Sandwiched between a story on the European Commission website about halting decline in the pollinating insect population and a piece marking a breakthrough in relations between Armenia and the trade bloc, was a 1 June change to the Capital Markets Union structure designed to ease insurer access to securitised assets. The revised framework will bring Solvency II, which regulates Europe’s insurers, treatment of securitisation broadly in line with its banking equivalent when the CMU comes in force at the start of January 2019.
The changes to the insurance sector regulatory treatment are part of broader moves intended to reboot a European securitisation market which saw its peak issuance of €594 billion in 2007, according to the Association of European Financial Markets, before falling sharply, with the industry group reporting figures of just €235 billion for 2017. This was explicitly recognised by Valdis Dombrovskis, the Latvian commissioner for financial stability, who cited the potential for European securitisation volumes to increase by up to €150 billion a year when announcing the change. Initial market reaction was favourable, to the original consultation at the end of April, with analysts at Dutch lender Rabobank hailing it as a “game-changer” for the European asset-backed security market.
On paper this should provide a knock-on boost to a European collateralised loan market which rebounded into rude health in 2017. The problem is not all securitisations are treated equally. The STS (simple, transparent and standardised) framework separates securitisations into three types: senior STS, non-senior STS and non-STS, with capital charges escalating for each category. So capital charges for the most highly rated and transparent securitisations (senior STS), such as those backed with an underlying portfolio of car or mortgage loans, have been reduced from 2.1 percent, to 1 percent per year. Critically, this is almost identical to the 0.9 percent figure levied on covered bonds with a similar risk profile.
“The huge cliff effects of the current proposals mean insurance investors are unlikely to embrace the new STS framework, [so] there is unlikely to be any significant effect on participation and therefore pricing”
But while those securitisations which receive the STS kitemark will be subject to capital treatment in line with similarly rated cash instruments – a concession loudly demanded by the market – the treatment of non-STS paper remains harsh. And CLOs sit firmly in the non-STS bucket. Securities with this appellation face unchanged capital charges of 12.5 percent a year – so an insurer holding a five-year CLO will need put aside 60 percent of the value of the security at investment. Meaning they won’t.
“[CLOs and CMBS] have basically have been ignored as their capital charges will remain unchanged,” says London-based fund manager Rob Ford, portfolio manager, at TwentyFour Asset Management, in a note published at the time of the consultation.
Ford said insurers’ durations and yield requirements meant that typically they are more interested in non-STS assets and the overall effect of these changes on insurance participation in the broader European securitisation market as a whole would be muted.
“The huge cliff effects of the current proposals mean insurance investors are unlikely to embrace the new STS framework, [so] there is unlikely to be any significant effect on participation and therefore pricing.”
But, according to a London-based head of insurance structuring, that doesn’t necessarily mean bad news for the private debt market as a whole.
“The latest revisions come as those regulators change their attention from fighting the last war of what impact securitisations had on the financial crisis, to the next battle of getting their economies going. But previous rounds of regulation may have permanently changed insurer behaviour.
“With non-STS assets such as synthetic CDOs, or CLOs, it makes more sense to invest directly. This is also true for CMBS. Insurers have got used to making direct allocations to private credit – one impact of the changes may be a reversal of the disintermediation of banks in this sector. Or have insurers got a taste for investing privately?”
The Capital Markets Union is part of broader plans by the EU to bolster investment throughout the region
The CMU is an attempt by the European Commission to boost investment flows between member states from their current patchy levels. Even the most liquid form of investment – standard mutual funds – has just 37 percent of its products for sale in more than three of the EU’s member states, and this figure plummets to as low as 3 percent for alternative investment funds.
The EC set out its CMU plans to increase capital fungibility and help jump-start the EU economy in 2015 when it listed 33 tasks to be completed. The list of tasks covered a wide range of areas, such as expanding funding options for businesses, rationalising incentives for large and small investors, tackling structural barriers from diverging tax systems, insolvency regimes and securities laws, and integrating Europe’s capital markets – all to be done by 1 January, 2019.
One area already complete is another overhaul of the EU’s securitisation regime. The resulting standard transparent securitisation framework has been met with guarded optimism by the market and it remains to be seen if Commission vice-president Valdis Dombrovskis, who is responsible for the programme, will see his ambitions to “diversify funding sources for companies, knock down barriers to investment and increase options for investors” are met.