THE POST-FINANCIAL CRISIS RE-EMERGENCE OF
SECURITISATION AS A FINANCING TOOL IN THE
CAPITAL MARKETS UNION
How is the systemic risk caused by securitisation tackled by the new EU legislative securitisation framework?
Jocelyn van Moergastel jocelynvanmoergastel@gmail.com
12285153
Master’s Thesis LL.M. Law & Finance University of Amsterdam Supervised by Jennifer de Lange-Collins Marcel Peeters 12 July 2019
Abstract
The US financial crisis, which took place from 2007 to 2009 and in which securitisation as structured finance mechanism predominated, has affected and in turn contracted the EU securitisation market. Many regulatory interventions have tried to resurrect this market but turned out to be insufficient. As of 1 January 2019, a new EU legislative securitisation framework entered into force. One of the main objectives of this framework is managing systemic risk. Systemic risk is a financial risk that refers to the collapse of the financial system due to a domino-effect of events. This thesis offers an analysis of the new framework regarding whether and to what extent it addresses the contribution of securitisation to systemic risk. Systemic risk is created by various factors and is an uncertain concept for which no generally accepted definition is given. By studying a variety of literature, the research concludes on systemic risk as the risk that a shock, through panic, lack of confidence in the market or otherwise, triggers a chain of failures of or losses to financial institutions where that shock is multiplied by a transmission mechanism throughout the financial system, which in turn results in either increases in the cost of capital or decreases in its availability and therefore negatively affects the real economy. This research reveals, after studying securitisation as structured financing mechanism, that asymmetric information, misalignment of incentives, and interconnectedness of bank and non-bank financial institutions, as dynamics of unregulated securitisation, contribute to the build-up of systemic risk. By examining the framework, this research shows that the framework offers provisions that largely tackle the systemic risk caused by securitisation. However, this thesis observes that the framework could as well enhance the build-up of systemic risk by providing a specific framework with respect to STS securitisation. The amount of similar risk exposures might increase by incentivising the market to issue and invest in the same securities which in turn will intensify the systemic risk throughout the financial system.
Table of Contents
List of Abbreviations 3
1 Introduction 4
1.1 Research plan and methodology 5
1.2 Securitisation as financing tool 6
1.3 (Dis)advantages of the securitisation product 8
1.3.1 Advantages of securitisation 9
1.3.2 Disadvantages of securitisation 10
2 Securitisation and its role in the US financial crisis 11
2.1 Traditional securitisation products 11
2.2 Securitisation during the financial crisis 12
3 Systemic risk through securitisation 15
3.1 Systemic risk defined 15
3.2 Systemic risk caused by securitisation 17
4 EU securitisation legislation before and after the financial crisis 19 4.1 The EU approach in the run-up to the financial crisis 19 4.2 The way the financial crisis affected the EU securitisation market 20 4.3 Significant changes in EU legislation resulting from the financial crisis 21
5 The EU securitisation framework 24
5.1 The Securitisation Regulation 25
5.1.1 General Provisions 25
5.1.2 Specific Provisions 28
5.2 The CRR Amendment 31
6 Considerable challenges of securitisation in the EU 33
6.1 Systemic risk tackled by the legislative framework 33
6.2 The shortcomings of the legislative framework 35
7 Conclusion 39
Annex I 42
Annex II 43
List of Abbreviations
ABS – Asset-Backed Securities
BCBS – Basel Committee on Banking Supervision CDO – Collateralized Debt Obligations
CMBS – Commercial-Mortgage-Backed Securities CMU – Capital Markets Union
CRA – Credit Rating Agency
CRD – Capital Requirements Directive CRR – Capital Requirements Regulation FSB – Financial Stability Board
ECB – European Central Bank
ERBA – External Ratings Based Approach ESRB – European Systemic Risk Board EU – European Union
IRBA – Internal Ratings Based Approach LTV – Loan-To-Value
MBS – Mortgage-Backed Securities (use interchangeably with RMBS) RWA – Risk Weighted Assets
SA – Standardised Approach
SME – Small-and-Medium-sized Enterprise
SPE – Special Purpose Entity (use interchangeably with SPV or SSPE) SPV – Special Purpose Vehicle (use interchangeably with SPE or SSPE) STS – Simple, Transparent and Standardised
1 Introduction
The risk of a downfall of the financial system caused by the risks associated with activities of fundamental components of the financial system that can negatively affect the real economy is, in finance, broadly referred to as systemic risk.1 The impact of systemic risk was felt in the
US subprime mortgage crisis (hereafter: the financial crisis), which started in the beginning of 2007 and was later called the global financial crisis as the ripple effects were felt throughout the global economy. Since this time, the EU securitisation market has become restricted.2 This
thesis focuses on European securitisation, while keeping the securitisation products that played a fundamental role in the financial crisis in the back of my mind. In short, securitisation entails transactions entered into by financial institutions to refinance some of their assets by converting these assets into tradable notes.
In 2015, the European Commission announced an action plan to build a strong EU Capital Markets Union (CMU). The CMU aims to organise the capital markets of the Member States more integrally and deeply.3 The economy needed to be more resilient; stronger capital markets
would toughen long-term investment. The post-financial crisis re-emergence of securitisation as financing tool in the CMU was one of the fundamental concerns of the action plan. More than 100 billion additional euros of credit to the private sector would be provided by banks if only the securitisation market in Europe would be restored to pre-crisis average issuance levels.4 In short, the idea of a strong CMU is that, when capital can flow through the EU
without too many barriers, the economy is stimulated in good times, and resilient and capable of loss-absorbing in bad times. As per 1 January 2019, a new legislative securitisation framework entered into force in the EU. The framework consists of a new regulation on ‘simple, transparent and standardised’ (STS) securitisations – the Securitisation Regulation, and a regulation that amends the Capital Requirements Regulation (CRR) – the CRR Amendment.5 The underlying purpose is to focus on the “risks inherent in highly complex,
opaque and risky securitisation”.6 This thesis aims to answer whether, and to what extent, these
Regulations address the contribution of securitisation to systemic risk.
