The first year of our blogging activities concerning Securitization and Structured Finance Issues is over. We have received quite some feedback from you and would like to thank you accordingly. Knowing that our topics are of interest to the Securitization community is key for us and guides us to compile not only informative but also relevant posts.
Therefore, our first post of 2020 will provide you with a short recap of what happened in 2019 and our expectations of the key market developments for 2020. We welcome your input on this and will provide you with an update on our expectations at the end of this year. As always, we take a regulation-driven look and analyze its effects on market developments.
Stephan, Philipp & Petr
2019 short recap
2019 was one of the most important years for the Securitization markets since 2009. New regulatory provisions for Securitizations came into effect and – unlike to what had happened in recent years when new regulation was introduced – markets saw an increase in activity.
Their first reaction to the new regulation was surprisingly positive. Even an increase of risk weights for the better-rated senior tranches (moving from a floor of 7% to 10% means an increase by over 40% after all) while more subordinated tranches profit from lower risk weights in many cases, depending on the approach used (interestingly, under SEC-ERBA it is not possible to calculate a risk weight of exactly 1250% for a first loss piece due to the formula’s math but the resulting risk weight will remain some percent below 1250%). The reaction of the markets was positive however. This was probably due to investors valuing the decisive step to higher transparency which the disclosure requirements introduce, independently of whether the transaction is STS or not (although STS transactions fulfill even higher transparency requirements than other transactions). While there was little activity in the first quarter, STS transactions started to appear with a clear trend visible in the second half of the year.
Despite total volume issued in 2019 was lower than in the previous years, we could observe a growing ratio of publicly placed to total issuances which continues to follow the trend from previous years. This is clearly a positive signal demonstrating a healthy securitization environment.
Even though we do not expect final 2019 issuance (as soon as Q4 numbers are available), to reach the heights of the previous years, we still see the market positively. Lower issuance in 2019 was caused by almost ceasing market activity in Q1 as a cautious as well as preparatory reaction to new regulatory rules. During that period during the impression was that markets were literally gaining momentum for the issuance of transactions which had been under preparation for months. Market pick-up can be seen form March on where both “classic” transactions as well as STS deals started being issued. The STS label became quickly recognized and used by many originators. The following figure illustrates its growing popularity throughout 2019.
Peak regulation most likely reached Regulation activity has been going on since Securitization Regulation and the CRR Amendment came into effect in January 2019. EBA issued, among others, draft technical standards on Weighted Average Maturity and STS for Synthetics or its Opinion on NPE securitizations while ESMA published their Draft Technical Standards on the templates for disclosure under article 7 of the Securitization Regulation. Although it seems like a lot of additional regulation and thus business as usual, the list for 2020 has become shorter. We expect to see work on the application of Article 7 for third country issuances, a finalization of the STS for Synthetics and – towards the end of the year – a new draft of the DP on Significant Risk Transfer (see (4)). ESMA will start the process of licensing Securitization Repositories (see [Link]). Although this sounds like a lot, we clearly expect the regulation activity to slow down in 2020 compared to the past years. This will give market players the possibility to further develop their business under existing rules and develop market standards for STS and other open issues (e.g. Data Quality under Article 7 or expectations on Cash Flow Models).
1. Loan-level data becomes the topic of the day
Loan-level data or underlying exposures, as commonly being referred to by ESMA, will in 2020 find its way to regulators and investors in two formats – by ECB templates and newly by ESMA templates. Even though the reporting logic is similar, the data reported differ to some extent (depending on asset class). In general, the new ESMA templates cover a wide range of new data fields which we expect to be quickly leveraged by investors and regulators to better understand embedded risks. Further, we expect ECB to incorporate ESMA templates to its eligibility requirements defining what is an acceptable collateral for ECB liquidity. Is effectively means that ECB will gradually move away from its own loan-level data templates over the next years, likely starting in the second half of 2020.
2. STS takes over public transactions
The 2019 trend towards the issuance of STS transactions will gain additional momentum. Big market players have already done their first issuances in 2019, as illustrated by Figure 3. Smaller players will now learn to achieve STS compliance. 2020 will also see a further increase of the use of third-party verification agents who, after their first verification, will help smaller players by spreading Know-how gained in 2019. A specificity of the German market, smaller Cooperative and Savings Banks without an individual capital market access will enter the market via private transactions hosted by their respective core institutions (DZ BANK and the Landesbanken). Relevant asset classes will be car loans and leases at first with MBS assets classes next in line.
Besides cashflow securitizations, the success of STS and thus the principles governing it (a better understanding of each transaction leading to enhanced market resilience from policymaker’s perspective) will also depend on the further development of STS for Synthetics. Although in the end a decision taken by COM (not in 2020), in the course of this year market players will gain insight into the political sphere´s appetite to extend STS to other transaction types. This will have impact on the further development of the market for Synthetics and thus the availability of efficient solutions for SRT (see (4)). We do not expect a final decision on the matter in the course of 2020.
3. SRT is back on the agenda
Basel IV, supervisory capital add-ons as result of the SREP process (in many cases due to IT / Data deficiencies, see (2)) and the macroeconomic environment will see a rise in securitization transactions targeting risk transfer. This will lead to each risk transferring bank developing its own understanding of compliance with the 2017 EBA DP on risk transfer. Under market conditions of increasing demand for SRT, ECB will communicate its own view of the 2017 DP bilaterally. Lawyers and professional services firms will spread the word, moving the system to a more homogeneous implementation of the 2017 DP. EBA is expected to take market developments into account and will likely issue an updated version of the DP towards year end. EBA will most likely position itself concerning tranche thickness, commensurate risk transfer and structural features. Whether EBA offers one or more approaches such as it did in the 2017 DP, towards the end of 2020 market players can be expected to have gained a substantially better understanding of the way SRT takes that at the beginning of the year.
4. Registration of multiple Securitization Repositories
The first and currently only Securitization repository was established as a part of the ECB’s loan-level data initiative in June 2012 and became fully operational in January 2013. Since then, it has been the only place to store and access underlying information on collateral backing publicly issued ABS bonds. The Securitization Regulation, however, brings forth a provision which allows ESMA to register more Securitization repositories, eventually leading to decentralization of the information curtail for all data users. We are likely to see more than one Securitization Repository registered by the end of 2020. It is yet to be seen whether de-monopolization of this business justifies the costs and efforts made by investors, supervisors, rating agencies and researchers to acquire relevant information and data from multiple sources and will as such enhance transparency and resilience of Securitization markets. It is unlikely that ESMA will reveal its interpretation of the related regulation in 2020, so cost structures originating from Repository-stored data use will remain an open issue during 2020. Further, we expect ESMA to finalize its consultation period for data completeness scoring which will consequently be implemented by the Securitization Repositories. Given ESMA’s intention to gradually increase the scoring requirements we expect this to create dynamics for the originators, leading eventually to enhanced data availability for investors. We expect ESMA to release its first data completeness thresholds in second half of 2020 with further revisions to them in the coming years.
Dr. Philipp Völk – Mail: firstname.lastname@example.org
Petr Surala, CFA – Mail: email@example.com