December 8, 2016 / 5:40 PM / in 2 years

REFILE-EU lawmakers table compromise on ABS "skin in the game"

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* EU Parliament votes to move forward with STS draft

* Opts for nuanced approach to ABS risk retention

By Mariana Ionova

LONDON, Dec 8 (IFR) - European lawmakers gave initial backing to tougher regulation for the securitisation market on Thursday, but offered an olive branch to the industry through a more nuanced approach to risk retention rules.

Members of the European Parliament voted to move forward with a set of proposals that aim to recast the rules around securitisation and encourage “simple, transparent and standardised” (STS) transactions by rewarding them with better capital treatment.

At the centre of the draft regulation was a controversial call to raise the current level of risk retention from 5% to potentially as high as 20%, in a bid to better align the interests of issuers with those of investors.

But lawmakers signalled a softer stance on the issue on Thursday, voting for a proposal that laid out a tiered system for “skin in the game” dependent on how retention is achieved.

For transactions with revolving collateral and for trades where the slice of risk is held “vertically” across the capital stack, originators would be required to hold at least 10% of the deal under the current proposal.

But if only the equity chunk is retained in a “horizontal” or first-loss arrangement, they would have to hold at least 5% of the risk, which is in line with current rules for the sector.

These more nuanced rules were a departure from proposals made by MEP Paul Tang in June, which called for a four-fold hike to risk retention requirements for potentially all ABS deals, signalling that lawmakers are keen to take a more toned-down approach to securitisation.

“Theoretically, what they’ve proposed makes sense because the risk profile of a vertical slice is very different from that of a horizontal slice at the equity level,” said Edward Panek, head of ABS investment at Henderson Global Investors.

“Once Tang came out with the 20% in June, it was always likely that there would be some compromise from the 5%. But I also think this compromise shows there is probably significant support for the asset class in the Parliament.”

Yet the approved draft also leaves the door open for the European Systemic Risk Board (ESRB) or the European Banking Authority (EBA) to be “mandated to increase required retention rate to 20% in light of market circumstances”.

Under the proposal, the EBA will develop draft “regulatory technical standards” and revise them every two years to specify the level of risk retention, ranging from 5% to 20%.


Some said opening the door for more tinkering with risk retention rules will damage the recovery of the European securitisation market, which remains about half the size it was pre-crisis.

The Association for Financial Markets in Europe noted in a statement on Thursday the proposal threatens to make ABS “prohibitively burdensome in Europe”, undermining the EU’s plan to help banks free up more capital and increase lending to the real economy.

“We welcome the fact that the European Parliament and Council have now endorsed the establishment of an STS framework,” said Richard Hopkin, head of fixed income at AFME.

“However, we are concerned that many aspects of the proposals run counter to the objective of reviving securitisation in Europe and, if adopted as currently proposed, will discourage the use of securitisation as a funding and risk transfer technique.”

Even 10% risk retention would make it difficult to move assets off balance sheet and achieve capital relief. More risk retention would also be particularly punitive for parts of the market that aim to capitalise on the arbitrage between asset and liability spreads.

“Where it’s going to hit hard is CLOs and portfolio asset deals,” said Simon Schiff, of counsel in Baker & McKenzie’s securitisation practice. “It would be really negative to increase the level of retention in those deals.”

“But the vote is just a proposal and the Council seems very much behind the 5% level. There is still a long way to go before a final decision is made. And I don’t think we can assume that the 10% is what it will be in the end.”

The European Parliament and the European Council will in January move forward with informal negotiations on the draft. (Reporting by Mariana Ionova, editing by Robert Smith and Helene Durand)

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