A summary of the “Implementation of Securitization Regulatory Reform” panel discussion highlights topics critical to the successful return of securitization.
The reemergence of securitization as a viable financing mechanism is a global issue. An informed exchange among representatives from the legal, structured finance, credit rating, and investment banking industries addresses the main issues during a panel discussion held in February 2015.
How Is This Research Useful to Practitioners?
The panelists consider several issues related to best practices in the implementation of regulatory reform in the wake of the financial crisis. Although desirable, achieving the objectives of growth and safety may prove to be somewhat elusive, which the participants reveal in their discussion.
High-quality securitization would appear to be a valid attempt to strengthen the global financial system, but it could bring unintended consequences. The focus on quality certification of certain securitized products comes from policymakers in Europe, where the economic rebound has been more uneven. Such institutions as the Basel Committee, Bank of England, and European Central Bank issued a number of consultative papers on high-quality securitization in 2014. Asset-class markets have recovered more fully in the United States, where there seems to be more flexibility in ideas about how the process should be rekindled.
Market observers fear that the practice of conferring a preferred status on select securitizations will give rise to a divided market of products that attract investors because of a seal of approval versus all other products. Many of the products are otherwise quality deals that should not fail because of their merits, but they would not attract investors and could actually become less liquid. Such a practice could impede issuance and hinder growth. Given the interconnectedness of global financial markets, such a “Scarlet Letter” effect could be far reaching.
Should such a quality assurance process prevail, then the scope of implementation could create a host of problems with regulatory compliance and disclosure if interjurisdictional application is not consistent. Indeed, inconsistent treatment of securitizations could foster regulatory arbitrage.
Determining how to implement an approach could be an involved process as well. The more prescriptive and restrictive the conditions are for assets’ inclusion in high-quality securitizations, the more proscriptive they appear. For example, the European Banking Authority’s terms would exclude collateralized loan obligations, commercial mortgage-backed securities, and certain pay structures. Additionally, small and medium-sized enterprises employ much of Europe’s workforce, but they could find themselves excluded from securitization because of such rigidity in standards and qualifications.
Other critical issues include disclosure requirements, criteria for a review of securitizations in the event of delinquent payments to note holders, and attendant dispute resolution upon such occurrence. Complicated as well are the new due diligence and reporting requirements specified under the new rules of the Nationally Recognized Statistical Rating Organizations. When those are coupled with the new issuer risk retention requirements, they should deter fraud at the point of asset origination and pooling. High-quality securitization proposals that emphasize simplicity over complexity may well stifle originality and creativity. Securitization misconduct that led to the financial crisis arose from moral hazard in the loan creation process, not complexity, in most instances. Regulation has come a long way in remedying such problems through greater issuer and third-party due diligence disclosure along with risk retention and rating agency accountability. Going too far may well stifle securitization’s renaissance through increased costs to issuers and investors.
A thoughtful evaluation of securitization in the wake of the financial crisis entails a detailed evaluation of numerous topics. Institutional players in this space would need to understand the nuances of the myriad issues surrounding transparency and issuance and how a surfeit of regulation could produce undesirable results.
How Did the Authors Conduct This Research?
The panel members’ backgrounds inform the discussion with points of view from different corners of the industry. Rather than a research process, the authors offer numerous scenarios and examples of issues surrounding regulatory reform born of their experience in regulation, analysis, and oversight. Such narrative only underscores the varied nature of securitization markets, the regulatory sphere within which they fall, and the difficulty of reconciling their treatment under a common umbrella.
Balancing the desire for growth with the need for quality assurance in the securitization market, practitioners and regulators would be smart to take things slowly. Developing a uniformly agreed-on process is quite difficult. Implementing it consistently across regulatory regimes is fraught with obstacles. Any quality assurance initiative could actually constrain issuance by causing prospective buyers to focus only on those products that afford the purchasing financial institution preferential capital treatment to the exclusion of many otherwise deserving structures. A common set of standards across countries in the OECD would be desirable.