Draghi calls on old friend ABS to save Europe
Ten years ago this month, Mario Draghi gave a speech to the European Central Bank’s (ECB) Eurofi Financial Forum making the case for reforming securitisation regulation in order to revive the asset-backed securities (ABS) market in the wake of the global financial crisis. For the ECB and its then-president, this was part of a wide-ranging effort to ease incredibly tight lending conditions and help finance the real economy (it would start purchasing ABS through its quantitative easing programme the following month).
Fast forward to September 2024 and Draghi has once again called for fairer capital treatment for securitised assets, this time in his hotly anticipated report to the European Commission that concluded the European Union must unlock an extra €800bn of investment a year if it is to keep up with the US and China.
An efficient and well-regulated securitisation market is a conduit for growth and financial stability. It provides term funding for banks and lenders, and facilitates balance sheet mobility by allowing risks to be efficiently allocated. The combination of these factors allows capital to be recycled into further lending, spurring growth and competitiveness.
Of course, in 2014 Draghi’s ECB removed some of the immediate need for the securitisation reform he was championing by buying ABS. It is perhaps not surprising that now the era of extraordinarily loose monetary policy is at an end, policymakers’ desire for securitisation to take a more central role has become more urgent.
As ABS investors, we welcome Draghi’s promotion of securitisation as a contributor to the plan for increased competitiveness of European financial markets.
Before we delve into the outlook from here, it is worth noting that the market is already in far ruder health than it was when the ECB became a buyer 10 years ago. European ABS issuance passed €105bn year-to-date earlier this month, an 80% increase on the same point last year and comfortably the most active market since the global financial crisis. The issuance has been diverse across asset sectors and geographies, and we have increasingly seen banks using ABS as both a funding and capital tool, with several new issuers and several more returning after a hiatus. So far so positive, until you remember securitisation volumes in Europe run at just 0.3% of GDP, compared to 4% in the US.
So, what is Draghi suggesting to close the gap? First and foremost, adjusting prudential requirements for securitised assets and reducing capital charges for the most liquid securities, which account for a large share of bank issuance. Another proposal is setting up a dedicated securitisation platform to reduce costs for banks and drive more standardisation. Notably, Draghi also urges the EU to consider targeted public support in the form of “well-designed public guarantees for the first-loss tranche”.
A more nuanced suggestion is to reduce barriers to investing in the market, and Draghi’s report recommends a “review” of transparency and due diligence rules which are “relatively high compared to other asset classes and reduce their attractiveness”. In recent years, ABS investors have indeed been subject to stringent due diligence requirements – assessing issuer economic alignment, credit lending standards and stress testing – something most investors were doing already anyway. True, some requirements are excessive and some add little to the investment process. However, in return investors get an abundance of data from issuers, and features such as risk retention that help to align the interest of investors and issuers and support good practices within the market. We would caution against reaching for a US approach in all areas of securitisation standards; those in disagreement can check the difference in asset performance between 2007-vintage European and US ABS.
This is not the first call for a shake-up of the regulation behind the European securitisation market as a driver for credit growth in the region. It is, however, the first time we have seen a concrete plan explaining how this could happen. Investor capacity has been evidenced through subscription levels and issuance this year, and we welcome the push for securitisation from the European Commission. But we would also stress that the biggest barrier to entry is probably still excessive capital requirements. Insurance companies, for example, still struggle to invest in ABS thanks to the overly punitive Solvency II regulation, despite these high quality assets being a good fit for their liability needs. Creating the framework for broader participation across ABS would help to deliver much needed credit to consumers and corporates across the bloc.
As the 10-year period between Draghi’s calls for action demonstrates, both the need and policymaker willingness to address the imbalance of securitisation’s regulatory treatment in Europe has ebbed and flowed over the years. However, the need and the willingness now appear to be present at the same time, with a high profile cheerleader and a sensible plan thrown in. Watch this space.
