, the European Commission** recently launched a consultation on potential improvements to the functioning of the securitisation market.

Securitisation in Europe was particularly hard-hit by the 2008 financial crisis. Prior to the crisis, the European market (including the UK) represented 75% of the US market. By 2020, however, it had contracted to just 6% of the US market’s size, with stricter EU regulations largely responsible for this gap.

Post-Crisis Regulation

In response to the financial crisis, European legislators reinforced the securitisation framework in 2017 through EU Regulations 2017/2402 and 2017/2401.

• To combat moral hazard—whereby banks originating securitisation transactions may inadequately assess borrowers’ credit risk because the risk is transferred to third-party investors, leaving banks with minimal exposure to losses—the legislation requires originators to retain at least 5% of the securitised risk. It also mandates that banks apply strict due diligence measures to securitised loans.
• The prudential requirements for Asset-Backed Securities (ABS) have been increased, and reliance on rating agencies has been reduced. Before the crisis, the prudential treatment of securitisation often relied on ratings assigned by these agencies to ABS tranches. However, it was later revealed that the agencies had incorrectly modelled the risk associated with some tranches, leading investors to believe that these securities were almost risk-free.
• Specific rules now define which assets are eligible for securitisation and set out the obligations of the seller in selecting assets for securitisation.
• Investor information requirements have been strengthened

The European Commission has also promoted the introduction of ‘Simple, Transparent and Standardised’ (STS) transactions by reducing their capital cost. These transactions are restricted to specific types of assets that comply with quality and diversification rules. However, obtaining the STS label requires?relatively complex reporting to the European Securities and Markets Authority (ESMA).

Recovery Is Still a Long Way Off

The new regulations came into force on January 1, 2019, but more than five years later, it is evident that activity has not significantly increased. In a report dated October 2022***, the Commission noted that market participants do not believe the regulations have successfully revived securitisation. Furthermore, the investor base has remained narrow.

However, securitisation is an attractive funding technique for companies, especially in the current economic climate, which impacts working capital levels. Companies use securitisation to secure financing at significantly lower spreads than if they borrowed directly from banks. For instance, a BB-rated company can, through the tranching of risk, obtain AA-rated securitisation financing, significantly reducing its funding cost.

Towards Far-Reaching Reform

Several stakeholders, including the Association for Financial Markets in Europe (AFME), the European Banking Federation, and Paris Europlace, have proposed a series of concrete measures to enhance the attractiveness of the securitisation market.

In its current market consultation, the European Commission echoes some of the criticisms raised by these stakeholders, aiming to assess the merits of the following measures:

? Clarification of the definition of securitisation ? Reduction of due diligence and transparency requirements ? Lower capital requirements for securitisation transactions involving financial institutions ? Improved prudential treatment for investors such as insurance companies and pension funds

The Commission’s approach is not limited to bank securitisation; it also addresses the direct securitisation of trade receivables and leasing contracts by companies.

It is highly likely that the securitisation framework will soon improve, generating savings for issuers. Accola and Redbridge possess unique expertise in this area. In 2024, we closed three transactions with a combined volume of €1.7 billion. To learn more about these engagements:

Client case – NGE – Securitisation

Client case – Saint Gobain – Securitisation

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* Sept 24, The future of European competitiveness – A competitiveness strategy for Europe

** Oct 24, Targeted consultation on the functioning of the EU securitisation framework

*** Oct 22, Report of the Commission to the European Parlement on the functioning of the securitization regulation.

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