## EXECUTIVE SUMMARY

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### Executive summary (key findings)
- Placing private securitization markets back on a firm and sustainable footing has never been more important.
- Securitization has yet to retake its instrumental role in rekindling credit flows and diversifying risks; it must be managed to support financial stability rather than pose risks to it.
- Reforms should address the four-stage financial intermediation chain: loan originators, securitization intermediaries, credit rating agencies (CRAs), and end-investors.
- Priority reforms:
  - Strengthen the quality of underlying loan origination practices to restore the appetite for securitization.
  - Encourage securitization intermediaries to adopt transparent, straightforward-to-value structures primarily designed to finance the real economy.
  - Avoid legal ambiguities related to the rights and obligations of servicers, trustees, and investors; establish secure, transparent, and cost-effective transfer of claims on collateral.
  - Improve the use of credit ratings by standardizing definitions of securitization characteristics, requiring full disclosure of the rating process, disclosing rating shopping, and accelerating removal of references to external ratings in regulations.
  - Ensure consistent application of capital charges across asset classes and borders; avoid large step-changes in charges (“cliff effects”) between securitized asset classes with similar underlying quality.
- Standardization of industry risk classification should be granular (individual risk factors such as duration, prepayment risk, collateral fungibility, track record of credit performance) rather than a single aggregate label to reduce investor shirking and pricing discontinuities.
- Foster a diversified nonbank institutional investor base with a long time horizon; in Europe this requires pan‑European harmonization of loan-level reporting standards, documentation standards, insolvency regimes, and taxation treatment of securitizations.
- Encourage greater sponsorship from European insurers and pension funds to provide patient, long-term capital and diversify financing for the European economy.

### Key statistics and patterns observed
- Securitization issuance in the United States and Europe is currently running at less than half the levels observed in 2003.
- In Europe, total securitization issuance declined to a 10-year low in 2013, more than 40 percent below the post-1999 average.
- Since 1999, the average composition of European securitization issuance was: RMBS (54 percent), ABS (17 percent), CDOs (10 percent), SMEs (9 percent), CMBS (7 percent), and WBS (3 percent).
- Much of European issuance since the crisis has been retained by issuing banks for use as collateral with the European Central Bank and the Bank of England.
- In the United States, agency-related issuance remained firm; nonagency ABS and CMBS issuance is slowly recovering back to long-term averages.
- Globally, CDO issuance is picking up.

### Introduction (context and objectives)
- When operating efficiently, securitization supports economic growth and financial stability by:
  - Enabling issuers and investors to diversify and manage risk.
  - Transforming pools of illiquid assets into tradable securities, freeing up bank capital to extend new credit to the real economy, and supporting monetary policy transmission.
- Securitization can also amplify credit flows, increase leverage, exacerbate misaligned incentives in the intermediation chain, and amplify systemic risk; thus the asset class should be as simple, transparent, and robust as possible.
- Recent patterns show selective recovery in certain asset classes/regions while other classes/regions remain moribund; vigilance is required as spreads in corporate credit markets approach historic lows amid prolonged low interest rates.

### Policy recommendations — A. Building a Sound Framework for the Financial Intermediation Chain
- Overview:
  - View securitization as a multi-dimensional financial intermediation chain comprising loan originators, securitization intermediaries, CRAs, and investors.
  - Propose policy measures for each element, drawing lessons from the global financial crisis and focusing on preconditions for strengthening securitization practices.
- Self-reinforcing cycle and vulnerabilities:
  - Faulty loan origination practices, complex and opaque securitization issuance, upwardly biased ratings and underestimated correlations, and investors’ “search for yield” and retained contingent exposures contributed to systemic vulnerabilities.
- Loan origination (findings)
  - Deterioration in loan origination practices was a central contributing factor to the financial crisis:
    - Faulty loan origination practices in some mortgage markets.
    - Lending standards deteriorated sharply.
    - Origination of mortgages and other consumer debt was not well regulated.
    - Mortgage documentation and registration practices were inappropriate.
  - Compensation practices were often tied to origination volumes and high-fee products.
  - Property appraisers selected by mortgage originators often inflated real estate valuations.
- Loan origination (policy recommendations)
  - Broad-based regulatory measures to secure high-quality underlying loan origination practices are essential.
  - Dodd-Frank Act stipulations promising for appraisal supervision may be applicable elsewhere:
    - Having loan officers (rather than mortgage brokers) select appraisers.
    - Maintaining records on appraiser performance via a property value registry.
  - Prudential policies to complement loan origination practices could include:
    - (i) risk-based frameworks to define regulatory provision and capital requirements;
    - (ii) regulation to ensure collateral accepted as the basis for additional new borrowing emphasizes cash and income relative to unrealized capital gains in asset prices;
    - (iii) focus on borrowers’ maximum loan-to-value (LTV) ratios and debt-to-income ratios, limits on second liens, and hypothecation of unrealized capital gains.

