EU Lawmakers Set to Soften Risk Retention in ABS Overhaul

(Bloomberg) -- European Union lawmakers plan to soften draft rules on asset-backed securities after concerns that an earlier proposal would hinder a market-revival drive.

Negotiators for the main political parties in the European Parliament’s Economic and Monetary Affairs Committee agreed to give ground on risk-retention levels, the most contentious aspect of their initial plan. The risk-retention requirement is intended to make sure issuers maintain “skin in the game,” so their incentives are aligned with those of investors.

Under legislation presented last year by the European Commission, at least 5 percent of a bundled loan portfolio must be retained by the originator. The parliament’s lead lawmaker on the bill, Paul Tang, countered with a proposal of 20 percent. On Nov. 30, lawmakers settled on two levels, 10 percent and 5 percent, depending on the retention arrangement, according to a draft document seen by Bloomberg.

The parliament may face pushback from EU member states and the commission, but as the commission “might be in a hurry to adopt these bills relatively soon, we doubt how much resistance there will be,” said Ruben van Leeuwen, a senior ABS analyst at Rabobank Groep in Utrecht.

Funding Sources

The Brussels-based commission presented the asset-backed debt plan in a bid to deliver as much as 150 billion euros ($159 billion) of new lending and diversify funding sources for companies traditionally reliant on banks. By bundling assets and selling them on as securities, banks can free up balance-sheet capacity to offer new loans to companies, according to the plan.

The European market for ABS, like that in the U.S., was decimated in the financial panic of 2008. This was fueled in part by banks taking heavy losses on securitized U.S. subprime-mortgage debt even though the tranches they held had been considered high-quality. And the European market has been slow to recover. Issuance last year amounted to 214 billion euros, down from 819 billion euros in 2008, according to data from the Association for Financial Markets in Europe.

The push to revive the securitization market includes the creation of a new class of “simple, transparent and standardized” products that qualify for preferential capital treatment.

The compromise deal assigns broad oversight of the EU securitization market to the Frankfurt-based European Systemic Risk Board, led by European Central Bank President Mario Draghi, while firm-level supervision will be handled by the European Banking Authority in London.

Broader Debate

Macroprudential oversight was “introduced to reach the compromise,” Tang said on Dec. 1. The idea is “to keep it on a close watch and monitor, but also give the supervisors the tools to intervene in case something goes wrong. They’re on the spot. The burden of proof is again and again on the supervisors.”

Tang said he “tried to break away from just the retention rate, because that’s just one number and just one instrument.” 

The parliament committee will vote on the compromise on Dec. 8.

Under the parliament’s plan, the 10 percent requirement applies to so-called vertical retention, whereby the originator retains a portion of the nominal value of each of the tranches sold or transferred to investors. Under the horizontal option, or retention of the first-loss tranche, the requirement is set at 5 percent.

“This approach would mainly affect arbitrage-driven transactions, as these deals will simply get less economical with higher risk retention,” van Leeuwen said. Collateralized loan obligations “could potentially be most affected, although we note that arbitrage has recently also entered” the residential mortgage-backed securities market, he said.

In addition, the proposal requires the EBA to make a “reasoned decision on required retention rates up to 20 percent in light of market circumstances.”