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‘This is probably going to stimulate some interest for triple As’
by Lisa Lee
The European securitisation market has come under new regulatory scrutiny this year, with a series of rules being published which have shifted manager obligations.
In addition to Solvency II, the European Commission has updated its securitisation rules to remove the use of conditional sale agreements by CLO managers. In June, the European Commission adopted a series of proposals designed to strengthen and streamline various securitisation regulations. Alexander Batchvarov, managing director, Bank of America Merrill Lynch, explains what this all means for CLO managers.
Lisa Lee, Creditflux: Why has the European Commission been paying so much attention to the securitisation market this year?
Alexander Batchvarov: The bottom line is that the market is not working to its potential. We’re not talking about the market working to its potential for its own sake, but rather for the sake of the European economy and financing availability for the biggest priorities of Europe: transition, digitalisation, defence, productivity, and so on.
CLOs will qualify for lower regulatory capital under the Solvency II proposal
Alexander Batchvarov
Managing director
Bank of America Merrill Lynch
LL: What does this new regulatory landscape mean for CLOs?
AB: It looks like from the definition of public/private securitisation, CLOs will likely be public securitisations, which means that all the disclosure has to go on a repository. I don’t think this is a problem.
The second aspect that would affect CLOs is that they will qualify for lower regulatory capital under the Solvency II proposal. Being non-STS, CLO triple As are attracting 12.5% capital per unit of duration, which is extremely high. The new proposal is to bring it down to 2.7%. On the face of it, this looks like a significant reduction. But the devil is in the detail.
The proposal for STS triple A is to drop from 1% to 0.7% for triple A senior, which effectively makes the differential between STS and non-STS triple A about four times, from 0.7% to 2.7%, which is not justified. And secondly, at 2.7%, it’s still pretty high relative to corporate triple A at 0.9%. Nonetheless, that significant reduction from 12.5% to 2.7% is probably going to stimulate some interest for triple As.
The regulatory capital reduction for mezzanine and junior tranches or non-senior tranches for both STS and non-STS is also significant, but again, not sufficient to stimulate interest. The key element in my view for these kinds of discussions is that it doesn’t make sense for the regulatory capital for senior and IG tranches of securitisation to be set higher than the regulatory capital for the underlying, which could be much lower rated. So you end up in a situation where the senior IG tranches have more capital than the underlying sub-IG assets of a securitisation. And this leads to the discrepancies we have seen in the market where investors, particularly insurers, prefer high risk, less liquid products.
Another angle that could affect CLOs is the concept of resilience. In order to support and justify a further reduction in regulatory capital, there is a proposal that the senior-most tranches can qualify as ‘resilient’.
CLOs theoretically could fit into the resilient triple A definition. It’s something that we need to clarify.
