Market updates and sector developments

A new SIFMA blog highlights three actions that will mitigate what the association calls the “perverse incentives” created by the lack of appropriate risk-sensitivity of the SEC-SA framework, under the US Basel 3 Endgame (B3E) proposal. The blog describes the proposal as “the most restrictive approach to set capital requirements for banks’ securitisation exposures in the developed world”.

As proposed, the B3E rules will - in many cases - result in significantly more capital for securitised assets than what is required under the current rules. Additionally, because the rules are not risk-sensitive, more capital will be required for securitisations of loans that are expected to experience relatively lower losses than for loans expected to experience higher losses.

The first action recommended by SIFMA is to revert the p-factor to 0.5 from 1 to reduce the degree of securitisation capital surcharge. “Our concerns with the excessive securitisation capital non-neutrality are shared by several major jurisdictions where mitigation actions are being taken. For example, considering that the ‘[risk-weighted amount] resulting from the application of the SEC-SA is not commensurate with the risks posed to the institution or to financial stability’, the UK Prudential Regulatory Authority published a discussion paper on ‘adjustments to the Pillar 1 framework for determining capital requirements for securitisation exposures’”, the association notes.

The second action is to adopt the SEC-IRBA framework, which takes into account the expected performance of the underlying pool of assets in setting capital requirements for securitisation exposures. SEC-SA, however, ignores the expected performance of the underlying pool. As a result, it is the least risk-sensitive and most conservative securitisation framework offered by the Basel standards.

Finally, B3E should implement the simple, transparent and comparable (STC) framework, according to SIFMA. The association says that less uncertainty and more confidence in the performance of STC transactions would justify a reduced degree of conservatism being built into the securitisation capital frameworks through capital non-neutrality. It adds that the STC framework would help lower the hurdles of assessing securitisation exposures and incentivise healthy and responsible growth of the US securitisation markets.

In other news…

Hercules NPL scheme renewed
The European Commission has approved the reintroduction of the Greek Hercules Asset Protection Scheme (HAPS), thereby supporting the reduction of non-performing loans in the jurisdiction, without involving state aid. The Commission initially approved the scheme in October 2019, for a duration of 18 months, which was prolonged in April 2021 and ultimately expired on 9 October 2022. The renewal of HAPS will run until end-December 2024.

Under the scheme, a private SPV acquires NPLs from banks and sells notes to investors. The Greek state will provide a public guarantee for the senior notes of the securitisation vehicle, in exchange for a remuneration at market terms.

All four most significant Greek banks which benefitted from the scheme observed a drastic reduction in the stock of their NPLs. It is estimated that, as a result of the implementation of the scheme, the NPL ratio reduced from 42% in September 2019 to 8.7% at end-2022 (corresponding to NPL securitisations of €49.5bn gross book value).

Irradiant closes CLO equity fund 
Irradiant Partners has closed U$411m in commitments for the third vintage of the Irradiant CLO equity strategy (ICLOP III), eclipsing its fundraising target of US$400m. Over 95% of investors in ICLOP III are returning investors from the last vintage of the strategy.

In addition to investing in the equity tranches of Irradiant-managed CLOs, ICLOP III allows for investment in both the equity and mezzanine tranches of third-party managed CLOs, with the aim of adding alpha to ICLOP III investors regardless of market environment. Irradiant’s CLO equity strategy first launched in 2017 and the firm has issued 21 CLOs for over US$8bn since inception.

Modified conflicts rule adopted
The US SEC has adopted Securities Act Rule 192 to implement Section 27B of the Securities Act of 1933, which is intended to prevent the sale of ABS that are tainted by material conflicts of interest. Although the SEC has incorporated a number of changes to the initial rule that was re-proposed earlier this year (SCI 26 January), following extensive industry feedback, the SFA says it continues to analyse the rule.

The new Rule 192 prohibits a securitisation participant, for a specified period of time, from engaging in any transaction that would involve or result in any material conflict of interest between the securitisation participant and an investor in the related ABS. Under the rule, such transactions would be ‘conflicted transactions’.

Conflicted transactions include a short sale of the relevant ABS, the purchase of a CDS or other credit derivative that entitles the securitisation participant to receive payments upon the occurrence of specified credit events in respect of the ABS, or a transaction that is substantially the economic equivalent of such a transaction - other than those that only hedge general interest rate or currency exchange risk. However, consistent with the statute, Rule 192 provides exceptions for risk-mitigating hedging activities, liquidity commitments and bona fide market-making activities of a securitisation participant.

The SFA, in particular, is working to understand what “substantially the economic equivalent” means and how to comply with that requirement. Nevertheless, it appears that modifications to the rule should allow many market participants to continue to hedge themselves against macro risks without running afoul of conflict-of-interest limitations, according to the association.

“Hedging is an essential tool in protecting securitisation markets that are a vital source of financing for trillions of dollars in consumer and business credit. We appreciate as well that the SEC altered its initial proposal, so that affiliates and subsidiaries of securitisation desks would not automatically be subject to SEC restrictions,” comments Michael Bright, ceo of SFA.

Rule 192 will become effective 60 days after publication in the Federal Register. Compliance with the rule will be required with respect to any ABS, the first closing of the sale of which occurs 18 months after the date of publication in the Federal Register.