1 Dwyer & Tkac (2009), p. 3.
2 EC, FAQ on Securitisation, (2015).
3 EC Communication (2015).
4 Ibid.
5 Council of the European Union (2018).
1.1 Research plan and methodology
Due to the destructive effect of the financial crisis, securitisation in the EU is still largely affected and still has to return to pre-crisis level. The lack of confidence and the, although relatively small-scaled, write-downs on the value of the securities had driven the regulator to require higher capital ratios in order to deleverage the financial sector, which in turn restricted the lending of banks to the real economy.7 The motivation of the EU regulators for
reinvigorating this particular market will be outlined in paragraph three of this chapter. Why would we want to resurrect a market that had such destructive consequences over a decade ago? I will start this research by describing securitisation as financing tool with its different types and characteristics throughout the first two chapters and starting in the next paragraph. I will thereby set out the benefits and main drawbacks of securitisation and the role of securitisation during the financial crisis. In chapter three I will discuss the concept of systemic risk and how systemic risk is caused by securitisation. The underlying question here is: What went wrong during the financial crisis and how did securitisation contribute to systemic risk? In chapter four, I will examine and determine the actual effect the financial crisis had on the EU securitisation market and legislation; what changed and what is new? In chapter five, I will critically zoom in on the new EU legislative securitisation framework and what effects it has on securitisation as financing tool in the CMU. The sixth chapter will discuss the way the framework addresses systemic risk. The conclusion will answer the question if the effects of the framework on securitisation are in my view sufficient to tackle the systemic risk problem that I identify in chapter three.
To answer the research question, two separate questions are the common thread throughout this thesis. How does securitisation cause systemic risk and is this systemic risk caused by securitisation tackled by the new framework? Therefore, I will set forth two aspects of the financial system: (i) securitisation as financing tool and (ii) systemic risk as amplifier of the global financial crisis. I then analyse the way these two are related and to what extent the new EU legislative securitisation framework tackles the systemic risk caused by securitisation. Was it only a lack of regulation that created an opportunity for securitisation to have such detrimental consequences?
1.2 Securitisation as financing tool
A couple of decades ago, securitisation was a predominant and typical financial transaction in the US.8 The idea behind securitisation was diversification of financial risks by transferring
risks from the banking sector to investors, the risk ‘receivers’, that were supposed to be outside the banking sector and had a different risk tolerance.9 The definition and use of securitisation
has developed over time. From the simplified ‘disintermediation agreement’ a couple of decades ago, to a penetrating and complicated structure nowadays.10 To understand the
securitisation progress, the basic form of securitisation must first be explained.
Figure 1: Typical (true sale) securitisation structure. Source: Loyens & Loeff (2019)
The originator - a company that has income-producing assets such as loans or other assets with periodic cash flows, e.g. a bank - undertakes business activities. Therefore, the originator needs financing and securitisation is a way of meeting that need.11 Rather than waiting for all the
loans or receivables to be repaid or paid, a business might sell the assets to an SPV for which it gets paid immediately. The originator no longer has to wait for the loans to be repaid but, by securitising the assets, can directly invest the money received from the SPV in its business activities. In its simplest structure, two steps are included in the securitisation process. First, the originator pools the assets it wants to eliminate from its balance sheet, usually receivables from debtors or customers, into a reference portfolio. After pooling the assets, the originator transfers this asset pool to an SPV that has been specially set up by, but legally separated from, the originator to enter into the securitisation transaction. Second, the SPV converts the assets
8 Baums, (1996), p. 3.
9 Acharya, Schnabel & Suarez (2013), p. 518.
10 Fabozzi & Kothari (2008) p. 1-12.
11 In principle, banks will usually obtain financing by collecting deposits and issuing bonds or shares. In the event
of a bank securitising assets, it do so to reduce the capital needs to cover the risk of the loans it has outstanding. By removing these loans from its balance sheet through securitisation it frees up capital and therefore is allowed to issue new loans to the public.
into one or more marketable securities backed by the asset pool, so-called asset-backed securities (ABS).12 The securitised assets are divided into different layers - tranches - adapted
for the investment risk tolerance of different types of investors with each tranche being represented by a different class of securities. The securities are then typically assessed by credit rating agencies (CRA) in order to give them a rating. CRAs make up relative judgments of the creditworthiness, so the probability of default over a particular time frame.13 See Figure 2 for
a typical credit tranching structure. Hereafter the notes are sold to capital market investors.14
Most investors require the investment to consist of a certain minimum rating grade before investing in the securities. Due to the interdependence of risk and rating, securities with a better rating are more likely to attract investors than lower-ranked securities.15 The investors receive
a right to payments backed by the cash flows from the asset pool that lies with the SPV.16 The
performance of these securities is directly derived from that of the underlying assets and there is no remedy back to the originator, except in case of violation of certain agreements.17
Figure 2: Credit Tranching. Source: American Association of Private Lenders (2017) (Edited by author)
In most securitisations, the debtors of the securitised receivables are not aware that the receivables are securitised because the transfer is not communicated to the debtors.18 The
originator continues to service the asset pool on behalf of the SPV. This means that the originator performs administrative tasks on behalf of the SPV, such as collecting invoices, collecting payments and viewing non-payments.19 The SPV uses the cash flow (the receipt of
12 Fabozzi & Kothari (2008), p. 1-12.
13 White (2018), p. 5-7.
14 Jobst (2008), p. 49.
15 Hemraj (2015), p. 27/28.
16 BCBS (July 2011), p.1.
17 Gomez (2008), p. 452.
18 Comptroller of the Currency Administrator of National Banks (1997), p. 8.
19 Gomez (2008), p. 452. Last Loss First Loss Lowest risk Highest risk Lowest yield Highest yield
principal and interest on the receivables) to pay principal and interest on the securities and certain costs of the transaction in accordance with a waterfall, the so-called priority of payments. As a result, certain payments from the SPV will be subordinated to other payment obligations.20 The SPV provides security rights to a security trustee, who keeps the security
rights in the interests of and for (among others) the holders of the securities.
The securitisation structure as discussed in this paragraph is a true sale securitisation because the SPV obtains legal title to the receivables. The term ‘true sale’ must be understood as the opposite of a synthetic securitisation. Synthetic securitisation works the same as a true sale securitisation but with the former type, there is no transfer of legal title. Only the credit risk of the underlying assets is sold through a credit derivative while the underlying assets remain on the balance sheet of the originator.21 The rationale for true sale securitisation is that the
originator receives funding when the loans are sold to the SPV. The purpose of synthetic securitisation is not funding but rather credit risk hedging or other capital management goals.
Credit Risk: Loss of principal and interest are the result of defaults in the asset pool, thus the collateral pool. When
the debtors of the securitised assets are unable to pay the interest payments on their loan (on time), there will be no cash flow to distribute among the investors. Investors are exposed to these losses through the securities and thus losses that are generated by the defaults are shifted to the investors. Credit risk find its origin in the type of
assets that are in the collateral pool.22 It is therefore important for investors to examine the quality of the assets in
the asset pool.
