Draft LCR poses new questions on benefits to ABS

Fri May 16, 2014 2:46pm EDT

LONDON, May 16 (IFR) - ABS backed by assets other than mortgages are set to make it to the liquidity buffer elite if unofficial proposals by EU policymakers become law, but they may still be left lagging behind their luckier counterparts - covered bonds.

Despite the draft of the Liquidity Coverage Ratio buoying market players by upgrading covered bonds and broadening the scope of ABS to qualify for higher liquidity status, some critics fear that the benefits brought to structured products are much less defined and substantial.

Under preliminary proposals by the European Commission, which are being discussed informally with member states and stakeholders, ABS backed by auto, SME and consumer loans would count as Level 2B buffers, haircut by 25%.

Comparatively, haircuts on the most liquid covered bonds would drop from 15% to 7%.

"Covered bonds could take an even bigger regulatory leap," said Ruben van Leeuwen, senior ABS analyst at Rabobank, "and the regulatory gap between the two asset classes could therefore widen further."

According to the Commission's draft, eligible ABS would have to be rated AA- or above, which would leave peripheral players practically out of the game - a result that would conflict with policymakers' publicised goal to kick-start SME lending across the region, van Leeuewn said.

However, van Leeuwen and others remain positive that there is still room for compromises on important aspects of the LCR definition.

"If we consider that the document was circulated to sector representatives for the purpose of getting more input back  there is still room for lobbying around those definitions that have been left unclear," he said.

Especially for rules around ratings and underlying pools, "there could be some important departures" from what was seen in the draft, van Leeuwen said. WANTING MORE LEEWAY Srikanth Sankaran, head of European ABS strategy at Morgan Stanley, said that sector participants could relatively easily push their arguments for more relaxed ratings rules. Regulators still need to fill "a gap of understanding" on the limitations to ABS ratings imposed by current sovereign ratings, he said.

As to the definition of the underlying collateral, RMBS backed by guaranteed loans would also win better treatment under the Commission proposal, and be accepted as highly liquid - a move that would boost prospects for markets such as France and the Netherlands where mortgage guarantees are commonly used.

But the new draft would reintroduce a loan-to-value threshold, and include rules on back-up servicing agreements that could limit the eligibility of auto ABS.

Compared with the pre-set 80% LTV threshold of the Basel LCR framework, the Commission would leave it up to a "competent authority" to determine the maximum levels that should be accepted, allowing national policymakers to take into account the specificity of their local markets.

But apart from the technical changes in the LCR definitions, analysts agree that markets' behaviour will depend on other factors.

The risk that the different magnitude of changes in LCR rules for ABS and covered bonds could push investors towards the latter class could be outweighed by the fact that ABS may have a stronger story ahead in terms of spread tightening, both van Leeuwen and Sankaran argued.

"I don't expect a re-allocation [from ABS] towards covered bonds to follow," Sankaran said.

Moreover, "the LCR is just one piece of the puzzle," Sankaran said. The inclusion of ABS in LCR would not necessarily guarantee a level playing field, as uncertainty about the levels of capital charges for structured products still weighs more on the future of the sector, he said. (Reporting By Anna Brunetti, editing by Anil Mayre)

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