### Securitization intermediaries — role, failures, and policy responses
- Role and failures during 2000–07
  - Practices employed by securitization intermediaries over 2000–07 amplified the financial crisis through misaligned incentives, emergence of complex and nontransparent products, and operational infrastructure problems.
- Operational infrastructure problems identified
  - Three key problems: (i) Ambiguity and lack of enforcement of representations and warranties; (ii) Conflicts of interest affecting quality-control firms; (iii) Deficient technological infrastructure.
  - Examples: Mortgage Electronic Registration Systems, Inc. (MERS) faced legal and operational challenges; Germany’s refinancing register and France’s mortgage-transfer legislation cited as robust examples.
  - Servicers in the United States were under-resourced when defaults surged.
- Recent measures to reduce operational uncertainty
  - New U.S. regulations require CRAs and issuers of ABS to disclose information on representations and warranties.
  - Fannie Mae and Freddie Mac announced a framework clarifying representations and warranties and remedial relief conditions.
- Policy recommendations (operational, disclosure, and incentive alignment)
  - Align incentives across the financial intermediation chain; originators retaining an economic interest (“skin in the game”) is necessary but not sufficient.
  - Require timely, sufficiently granular loan-level performance data disclosure from servicers to investors and regulators.
  - Encourage simple, standardized “plain vanilla” securitizations; hold idiosyncratic/complex securitizations to higher regulatory and capital standards.
  - Favor underlying collateral that:
    - consists of a claim on real assets (not another financial security),
    - is valued on conservative recovery rates,
    - offers fungibility enabling repossession and low-cost resale.
  - Minimize legal ambiguities among servicers, trustees, and investors; regulate servicer conflicts where servicers are bank-owned.
  - Regulate payment models and transparency of quality-control firms to reduce conflicts of interest.
  - Promote a centralized electronic mortgage transfer system to ensure secure, transparent, and cost-effective transfer of claims.
  - Require adequate technical infrastructure and resourcing to process large foreclosure volumes in stress scenarios.

### Regulatory treatment: comparable treatment and asymmetries
- Securitizations should be treated comparably to securities with broadly similar risk characteristics to avoid concentration of risk and regulatory arbitrage.
- Examples of asymmetric treatments:
  - CRD IV: covered bonds meeting certain criteria attract significantly lower risk weight than comparable securitization exposures.
  - Proposed EU Solvency II capital requirements may skew capital charges in favor of covered bonds over securitized products with similar credit, duration and liquidity risk characteristics.
  - BCBS (2014b) reduced the minimum capital charge for securitizations from 20 to 15 percent.
  - LCR: covered bonds with an AA rating or higher are Level 2A with a haircut of 15 percent; RMBS are Level 2B with a haircut of 25 percent and additional conditions often rendering many RMBS ineligible.
  - NSFR effectively incentivizes issuance of covered bonds relative to securitizations.
- Policy recommendations
  - Address asymmetric capital treatment and avoid cliff effects.
  - Formalize and make permanent relief for securitization vehicles from swap clearing rules.
  - Clarify tranche maturity boundaries to avoid arbitrary caps.
  - Finalize Solvency II capital requirement rules for European insurers.
  - Ensure formal application of the qualified residential mortgage (QRM) rule in the United States as scheduled.

