Towards a resilient securitization framework for the post-crisis era Oscar Arce Research and Statistics, Director Comisi

1. Workshop on Securitisation, OECD - Banco de EspañaMadrid 27-28 May 2010 Towards a resilient securitization framework for the post-crisis eraOscar ArceResearch and Statistics, DirectorComisión Nacional del Mercado de Valores

2. Focus & Outline of the talk • Where do we come from? • The macrofinancial environment of the securitisation boom • What went wrong? • Vulnerabilities in the global risk transfer framework • Some lessons for the future • Building up a resilient framework for securitisation • The current regulatory initiatives

3. The environment of the securitisation boom • A macrofinancial perspective on the origin of the boom: Global current account imbalances Source: IMF • Global imbalances (plus demographic factors) caused a global “savings glut” • Much pressure from the demand for assets (specially, high-quality) on their supply • A potential problem of assets scarcity…….. [Back]

4. The environment of the securitisation boom • ….that was largely resolved through the massive growth of securitisation Global issuance of AAA-rated long-term fixed income assets (1990-2009) Source: Dealogic • The rapid global growth in AAA-assets (from 20% of total assets in 1990 to 60% in 2003) was largely due to securitisation

5. The environment of the securitisation boom • Indeed, securitisation was an extremely productive technology of AAA-securities Global issuance of long-term fixed income assets (1990-2009) Source: Dealogic Average proportion of AAA-assets: corporate (9%), sovereign (48%), securitisation (75%)

6. What went wrong? • The collapse of the US subprime market was sufficient to trigger a global debacle in securitisation markets… Dynamic distribution of the stocks of ABS according to Moody’s ratings USEurope Source: European Securitization Forum • ….with sharp falls in prices, vanishing private demand and secondary markets drought

7. Lessons from the crisis • Some lessons from this episode include: • CRAs ratings overestimated real risks (bad models, bad calibration, failures in tranching, misperceptions on correlations, etc.) • ABS complex structures gave rise to multiple problems of incentives and conflicting interests (between originators/investors, within CRAs, etc.) • Buoyant demand conditions allowed for successful trading of very opaque products (squared-CDO, re-securitisations, etc.) of more than dubious social added value • Bottom line: the mechanism for massive risk transfer through securitisation contained important deficiencies

8. Lessons from the crisis • Other lessons (equally important but less obvious): • The global high quality-asset scarcity problem is likely to persist for some time [Figure 1] • At the present, public debt fills the gap, but (hopefully) this trend will reverse as the world economy recovers. • Moreover, robust recovery will only take place is the transfer of private risks (i.e. credit) recovers • Securitisation is a key tool for transferring and managing private risk, with unique advantages: - Liquidity transformation - Asset-liability maturity alignment - Risk management/diversification

9. Building up a resilient framework for securitisation • Putting things together: In principle, there are incentives for the revival of both the supply and the demand sides of the market • A complex task for both regulators and the industry: to set up a framework that brings demand and supply together and to do it in a swiftly and sustainable manner, avoiding the mistakes of the past • Two main areas for regulatory action: • Incentives • Transparency

10. 1. Incentives alignment • Minimum retention rules (supported by G20, followed by 5%-rules by EU, US Government): • Likely to induce a more diligent attitude by originators and remove incentives for the revival of the “originate-to-distribute” model. • In the EU the restriction is implemented through a ban on the credit institutions’ portfolios of securitisations (CRD III). Thus, a symmetric measure is needed on other potential holders of securitisations (pension funds, investment funds, etc.) to avoid regulatory arbitrage. • More generally, the implementation of retention rules should be flexible enough to avoid undue distortions. In particular: • Different classes ABS have different risk profiles which change over time • The mapping between retention rules and incentives for responsible origination is largely imperfect

11. 1. Incentives alignment Source: IMF Source: CNMV

12. 2. Transparency • The sudden collapse of worldwide ABS markets in 2007 reflects a lack of confidence i.e. information on these products (this applies to investors, CRA’s, insurers, supervisors and, even, originators). • Some recent initiatives try to fill this gap: • IOSCO (ABS Disclosure Principles, April 2010) provides set of standards on the information to be included in public offerings and listings of ABS, including: • identity, functions and responsibilities of the intervening parts; • main characteristics of the pool of assets (legal nature of the asset, rate of return, average life, delinquency and loss information, etc.); • structure of the transaction (flow of funds, distribution frequency and cash maintenance, fees and expenses, prepayment considerations, etc.); • credit enhancements; • use of derivatives (interest rate and currency swaps, etc.) • markets (secondary market venues in which the ABS can be traded, etc.) • Some central bank recent initiatives to implement very demanding disclosure regimes on loan-level information (ECB, BoE, in the context of their collateral framework)

13. 2. Transparency • Also some national supervisory authorities have insisted upon this theme (like the recent US SEC proposal)…. …..and the pioneering regulation by CNMV (Circular 02/2009), that includes new homogeneous industry-wide public periodic disclosure requirements on: • Accounting items: flow of funds, balance-sheet, profits and losses according to the IFRS; • Disaggregated data on the pool of assets: number and type of assets, average life, prepayment rate, loan-to-value, degree of concentration (sectorial, geographical and by type of debtor) • Funds liabilities: structure and cost of funding, changes in ratings, etc. • Credit enhancements, including a dynamic track system • From January 2010, some of this information is sent monthly, some half-yearly, to the supervisor by the Securitisation Funds Managers.

14. 2. Transparency • Liquidity in secondary markets has plunged during the crisis (RMBS trading in Europe has fallen by 45% during the crisis) • Although there are no large-scale problems on market microstructure, there is high potential to increase post-transparency (i.e. public disclosures on transactions) with direct benefits on: • more efficient price formation (price discovery) • higher liquidity • wider investor base beside hold-to-maturity buyers • Both CESR (2009) and IOSCO (2009) have launched a set of recommendations in this area. • In the EU, some possible venues for future action include: • a common (or reasonable similar) regime for the main organised markets; • the establishment of one or several platforms to receive and disseminate post-trade information (like US TRACE system).

15. 2. Transparency • There are important positive synergies between transparency and simplification and standardisation measures. • Simplification: • shorter securitisation chains tend to be more transparent robust in face of incentive problems; • too complex structures (squared-CDO) have shown very opaque, fragile and with little social added value, so recent Basel II revision is welcome; • Standardisation: • comparison of information across different ABS is only meaningful if there is a minimum degree of standardisation; • transparent and liquid secondary markets require some form of asset homogenisation; • the industry must play a leading role in this field.