Today’s constrained market, characterised by high interest rates and soaring inflation, has not spared the world of securitisation. However, sluggish securitisation issuance in Europe can be traced back decades to regulations issued after the global financial crisis (GFC).
The U.S. subprime mortgage crisis revealed how securitisation can create vulnerabilities across the financial system if left unchecked. Since 2008, EU regulators have worked hard to bolster underwriting standards, increase transparency and improve risk assessment and monitoring to avoid a painful repeat of the past.
But these same standards have contributed to a significant decline in the European securitisation market. In 2022, EU annual securitisation issuance equalled 0.3% of GDP, a stark contrast compared to U.S. issuance at 1.4% GDP and Australian issuance at 2.8% in the same year.
In this article, we’ll explore the challenges of securitisation regulation in Europe and how firms can best navigate them.
The regulatory landscape
Europe’s post-GFC regulatory transformation has been marked by stricter debt linkage and reporting standards, both aimed at minimising systemic risk.
Historically, banks could transfer the risk of some loans to other investors via securitisations, freeing capital for new loans. In 2017, the EU adopted a new regulatory framework designed to retain the benefits of securitisation while mitigating its risks. The regulations introduced criteria to differentiate simple, transparent and standardised (STS) securitisations from their complex, opaque and risk-heavy counterparts.
Perhaps most notably, the regulation requires that originators retain economic exposure to the securitisations they sell. This focus on risk retention and stricter reporting requirements ensures that every securitised product is adequately tracked back to its origins, effectively requiring originators to keep a clear linkage to the debt on their balance sheets.
Challenge 1: Risk retention
Under Article 6 of the Securitisation Regulation, the originator, sponsor or original lender of a securitisation must retain a net economic interest of at least 5%. While this approach is meant to increase transparency and accountability, it also effectively requires originating entities to repurchase products after putting them into a structure. Because the linkage back to the debt remains unsevered, the debt stays on their balance sheets, tying up capital that might otherwise be funneled into deserving initiatives.
Challenge 2: Reporting
EU regulations also require extensive investor transparency, including detailed disclosure of assets and liabilities. Some of these disclosures must adhere to the form of templates developed by the European Securities and Market Authority (ESMA), which require a high level of detail on a loan-by-loan basis.
Entities are also bound to report to their respective jurisdictions’ central banks, adding to the operational burden. In Ireland, securitisation vehicles known as financial vehicle corporations (FVCs) must be reported quarterly to the Central Bank of Ireland. The Central Bank must also be notified of any in-scope securitisation transactions no later than 15 working days after the issuance of securities.
In Luxembourg, ‘securities’ are not explicitly defined under local law, so the recently amended framework refers instead to ‘financial instruments.’ But the Luxembourg securitisation regime is also clearly aligned with the EU Securitisation Regulation, ensuring that any securitisation transaction is subject to the same reporting requirements to the competent authority.
Are the barriers to entry too high?
Given these stringent regulatory standards, the securitisation market in Europe has seen a marked decline. The market has contracted by approximately 40% since 2012, raising questions about whether the framework has imposed punitively high barriers.
In Ireland and Luxembourg, the two leading European centres for securitisation and structured finance vehicles, regulators have taken steps to clarify requirements and increase the appeal of SVs, hoping to prompt interest in new securitisation opportunities.
The UK, though no longer a part of the EU, is closely monitoring European regulatory trends and may soon adopt a similar stance. According to Dentons, “the UK securitisation regime will not be a huge sea-change from the EU securitisation regime,” and a general increase in the complexity of the UK securitisation regime is expected.
Conquer complexity with IQ-EQ
IQ-EQ adeptly navigates the intricate regulatory landscape, offering comprehensive solutions tailored to address the complex challenges posed by robust reporting standards. Our decades of industry experience combine with cutting-edge technology to ensure that we can always deliver the best solution for any regulatory challenge. Our holistic approach ensures that clients remain compliant without compromising their core operations, fostering growth and minimising operational hassle.