1.3 (Dis)advantages of the securitisation product
The main rationale for securitisation, in general, was that it was a whole new source of funding, and even less expensive compared to other structured finance mechanisms. Therefore, securitisation is driven by economic motivation.23 But why do we need this financing
instrument anyway?Simplistically, a bank could either fund the asset side of their balance sheet by securitising the assets or by holding deposits on their liability side. Instead of ‘originate-to-hold’ credit until maturity and repayment, securitisation leads to more liquidity of the assets
20 Jönsson & Schoutens (2009), p. 4.
21 EP (2015), p. 10.
22 Jönsson & Schoutens (2009), p. 6.
and more room for lending by the bank because now loans are sold to third parties. Issuing loans with the intention to sell them is called ‘originate-to-distribute’.24
1.3.1 Advantages of securitisation
There are three main advantages of securitisation. First, illiquid assets such as loans transform into liquid securities that can be used as collateral or as funding mechanism for the originator. In the second place, originators can reduce their borrowing costs by removing certain risk-weighted assets from their balance sheets. In the case of banks as originators, this lowers their minimum capital requirements and keeps their capital requirements constant while increasing their funding capacity.25 Third, securitisation increases demand for loans because of lower
interest rates charged by the bank because it has diversified its risks and therefore has more room for lending.26 Aside from the fact that securitisation creates an opportunity to obtain
off-balance financing, it diversifies sources of funding and the originator can manage certain risks because the credit or interest rate risks of the assets are now transferred to investors.27 Because
credit or interest rate risks affect the rating of the assets, the originators look healthier to the financial market by disconnecting the securitised assets’ rating from their own.28 That is why
the originator has access to funding more easily and the interest rates on funding are decreased.
Besides the rationale of originators, securitisation could be beneficial for other market participants as well. Both risk-seeking and risk-averse investors, who receive the risk associated with the asset, now have a variety of product choices that respond to the needs of those investors. Tranching of securities is a crucial aspect of securitisation to meet investors’ desires.29 Finally, markets benefit from the sale of securitised assets because for assets that are
hard to value and therefore difficult to trade there is a publicly available price through securitisation.30 From the capital market perspective, more tailored investment opportunities
are created that have different risks, returns, maturities, and diversified underlying assets. What previously were illiquid assets, which were hard to trade on their own, are converted into liquid tradable securities.31 Less costly and further financing in the primary lending markets is
accessible due to the presence of liquid and adequate secondary securitisation markets. Without
24 DNB (2008), p. 40.
25 Jobst (2008), p. 49.
26 Bonner, Streitz & Wedow (2016), p. 3-5
27 Fabozzi & Kothari (2008), p. 1-12.
28 EP (2015), p. 10.
29 Ibid.
30 Levinson (2014), p. 97.
securitisation, banks carry a lot of risk on their assets and thus will not or hardly be able to obtain funding from the financial market. Banks will be limited in their lending to the real economy – e.g. homeowners or small-and-medium-sized enterprises (SMEs), because they might have reached their maximum funding capabilities if they have to hold on to all the debt until it is repaid.32
1.3.2 Disadvantages of securitisation
Although securitisation implies a great number of advantages, the drawbacks must not be overlooked. First, the structure of a securitisation transaction is more complicated and therefore costly in comparison to the structure of traditional types of debt, it requires a lot more due-diligence. This is the consequence of asymmetric information. The originator has an advantage by being informed on the historical conduct of the asset exposures and the current quality of the borrowers.33 Second, securitisation comes with an agency problem. The originator, i.e. the
agent, should act on behalf of the investor, i.e. the principal, without any conflict of interest.34
However, by securitising the assets, the originator maintains barely any interest in the assets. Therefore, the originator might no longer find purpose in monitoring the creditworthiness of the securitised assets’ debtors. Third, securitisation exposes investors not solely to the underlying exposures’ credit risk but also the structuring manner of securitisation may result in exposure to various additional risks. For this reason, it is of fundamental importance that investors are subject to extensive due-diligence requirements.35
32 European Securitisation Forum (1999), p. 6.
33 Pinto & Alves (2016), p. 118.
34 Ibid., p. 117.
2 Securitisation and its role in the US financial crisis
In this chapter, the main types of securitisation and their role during the US financial crisis will be explained. This chapter provides an explanatory framework to gain a broader understanding of the potential problems of securitisation as financing tool.
2.1 Traditional securitisation products
In the 1970s, the US mortgage market faced the introduction of securitisation. Over the years, securitisation structures were no longer only backed by mortgages, but the developed techniques of securitisation applied to diversified and ever-expanding classes of assets, such as corporate receivables or banks assets.36 To elaborate on the basic types of securitisation, we
assume that there are two main classes of notes issued on the capital market: the ABS and collateralized debt obligations (CDO).37 ABS are either mortgage-backed securities (MBS) or
non-mortgage-backed securities.38 MBS can be further divided into two categories: the MBS
backed by residential mortgages (RMBS) and the commercial mortgage-backed securities (CMBS).39
Figure 3: ‘Traditional’ securitisation products.
36 Vink & Thibeault (2008), p. 3.
37 Fabozzi & Choudhry (2004), p. 5.
38 Non-MBS are backed by e.g. car loans, consumer loans, and credit cards.
39 EP (2015), p. 6. 'Traditional' securitisation products ABS MBS RMBS CMBS Non-MBS CDO Heterogeneous debt obligations
All categories of notes are backed by debt obligations. Nevertheless, the asset pool of a CDO is not homogeneously backed by solely mortgages (MBS) or non-mortgages, but instead consists of a wide variety of heterogeneous financial assets, such as loans, bonds or other debt including ABS.40 The nature of a CDO is therefore often complex. The repackaging of earlier
securitised notes, which is the case when the CDO is backed by ABS, CDO41 or ABS and
CDO, is referred to as ‘re-securitisation’.42 The second part of this chapter will analyse the role
securitisation played during the financial crisis.
Figure 4: Example of a CDO asset pool based on fictive numbers.
