It’s time to get on again! – Securitisations back on the rise
For the better part of the last decade, securitisations have enjoyed a bad reputation. They have been blamed for causing the financial crisis of 2007/08. But is securitisation really this bad? Should securitisation be blamed as all evil of the financial market?
I do not believe so – but let us take a step back to reflect on the essence of a traditional securitisation: A securitization is a form of structured finance that consists of the pooling of assets in a securitisation special purpose entity (SSPE). The SSPE acquires – usually in a true sale – assets like loan, lease or trade receivables from an originator (i.e. a lender, lessor or seller of goods). Such acquisition is refinanced e.g. by the issuance (of the SSPE) of senior and junior notes or the borrowing (by the SSPE) of a senior and junior tranched loan. The receivables acquired by the SSPE serve as collateral for these notes or loans.
In a nutshell: Different assets are bundled together in a special purpose vehicle and tradeable securities of that vehicle are sold to the market. This basic concept behind a securitization is a very simple one andcan be found in different shapes and forms on the financial market. Even a simple UCITS fund follows this idea.
Why the bad reputation?
So how comes that securitisations enjoy such a bad reputation? As often happens, simple concepts had been twisted by the market or certain market participants. Prior to the financial crisis, securitisations were more and more becoming money-printing-machines for investment banks. Structures were getting increasingly opaque, be it because of the assets serving as pool of collateral (e.g. CDOs are themselves securitisation exposures) or because of additional layers or structural features like hedging arrangements or other forms of external credit enhancements being introduced, thereby clouding the comprehensibility of the securitisation structure.
In addition, the credit quality of underlying assets decreased rapidly and bundling of assets got sloppier (too many non-performing assets bundled together etc.). At the height of the boom, loans were originated for the sole purpose of being securitised – with lenders lacking to exercise due diligence and care when granting the loans. Lack of transparency did not allow investors to exercise their due diligence. On the other hand, some institutional investors further placing the issued notes did not even care to exercise due diligence – after all, the risks were not born by them but transferred to the ultimate investors anyway. Rating agencies nonetheless often granted favourable ratings for securitisation exposures.
Securitisations are important in a financial system
However, these shortcomings rather stem from the careless usage of the tool of securitisation than from the tool itself. Meanwhile carefully structured securitisations have also been recognized as an important factor for a sound financial system.
- They allow for a diversification of funding.
- They help companies raise funds outside of the traditional lending market.
- They help to free up originators’ balance sheets for further lending or business activities.
- They facilitate additional investment opportunities for investors by allowing investments in assets that would otherwise not be available to investors.
For example, while lease receivables or trade receivables may be an attractive asset to invest (because e.g. they have a predictable cash flow), such assets are not easily tradeable. In a securitization, however, such assets are pooled and turned into tradeable securities that can easily be subscribed for, and traded, by investors. The tranching in risk classes allows investments in accordance with one’s risk appetite.
Still, securitisations bearcertain risks. Even with tighter regulation, risks can never be totally excluded and investor’s return will ultimately depend on different factors such as the credit quality of the securitised assets. But regulation may help to better understand risks involved with a particular securitisation, its assets and its structure.
On 1 January 2019, the new European framework for simple, transparent and standardized (STS) securitisations will apply. The STS Regulation (Regulation (EU) No. 2017/2402) strives to prevent certain causes that helped fuel the financial crisis: re-securitisations are in principle banned, underlying assets shall in principle not consist of tradeable securities, origination-to-distribute is banned,due diligence requirements are tightenedandtransparency is increased by registers providing investors with detailed information oninter aliasecuritised assets.
Securitisations that fulfill further criteria will benefit from the newly created ‚STS‘ label. The STS label shall serve as quality seal aimed at increasing the trust of the financial market in securitisation again.
Among these criteria are:
- no non-performing assets shall serve as collateral pool
- assets shall be bundled together in a homogeneous way
- the assets shall be originated in ordinary course of business
The new legal framework will hopefully serve as boost for a revitalised and striving securitisation market. Let’s take (manageable) risks to take advantage of the many chances that the instrument of securitisation offers to originators, sponsors and investors alike.
For more information please contact:
Head of Capital Markets
Senior Manager, Attorney-at-Law, PwC Legal Austria