### Harmonization of industry standards for risk and data disclosure
- Findings
  - Standardization can improve deal distinction and secondary-market liquidity, but aggregate risk labels can encourage investor shirking, herding, forced buying/selling, and cliff effects.
- Policy recommendations
  - Standardize along multiple risk dimensions (duration risk, prepayment risk, collateral fungibility, track record of credit performance) rather than single aggregate labels.
  - Harmonize loan-level reporting standards and documentation standards.
  - Develop centralized information platforms and exchanges, including credit registers and public databases.
  - Harmonize national insolvency regimes; consider corporate law revisions to facilitate preemptive reorganization.
  - Harmonize tax treatment of securitization vehicles.
  - Carefully weigh credit enhancement features (including limited public sector guarantees) against moral hazard risks.
  - Encourage CRAs to publish matrices showing implied tranche ratings under alternative sovereign and ancillary facilities’ rating caps.

### Development of nonbank institutional investor bases for securitization
- Findings and key statistics
  - A diversified investor ecosystem and stable funding sources are important for financial deepening and balanced growth.
  - Outstanding securitization issuance comprises 59 percent of U.S. GDP, vis-à-vis just 11 percent in Europe.
  - Figure 6 (in trillions of U.S. dollars) shows numbers: 16.8; 3.8; 1.3; 17.4; 2.0; 0.3.
  - Within Europe, banks dominate investment demand; pension and insurance funds have a trivial share for many securitization classes compared with the United States.
  - Pension fund characteristics:
    - United Kingdom pension fund assets: US$3.3 trillion.
    - Netherlands pension fund assets: US$1.4 trillion.
    - These two account for around 85 percent of European pension fund assets.
    - Defined-benefit share: United Kingdom 72 percent; Netherlands 95 percent.
    - Ratio of pension fund assets to GDP: Netherlands 170 percent; United Kingdom 131 percent.
    - For Germany, France, Italy, and Spain, the ratio of pension fund assets to GDP is below 15 percent.
  - Obstacles: short-maturity ABS (amortizing in around two to five years), prepayment risk on long-duration RMBS, and Solvency II capital charge effects on insurers.
- Policy recommendations
  - Harmonize loan-level reporting and documentation standards; develop centralized data platforms and credit registers.
  - Harmonize insolvency regimes and corporate law; harmonize tax treatment of securitization vehicles.
  - Scale and design credit enhancement features carefully; existing public guarantees have tended to be too small, idiosyncratic, or narrowly focused.
  - Level the playing field for capital charges to reduce forced sales by European insurers and encourage insurers to become a key source of demand.
  - Industry and regulators should pursue market-based initiatives to invite greater participation from Europe’s defined-benefit pension funds by creating low-credit-risk and long-duration cash flows, lengthening ABS duration, and allowing better hedging of prepayment risk.

