{"id":7176,"date":"2021-12-22T08:19:00","date_gmt":"2021-12-22T08:19:00","guid":{"rendered":"https:\/\/iqeq.com\/?p=7176"},"modified":"2023-05-02T10:11:52","modified_gmt":"2023-05-02T10:11:52","slug":"where-srts-are-going-and-where-theyve-been","status":"publish","type":"post","link":"https:\/\/iqeq.com\/insights\/where-srts-are-going-and-where-theyve-been\/","title":{"rendered":"Where SRTs are going (and where they\u2019ve been)"},"content":{"rendered":"
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At a time when banks are gearing up for the capital requirements of\u00a0Basel IV<\/a>\u00a0(due for implementation in January 2023), regulatory capital relief transactions\u2014also known as significant risk transfer (SRT) transactions\u2014are 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.<\/p>\n

These transactions involve diversified portfolios of performing loans\u2014most often corporate and SMEs\u2014and 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.<\/p>\n

In this post, we\u2019ll review the history of SRTs and why they\u2019re so attractive to financial institutions before we explore our predictions for the future of the market.<\/p>\n

Spoiler alert: We expect to see more activity than ever in 2022.<\/em><\/p>\n

Why Significant Risk Transfer?<\/h2>\n

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\u2014and considering that required capital levels are set to rise again in a year\u2019s time under Basel IV\u2014banks want the widest possible range of options to optimise their balance sheets.<\/p>\n

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.<\/p>\n

On the investor side, SRTs provide the potential to earn high returns that are somewhat insulated from fluctuation during periods of market stress.<\/strong><\/p>\n

Over the past 20 years or so, securitisation markets have been key in transferring credit risk from a regulated firm\u2019s 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.<\/p>\n

It\u2019s 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.<\/p>\n

A small number of banks have been active since the late 1990s, so the SRT market is hardly new\u2014but 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.<\/p>\n

Growing assets and geographies<\/h2>\n

2019 was a record year<\/a>\u00a0for 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\u00a0Basel II<\/a>\u00a0supervisory regime for all transactions completed before the end of 2019, allowing banks to free up more capital than was possible under Basel III.<\/p>\n

With a similar deadline looming in the next year, 2021 marks a return to growth\u2014the market fell short of expectations in 2020, partly due to fears about unreliable data coming out of the pandemic.<\/strong><\/p>\n

At present, the SRT market is predominantly European; Europe represents\u00a086% of all market transactions<\/a>\u00a0since 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.<\/p>\n

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.<\/p>\n

Anticipated trends in 2022 and beyond<\/h2>\n

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.<\/p>\n

Beyond simple growth, here are the trends we anticipate over the next five years:<\/strong><\/p>\n