Capital cut for synthetic securitisations splits regulators

European rulemakers wary of diverging from Basel standards

EBA paper stops short of recommending lighter capital charges for high-quality synthetic securitisations
Photo: EBA

European regulators are divided on easing capital charges for balance sheet synthetic securitisations that earn the label ‘simple, transparent and standardised’ (STS), market sources reveal.

Since 2019, true sale securitisations have been able to qualify for the STS label. In a draft report published on September 24, the European Banking Authority now proposes to extend the label to balance sheet synthetic securitisations. These are used by banks to transfer the credit risk of a portfolio of loans to an investor without transferring ownership of the underlying assets.

“There is no agreement among the EBA and various national competent authorities about granting preferential capital treatment to STS for synthetics,” says one European bank senior structurer, quoting a regulatory source. “The EBA got enough support to recommend STS for synthetics but not enough to recommend preferential capital treatment.”

The draft report is in consultation phase with industry stakeholders until November 25. The EBA’s final report will form the basis of legislation to be drafted by the European Commission.

Despite its recommendation to extend STS labelling to synthetic deals, the EBA has not made a call on whether synthetics should also qualify for the lower capital charges enjoyed by true sale securitisations.

A footnote in the draft report states: “Depending on the conclusions following the public consultation, the EBA may consider introduction of an additional recommendation on possible differentiated capital treatment.”

Sources tell the reason the EBA has not yet made a recommendation is because European regulators are divided on the question of lower capital charges.

“The EBA is not ruling out preferential capital treatment yet, but it has been difficult for them to get all EU countries to approve it for synthetic STS,” says a senior investor at a buy-side firm, who learned of the regulatory split on a call with market participants.

Market sources could identify only four national supervisors in favour of the lighter touch treatment for synthetics, according to one lawyer.

In its discussion paper, the EBA lays out the positives and negatives of easing capital requirements for these deals. Positives include encouraging more issuance of synthetics meeting STS criteria. Negatives include deviating from international standards set by the Basel Committee on Banking Supervision, which don’t allow lower capital treatment for synthetics.

One regulatory source says there is no unanimity among national supervisors, with parties on both sides of the debate. For a policy to make the final report, the tally requires a simple majority of supervisors.

Christian Moor, principal policy officer at the EBA, stresses that regulators are yet to make a final decision. They and the EBA will make the call in line with the consultation.

“We have been discussing the pros and cons within the regulatory community but we have not had any kind of vote or any hard discussions around the capital treatment,” says Moor. “It was seen as too early to include in the discussion paper and we want to see what the industry reaction is to these proposals.”

Taste test

Some sources say it is unsurprising regulators diverge on the issue.

Robert Bradbury, a managing director at advisory firm StormHarbour Securities, suggests the attitude toward preferential capital treatment for these deals is likely to mirror the approach taken by different EU regulators towards the significant risk transfer techniques that underpin them. Banks need to apply to their local supervisor to confirm that risk has been transferred off their balance sheets through synthetic transactions.

“Some countries have embraced the technology with little idiosyncratic variation. Other regions, however, remain less broadly supportive,” says Bradbury.

Banks and investors say a primary benefit of the STS label is that lighter capital charges could spur banks to issue more deals and in greater volume.

Lighter charges would bring the capital treatment for bank investors closer to the risk weights banks were applying to senior tranches of synthetics before the 2019 securitisation regulation came into force. The risk-weight floor had been set at 7% for senior tranches under the internal ratings-based approach but the new rules hike the floor to 15%. It falls to 10% for deals attaining the STS label.

Current investors are typically non-banks, who say there is little benefit for them in the STS label as they are already sophisticated enough to understand the complexities of the risks and structuring of the deals. However, if banks were to receive lighter capital charges, investors could benefit from the greater potential deal flow.

In theory, it could lead to new investors becoming more comfortable in investing in synthetic deals that make the STS cut. Boosting competition in the market could narrow bid/offer spreads and make these deals cheaper for banks to issue.

“If you assume you can get more investors into this space, you will naturally see pricing move over time and potentially tighten. I think that could be the only real benefit for banks in the absence of lighter capital charges,” says the senior buy-side source.

Editing by Louise Marshall

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