Make Europe (securitization) great again

Europe pioneered mortgage-backed bonds even before the US was born, but today its securitized bond market pales in comparison to America’s. Mario Draghi thinks that should change.

MainFT has already written Draghi’s main gist The future of European competitiveness report, but FTAV couldn’t resist taking a deeper look into it to see if it was all the usual hoax that has been told many times before. Fortunately, several sections caught our attention.

First, Draghi argues that Europe should overcome the obstacles and actively cultivate much more securitization.

This report recommends that the Commission make a proposal to adjust the prudential requirements for securitized assets. Capital expenditure should be reduced for certain simple, transparent and standardized categories for which charges do not reflect real risks. In parallel, the EU should review the transparency and due diligence rules for securitized assets, which are relatively high compared to other asset classes and reduce their attractiveness. Creating a dedicated securitization platform, as other economies have done, would help deepen the securitization market, especially if supported by targeted public support (eg well-designed public guarantees for the first loss tranche).

Intrigued, I downloaded the separate “in-depth analysis and recommendations” report, hoping for more meat on the bone. Unfortunately, there weren’t tons, but here are the concrete steps that Draghi thinks the European Commission should follow.

— The Commission should make a proposal to adjust the prudential requirements for securitized assets. First, capital charges must be reduced for certain STS categories for which the capital charge does not reflect the real risk

— Second, a targeted and appropriate reduction of the p-factor (which increases capital requirements for securitized assets and is criticized under current rules as being excessive and discouraging securitization, especially for portfolios) should be considered of enterprises and SMEs)

— The Commission should review transparency and due diligence rules to facilitate the issuance and purchase of securitized assets Currently, the transparency requirements for these assets are relatively high compared to other asset classes and reduce the attractiveness of securitized assets for financial parties

— The EU should create a securitization platform to deepen the securitization market, as other economies have done. This would reduce costs for banks (especially smaller ones) and could encourage standardization of securitized products Greater standardization would make investments in securitized products even more attractive.

— The EU needs to consider targeted public support (eg well-designed public guarantees for the first loss tranche). This could encourage the issuance and growth of lending in certain sectors that are particularly relevant for competitiveness, while ensuring adequate incentives for risk management

All of this makes a lot of sense. Draghi points out that annual securitization volumes in Europe run at a rate of about 0.3% of GDP per year, compared to 4% in the US. Bridging this gap would be a huge advantage.

The king of online brain rot seems to agree, though, which gives us pause.

Of course, Europe also has a covered bond market of around €3 billion – this is the market that dates back to the reconstruction of Prussia by Frederick the Great after the Seven Years’ War – and there are many people who believe that this is a superior structure.

These are bank bonds backed by a pool of underlying mortgages. Due to dual recourse (investors have collateral in both the bank and the foreclosed assets) and overcollateralization (banks typically pool mortgages worth much more than the collateralized bond), no collateralized bond has ever implicit. Which, well, is not a boast that US MBS can make.

However, there are some downsides to covered bonds – mainly that it’s basically just a form of cheap bank financing. A covered bond doesn’t actually move any assets off a bank’s balance sheet, so it doesn’t free up capital for new loans.

As Draghi points out:

Securitization makes banks’ balance sheets more flexible, allowing them to transfer some risk to investors, free up capital and unlock additional lending. In the EU context, it could also replace the lack of capital market integration by allowing banks to package loans originating from different member states into standardized and tradable assets that can also be purchased by non-bank investors.

The other main standout for the FTAA was Draghi, who called on Europe to press ahead with the “capital markets union” project that Jean-Claude Juncker launched more than a decade ago.

To do this, Draghi says Europe should introduce a harmonized insolvency regime to replace the current patchwork of messy, opaque and often unpredictable national systems and turn the European Securities and Markets Authority into a true European SEC, supranational and independent.

This is not a new idea, but intriguingly it mirrors exactly what Christine Lagarde, Draghi’s successor at the ECB, has been arguing lately. Draghi and Lagarde are tough, and we assume they wouldn’t have argued so strongly if it wasn’t for something.

The recommendations report is also much more in-depth on this topic. Here are his main points, which we’ll quote in full because the details matter (he even included a rough suggestion of phasing in supervision to overcome resistance from national regulators and the financial industry).

— As a key pillar of the EMU, ESMA should move from a body coordinating national regulatory authorities to a single common regulator for all EU security markets. For this purpose, ESMA should be entrusted with the exclusive supervision of: (i) large multinational issuers (i.e. those with subsidiaries in different jurisdictions of EU Member States and revenues and/or total assets above a certain threshold, a natural criterion of identification would be issuers). belonging to major indices such as CAC40, DAX, Euro Stoxx 50, FTSE MIB, IBEX 35, or otherwise — if we want to be more comprehensive — STOXX Europe 600); (ii) major regulated markets with trading platforms in different jurisdictions, such as EuroNext (where ongoing supervision would be carried out by ESMA, while visual visits could be carried out by joint supervisory teams with national competent authorities (NCAs, such as Consob, AMF, BaFin), and (iii) central counterparty platforms (CCP);

— A key step in transforming ESMA into a regulatory and supervisory agency similar to the SEC is to modify its governance and decision-making processes along similar lines to those of the ECB Governing Council, so as to detach them as much as possible from the national level ; the interests of EU member states. Currently, ESMA’s governing bodies are composed of national competent authorities, plus a chairman and some non-voting members. To enable ESMA to take swift and decisive action in sensitive areas, it would be important to add six independent and highly qualified persons, including the Chairman, to ESMA’s Management Board, as proposed in the Letta report. Another extremely important step in this transition is to change EU securities market legislation to a principles-based approach, highlighting the key strategic choices of co-legislators, while delegating technical work to ESMA and increasing its powers to develop and amend rules technical. and streamlining their adoption; and increasing its funding to enable it to carry out its regulatory and supervisory tasks effectively.

— To overcome a likely opposition, the EU regulator will need to share supervision with national regulators and obtain their cooperation along similar lines to what the ESM does with national central banks in the supervision of euro area banks. The transformation of national securities market regulators into subsidiaries of a single EU-wide one will face fierce resistance, not only from national bureaucracies that will feel directly displaced, but also from trading platforms and participants to the market that derive considerable rents from the fragmentation of the status-quo. , as both theory and evidence suggest. Therefore, tactically wise steps would be to: (i) leave the supervision of purely local issuers to national regulators, as is done for the prudential supervision of smaller banks within the Eurosystem; (ii) it starts with the supervision of issuers and market structures, and then moves on to that of mutual funds, which is probably more controversial; (iii) create joint supervisory teams between ESMA and national supervisory authorities to supervise significant issuers and market structures, as well as mechanisms to ensure a constant and timely flow of information between them.

If Trump wins the presidency and ousts Gary Gensler, maybe he could come here and do a job?

Further reading:

– A Kantian change for the Capital Markets Union (CMU)