### Conclusions — key assessment and remaining priorities
- Key assessment
  - Significant progress has been made since the global financial crisis, but ensuring securitization markets contribute to economic growth and financial stability is unfinished.
  - Recommendations are distilled along three lines: strengthening the financial intermediation chain, applying consistent granular risk classification, and broadening the institutional investor base.
- Strengthening the financial intermediation chain
  - Loan-origination measures: include maximum loan-to-value (LTV) ratios, debt-to-income (DTI) ratios, and countercyclical macroprudential policy.
  - Securitization intermediaries: develop transparent, low-complexity structures; minimize legal ambiguities; implement secure automated claims transfer systems.
  - Credit ratings and disclosure: standardize securitization definitions; require full disclosure of ratings process; provide guidance on granular loan data disclosure; disclose and address ratings shopping; accelerate removal of external ratings references in the EU and under BCBS.
  - Capital charges and cliff effects: address inconsistencies and cliff effects across borders and asset classes.
- Granular risk classification
  - Aggregate risk labels can induce due-diligence shirking and market fragmentation; adopt consistent industry standards to classify risk at granular levels (duration, credit, collateral fungibility).
- Diversified institutional investor base
  - Broaden investor participation beyond banks to include insurers and pension funds with long-term capital, particularly in continental Europe where this could diversify financing sources.
- Remaining open issues and regulatory priorities (selected)
  - Include Maximum LTV and DTI ratios in QRM, QM, and similar measures.
  - Introduce counter-cyclical macroprudential policies (for instance, variation of LTVs or DTIs across the cycle).
  - Standardized definitions of securitization characteristics and full disclosure of the ratings process for bonds.
  - Provide guidance on granular loan data information disclosure.
  - Accelerate removal of reference to external ratings in the EU and under the BCBS as reasonably as possible.
  - U.S. regulators should implement rules preventing ratings shopping in accordance with DFA 939F.
  - Address possible capital arbitrage and cliff effects.
  - Avoid unfavorable treatment of securitizations compared to products with similar risk features.
  - Adopt a more realistic definition of maturity; consider use of the actual cash flow waterfall.
  - BCBS and local authorities should coordinate to ensure formulae, assumptions, and implementation of capital charge estimates are consistent across jurisdictions.
  - U.S.: Provide relief for securitization vehicles from compliance with swap clearing rules.
  - Promote securitization structures of low complexity.
  - Minimize legal ambiguities related to rights and obligations among servicers, trustees, and investors.
  - Implement secure, transparent, and automated claims transfer.
- Selected regulatory measures and numeric policy parameters
  - EU: Issuers to retain material net economic interest of at least 5%. (CRR Art. 405)
  - BCBS (Revision of securitization framework, Dec. 2014; coming into effect in January 2018):
    - Reduction of reliance on external ratings through formula-based approaches.
    - Minimum Risk Weight floor 15%.
    - Increased Risk Weights for highly-rated exposures, reduced ones for low-rated ones.
  - EU: Remove all references to CRAs for regulatory purposes by 2020. (CRA3 Art. 5c)
  - BCBS new hierarchy of approaches:
    - Securitization-IRB Approach (SEC-IRBA) where allowed and approved.
    - Securitization-External Ratings-Based Approach (SEC-ERBA) if SEC-IRBA not available and jurisdiction allows ratings.
    - Securitization Standardized Approach (SEC-SA) if neither SEC-IRBA nor SEC-ERBA can be used.
    - All approaches include a risk-weight floor of 15 percent for any securitization tranche.
  - SSFA (Simplified Supervisory Formula Approach) inputs: (i) capital charge of the underlying pool; (ii) tranche thickness; (iii) credit enhancement; (iv) supervisory adjustment factor p.
  - Supervisory adjustment p:
    - Under SEC-IRBA, p is subject to a 0.3 floor and is determined by inputs including number of loans in the pool, loss given default of underlying loans, and tranche maturity.
    - Under SEC-SA, p is uniformly set to one.
  - SEC-ERBA requires one eligible credit rating for securitization exposures and distinguishes between senior and nonsenior tranches.
  - Note: “Retained securitization” refers to a securitization that remains 100 percent with the originating bank; maximum capital charge for a retained securitization is not supposed to exceed the exposures of the pool of underlying assets.
- Illustrative capital-calculation context (examples)
  - U.S. High-Quality Mortgage example: A US$100 million transaction; risk weight of underlying loans set at 50 percent, implying total capital charge for underlying loans of 4 percent (i.e., 50 percent of 8 percent), or US$4 million.
  - Consumer securitization example: A US$100 million transaction; risk weight of underlying loans set at 75 percent, implying total capital charge for underlying loans of 6 percent (i.e., 75 percent of 8 percent), or US$6 million.

*sdn1501 - EXECUTIVE SUMMARY*

### EXECUTIVE SUMMARY ___________________________________________________________________________

### EXECUTIVE SUMMARY

### Executive summary (key findings)
- Placing private securitization markets back on a firm and sustainable footing has never been more important.
- Securitization has yet to retake its instrumental role in rekindling credit flows and diversifying risks; it must be managed to support financial stability rather than pose risks to it.
- Reforms should address the four-stage financial intermediation chain: loan originators, securitization intermediaries, credit rating agencies (CRAs), and end-investors.
- Priority reforms:
  - Strengthen the quality of underlying loan origination practices to restore the appetite for securitization.
  - Encourage securitization intermediaries to adopt transparent, straightforward-to-value structures primarily designed to finance the real economy.
  - Avoid legal ambiguities related to the rights and obligations of servicers, trustees, and investors; establish secure, transparent, and cost-effective transfer of claims on collateral.
  - Improve the use of credit ratings by standardizing definitions of securitization characteristics, requiring full disclosure of the rating process, disclosing rating shopping, and accelerating removal of references to external ratings in regulations.
  - Ensure consistent application of capital charges across asset classes and borders; avoid large step-changes in charges (“cliff effects”) between securitized asset classes with similar underlying quality.
- Standardization of industry risk classification should be granular (individual risk factors such as duration, prepayment risk, collateral fungibility, track record of credit performance) rather than a single aggregate label to reduce investor shirking and pricing discontinuities.
- Foster a diversified nonbank institutional investor base with a long time horizon; in Europe this requires pan‑European harmonization of loan-level reporting standards, documentation standards, insolvency regimes, and taxation treatment of securitizations.
- Encourage greater sponsorship from European insurers and pension funds to provide patient, long-term capital and diversify financing for the European economy.

