The European Parliament's 5% retention requirement is "not a panacea for previous issues that arose in securitisation", according to a report published today by the Committee of European Banking Supervisors (CEBS).
The 60-page report - which had been mandated by the European Commission (EC) as part of its consultation period on the Capital Requirements Directive (CRD) - recommended the EC should not increase the 5% retention threshold, as it is not clear a higher number would result in better alignment of incentives between originators and investors. Moreover, an increase in the level of retention could impede originators from achieving regulatory capital relief via significant risk transfer.
A 15% retention level had originally been mooted, but was subsequently reduced to 5% when the CRD was passed by the European Parliament on May 6. In September, a paper entitled Incentives and Tranche Retention in Securitisation: a Screening Model - penned by Ingo Fender of the Bank for International Settlements and Janet Mitchell from the National Bank of Belgium - suggested a flexible level of retention is needed to ensure incentives are aligned across different asset classes. However, politicians are standing firm on a 5% minimum retention level.
"The requirement for originators to retain a 5% exposure to securitisations is a crucial element. The percentage itself might be higher but given the [current] situation with an almost dead market in need of rebuilding, the 5% was the only possible political compromise. Europe has to show the political willingness to learn from the crisis and to avoid future ones, therefore the political sign with the retention rate is crucial to rebuild trust," Othmar Karas - Member of the European Parliament, who sits on the Committee for Economics and Monetary Affairs - told Risk.
Originators are less than convinced by this argument, however. "We don't believe 5% retention will have any effect whatsoever in aligning incentives - it's a complete red herring. The so-called abuse is related to a very small sector of issuers, principally in the US," says one London-based head of securitisation.
The CEBS paper acknowledges European originators tended to retain exposure to securitisations prior to the crisis. It also believes the four retention options mooted by the EC should be kept as each has "advantages and disadvantages relative to the others". The paper proposes a fifth "L-shaped option" to be potentially introduced in the future, which would combine first loss retention with vertical slice retention. However, one regulator Risk spoke to called into question the viability of such an option.
Elsewhere, CEBS recommends new wording for two of the retention options to increase their coverage to other forms of securitisation, and calls for the EC to clarify the ban on originators hedging retained exposures. The report also indicates further safeguards against abuse in the securitisation markets could be added via enhanced disclosure on the nature of retained exposures, fees, remuneration structures and the holding period for the securitised assets.
There has been a general industry push towards greater disclosure in the securitisation markets recently. In February, the European Securitisation Forum released best practice guidelines for disclosure around residential mortgage-backed securities. And at the moment, the European Central Bank is understood to be encouraging originators to provide loan-level disclosure via its repo window. Originators complain significant increases in disclosure could be costly.
"If there are much greater requirements for enhanced disclosure, there's certainly going to be additional costs. Originators may need to consider whether their reporting systems capture the information that's required," says one senior banker in London.
The EC is due to report back to the European Parliament with its recommendations on the CRD before the end of the year. The CRD should come into force in 2011.