2.2 Securitisation during the financial crisis
Since the late 1990s, the US house prices had risen extremely.43 From 2001 to 2004, The
Federal Reserve of the US lowered the interest rates in order to bust the economy.44 These low
interest rates increased the demand for houses since it was now cheaper to obtain a mortgage. Housing prices rose significantly because of the increasing demand for houses and the housing bubble got inflated.45 An asset bubble is an economic term and can be generally explained as
“the significant increase in the price of an asset, e.g. houses, in a short period of time and then
40 ECB, Financial Stability Review, (2005), p. 140.
41 A CDO of CDO is often referred to as CDO2.
42 EP (2017), p. 2.
43 Bullard, Neely & Wheelock (2009), p. 405.
44 Labonte & Makinen (2008), p. 2.
45 Baily, Litan & Johnson (2008), p. 12.
8%
62% 13%
17%
suddenly implodes”.46 US banks47 saw an opportunity to make money out of the housing
market. They were able to earn fees by granting mortgages that they subsequently held no risk in because they securitised the mortgages and sold them to investors. People were required to make a down payment and to provide proof they were able to repay the loan in order to obtain a mortgage loan – the so-called ‘prime’ mortgages.48 Mortgage loans are usually categorised
by either prime or subprime. Subprime mortgages are mortgages with higher credit risk than prime mortgages and therefore the interest rates on subprime mortgages are higher.49 Many
investors sought riskier investments because of the higher returns and were willing to invest in the subprime mortgage market.50 Banks, therefore, relaxed their lending standards and issued
loans against variable interest rates to borrowers with a low income, no required down payment and that had a history of high risk of default.51 These subprime mortgages were packaged into
RMBS and divided into different tranches based on order of payment, risk, and degree of credit support.52 Over time, a new financial product was developed in order to securitise subprime
mortgages: the CDO. Different low-rated tranches of RMBS were purchased and pooled together with other assets, which was in a sense the re-securitisation of already existing securities.53 In this way, securities became re-tranched and were sold off as new securities.
Even though as much as 20% of the CDO was created from BBB or worse RMBS54, the issuers
of CDOs succeeded in convincing the CRAs to rate the CDOs as AAA.55 Big financial
institutions, that require a certain minimum rating grade, thought that they were investing in safe securities with low risks of default, while they were holding the notes backed by the ‘mortgage mess’.
The indifferent lending by banks was concealed and a lot of time had passed before real failure occurred. In this way, markets were not regulated or punished in time.56 Due to the
under-
46 Barlevy (2007), p. 44.
47 Throughout this research I acknowledge the major role investment banks, apart from commercial banks,
played during the financial crisis. However, this research focuses on commercial banks: “an undertaking the
business of which is to take deposits or other repayable funds from the public and to grant credits for its own account”. (Art. 4 Regulation (EU) No 575/2013 – CRR).
48 Eggert (2009), p. 1271.
49 Sengupta & Emmons (2007).
50 Eggert (2009), p. 1266-1267.
51 Dell’Ariccia & Marquez (2003), p.4.
52 Baily, Litan & Johnson (2008), p. 25.
53 Eggert (2009), p. 1267.
54 Ibid.
55Baily, Litan & Johnson (2008), p. 27.
regulation of securitisation, private-label securitisation57 was unsustainable during the US
housing bubble of 2008.58 The Federal Reserve had pushed the interest rates up again59 and the
subprime borrowers were no longer able to repay their mortgages, which led them to default on their mortgage. The banks massively tried to sell the houses, creating more supply than there was demand and therefore house prices dropped significantly. The housing bubble had burst and the financial crisis in the US had begun. At that time, the financial market was based on the securitisation of mortgages and was dominated by only a few major investment banks, insurance companies, and rating agencies.60 Trust in the securitisation market had faded.
Liquidity had dried-up and the price decline in MBS resulted in significant losses on the asset side of banks’ balance sheet and therefore most of them were unable to meet their short-term funding obligations. Banks were weak in the run-up to the financial crisis because their short- and long-term liquidity was insufficient and their capital reserves were of lacking quality and quantity.61 When focusing on US and European banks during the global financial crisis, the
banks that fell (determined by systemic risk and the need for liquidity and capital assistance) were specifically those banks that depended heavily on short-term market funding and that had low capital ratios.62 There was not enough liquidity available and due to their
interconnectedness in these securitisation transactions, the fall of one institution became the fall of many.63
57 Private-label securitisations are those that are not backed by the government and thus bear greater risk.
58 McCoy, Pavlow & Wachter (2009), p. 493.
59 Labonte & Makinen (2008), p. 2.
60 Thakor (2015), p. 161.
61 EC, Prudential requirements, (2017).
62 Haan, de & Kakes (2018), p. 3.
3 Systemic risk through securitisation
Empirical evidence shows that “the securitisation process, including the assignment of credit ratings, provided incentives for securitising banks to purchase loans of poor credit quality in areas with high rates of house price appreciation”.64 In the financial crisis systemic risk was
triggered by the interaction of people in the financial markets who at the worst possible time all came together, behaving the same way, selling the same assets causing the financial markets to crash. Banks were trying to do the best for themselves and not to fall by removing assets’ credit risk from their balance sheet, but perversely that is exactly what made the whole system fall down. But what is systemic risk and what dynamics support the establishment of systemic risk?
3.1 Systemic risk defined
According to the ECB, systemic risk is the risk that a trigger will occur, either an exogenous (i.e. source outside the financial system) or endogenous event (i.e. collective actions by a systemically important financial institution or a group of financial institutions), which harms the financial markets and the entire economy.65 Steven L. Schwarcz defines systemic risk as:
“the risk that (i) an economic shock such as market or institutional failure triggers (through a panic or otherwise) either (X) the failure of a chain of markets or institutions or (Y) a chain of significant losses to financial institutions, (ii) resulting in increases in the cost of capital or decreases in its availability, often evidenced by substantial financial-market price volatility”.66
After comparing many definitions of systemic risk given in a variety of literature, I can conclude on some overlapping elements. Systemic risk (i) refers to a substantial amount of financial institutions that often comprise a big portion of the financial system, (ii) indicates that economic shocks, systemic events, or disruptions are passed on between interconnected fundamental elements of the system, (iii) is viewed as damaging to the functioning of the financial system, and (iv) affects the real economy. Additionally, and in my view, Schwarcz takes into account the loss of confidence in the market by including ‘panic or otherwise’ in his definition. Although there is no single accepted definition of systemic risk, I can provide two elements that form the concept of systemic risk. First, there is an exogenous or endogenous shock that, through panic, lack of confidence in the market or otherwise, triggers a chain of