*Key statistics and patterns observed*
- Securitization issuance in the United States and Europe is currently running at less than half the levels observed in 2003.
- In Europe, total securitization issuance declined to a 10-year low in 2013, more than 40 percent below the post-1999 average.
- Since 1999, the average composition of European securitization issuance was: RMBS (54 percent), ABS (17 percent), CDOs (10 percent), SMEs (9 percent), CMBS (7 percent), and WBS (3 percent).
- Much of European issuance since the crisis has been retained by issuing banks for use as collateral with the European Central Bank and the Bank of England.
- In the United States, agency-related issuance remained firm; nonagency ABS and CMBS issuance is slowly recovering back to long-term averages.
- Globally, CDO issuance is picking up.

### Introduction (context and objectives)
- When operating efficiently, securitization supports economic growth and financial stability by:
  - Enabling issuers and investors to diversify and manage risk.
  - Transforming pools of illiquid assets into tradable securities, freeing up bank capital to extend new credit to the real economy, and supporting monetary policy transmission.
- Securitization can also amplify credit flows, increase leverage, exacerbate misaligned incentives in the intermediation chain, and amplify systemic risk; thus the asset class should be as simple, transparent, and robust as possible.
- Recent patterns show selective recovery in certain asset classes/regions while other classes/regions remain moribund; vigilance is required as spreads in corporate credit markets approach historic lows amid prolonged low interest rates.

### Policy recommendations — A. Building a Sound Framework for the Financial Intermediation Chain
- Overview:
  - The paper views securitization in the context of a multi-dimensional financial intermediation chain comprising loan originators, securitization intermediaries, CRAs, and investors.
  - Policy measures are proposed for each element, drawing lessons from the global financial crisis and focusing on preconditions for strengthening securitization practices.

- Self-reinforcing cycle and vulnerabilities:
  - In the years before the global financial crisis, elements of the industry became intertwined in a powerful self-reinforcing cycle (loan originators, securitization intermediaries, CRAs, and investors) against a backdrop of highly accommodative monetary policies.
  - Faulty loan origination practices, complex and opaque securitization issuance, upwardly biased ratings and underestimated correlations, and investors’ “search for yield” and retained contingent exposures contributed to systemic vulnerabilities.

- Loan origination (findings)
  - Deterioration in loan origination practices was a central contributing factor to the financial crisis, specifically:
    - Faulty loan origination practices in some mortgage markets.
    - Lending standards deteriorated sharply.
    - Origination of mortgages and other consumer debt was not well regulated.
    - Mortgage documentation and registration practices were inappropriate.
  - Compensation practices were often tied to origination volumes and high-fee products.
  - Property appraisers selected by mortgage originators often inflated real estate valuations.

- Loan origination (policy recommendations)
  - Broad-based regulatory measures to secure high-quality underlying loan origination practices are essential.
  - Some Dodd-Frank Act stipulations designed to enhance supervision of the home appraisal process are promising and may be applicable in other jurisdictions:
    - Having loan officers (rather than mortgage brokers) select appraisers.
    - Maintaining records on appraiser performance via a property value registry (with focus on identifying consistently inflated valuations).
  - Prudential policies to complement loan origination practices could include:
    - (i) risk-based frameworks to define regulatory provision and capital requirements;
    - (ii) regulation to ensure collateral accepted as the basis for additional new borrowing emphasizes cash and income relative to unrealized capital gains in asset prices;
    - (iii) focus on borrowers’ maximum loan-to-value (LTV) ratios and debt-to-income ratios, limits on second liens, and hypothecation of unrealized capital gains.

