In conjunction with the public consultation on Capital Markets Union, launched on February 18, the Commission is carrying out a comprehensive review of securitisation. The three month consultation seeks views and input from stakeholders on the current functioning of European securitisation markets and how the EU legal framework can be improved.  On the basis of the feedback received, the Commission will put forward a proposal on how to build a sustainable securitisation market.

What is securitisation?

There are three stages to securitisation. First, a lender – frequently a bank – pools a set of loans, assets or other receivables (such as mortgages, car loans, consumer loans, credit cards). Second, this pool is converted into tradable securities. Finally, these securities are put into different priorities of payment (or "tranches") to tailor to the risk/reward characteristics of different investors. Investors are then repaid by the cash-flows generated by the underlying loans.

Chart 1: The three steps to creating a securitisation of mortgages

Source: European Commission

Lessons from the crisis

Securitisation is a vital funding tool that can help free up banks’ balance sheets so they can lend to households and businesses. But the experience of the past few years has shown that securitisation can only be beneficial to the economy if it is sound and well-structured. The Commission is putting great emphasis on the need for high-quality structures and processes and stresses that the flawed products that were the catalyst for the financial crisis in the US must not be allowed to return.

‘We will not be going back to the bad old days of subprime mortgages,’ said Jonathan Hill, Commissioner for Financial Stability, Financial Services and Capital Markets Union. ‘Our door will remain firmly closed to the highly complex, opaque and risky securitisation instruments which were part of the crisis.’

Looking back, European securities actually fared relatively well in the crisis. For example, a study of all Fitch rated tranches between 2000 and 2014 reveals that realised and expected losses in European consumer- and residential mortgage-related products have been negligible, at 0.1% for consumer- and 0.2% for residential mortgage-related securitisations. In contrast, the losses for US residential mortgage-related deals were 7.9% over the same period. Despite this, securitisation markets in the EU have been slower to recover compared to the US.  This can in part be explained by differences in the structural features of these markets. In the US, 80% of securitisation instruments benefit from public guarantees from the US Government Sponsored Enterprises (e.g. Fannie Mae and Freddy Mac).

Chart 2: Cumulative losses for Fitch rated 2000-2014 issuances, by region and product type

Notes: ABS = Asset Backed Securities (e.g. consumer ABS); CMBS= Commercial Mortgage Backed Securities; RMBS = Residential Mortgage Backed Securities; SC = Structured Credit (e.g. CDO squared).
Source: Fitch Ratings

An important lesson from the financial crisis was that the securitisation structure itself can represent a source of risk: complex and opaque structures may render it infeasible for some investors to understand the cash flow-generating mechanism and where disruptions may arise in the future.

An EU framework

Given the potential benefits of better-developed securitisation markets to the EU economy, the Commission has been working, together with EU authorities and central banks, to develop criteria that promote simple, transparent and standardised structures.  The identification of these criteria is intended to help the relevant parties, particularly investors, evaluate the risks of a particular securitisation and across similar products.

This process has already started. Two delegated regulations – on prudential requirements for insurers (under the Solvency II directive) and on liquidity for banks (the Liquidity Coverage Ratio) – introduced criteria for simple and transparent securitisations. The EU's adoption of these delegated acts were preliminary steps that now need to be complemented by further action, building on a wider range of EU and international initiatives.

The consultation also raises questions on the prudential treatment of securitisations, including on bank capital requirements, and the regulatory frameworks applicable to other institutional investors. 

Targeted initiative

On the basis of the feedback received, the Commission will put forward a proposal on how to build a sustainable securitisation market.

The main objectives are to:

1. Revive markets on a more sustainable basis, so that simple, transparent and standardised securitisation can act as an effective funding channel to the economy;
2. Allow for efficient and effective risk transfers to a broad set of institutional investors as well as banks;
3. Allow securitisation to function as an effective funding mechanism for some non-banks as well as banks;
4. Protect investors and manage systemic risk.

The overall goal is for Europe to benefit from a deep, liquid and robust market for securitisation – one that is able to attract a broader and more stable investor base to help channel funding where it is most needed in the economy.

Read more on the Consultation on high-quality securitisation and the BCBS-IOSCO consultative document