The EC proposals, published on July 13, fall in line with guidelines issued by the Basel Committee on Banking Supervision and call on supervisors to enforce greater due diligence standards on banks investing in highly complex re-securitisations. Where due diligence is inadequate, institutions would either have to pay higher capital charges or be banned from investing in such instruments.
The increased capital requirement would be calculated through a risk weight of 1250% applied to the re-securitisation, which would apply to new issues after December 31, 2010. The Committee of European Banking Supervisors will be asked to define which instruments qualify as sufficiently complex.
"The impact of these measures on the future credit supply – the funding of which is facilitated in part by issuance of re-securitisations such as certain collateralised debt obligations (CDO) – should be assessed in the light of the level of their issuance in the post-crisis market environment," the EC said.
According to the EC, CDO issuance in Europe contracted from €88.7 billion in 2007 to €47.9 billion in 2008 but would have contracted far more had the European Central Bank and the Bank of England not accepted securitisation as collateral – in 2008, 95% of all securitisation issues was retained by banks to use in repo deals with central banks, "with the primary market remaining effectively closed", the EC wrote.
The EC also wants to increase the disclosure requirements for securitisation exposures in the trading book and off-balance-sheet instruments, estimating that the additional administrative costs for the banking industry will total roughly €1.3 million a year.
The proposals, which also include measures to create sound remuneration policies that do not reward excessive risk-taking, will now pass to the European Parliament and Council of Ministers for their approval.
"These new rules target some of the investments and practices that lie at the root of the financial crisis. New rules on re-securitisations will require banks to hold significantly more capital to cover their risks when investing in these products, while the additional disclosure rules will help to create a climate of market confidence," said internal market and services commissioner Charlie McCreevy.
Separately, the EC is also re-evaluating plans to enforce a 5% retention charge on issuers for all securitisations from 2011. The idea was approved by the European Parliament on May 6, despite intense opposition among market participants, but the EC is considering whether the charge should be higher than 5%, with its conclusions due by year-end.
According to research published this week by data provider Xtrakter, asset-backed new issuance dropped by 54.1% in the second quarter, compared with the same period in 2008, accounting for $100.6 billion of all issues. But the euro was the preferred currency of issue, capturing 51.6% of the market.