In our view the approach taken in the current draft of the RTS does not prevent regulatory arbitrage, but there are aspects that might even promote it, as prudent levels of synthetic excess spread are “punished” by high exposure values and subsequently weaker capital relief, while excessive levels of synthetic excess spread do offer relative lower exposure values for excess spread and subsequently better capital relief. In our view, this is rather an incentive for regulatory arbitrage than a restriction to it. This is due to the fact
that the exposure value for future excess spread is limited by the total expected losses according to the asset model approach instead of being based on the amount exceeding expected losses. Increasing excess spread levels would provide substantial credit support to the tranches and therefore strongly improve the risk profile of the tranches. In order to illustrate we would like to refer to the representative transaction on page 25 of the draft RTS. The following table does show that the exposure value does only increase marginally with higher excess spread levels (see table 1 in the attached).
As mentioned, in our view this would rather promote regulatory arbitrage than restrict it.
On top the current approach would not result in a level playing field between traditional and synthetic transactions, as only synthetic transactions would be
affected, while an equivalent traditional transaction would not be. Having in mind the intentions outlined both in the CRR Quick Fix as well as in the current draft, an approach along the following lines would be more appropriate, economically meaningful as well as also consistent with the Level1 text in our view: By way of derogation from the treatment of traditional securitizations under the CRR one can argue that future excess spread of a securitization covering the expected loss is already risk-weighted under the existing rules of Chapter 5. As indicated in 8 (ii) of the draft RTS in a traditional securitization the originator is giving up future income of securitized assets. This does include the excess spread portion of the future income of assets, which is available to cover losses of the securitized portfolio within the traditional securitization structure in the first place. This credit support in form of future excess spread is of course affecting the risk profile of the tranches and is also considered in pricing. Subsequently applying the rules of Chapter 5 for calculation of the risk-weights of tranches implies that credit support provided by future excess spread is already considered in the risk weighting of tranches for traditional securitizations. This is supported by the fact that SEC-SA and SEC-IRBA effectively assign a multiple of the risk-weighted assets of the underlying portfolio to the various tranches according to an exponential function, therefore already considering the expected loss of the underlying portfolio. So while in a traditional securitization future income (including the excess spread portion of it) is given up by the originator, in an synthetic securitization the future income (including the excess spread portion of it) stays with the originator, as you correctly state in 8 (ii), if no synthetic excess spread is provided. A synthetic securitization therefore is equivalent to a traditional securitization if and only if the originator assigns the excess spread portion of the future income to the structure to cover expected losses in the portfolio in form of a synthetic excess spread. This is both true for the originator’s position in terms of future income as well as in terms of the risk profile of the tranches. In this context we would like to highlight the last paragraph of 248 (e). In our view by way of derogation from the treatment of traditional securitizations it is economically intuitive and well arguable that future synthetic excess spread up to (!) the expected loss is already risk-weighted under the rules of Chapter 5, while any synthetic excess spread portion exceeding the expected loss is not.
We therefore would consider it to be economically meaningful as well as both in line with the Level-1 text and the intentions of the legislators to focus on future excess spread exceeding the expected loss of the securitized portfolio (plus past/current excess spread which is already considered in the income statement/balance sheet) for calculating the exposure value instead of the future excess spread up to the expected loss. In our view such an interpretation would also better serve the goal to prevent regulatory arbitrage by requiring risk-weighing of excessive future synthetic excess spread.
Finally, the current draft does “punish” smaller banks excessively in our view by requiring substantial risk-weighting for prudent levels of synthetic excess spread: Due to their smaller loan books both in size and number securitized portfolios are often longer in average life and therefore more dependent on excess, while a prudent level of excess spread is economically justified. Also securitized portfolios of smaller banks are often more focused towards SMEs, therefore being somewhat riskier, generating higher income, having higher
expected losses and again as a result being more dependent on a prudent level of synthetic excess spread. In case the approach currently taken in the draft RTS is to stay we would also like to comment on the following aspects: we clearly miss a grandfathering or phase-in provision for existing transactions. Existing transactions structured with excess spread will become uneconomic and even lose their complete RWA relief in worst case (especially EIF structures include excess spread and a retained first loss tranche that have the risk of falling below 1250% RW with future excess spread inclusion in SEC IRBA formula and thus not be capital deducted anymore but with high RWAs to be considered). This could trigger a high number of regulatory calls. The consequence will be a big negative effect from loss of capital relief for many European banks in a difficult environment at effectiveness of the
proposed paper if the future excess spread calculation is not reconsidered. On top this would again be especially burdensome for smaller banks as due to typically smaller transaction sizes and often longer WALs of securitized portfolios sunk costs due to regulatory calls would be higher from a relative perspective.