*Italic source attribution:* _sdn1501 - EXECUTIVE SUMMARY_

### 2. Securitization Intermediaries

### 2. Securitization Intermediaries

### Summary of role and failures during 2000–07
- Practices employed by securitization intermediaries over the 2000–07 period amplified the financial crisis.
- Key contributors included misaligned incentives for originators and broker dealers, the emergence of complex and nontransparent products (where risks were difficult to assess), and problems with the operational infrastructure used by securitization intermediaries—particularly where U.S. subprime mortgages were involved.

### Regulatory responses to incentive and disclosure problems
- Regulators in the United States and Europe have taken steps to address incentive problems due to asymmetric information, principally through the requirement that originators retain an economic interest (“skin-in-the-game”) in the performance of the underlying loans.
- The Basel Committee on Banking Supervision (BCBS) has discouraged securitizations that are idiosyncratic or complex in nature.
- Regulators in the United States and Europe have introduced measures requiring issuers of ABS to enhance disclosure of information pertaining to the underlying assets.
- Promotion of simple, generic, and standardized financing vehicles is recommended to help address remaining impediments.

### Operational infrastructure problems identified
- Three key problems emerged in the operational infrastructure of mortgage securitization markets during the financial crisis:
  - (i) Ambiguity and lack of enforcement of representations and warranties.
  - (ii) Conflicts of interest affecting quality-control firms.
  - (iii) Deficient technological infrastructure.
- Quality-control firms were hired by originating banks to test samples of to-be securitized mortgages to ascertain compliance with underwriting guidelines and other eligibility factors; issues over rule clarity, proper enforcement of representations and warranties, and conflicts of interest surfaced mainly in U.S. mortgage markets.
- Examples of operational challenges:
  - Mortgage Electronic Registration Systems, Inc. (MERS) in the United States experienced significant legal and operational challenges post-crisis.
  - Germany’s refinancing register and mortgage-transfer legislation in France are cited as examples of cost-efficient systems with robust legal frameworks.
- Servicers’ business models in the United States were usually calibrated to “normal times” of low defaults; once the U.S. mortgage crisis intensified, servicers and trustees were insufficiently resourced to properly address the flood of foreclosures.

### Recent measures to reduce operational uncertainty
- New U.S. regulations require CRAs and issuers of ABS to disclose information on representations and warranties.
- Fannie Mae and Freddie Mac announced a new framework to address concerns over vaguely worded representations and warranties, clarified enforcement procedures, and extended relief to originators from an obligation to remedy mortgage loans that are in breach of representations and warranties if specific requirements are met.

### Policy recommendations (operational, disclosure, and incentive alignment)
- Policymakers’ attention should be focused on aligning incentives, in a comprehensive and consistent manner, across the entire financial intermediation chain. Ensuring that originators retain an economic interest in the securitization (“skin in the game”) should be viewed as a crucial, though not sufficient condition for a healthy functioning securitization market.
- Regulators should provide guidance regarding the timely disclosure of up-to-date underlying loan-level performance data from servicers to investors, regulators, and other interested parties. Data need to be sufficiently granular to allow proper independent investment and risk evaluation.
- The development of relatively simple and standardized “plain vanilla” securitizations (with a direct and transparent transfer of cash flows from borrowers to lenders) should be encouraged, relative to securitizations that are idiosyncratic or complex in nature. The latter should be held to relatively higher regulatory and capital standards, and made robust to changes in parameter assumptions.
- The securitization market is likely to be strengthened where timely information on changes in quality and composition of the collateral pool is provided to investors; and where underlying collateral:
  - consists of a claim on real assets (not another financial security),
  - is valued on the basis of conservative recovery rates,
  - offers the benefits of fungibility (where the underlying collateral can be repossessed and sold at low cost).
- Efforts must be made in all jurisdictions to minimize legal ambiguities related to the rights of and obligations between servicers, trustees, and investors.
- Regulators must be mindful of conflicts of interest where servicers are owned by banks, and, where possible, assist in enforcing existing contracts between bank-owned servicing firms, trustees, and the investors in the securitization vehicles.
- Conflicts of interest with quality-control firms should be minimized through the regulation of payment models and enforcement of transparency of business practices.
- Regulators and supervisors must ensure that the legal foundation and operations of any mortgage transfer system are robust. A centralized electronic system would be preferable to ensure the secure, transparent, and cost-effective transfer of claims on collateral.
- The provision of adequate technical infrastructure and resources by industry participants should be regulated to guarantee the efficient processing of large amounts of foreclosures in case of market distress.

