Response to discussion on simple standard and transparent securitisations
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We hope that criterion 4 “the securitisation should be backed by assets that are homogeneous in terms of asset type, currency and legal system under which they are subject” will be interpreted in such a way that there can be only one type of asset in the pool of qualifying securitisations, in order to ensure homogeneous cash flows. This would also be consistent with the definition adopted in the recent European Commission Delegated Act on Solvency II.
We believe, however, that one other criterion should be added: qualifying securitisations should not be allowed to use tranching. As discussed in our recent position paper (cf. pages 35, 42, 43, 59) tranching creates model uncertainty and manufactures complex risks that are very hard to assess. It amplifies the impact of mistakes in the assessment of underlying asset default risk and correlation. It also creates additional procyclicality, enables more risk taking and reduces banks' ability to play a countercyclical role. It increases the length of credit intermediation chains and creates conflicts of interests. Lastly, it attracts as well less informed investors who are more likely to neglect tail risks.
A recent BIS paper called “Securitisations: tranching concentrates uncertainty” found that “even when securitised assets are simple, transparent and of high quality, risk assessments will be uncertain. (..) Substantial uncertainty would remain and would concentrate in particular securitisation tranches. Despite the simplicity and transparency of the underlying assets, these tranches would not be simple.”
Lastly, on the argument that tranching enables the creation of securities that fit investors' preferences, we accept that non-tranched securitisations might find less appetite from institutional investors due to the lower proportion of investment grade securities created. However this would raise the case to refocus, where needed, investment mandates on the true drivers of risk and return, which would admittedly be a more ambitious undertaking but a much healthier one. The less that assets are transformed, the lower the risk that investors suddenly doubt the quality of their assets in times of stress.
As there are still no credible countercyclical private backstops and as it would not be desirable to extend public safety nets any further to avoid increasing moral hazard, we should be wary of such a development.
More generally as much as collateralised funding is useful in times of stress when trust disappears very quickly, it would be very unhealthy in our view to make collateralised funding the new norm. We should work instead to promote unsecured lending.
Question 2: Should synthetic securitisations be excluded from the framework for simple standard and transparent securitisations? If not, under which conditions/criteria could they be considered simple standard and transparent?
Yes, synthetic securitisations should be excluded from the framework for simple, standard and transparent securitisations.Question 8: Do you agree with the proposed criteria defining simple standard and transparent securitisations? Do you agree with the proposed credit risk criteria? Should any other criteria be considered?
We do agree with the proposed criteria defining simple standard and transparent securitisations. In particular we welcome the non-reliance on external ratings and the absence of maturity transformation.We hope that criterion 4 “the securitisation should be backed by assets that are homogeneous in terms of asset type, currency and legal system under which they are subject” will be interpreted in such a way that there can be only one type of asset in the pool of qualifying securitisations, in order to ensure homogeneous cash flows. This would also be consistent with the definition adopted in the recent European Commission Delegated Act on Solvency II.
We believe, however, that one other criterion should be added: qualifying securitisations should not be allowed to use tranching. As discussed in our recent position paper (cf. pages 35, 42, 43, 59) tranching creates model uncertainty and manufactures complex risks that are very hard to assess. It amplifies the impact of mistakes in the assessment of underlying asset default risk and correlation. It also creates additional procyclicality, enables more risk taking and reduces banks' ability to play a countercyclical role. It increases the length of credit intermediation chains and creates conflicts of interests. Lastly, it attracts as well less informed investors who are more likely to neglect tail risks.
A recent BIS paper called “Securitisations: tranching concentrates uncertainty” found that “even when securitised assets are simple, transparent and of high quality, risk assessments will be uncertain. (..) Substantial uncertainty would remain and would concentrate in particular securitisation tranches. Despite the simplicity and transparency of the underlying assets, these tranches would not be simple.”
Lastly, on the argument that tranching enables the creation of securities that fit investors' preferences, we accept that non-tranched securitisations might find less appetite from institutional investors due to the lower proportion of investment grade securities created. However this would raise the case to refocus, where needed, investment mandates on the true drivers of risk and return, which would admittedly be a more ambitious undertaking but a much healthier one. The less that assets are transformed, the lower the risk that investors suddenly doubt the quality of their assets in times of stress.
Question 9: Do you envisage any potential adverse market consequences of introducing a qualifying securitisation framework for regulatory purposes?
A potential adverse market consequence of introducing a qualifying securitisation framework for regulatory purposes could be to indirectly strengthen the central role of collateral in our financial system: a renewed popularity of securitisation would create more assets that can be used as collateral and promote securities financing. In turn this could lead to additional procyclicality, interconnectedness and negative externalities, as discussed (on page 77-80) in our recent position paper .As there are still no credible countercyclical private backstops and as it would not be desirable to extend public safety nets any further to avoid increasing moral hazard, we should be wary of such a development.
More generally as much as collateralised funding is useful in times of stress when trust disappears very quickly, it would be very unhealthy in our view to make collateralised funding the new norm. We should work instead to promote unsecured lending.