After many more or less successful initiatives to integrate capital markets at EU level for at least a decade, a new start has recently been made in view of the massive European investment and thus financing needs. In March, the EU Commission presented 22 initiatives to deepen, in particular, the Capital Markets Union (CMU) under the title Savings and Investment Union (SIU). The first legislative initiative to implement the SIU took place on 17 June, when the EU Commission proposed several measures to relaunch the EU securitisation framework. The aim is to facilitate securitisation activity in the EU while continuing to safeguard financial stability. The securitisation framework should therefore become simpler and more fit for purpose. However, this project is rightly controversial.

Securitisation. From loans to securities

When granting loans, banks are bound by the Tier 1 ratio and must therefore hold capital. In this way, credit defaults can be compensated without jeopardising a bank’s solvency and, in relation to the financial markets as a whole, financial stability. In the case of securitisations, many individual loans or other debt instruments are bundled and converted into tradable securities. These are either retained by the bank or sold to other financial institutions – again banks, insurance companies, hedge funds, pension funds, investment funds, etc. In the course of securitisation, for example, several mortgage loans are removed from the bank’s balance sheet and core capital becomes ‘free’. This allows the bank to grant further loans or to distribute dividends. The return on equity (ROE) might increase. At the same time, credit risk is further distributed beyond the issuing bank and, in some cases, beyond the banking system itself.

In 2008, securitisation became the focus of public attention, as its widespread use after the default of numerous mortgage loans in the US had led to fatal chain reactions in the financial sector. In the wake of the ‘subprime crisis’, there was also a severe financial crisis in Europe with a massive impact on the economy as a whole. In response, several steps have been taken in the area of regulation and financial market supervision to enhance the stability of the financial sector. Under the Capital Requirements Directive IV and the Capital Requirements Regulation, the Tier 1 ratio has been increased in general and in particular for securitisations.

EU plans to revive securitisation

The current framework entered into application in 2019. The Commission now intends to remedy its “shortcomings”, which, according to the Commission, “are hindering market developments”. Commissioner Maria Luís Albuquerque said: "This review can contribute to deepening our capital markets and financing the EU’s strategic priorities, in line with the Savings and Investments Union objectives. (…) We count on the support of the financial industry to strengthen the EU securitisation market and I clearly expect it to use this fit-for-purpose framework to provide more funding to households and business, including SMEs.” The Commission's proposals follow, inter alia, the calls of the Eurogroup and the European Council. The Draghi report also recommended relaunching securitisation as a means of strengthening the lending capacity of banks, deepening capital markets, achieving the European Savings and Investment Union and increasing the EU’s competitiveness.

Implementation of the revival concerns several legislative acts

Firstly, the Securitisation Regulation is to be amended with the aim of simplifying due diligence and transparency requirements and reducing costs for issuers and investors. Secondly, the Capital Requirements Regulation is to be changed in order to adapt the capital requirements for securitisations by introducing more risk sensitivity through a complex procedure. Both proposals will now be discussed and decided in the European Parliament and the Council. A third approach is to propose amendments to the Liquidity Coverage Ratio (LCR) Delegated Regulation, which will be submitted for consultation. This concerns the requirements that securitisations must meet in order to be included in the liquidity buffer that banks must meet. Fourthly, proposals for amendments to the Solvency II Delegated Regulation are also to be published for consultation in order to amend the prudential framework of insurance to better account for ‘actual’ risks of securitisation and to remove ‘unnecessary’ prudential costs when investing in securitisations.

Concerns about financial stability and doubts about effects on investment activity

From AK's point of view, those efforts within the framework of the SIU that are at the expense of the achieved stability of financial markets after the financial crisis, including the revival of securitisation, are problematic. The simplification measures in the area of transparency and due diligence as well as a concentration of prudential requirements are particularly dangerous here, as the assessment and the carrying of credit risk are fundamentally separated. In this way, problems of information asymmetry are exacerbated and incentives for risky taking enhance. Together with a weakening of capital requirements, the stability of the financial sector might again be undermined.

The extent to which the relaunch of the securitisation market can help meet the EU's investment needs is questionable. Weak investment activity stems from a number of factors, including currently clouded sales expectations and high uncertainty, and generally too low yields and specific market structures. Limited funding opportunities play a subordinate role. In addition, securitisations are also used for purposes other than lending (see above), and lenders are more likely to call in the loan and seize their collateral. In contrast, plain covered bonds and Pfandbriefe have proven effective in financing private investment. However, it is precisely these segments that could come under pressure as a result of the promotion of securitisation. Overall, reducing uncertainty through stabilising economic demand, public investment and reliable regulatory pathways would also incentivise private investment and increase the EU’s competitiveness.

Further information:
European Commission: Commission proposes measures to revive the EU Securitisation Framework
European Commission: Savings and Investment Union
Finance Watch: Can Securitisation Reboot the Capital Markets Union? The limits of recent policy proposals to ‘revive’ the market for asset-backed securities in Europe
A&W-Blog: Spar- und Investitionsunion – das Pferd weiter von hinten aufzäumen? (nur Deutsch)