64 Nadauld & Sherlund (2009), p.3.
65 ECB, Financial Stability Review, (2009), p. 100-103.
failures of or losses to financial institutions and second, the shock is multiplied by a transmission mechanism throughout the financial system, which results in either increases in the cost of capital or decreases in its availability and therefore negatively affects the real economy. The transmission mechanism is known as the domino effect of systemic risk.67
Figure 5: The domino effect. Source: Lublóy (2004)
Systemic risk is often recognised ex-post because timing and occurrence of the systemic event or ‘shock’ are uncertain. However, in a paper of the Systemic Risk Centre, Pawel Smaga concludes on factors that cause the build-up of systemic risk. He thereby states that the domino effect is caused by “market participants insufficiently taking into account negative externalities (increase systemic risk) caused by their activities and interconnectedness.”68
Figure 6: Factors that contribute to systemic risk. Source: Smaga, SRC (2014) (Edited by author)
67 Smaga (2014), p. 11.
3.2 Systemic risk caused by securitisation
The wave of defaults during the financial crisis resulted in institutional failures which affected the whole intermediation chain of the securitisation process. This failure of the chain of institutions and the significant losses to the financial institutions (mainly because of interbank-lending) resulted in a decrease in the availability of capital. But how is this the result of securitisation? First, during the financial crisis, the ‘originate-to-hold’ model was replaced by the ‘originate-to-distribute’ model.69 As soon as the mortgage broker connected the
homeowners with the bank, any problems were now the bank’s problems. If the homeowners were to default, the banks did not care because they sold the mortgages to the investment banks, so it was now the investment banks’ problem and so on. If we assume securitisation is not regulated and purely observe its structure, we can conclude that securitisation as financing tool creates the opportunity for institutions to make money out of a transaction where they hold no risk in. They simply sell it to another institution, get their fee and turn their back to the effects of the securitisation if something is to go wrong. This is, in my opinion, the core of misalignment of incentives or the agency problem of securitisation which leads to greater willingness of risk-taking by the originator. Secondly, by (re)packaging assets and tranching them into different layers, information on those assets gets hidden and risks are transferred to fundamentally important institutional investors without their knowledge of these risks.70 This,
without a sufficient level of due-diligence by investors and with sole reliance on external risk ratings, creates information asymmetry between originators and investors. Asymmetric information results in coordination failure in the matching of risk-taking to risk tolerance by investors. Lastly, the interconnectedness in securitisation results in financial institutions responding to economic shocks in similar patterns, as the financial institutions have similar exposure to potential risk. Banks became more interconnected as they were acting as buyers and sellers at the same time.71 Chen, John, Hong Liu & Zhou concluded in their paper that the
systemic risk increase effect is interconnectedness driven and is contributed significantly by larger and more complex and diversified securities.72 The risks attached to particular assets are
diversified through securitisation. However, if bank and non-bank financial institutions are both buyers and sellers in the securitisation transaction the commonality of asset holdings of different banks increases, which exposes them similarly to the possible risks of the assets.73
69 Pinto & Alves (2016), p. 112.
70 La Torre & Mango (2011), p. 117.
71 Chen, John, Hong Liu & Zhou (2017), p. 6.
72 Ibid., p. 23.
Risk exposures will then be concentrated in the financial system, depending on the size of the involved financial institutions and the amount of risk exposures.74 Banks, which hold claims
against other banks that suffer a crisis, must absorb the devaluation of these assets. This devaluation spreads, depending on the amount of similar exposures, throughout the chain of financial institutions that are involved. The more the exposures of a defaulting bank correspond to exposures of other banks, the greater the domino effect.75
To conclude on the question how systemic risk is caused by securitisation, this is done by three (correlated) factors: (1) Information asymmetry between originators and investors because of (re)packaging assets and tranching them into different layers leading to coordination failures, (2) The agency problem of securitisation because of misalignment of incentives leading to greater willingness of risk-taking by the originator, and (3) Interconnectedness of bank or non-bank financial institutions in which the responding to economic shocks in similar patterns depends on the amount of exposure to possible risks these institutions have in common. The presence and contribution of these factors grows as the complexity of the securitisation increases. It is important to notice that systemic risk is created by various factors. Securitisation is only one mechanism of which the elements contribute to the establishment of systemic risk. Securitisation, therefore, does not create but causes systemic risk.
74 IOSCO (2014), p. 29.
4 EU securitisation legislation before and after the financial crisis
Many believe that the EU crisis of 2008-2013 was a stand-alone crisis but that it found its origin in the financial crisis. During the EU crisis, mostly economic, fiscal and financial frictions were noticed, and the economy grew slowly due to liquidity and solvency issues.76
But how are these failures connected with the financial crisis, and why do we call it the global financial crisis? Furthermore, what has changed in EU securitisation legislation? The chapter starts by discussing the securitisation legislation in the EU prior to the financial crisis. The second paragraph analyses the impact of the financial crisis on the EU securitisation market. Lastly, in paragraph three, significant changes in EU regulation resulting from the financial crisis are set out.
4.1 The EU approach in the run-up to the financial crisis
Before the financial disturbance of 2007-2008, regulators believed that by ensuring the safety and soundness of individual banks it would establish financial stability throughout the whole financial system. The adoption of Basel I in 1988 and Basel II in 2004 by the Basel Committee on Banking Supervision (BCBS) guaranteed that safety and soundness. Basel I required a minimum of 8% capital over risk-weighted assets (RWA), of which 4% must be common equity capital and disclosed reserves or preferred stock (Tier 1).77 This capital was required in
order to absorb potential losses on the RWAs. Basel II was agreed because of problems with Basel I, in particular the lack of risk differentiation that caused the actual risks and capital requirements to be misaligned. Moreover, Basel I could not provide an answer as to which capital requirements were appropriate for new financial products such as securitisations.78 The
aim of Basel II was amongst others to define risk weights more adequately.79 The 8% minimum
capital requirement, although differently structured, was kept untouched.80 The Basel Accords
led to better risk management and an improvement in banks’ capacity to absorb losses from shocks.81 In the EU, the Capital Requirements Directives (CRD) 2006/48/EC and 2006/49/EC
laid down rules for investment firms and credit institutions. By these Directives, the Basel II standards were implemented in the EU.82
76 Tuori & Tuori (2014).
77 Van Nieuwkerk & De Vries (2015), p. 7; BCBS (1988), p. 21-28.
78 BCBS (2004), par. 24.
79 Van Nieuwkerk & De Vries (2015), p. 7.
80 BCBS (2004), par. 538.
81 Yongoua Tchikanda (2016), p. 3.
4.2 The way the financial crisis affected the EU securitisation market
Before the end of the 1980s, the securitisation market in Europe was relatively small. The decades that followed showed an extreme increase in securitisation as financing tool as part of financial modernisation.83 European banks were buying RMBS issued in the US, which
internationalised the credit risk.84 The downturn in the value of collateral caused the US ABS
market to crash, which in turn affected the EU securitisation market. Inter-bank lending was highly determined by ABS triple-A securities as attractive collateral. The assets underlying the securities became poorly rated, the usage of securitised financial products was restricted for insurance companies and the inter-bank lending in Europe was contracted by the ECB.85 Since
there now was a lack of confidence in the securitisation market, demand for the ABS triple-A securities fell. This led to a sharp decline in the issuance of ABS immediately after the financial crisis.
