Risk transfer deals seek regulatory breakthrough

Panellists at SCI's inaugural capital relief trades conference last month discussed regulatory developments in the sector and the push towards accommodating synthetic securitisations under the new umbrella of standardisation. However, doubts persist over the viability of harmonisation in such a diverse market.

"The capital requirements regulation (CRR) has made some good progress with addressing harmonisation in detail, but there still needs to be a greater recognition for the distinctive differences among European jurisdictions," said Carlo de Donato, director of strategic risk solutions at Citi. "Trying to harmonise for the perfect trade is just simply impossible."

The EBA has already set out it own guidelines on significant risk transfer, with the goal of eliminating differences on a national supervisory level. But the independent jurisdictional mandates set out by national regulators have proven challenging. As a result, the EBA has been communicating with the market, in an attempt to identify an optimum framework.

"There are discussions ongoing between the EBA and multiple bodies about time calls, replenishment and other key factors - all of which are essential to risk transfer," added de Donato. "The more advanced regulatory models among European countries will need less treatment, but even these will still face certain tests too."

He continued: "There will be some problematic sticking points with certain regulators; one example being the resolution directive in bankruptcy. Countries like the UK and Italy don't like to apply the servicer terminating structure in the case of a CDS default like other European countries, so how would these distinctions be treated?"

A key development in the move to harmonisation was the European Commission's announcement last year of a Capital Markets Union (SCI 30 September). The plan proposed criteria for simple, transparent and standardised (STS) securitisation, but is not necessarily beneficial to risk transfers.

"I understand the motive behind STS, but I don't think it will achieve much. It is too opaque and doesn't consider the different jurisdiction, asset classes and investors," said Rasheed Saleuddin, portfolio manager at West Face Capital. "Perhaps more importantly, it is also meant to be capital efficient, but it's unlikely that it will actually help credit risk transfers at all."

This is because synthetic securitisations - a popular risk transfer structure - have been deemed by regulators to be ineligible for the STS framework (SCI passim). There are concerns that such an attitude will reinforce the stigma of synthetics by marking them out from deals labelled as higher quality.

"The positive is that the EBA recently sent out a letter signalling that is still considering synthetics within STS," said Kaiko Kakalia, cio of Chorus Capital. Indeed, the EBA has recently shown its support at least for a limited extension of the prudential treatment granted to STS to banks that originate and retain certain SME balance sheet synthetic securitisation positions. Other considerations for extensions could follow.

In contrast, the Basel Committee has stated that it will not consider synthetics in its own simple, transparent and comparable (STC) framework. However, even if synthetics are reconsidered down the line, the limbo created by differing regulatory approaches seems to be affecting potential issuance.

"I haven't seen a standardised bank come up with a synthetic transaction yet," added Kakalia. "The risk weight charge is clearly higher when you have a retained senior single-A tranche at 50%. It looks extremely expensive when contrastingly a bank that goes by an internal ratings-based (IRB) approach is getting the same opportunity at risk weight of 10-12%."

Nonetheless, the expectation is that the high risk weighted costs are unlikely to be resolved in the foreseeable future. "We are probably going to have to wait until Basel 4, whenever that does come out. It's obviously unknown what the risk weights will be, but this should create a clearer direction," said Romain Brive, director of global structured credit and solutions at Natixis. "Even then, I'm still not convinced that synthetics will make sense for standardised banks."

However, Reed Smith partner Claude Brown believes that if the regulators can address certain anomalies, standardised banks may see some opportunity. "What originators will ultimately need is a good, rated portfolio where there is going to be a difference between real risk and capital requirements. This is the arbitrage they must tackle," he said. "But the regulators must first overcome their scepticism that standardised banks can use risk trades to release capital."

For now, the panellists don't expect much movement to be made by standardised banks. On the other hand, IRB banks are expected to continue execute synthetics this year. The only part that remains unclear is just how many are launched.

"It will probably range somewhere between 15 and 25," said Kakalia. "It's hard to pin down because this market is not fully transparent."

Brown, however, pointed out that there is more to consider than just the beginning of the trade. "You have to remember that a lot of trades morph too. Where these deals start and finish often change over time."

JA