The Basel Committee announced its planned changes to the new Accord’s treatment of securitisation at the end of January.
The European Securitisation Forum (ESF) and the American Securitisation Forum (ASF), both part of the Bond Market Association, have been at the forefront of the securitisation industry’s lobbying effort on Basel-related issues. The announced changes from the Basel Committee come as a result of the ESF and ASF’s intensive work to put securitisation on a more even footing with other asset classes.
“It is evident that they [the Basel Committee] have been listening,” says Leon Dadoun, member of the ESF and ASF’s legal, regulatory and capital committees, and a managing director at CIBC World Markets. “At the start of the process there were some hurdles, many of which had to do with properly defining securitisation in relation to other kinds of credit risk.”
Dadoun adds: “In any standard-setting process there is a conceptual stage, an application stage, and a fine-tuning and calibration stage, which is where we are now. We wanted a neutral approach to securitisation, for there to be capital charges commensurate with risk, but no regulatory incentives or disincentives for doing securitisations.”
One big change set out by the committee is to use an internal assessment approach (IAA) for banks’ exposure to asset-backed commercial paper (ABCP) conduits, based on banks’ own methodologies, in lieu of the supervisory formula approach. The committee has outlined the prerequisites to be able to apply IAA and now those need to be clarified, says Dadoun.
“ABCP is a huge business. It will continue to flourish, notwithstanding the introduction of capital charges to liquidity facilities. The reason we couldn’t use the supervisory formula for all unrated exposures was because when assets are purchased by ABCP conduits, they are often from third parties, and getting the detailed information necessary for the supervisory formula is hit or miss,” says Dadoun.
While the introduction of the internal assessment approach is a huge step for the ABCP business, the 100% credit conversion on liquidity facilities is a sore point. Currently, ABCPs do not have to hold any capital against liquidity facilities for ABCPs.
Another pleasant surprise was that the new ratings-based approach to risk weighting for securitisation has eliminated the originator-held weightings. Previously, Basel II had different risk weightings depending on whether an asset was held by the originator or an investor.
Some weightings for the ratings-based approach have been lowered but, significantly, the 7% floor for triple-A tranches remains. Dadoun says the ESF and the ASF are providing the committee with extra data to make a case for lowering the floor. To date, the committee has been reluctant to lower the 7% floor as there was not enough historical loss data for triple-A tranches.
There is also concern that junior granular tranches still have the same risk weightings as their non-granular counterparts. The committee has made a differentiation between the risk weightings’ granular and non-granular tranches on the senior level.
“Under the current proposal, the risk weighting for granular and non-granular tranches rated at and below BBB– is the same,” says Birgit Specht, head of securitisation research at Dresdner Kleinwort Wasserstein.
However, Specht says there is a significant difference in ratings migration between granular and non-granular pools. While tranches of non-granular pools have experienced sometimes severe downgrades in the past, those of granular pools have almost exclusively seen upgrades. This has also been reflected in spreads. Treating them in the same way could lead to similar arbitrage as seen in the past, where a 100% risk weighting for corporate risk regardless of its rating led banks to invest in higher yielding, riskier assets.
Another item on the agenda will be to add triple-A tranches to risk weights for senior tranches, as for synthetic deals there is a super senior tranche. “We want all triple-As to qualify for the lowest risk weights whether or not the tranche is senior. If not, subordinated synthetic triple-As would be penalised,” says Dadoun.
With the committee indicating that it intends to meet the mid-2004 deadline for presenting the completion of the Accord, the securitisation industry will have to act quickly to have its demands met.