*Source: 2. Securitization Intermediaries — _sdn1501 - 2. Securitization Intermediaries*

### 22.      Securitizations need to be treated comparably to securities with broadly similar risk

### 22.      Securitizations need to be treated comparably to securities with broadly similar risk characteristics

### Regulatory asymmetries and market distortions
- Securitizations should be treated comparably to securities with broadly similar risk characteristics to avoid unintended adverse consequences, including concentration of risk in new areas and regulatory arbitrage.
- Asymmetric regulatory treatment examples:
  - The CRD IV stipulates that covered bonds meeting certain criteria attract a significantly lower risk weight than the risk weights applied to comparable securitization exposures.
  - The proposed EU Solvency II capital requirements for the insurance sector raise the prospect of heavily skewing capital charges in favor of covered bonds over securitized products with similar credit, duration and liquidity risk characteristics.
  - The BCBS (2014b) framework reduced the minimum capital charge for securitizations from 20 to 15 percent, narrowing the gap with covered bonds, but significant differences in capital charges remain in certain cases.
  - LCR treatment is more favorable to covered bonds: covered bonds with an AA rating or higher are classified as a Level 2A asset and attract a haircut of 15 percent; RMBS are classified as Level 2B assets and attract a haircut of 25 percent and must meet additional conditions (e.g., full recourse for mortgages and LTVs at or below 80 percent for each loan) that often render many RMBS ineligible.
  - The NSFR effectively incentivizes the issuance of covered bonds relative to securitizations (BCBS, 2014a).

Policy recommendations (as listed)
- Focus special attention on addressing asymmetric capital treatment in the instances outlined above.
- Note on covered bonds vs securitizations: while covered bonds’ dual-recourse nature may offer higher security, a number of risk factors reduce this potential advantage.

### Regulatory complexity and clarity
Findings
- Regulatory complexity and overlapping requirements hinder efficient functioning of securitization markets; clear, concise, and consistent "rules of the game" are needed.
- Arbitrary tranche maturity boundaries (minimum maturities of one year and maximum maturities of five years in BCBS (2014b)) open potential for regulatory arbitrage, including capping tranche maturities at five years for capital charge purposes even if economic maturity is much longer.

Policy recommendations (as listed)
- Formalize and make permanent the relief for securitization vehicles from compliance with swap clearing rules as soon as possible.
- Provide clarification on tranche maturity boundaries to avoid caps that create distortions.
- Finalize capital requirement rules under Solvency II for European insurers to help restore support for securitized assets in Europe.
- Ensure formal application of the qualified residential mortgage (QRM) rule in the United States (the final rule on QRM (October 2014) will be effective one year after publication in the Federal Register for RMBS and two years after publication for all other securitization types).

### Harmonization of industry standards for risk and data disclosure
Findings
- Standardization can improve investor, regulator, and central-bank ability to distinguish deals, and can contribute to better secondary-market liquidity, but aggregate risk labels can create problems:
  - Encourage investor shirking of due diligence and exacerbate investor herding and CRA modeling errors.
  - Create forced buying/selling pressure independent of investor-specific risk tolerance.
  - Binary high/low classifications risk creating fragmented markets with cliff effects.
  - Official-sector aggregate labels may introduce moral hazard and political pressure if labeled high-quality products perform poorly.

