* Market and regulators urge each others to make the running
By Anna Brunetti
LONDON, June 16 (IFR) - (This article first appeared in the June 14 edition of the International Financing Review, a Thomson Reuters publication) The face-off between industry players and regulators peaked at the Global ABS conference last week as they clashed on whether liquidity of the asset class should be spurred through the rules or by the markets.
Adam Farkas, executive director at the European Banking Authority, said the treatment under the Liquidity Coverage Ratio could be set for a more generous review in the future if the markets started shoring up ABS products and boosting trading.
“If the industry can do anything to improve the liquidity of these assets,” he said, the European Commission should “definitely” revise their treatment when it reviews the LCR in the upcoming years.
But the market opinion is that current LCR proposals risk making the ABS market more illiquid, creating a paradox that would be a stark contradiction of policymakers’ publicised efforts to revive securitisation.
Under the draft LCR by the European Commission - which took input from the EBA - certain RMBS would only count in the second tier of the second level of the liquidity buffer, a haircut by 25%.
“If regulators say that [that market] is going to be illiquid, then they are effectively making it illiquid,” said Richard Johns, chief executive of the Structured Finance Industry Group. This would deal securitised products a blow versus other better-treated asset classes if the LCR was applied as proposed, speakers at the conference said.
Regulators needed to synchronise the liquidity coverage ratio with the need for a liquid market, Johns said. This echoes worries that regulatory uncertainty could drive ABS outflows.
Some ABS investors are holding cash while waiting for clearer rules, Janet Oram, a director at BlackRock, said at the conference. “But the longer you leave it there, the more likely it will find another route to go,” she warned.
Farkas defended the LCR proposal, arguing that ABS’s historic performance wasn’t positive enough to grant them a stronger status, but encouraged proponents to create a strong market for high-quality products.
The EBA is in the process of defining what high quality securitisation (HQS) should look like, and will post final guidelines by October at the latest. “If we manage to arrive at a good definition” of HQS, Farkas said, then better liquidity and capital treatment could follow and help revive the market.
HQS definitions, such as that of the PCS label, are “very much in line with what are thinking” and should be widely used by the market, he said.
But critics say rules need to be eased earlier in the cycle, as the backdrop for ABS is already in a dangerous stalemate.
Data from the EBA itself showed that ABS issuance at the end of 2013 stood at 180.8bn, of which only 76.4bn was placed with investors. Levels of outstanding ABS dropped by 33.8% from their peak in the second half of 2009 to 1.5trn at the end of last year. Of this lump, 52.2% was retained for repo transactions.
DATA SUPPORTS HQS The PCS Secretariat published a paper last week providing empirical evidence to support a more favourable treatment of HQS. The data presented vindicate HQS, showing it as less volatile than suggested and even more liquid than covered bonds in select cases.
At the end of 2013, volatility (measured by changes in prices on individual tranches) on HQS assets was less than 1%, against approximately 2% on covered bonds.
Liquidity (measured by the average bid-ask spread) had plummeted more drastically for HQS than for covered bond in the first phase of the crisis, but then normalised from 2011. This enabled the average bid-ask spread to fall to around 0.4% in May 2012. At that time, HQS outperformed covered bonds, which had a bid-ask spread of about 0.7%.
After that, though, the trend reversed once more, with covered bonds exhibiting a narrower bid-ask spread. However, HQS actually remained less volatile than covered bonds across the core countries.
William Perraudin, who drafted the PCS report, argued that “the increasingly favourable treatment provided by regulators to covered bonds compared with securitisations is likely to have affected their respective levels of liquidity”.
This statement increases pressure on regulators to streamline their proposals and turn words into action.
On Monday, the European Commission is meeting national officials to further discuss LCR rules after a first draft was circulated at the end of May.
The range of ABS that would qualify as highly liquid was widened in that draft, while covered bonds received an even more substantial boost. Final rules are due on June 30, but given the intensity of the debate on the treatment of these two asset classes, some expect the Commission to postpone the deadline. (Reporting By Anna Brunetti, editing by Anil Mayre)