Figure 7: European ABS issuance. Source: AFME (2016)
Note that ABS issuance is only part of the total issuance of securitisation. Nowadays, the amount (in EUR) of total securitisation issuance is close to 270 billion. This is not yet half of the amount it was at the end of the financial crisis, i.e. June 2009.86 In comparison with the US,
where the current securitisation issuance level even exceeds its end of crisis level, empirical evidence shows that the EU securitisation market is still largely impaired. The ECB and the Bank of England have stated that if an ABS market is adequately regulated and structured it has the ability to increase efficient resource allocation in the real economy. By converting illiquid assets into liquid securities, originators collect funding and simultaneously transfer underlying risk to the investors who diversify their portfolios regarding risk and return. “This
83 Baums (1996), p. 7-15.
84 Zochowski (2017), p. 2-4.
85 Altomonte & Bussoli (2014), p. 2.
can lead to lower costs of capital, higher economic growth and a broader distribution of risk”.87 This citation and the rationales outlined in chapter one of this thesis, mainly show the
reasons behind the many attempts of regulators to obtain the pre-crisis level of European securitisation issuance. In the next paragraph, regulatory interventions and changes resulting from the financial crisis will be set forth.
Figure 8: European, US and Australia Historical Securitisation Issuance. Source: AFME (2019)
4.3 Significant changes in EU legislation resulting from the financial crisis
In Europe, the regulatory responses to the financial crisis were divided into five classes: (i) reforming rating agencies, (ii) setting (higher) capital requirements, (iii) increasing disclosure, (iv) requiring risk retention, (v) requiring due-diligence.88 The first class, reforming ratingagencies to make them accountable and more transparent, was implemented in 2013 with the CRA Regulation.89 With respect to the second class, the financial crisis painfully revealed that
the capital ratios required by Basel II proved to be insufficient. It turned out that too many banks had insufficient capital and too few of the capital was truly able to absorb losses. It missed the quality that capital was supposed to have.90 In addition, liquidity became a major
problem.91 It became clear that financial innovation had weakened the foundation under Basel
II. Securitisations had significantly increased the credit risks and an important driver for those securitisations was the lower capital requirement. The market had discovered an appealing way of financing these loans while at the same time lowering their capital requirements.92 Basel II
87 ECB & Bank of England (2014), p. 1.
88 Schwarz (2016), p. 121.
89 Regulation (EU) No 462/2013.
90 Van Nieuwkerk & De Vries (2015), p. 8.
91 BCBS (2010), par. 2-5.
had to be revised and eventually led to the adoption of Basel III.93 Basically, Basel III added
additional buffers in order to increase total capital requirements.94 The raise of the minimum
requirement for common equity (CET1) to 4.5% enhanced the quality of the capital.95 This
increased the Tier 1 ratio to 6%.96 Furthermore, the criteria that must be met to be designated
as common equity have been strengthened. 97 Also, by introducing liquidity ratios and putting
a maximum on the leverage ratio98 (capital/non-RWAs), Basel III strengthens the liquidity and
capital requirements for banks.99 It was expected, that by the adoption of Basel III, banks’
incentives to securitise would be effected considerably.100 For a clear overview of the Basel III
Accord, see Annex I.
As of the first of January 2014, a new legislative package that transposed the Basel III standards became applicable to credit institutions and most investment firms in the EU. The package consisted of two forms of legal acts: the Capital Requirements Regulation (CRR) and a new Capital Requirements Directive (CRD IV).101 The package builds upon Basel II standards and
implements the Basel III standards.102 CRD IV should be read together with the CRR; in this
way, the package provides capital requirements, liquidity requirements, leverage measurements, capital buffers, rules on governance and transparency, including disclosure and due-diligence requirements. Chapter five of the CRR consists of a specific part relating to securitisation and lays down rules for the calculation of risk weights and exposure values and the way transferring significant risk is recognised in both the true sale and the synthetic securitisations. Regarding the incentive of EU regulators to let originators maintain some ‘skin-in-the-game’, the ‘risk retention rule’ was first introduced in Europe in 2011.103 According to
the CRR approach, the minimum economic interest in the life of a transaction before they invest in securitisations that banks must reach is 5%.104 This is done to prevent the repetition
of the supposedly erroneous originate-to-distribute mechanism.105 As already put forward in
93 BCBS (June 2011), par. 4-6.
94 BCBS (June 2011), par. 122-150.
95 Ibid., par. 49-50.
96 Tier 1 = CET1 (Common Equity Tier 1) + AT1 (Additional Tier 1). AT1 can consist of e.g. preferred equity
instruments.
97 Van Nieuwkerk & De Vries (2015), p. 8.
98 BCBS (June 2011), par. 151-167.
99 ECB and Bank of England (2014), p. 1-5.
100 The Joint Forum (2011), p. 24.
101 Respectively Regulation (EU) No 575/2013 and Directive 2013/36/EU.
102 DNB (2013).
103 EBA (2016), p. 6.
104 Norton Rose Fulbright (2018).
the introduction, as of 1 January 2019, the CRR Amendment and the Securitisation Regulation entered into force and are the first cornerstones of a uniform securitisation framework in the EU. This legislative package will be critically analysed in the next chapters.
5 The EU securitisation framework
Previous to the introduction of the new EU legislative securitisation framework, which entered into force on 1 January 2019, the applicability of securitisation legislation was determined by the area the investor was investing in. With the new legislative securitisation framework, there is now one regime for banks, insurance companies, and alternative investment funds; it replaces earlier provisions in EU regulations regarding securitisations. To create a single securitisation regime, the individual undertakings such as banks, insurance companies, etc. are wrapped up into one term: ‘Institutional investors’.106The Securitisation Regulation provides (i) general
provisions, which replace the earlier provisions regarding securitisation and that apply to all forms of securitisation and (ii) a specific framework for STS securitisations. See Table 1 for the provisions regarding securitisation that got replaced by the general provisions of the Securitisation Regulation.
