EU Effectively Forces Securitization Reforms on the U.S.

Wow, the EU is increasingly taking steps to force foreign, meaning US and UK firms, to play by its rules or not have access to its investors. The first salvo occurred over private equity funds and hedge funds, where the EU will limit its investors to funds located in the EU, and is also limiting the ability of foreign funds to acquire firms in the EU.

The latest development is that the EU is implementing a rule called 122(a) which will have a significant impact on the private securitization market. EU investors will be penalized (via much higher capital requirements) if they invest in asset backed securities that they cannot understand. And of course, to understand them, the issuer has to make pretty complete disclosure (you can’t assess in a vacuum). That disclosure in turn happens to be higher than the norm pre-crisis.

A second element is that Rule 122(a) will also require issuers to retain 5% of their new issues. From Institutional Risk Analyst:

There is a five percent (5%) retention requirement for the issuer regardless of the type of underlying asset. Even as this article was being written, there is still debate between the regulators and the industry as to the form of the retention. For example, the retention could be a vertical or horizontal slice of the deal.

Much more important than the retention requirement is the disclosure requirement. Issuers are required under Paragraph 7 of Article 122a to “ensure that prospective investors have readily available access to all materially relevant data on the credit quality and performance of the individual underlying exposures, cash flows and collateral supporting a securitisation exposure as well as such information that is necessary to conduct comprehensive and well informed stress tests on the cash flows and collateral values supporting the underlying exposures.”

This appears similar to, but less comprehensive than an FDIC proposal earlier this year which was very much in keeping with what investors needed and therefore died on the vine. IRA contends implementation would not be difficult:

Issuers and the servicers involved in the daily billing and collecting of the underlying exposures are easily able to report all the data fields that they track in their data systems on an observable event basis. Issuers are in the best position to explain each structural element of a security and how they work together. In addition, the information technology exists to provide both the underlying exposure data and the structural features at very low cost. As a result, compliance is easy and several issuers are likely to comply to gain a competitive advantage over those issuers who do not comply and also to ensure ongoing access to the capital markets for funds.

The fact that the EU is muscling the US is a sign of both the US’s weakening authority and a lack of strategic vision. As strange as it may seem now, the reason the US has had the deepest capital markets wasn’t simply the size of our economy, but the perception that we had the most open and fairest regime for investors. The US markets are badly tarnished, yet the authorities continue to take their cues from the very same industry incumbents who created this mess.

The Japanese often would speak of “foreign pressure” as in using foreigners as an excuse to do things that the elite bureaucrats actually wanted to happen but found difficult politically. The worst is our top regulators still seem unable to believe that they can and must be much tougher with their charges.

Originally published at naked capitalism and reproduced here with author’s permission.