Insight

Where SRTs are Going (and Where They’ve Been)

srt

At a time when banks are gearing up for the capital requirements of Basel IV (due for implementation in January 2023), regulatory capital relief transactions—also known as significant risk transfer (SRT) transactions—are getting heightened attention. But despite increasing scrutiny from regulators, SRTs have the potential to help banks manage their risk-weighted assets (RWAs) responsibly and provide a desirable asset class for investors.

These transactions involve diversified portfolios of performing loans—most often corporate and SMEs—and have proved to be an effective solution in the face of a substantial increase in capital requirements. Banks are able to offset the hit to profitability created by higher capital requirements while maintaining core lines of business, and investors gain the potential to access exciting, diversified investment vehicles with a rate of risk and return they might not otherwise reach.

In this post, we’ll review the history of SRTs and why they’re so attractive to financial institutions before we explore our predictions for the future of the market.

Spoiler alert: We expect to see more activity than ever in 2022.

Why Significant Risk Transfer?

The required capital levels under Basel III have posed a significant challenge to bank profitability in recent years, and firms have been looking for ways to mitigate its effect. Given the magnitude of the change—and considering that required capital levels are set to rise again in a year’s time under Basel IV—banks want the widest possible range of options to optimise their balance sheets.

There are three primary tools at their disposal: raising capital, selling assets or limiting asset growth, or improving capital efficiency through SRT transactions. SRTs allow firms to continue lending to core clients without diluting existing investments or realising unnecessary losses.

On the investor side, SRTs provide the potential to earn high returns that are somewhat insulated from fluctuation during periods of market stress.

Over the past 20 years or so, securitisation markets have been key in transferring credit risk from a regulated firm’s balance sheet to a firm with a greater appetite for taking on that risk. With credit risk transferred, firms can leverage the released capital and redeploy it elsewhere. Regulators have accepted risk transfer to third parties as a legitimate means of risk mitigation, particularly as the market has matured.

It’s easy to see why an increasing number of banks have decided to free up RWAs instead of raising capital, which can be expensive and dilutive to existing investors.

A small number of banks have been active since the late 1990s, so the SRT market is hardly new—but true market growth sprang from the 2008 financial crisis. This trend is expected to continue as more firms and regulators get comfortable with the structure of SRT transactions and look to manage down their capital requirements for the end of 2022.

Growing assets and geographies

2019 was a record year for the SRT market, with the highest volume issued to date, the most transactions placed with private investors, and the largest number of bank issuers. This was due in large part to the temporary grandfathering of the Basel II supervisory regime for all transactions completed before the end of 2019, allowing banks to free up more capital than was possible under Basel III.

With a similar deadline looming in the next year, 2021 marks a return to growth—the market fell short of expectations in 2020, partly due to fears about unreliable data coming out of the pandemic.

At present, the SRT market is predominantly European; Europe represents 86% of all market transactions since 2010. However, U.S. banks have been accounting for an increasing percentage of the market over the past few years, with notable activity in Canada and Japan as well.

The asset class split is also changing. While corporates and SMEs still dominate, mortgage and consumer transactions are gaining ground steadily year over year. The more diverse the range of securitisation opportunities, the more firms will see opportunities to efficiently optimise their balance sheets through SRTs.

Anticipated trends in 2022 and beyond

We expect to see the supply of SRT transactions continue its trajectory of significant growth over the next five years, particularly since the market has matured a great deal in the last decade. Banks, investors, and regulators are more comfortable with its resilience and utility now than ever before, and that confidence has only been bolstered by the strong market interest post-COVID.

Beyond simple growth, here are the trends we anticipate over the next five years:

  • Expansion into new jurisdictions: SRT is just beginning to gain ground in the US, as most of its major banks are not yet active, so we expect growth in that market to spike. Other emerging markets of note (like Canada and Japan) will occupy a growing percentage of activity, and we expect to see the total list of jurisdictions grow significantly
  • Doubling or tripling of active firms under STS: In 2021, the EU extended the Simple, Transparent, and Standardised (STS) framework to SRT transactions. With a significantly lower cost of capital, SRT is much more accessible to smaller market players, who will become active in the market
  • Increasing adoption after sunk costs: The initial SRT transaction takes a year or more to execute and requires substantial up-front investment. But once that sunk cost is spent, the firm is incentivised to roll out to more asset classes and jurisdictions. As more and more firms apply SRT to a more diverse range of portfolios, the market will grow significantly ahead of Basel IV
  • Enhanced regulatory scrutiny: The PRA, EBA and ECB-SSM have all taken steps in the last year to enhance the level of supervision regulators have over SRT transactions, which will mean an increased regulatory burden for active firms. While there are plenty of benefits for firms looking to help revive securitisation markets, preparatory efforts aimed at appeasing regulators are strongly recommended

IQ-EQ has over 20 years of experience in securitisation services

IQ-EQ’s flexible, agile team is located across Europe, the U.S., and Asia. With localised expertise in key jurisdictions, we are well-equipped to handle anything from private or warehouse transactions to multi-tranche, multi-currency benchmarks. We have the experience, technology, and expertise to support any transaction throughout its life cycle, ensuring that everything runs smoothly and cost-effectively. And with our emphasis on client support and services, you’ll have all the expertise you need right at your fingertips.

Contact IQ-EQ to learn more about our securitisation services today.

 

This article has been issued by IQ-EQ and prepared for general circulation to clients and intermediaries. The article does not have regard to the particular circumstances or needs of any specific person who may read it.  Nothing in this publication constitutes legal, accounting, tax or investment advice.

The information contained in this article has been compiled by IQ-EQ and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied, is made as to its accuracy, completeness or correctness.  All opinions and estimates contained in this article are judgements as of the date of publication, and are provided in good faith but without legal responsibility.

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