Figure 9: Provisions that got replaced by the Securitisation Regulation.
The CRR amendment subsequently requires (i) the capital requirements for positions in a securitisation to “be subject to the same calculation methods for all institutions” and (ii) the regulatory capital requirements of the CRR to be amended in accordance with the specific characteristics of STS securitisation.107 The new Regulations apply to all types of, either private
or public, EU securitisation transactions.108 The EC intended to lay down a regulatory
proposition to regain trust in the securitisation market by simplifying the current framework, in order to restore the securitisation market.109 Below, the essence of both regulations will be
discussed.
106 Regulation (EU) 2017/2401, Art. 2(12).
107 Regulation (EU) 2017/2401, recital 4.
108 Norton Rose Fulbright (2018).
5.1 The Securitisation Regulation
The Securitisation Regulation is divided into two parts. The first is engaged with general provisions that apply to all securitisations and the second part sets out a new specific framework on STS securitisation.
5.1.1 General Provisions
The content of the general framework applies to all securitisations and is composed of the following provisions: definitions110, securitising to non-professional clients, due-diligence
requirements, risk retention, criteria for credit granting, transparency requirements, requirements for securitisation repositories and SPVs, and a ban on re-securitisation.111
The Securitisation Regulation encourages the alignment of interests of the originators and those of the investors.112 It does so by e.g. demanding that originators and original lenders
uninterruptedly maintain a minimum of 5% of material net economic stake in the securitisation.113 This percentage must be derived from off-balance-sheet assets’ notional
value, without the credit risk being hedged or reduced.Only one party is required to meet the risk retention criteria, the 5% cannot be split or applied multiple times and in case nothing is agreed on between parties vis-à-vis the risk retention, the originator carries the burden to retain the interest. In this way, avoidance of risk retention is reduced. The regulation prohibits originators from transferring particular assets to SPVs for the sole purpose of distributing the losses on those assets that are higher than the losses on equivalent assets maintained by the originator on its balance sheet, for which both periods of losses are determined by the transaction’s life or by a maximum period of four years.114 In the event the securitised
exposures are completely and unchangeably backed by specific institutions it is possible to derogate from the risk retention criteria.115 The Securitisation Regulation amends the risk
retention provision under the CRR by shifting the burden to ensure that the retention requirement is met from the investors to the originators while keeping the level constant at 5%.116 The alignment of interests addresses the systemic problem of securitisation to a certain
110‘Sponsor’ as defined in Art. 2 of Regulation (EU) 2017/2402 is left out throughout this research in order to
prevent the analysis from getting too complicated.
111 Regulation (EU) 2017/2402, Art. 2-17.
112 Ibid., recital 10.
113 Regulation (EU) 2017/2402, Art. 6.
114 Ibid., Art. 6 (2).
115 Ibid., Art. 6 (5).
level in my opinion. It enhances collaboration and agreement between parties which tackles the agency problem and reduces the greater willingness to take risks by the originator. In this way, systemic risk caused by securitisation is moderated.
The due-diligence requirements for institutional investors demand them, before holding a securitisation position, to verify that the originator or original lender (i) continuously maintains a material net economic interest of 5%; (ii) provides information on this risk retention to institutional investors; (iii) has granted all credits “giving rise to the underlying exposures on the basis of sound and well-defined criteria and clearly defined processes” for the acceptance, adjustment, renewal, and financing of those credits; and (iv) provided these in effective systems “for applying those criteria to ensure that the loan is based on a thorough assessment of the debtor's creditworthiness.”117 Furthermore, the institutional investors must carry out a
due-diligence assessment that enables him to assess the risks involved, at least (a) “the risk characteristics of the individual securitisation position and the underlying exposures”; (b) “all structural features of the securitisation that may have a material impact on the performance of the securitisation position”; and (c) that, if a securitisation such as STS is notified, the transaction meets the STS criteria in the Securitisation Regulation.118 While holding a
securitisation position, an institutional investor must at least: (i) “establish appropriate written procedures that are proportionate to the risk profile of the securitisation position” in order to continuously monitor “the performance of the securitisation position and of the underlying exposure”; (ii) conduct regular “stress tests on cash flows and collateral values supporting the underlying exposures”; (iii) guarantee “internal reporting to its management body so that it is aware of the material risks arising from the securitisation position and that those risks are adequately managed”; and (iv) demonstrate “to its competent authorities, upon request, that it has a comprehensive and thorough understanding of the securitisation position and underlying exposures and that it has implemented written policies and procedures for the risk management of the securitisation”.119 During the financial crisis, institutional investors tended to rely on
credit ratings by CRAs. In my opinion, the due-diligence requirements promote a system where information is checked in advance of market failure by creating additional detailed disclosure and verification criteria. Creating awareness among the investors of the underlying risks enhances certainty in the market and trust between investors and originators. Investors are
117 Regulation (EU) 2017/2402, Art. 5(1) jo. Art. 9.
118 Ibid., Art. 5(3).
expected to know how risky their investments are and if those risks complement their risk tolerance profile. This prevents coordination failure due to asymmetric information which in turn tackles systemic risk caused by securitisation.
The financial crisis showed amongst other things the need for high-quality transparency levels regarding information distribution towards institutional investors. Article 7 of the Regulation requires originators and SPVs to (i) disclose information about the underlying exposures (per month or per quarter, depending on the complexity and type of securitisation); (ii) disclose all data necessary for a good comprehension of the transaction (prospectus, offering document, transaction closing document, assignment agreement, etc.); and (iii) make all applicable documents available through a securitisation repository insofar as a prospectus has been prepared according to the Prospectus Directive or otherwise via a website that meets strict requirements.120 The information is disclosed “to holders of a securitisation position, the
competent authorities and, upon request, to potential investors”.121 By the frequency criteria
that apply to disclosures, the Regulation contributes to a higher level of transparency. The content of underlying documentation is not limited to the documents summed up in Article 7 paragraph 1b and shall at least consist of a writing on the priority of payments.122 Another
commendable feature of the regulation is that circumvention of obligations currently is relatively impossible through certain provisions. E.g. where a prospectus has not been agreed on, this should be replaced by an overview of the fundamental characteristics of the securitisation or a transaction summary.123 Furthermore, requiring all designated entities to
make this information available through a securitisation repository centralises the available information. In my view, enhanced transparency results in symmetric information between parties but also requires originators and SPVs to act on behalf of the investors without any conflict of interest.124 By securitising the assets, the originator maintains barely any interest in
the assets. However, by requiring high disclosure levels, the originator has to ‘come clean’ about the creditworthiness of the securitised assets’ debtors. This might give it the incentive to keep on monitoring the securitised assets in order to prevent reputational damage. In this way, both the agency problem as well as the problem of asymmetric information as contributors of securitisation to systemic risk are tackled by the Regulation.
