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By Owen Sanderson
LONDON, Dec 19 (IFR) - Market participants warned this week that a new consultation launched by the Basel Committee on securitisation fell into the same traps as previous initiatives.
Securitisations are backed by a huge variety of different claims, but the framework treats everything presented in securitised format as being part of the same asset class. The new paper aims to change the amount of capital banks hold against securitisations, despite the fact that current capital levels were only agreed in 2009 and will be further changed when Basel III is implemented.
Furthermore, it comes as the Financial Services Board aims to look again at securitisation as part of its shadow banking reforms, a project it only started late last year.
Market participants warned that there was much technical detail contained in the proposed new framework as well as other potential pitfalls.
“There is also initial concern that once again policymakers may have fallen into the trap of characterising all securitisations with the poor performance of certain markets during the crisis, namely US subprime and CDOs,” said Richard Hopkin, a managing director at the Association for Financial Markets in Europe.
One senior securitisation lawyer said: “Outside the securitisation framework, SME risk and mortgage risk are treated completely differently, but once you put them in a securitisation, for regulatory purposes, they become the same.”
The market will find some parts of the paper welcome, however. The release with the paper acknowledged “The Committee is well aware of the trade-off between the risk posed by securitisation and its function as an important tool for bank funding and liquidity.”
The high level aims of the paper also chime with themes that the industry has repeatedly raised. Basel’s Committee for Banking Supervision said it wanted to reduce cliff effects - where small changes in credit quality or rating can result in large capital requirement changes, and therefore price volatility - and reduce reliance on credit ratings.
Meanwhile, the Committee’s proposal to reduce risk-weights at the bottom of the capital structure could be a positive.
All non-investment grade securitisations were weighted at 1250% (formerly 1250% risk weight or a deduction from capital, at the bank’s choice), creating a “cliff”, with many trading desks unwilling to hold inventory in these names.
Under the new proposals, non-investment grade securitisations can be weighted anything from 153% up to 1250%, depending on seniority and thickness of the tranche. Below CCC-, all tranches get 1250% weighting.
Although the new proposals address cliff effects within the securitisation market, they do nothing to deal with the cliff effects created by moving in and out of securitisation treatment. At the other end of the scale is a cliff between securitisation treatment and resecuritisation - the securitisation of a securitisation.
This is intended to deal with the notorious CDOs of ABS, but could easily catch ABCP conduits or certain forms of commercial real estate securitisation - fairly vanilla forms of real economy lending.
And while the proposals are positive for non-investment grade securitisations, the changes are less welcome for investment-grade ABS.
Senior tranches of Triple A rated securitisations are given a 7% risk weighting today but this will be increased to 20%, which will become a floor for all securitisations.
The second major aim appears to be encouraging banks to rely less on rating agencies, but without pushing them to use sometimes over-optimistic internal models.
The floor on capital requirements, and much closer alignment between the Standard Approach (which uses ratings) and the Internal ratings Based Approach (which uses internal models) is supposed to stop banks being able to arbitrage regulatory capital requirements.
The Basel paper considers two possible “hierarchies” for calculating capital. A hierarchy means a bank must start with a particular method to work out the capital requirements, unless various conditions prevent it using this, in which case it moves to the next method in the hierarchy.
However, ratings still feature heavily in both Basel alternatives, despite the declared aims of the paper. In the first option, banks could still end up using a Revised Ratings Based Approach - which requires two rating agencies to rate exposures, rather than one as before.
In the second option, banks would have to distinguish “senior high-quality securitisation exposures” from others. The Basel paper says this could be done for securities with long term credit ratings of AAA to AA-.
It does acknowledge that “if jurisdictions permit or require external credit ratings to be the main driver in the determination of whether a securitisation exposure were high-quality, in practice, the reduction in reliance on external ratings would not be as significant as intended.”
As a backstop to both methods, regulators will be given greater powers to ensure consistency. For example, where banks could choose to use the “high-quality” framework for their securitisation, “the decision as to which approach to use would be based on an internal policy whose main intention is not to minimise capital requirements”. A bank would have to justify changes in methodology to its regulator.
Under the first alternative, if a bank does not use the Modified Supervisory Formula approach (at the top of the hierarchy), it must explain its decision.
“Under both hierarchies, supervisors could restrict or prohibit the use of the supervisory formula approaches,” the paper says. (Reporting By Owen Sanderson, Editing by Helene Durand and Julian Baker)