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The future of securitisation

The recommendations published recently by the Financial Stability Board may result in more rigorous regulation of securitisation transactions.

Legislative initiatives that may be undertaken in the upcoming months and years could have a fundamental impact on securitisation transactions. The increased interest in transactions of this type among regulators is part of the fallout from the economic crisis. Securitisation transactions were broadly blamed as one of the main reasons for the crisis. Whether or not this indictment is correct, it is important to take note of the initiatives underway at the international level seeking to regulate transactions of this type.

The Financial Stability Board, an inter-governmental body that monitors the global financial system, published a long-awaited set of reports on 18 November 2012 with recommendations concerning “shadow banking.” These documents provide a clear sense of the likely direction for legislative changes in this area in the upcoming years. The idea behind the FSB recommendations was to establish criteria for identifying entities from outside the regulated banking sector which should be subject to stricter oversight because of the systemic effects of their operations.

So far the notion of “shadow banking” has mostly been associated with loan-making institutions. But the FSB takes the view that this concept should be much broader. One of the most interesting aspects of the FSB recommendations involves institutions participating in the securitisation process. According to the FSB, while securitisation transactions and the entities that are involved in them can make a positive contribution to the overall economy, they can also generate certain risks. The FSB takes the view that it is necessary to take the appropriate legislative measures to minimise these risks.

The FSB suggests that entities participating in securitisation should be subject to stricter supervision in order to monitor the quality of collateralised assets. In this respect, the FSB recommendations may be particularly important for entities acquiring securitised assets (SPVs), which have so far not been regulated entities. The FSB also makes interesting recommendations for future regulations, such as the suggestion to introduce regulations that would enable elimination of “liquidity transformation” (the risk arising from the difference between the maturity of securitised assets and the maturity of the debt securities used to finance acquisition of the securitised assets). The FSB also recommends that regulatory restrictions on the level of exposure to investments in securitised assets within specific capital groups be introduced.

The FSB recommendations are largely consistent with the findings of the consultation report dated June 2012 by the International Organization of Securities Commissions and the IOSCO’s final report published on 16 November 2012. The IOSCO report focuses on the issues of risk retention (the requirement that the initiator of the securitisation have a “skin in the game” through partial participation in the risks associated with the collateralised obligations) and reporting standards (universal rules for providing information to investors acquiring securities backed by collateralised obligations—the IOSCO report suggests, for example, that the standard information should include the results of stress tests with respect to the collateralised assets).

These reports by the FSB and the IOSCO are clearly aimed at more rigorous regulation of securitisation transactions. By contrast, the adoption of amendments to the Liquidity Coverage Ratio by the Basel Committee on Banking Supervision on 6 January 2013 should also be noted. LCR is one of the key elements of the new “Basel III” set of safer capital requirements for the banking sector. The amendments involve expansion of the acceptable High Quality Liquid Assets in which banks may invest to achieve the required liquidity reserves to include “Level 2B assets.” Thus, as a result of the amendments, the permissible instruments now include, with certain limits, such assets as residential mortgage-backed securities rated AA or higher. The expansion of the HQLA list to include securities backed by securitised assets may lead to an increased interest in such instruments on the part of banks, and thus more activity in the area of securitisation transactions.

Krzysztof Wojdyło, Payment Services Practice, Wardyński & Partners