120 Ibid., Art. 7(1) & (2).
121 Ibid., Art. 7(1).
122 Ibid., Art. 7 (1)(b).
123 Ibid.
Finally, the re-securitisation prohibition implies that securitisation positions are not included in the underlying exposures in a securitisation. There are certain ways that derogation from the ban is allowed, e.g. for legitimate purposes or with permission of the competent authority.125
As I discussed earlier, re-securitisation increases the complexity of the securitisation structure and in a way covers up the underlying risks. For re-securitisations, the originator should disclose information on the performance and characteristics of the pool underlying the securitisation tranches, apart from information on the underlying securitisation tranches themselves.126 Without this ban, re-securitisation could hinder the aim of high transparency
levels. The provision therefore indirectly addresses the systemic feature of securitisation. 5.1.2 Specific Provisions
The Regulation sets out a specific framework for simple, transparent and standardised securitisations. This framework has been adopted to separate the complex and risky securitisation products clearly from the STS securitisations. In order to obtain the label STS, many criteria need to be met. But why would an originator apply for the STS label? If certain conditions are met, exposures to STS securitisations receive favourable regulatory capital requirements in comparison to non-STS securitisations. From the perspective of institutional investors, although they are still subject to due-diligence requirements, they may find it attractive that the securitisation structure is created in such a way that it obtained the STS label. This could create more certainty to the investors. However, it remains to be seen if STS securitisation will increase market liquidity.127 To analyse each single requirement of the STS
securitisation would go beyond the scope of this research. I will only discuss those criteria that are in my opinion relevant for the research analysis.
The simplicity requirements provide that the transfer of title to the underlying exposures to the SPV is only possible through “a true sale or assignment transfer with the same legal effect in a manner that is enforceable against the seller or any other third party”.128 In case the seller
becomes insolvent, the transfer of title cannot be subject to clawback provisions in which earlier paid money needs to be returned.129 Synthetic securitisation cannot qualify as STS. The
125 Regulation (EU) 2017/2402, Art. 8 (3).
126 BCBS (2014), par. 33.
127 Kastelein (2018), p. 471 & 472.
128 Regulation (EU) 2017/2402, Art. 20 (1)-(5).
underlying assets must be unencumbered, which encumbrance is such that it is foreseeable that the execution of the transfer will be hindered. The criteria for transfer must be based on predetermined eligible criteria.130 The pool of assets underlying the STS securitisation shall be
homogeneous and shall not consist of transferable securities (re-securitisation).131 To prevent
‘originate-to-distribute’ models from recurring, the securitisation is required to take place in the ‘ordinary’ business operations and receivables or assets that are being securitised have been established by applying underwriting criteria that are no less strict than the criteria applied for assets that are not to be securitised.132 Furthermore, there shall be no payment arrears with
regard to contributed assets. The debtor cannot have a credit rating that is an indication of payment issues and cannot be insolvent or in a restructuring procedure within three years prior to the origination date.133
With respect to transparency criteria in order to obtain the STS label, originators are required to disclose dynamic historical default and loss performance data, which should at least cover a period of five years. In my opinion, this seems an appropriate time frame taking into account the financial cycle and recession risk evidence.134 In this way, investors are better informed
and therefore enabled to make better decisions regarding their investment opportunities. In addition, the Securitisation Regulation requires external early verification of a sample of the underlying exposures, disclosure of a liability cash flow model, and frequent disclosure through statements, summaries or reports.135 However, in my opinion, the transparency requirements
for STS securitisations are not sufficiently clear to what exact extent information has to be disclosed. Additionally, I find it remarkable that the Regulation does not determine who carries the burden of the costs accompanied with the process of verification.
Lastly, the standardisation criterion covers technical details of the securitisation structure. The originator, sponsor or original lender is responsible for risk retention compliance. Moreover, measures should be taken in order to diminish interest-rate and currency risks and these actions should be disclosed. This facilitates a standardised risk-sensitive prudential framework and encompasses, as a result of transparency, the protection of investors. In the first place, SPVs
130 Regulation (EU) 2017/2402, Art. 20 (6) & (7).
131 Ibid., Art. 20 (8) & (9).
132 Ibid., Art. 20 (10).
133 Ibid., Art. 20 (11).
134 Borio, Drehmann & Xia (2018), p. 59-63.
are prohibited from including derivative contracts in the pool of underlying assets. However, it is possible to derogate from this prohibition in the event that entering into derivative contracts is solely aimed at hedging the currency or interest-rate risks.136 By requiring disclosure of the
hedging measures the provision enhances transparency making the securitisation, although more complex, less opaque. Furthermore, the interest rates used for interest payments need to be determined by generally used and accepted rates and should not include complex calculations or references to derivatives.137 In addition, the parties involved with the
securitisation transaction, the priority of payments, the triggers that change such priority of payments, the disclosure requirements in case of a change in the priority, as well as the actions and remedies in the event of debtors’ default or other asset performance remedies should be included in the transaction documentation.138 By providing a standardised structure, confidence
by investors increases which in turn resurrects trust in the EU securitisation market.
In case all relevant requirements are met, and the originator wishes to obtain the STS label, he must notify the European Securities and Markets Association (ESMA). ESMA will ask for an explanatory statement from the originator in which the originator is required to set out in what way the STS criteria are met. Although the compliance needs to be verified by an independent third party, this does not remove the originator’s responsibility for compliance.Finally, the STS notification will be published on ESMA’s official website. 139
In my view, the STS requirements definitely reduce credit risk, enhance transparency, create market confidence and therefore tackles systemic risk to a certain extent. However, and more importantly, there is, in my opinion, another side to the story. By creating a standardised securitisation product, an incentive for investors is created to (over)rely on the STS label. The framework even states that “investors should be able to place appropriate reliance on the STS label”.140 If all the transactions are the same, they will default in the same way. By incentivising
the financial market to hold positions in STS securitisations rather than other securitisations, the amount of similar risk exposures might increase which leads to similar responses to systemic events.
136 Ibid., Art. 21 (2).
137 Ibid., Art. 21 (3).
138 Ibid., Art. 21 (9).
139 Ibid., Art. 18 jo. Art. 27 & 28.
