Brexit Implications for Liquidity
10 August 2017 by Ben Hayward
One of the focuses when talking to investors about ABS over the years has been trying to highlight where the real risks are. Typically this involves pushing back on people’s assumption of fundamental credit risk (unemployment levels and consumer’s ability to service their debt) and instead point towards market volatility when material unexpected events happen that rock financial markets (think Q2 2011 or Q1 2016), or discussing what changes in capital requirements mean for bank and insurance companies investing in the asset class.
Investors who in the past focused on fundamentals have come back again recently, asking whether Brexit has changed our reasoning – could it have enough of a negative fundamental impact that we are now looking at consumer under performance leading to downgrades and defaults?
The answer is still no, but that doesn’t mean that there aren’t other Brexit impacts to be aware of, particularly given the material size of the UK component of the market.
One of these is liquidity; after all it was liquidity that was the big problem for US ABS ten years ago, forcing the closure of the BNP funds which signalled a material upscaling of the credit crisis.
So the question should be, will Brexit lead to a change in liquidity to the extent that prices will back up and the sector underperforms?
I think the main issue is whether there is a lot of cross-border investment between EU countries in UK deals. If so, in the event that there is a hard Brexit, would that be unwound in an abrupt manner that would create spread widening in the secondary market, and reduce investor appetite in primary markets that could stop deals from pricing?
The quick answer is I think that is a long way from being a real problem.
One of the characteristics of the last 10yrs within the ABS market is that we have seen less cross-border investment. This happened during the initial stages of the crisis as investors repatriated capital in the general panic, and has continued at key points, with the advent of the ECB’s ABS Purchase Programme being another key driver of capital into assets that would visibly appreciate in value as the central bank bought via the national banks.
This can be backed-up empirically by looking at published distribution statistics for UK RMBS deals placed this year.
Analysing deals that in aggregate have covered more than £15bn of issuance for this sector this year, the vast majority has gone into UK investors, with them accounting for c85% of bonds placed. While Europe was the second biggest geography (c8%), the interest from the US (6%) and increasingly from Asia points towards a market that is largely domestic and increasingly global, but without any material risk in the relationship between the UK and EU based investors.
Appetite changes with time and relative value, and this 8% might drop to zero, but it is hard to see that having a material price impact. Instead it is as likely that this number increases as Brexit becomes more transparent, and with a more material upside than 8% given the size of the potential investor base, and the premium available in the UK market. Indeed the appetite we see at 24AM now from European and global investors points to increased exposure going forward – clearly a positive for the market.
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