Policy recommendations (as listed)
- Encourage standardization along different risk dimensions rather than relying solely on aggregate labels; standardize duration risk, prepayment risk, collateral fungibility, and track record of credit performance to enable investors to assess overall risk.
- Harmonize loan-level reporting standards and documentation standards to address paucity of consistent information and reduce home bias.
- Develop centralized information platforms and exchanges, including credit registers and public databases, to improve availability and quality of underlying-loan and deal information.
- Harmonize national insolvency regimes and consider revisions to European corporate law to more closely embrace the spirit of U.S. insolvency laws to allow preemptive reorganization.
- Harmonize tax treatment of securitization vehicles to reduce cross-border cost and complexity.
- Carefully weigh credit enhancement features (including limited public sector guarantees) against moral hazard risks.
- Credit rating agencies could publish additional information showing implied tranche ratings under alternative sovereign and ancillary facilities’ rating caps (e.g., a matrix showing implied ratings if caps were set higher).

### Development of nonbank institutional investor bases for securitization
Findings and key statistics
- A diversified ecosystem of investors and stable sources of funding is important for financial deepening and balanced financial growth.
- Size and composition differences between U.S. and European securitization markets:
  - Outstanding securitization issuance comprises 59 percent of U.S. GDP, vis-à-vis just 11 percent in Europe.
  - Figure 6 (in trillions of U.S. dollars) shows numbers: 16.8; 3.8; 1.3; 17.4; 2.0; 0.3 (reported in the source).
- Within Europe’s smaller market, banks dominate investment demand; pension and insurance funds have a trivial share for select classes of European securitizations, unlike the United States.
- Pension and insurance roles and obstacles:
  - Pension funds’ limited role is linked to structural makeup of Europe’s pension systems, with a large proportion of assets in defined benefit systems requiring long-duration assets with limited prepayment.
  - Market-placed ABS often have short maturities, amortizing in around two to five years; longer-duration securitizations like RMBS face substantial prepayment risk.
  - Channeling of continental retirement savings through insurance industry brings Solvency II capital charge effects that make securitization unattractive.
- Pension fund statistics:
  - United Kingdom pension fund assets: US$3.3 trillion.
  - Netherlands pension fund assets: US$1.4 trillion.
  - These two account for around 85 percent of European pension fund assets.
  - Defined-benefit share: United Kingdom 72 percent; Netherlands 95 percent.
  - Ratio of pension fund assets to GDP: Netherlands 170 percent; United Kingdom 131 percent.
  - For Germany, France, Italy, and Spain, the ratio of pension fund assets to GDP is below 15 percent.

Policy recommendations (as listed)
- Harmonize loan-level reporting standards and documentation standards.
- Develop centralized information platforms and exchanges and credit registers to improve data availability and quality.
- Consider harmonization of insolvency regimes and corporate law to reduce recovery uncertainty and enable reorganizations.
- Harmonize tax treatment of securitization vehicles to reduce cross-border transaction costs.
- Scale and design credit enhancement features carefully; existing public guarantees (e.g., European Investment Fund, SME schemes in Germany and Spain) have tended to be too small, idiosyncratic, or narrowly focused to have broad impact.
- Level the playing field for capital charges (as proposed by the European Commission) to reduce forced sales and runoffs of securitizations by European insurers and help turn insurers into a key source of demand.
- Industry participants, working with regulators, should pursue market-based initiatives to invite greater participation from Europe’s defined-benefit pension funds by creating low-credit-risk and long-duration cash flows, lengthening ABS duration, and allowing better hedging of prepayment risk on long-duration assets like mortgages.

*Source: SECURITIZATION: THE ROAD AHEAD (excerpted section 22 and nearby sections) — INTERNATIONAL MONETARY FUND*

### CONCLUSIONS

### CONCLUSIONS

### Key assessment
- Though significant progress has been made in reconfiguring securitization markets in the aftermath of the global financial crisis, the task of ensuring that these markets contribute to economic growth and financial stability is unfinished. (para 29)
- Recommendations are distilled along three lines: strengthening the financial intermediation chain, applying consistent granular risk classification, and broadening the institutional investor base. (para 29–32)

### Strengthening the financial intermediation chain (para 30)
- Loan-origination measures
  - Securitization depends heavily on the quality of underlying loan origination practices.
  - Imposition of metrics and approaches to reduce probability of stress at the loan level and system-wide level:
    - maximum loan-to-value (LTV) ratios,
    - debt-to-income (DTI) ratios,
    - countercyclical macroprudential policy.
- Securitization intermediaries
  - Critical role in developing transparent securitization structures with low complexity.
  - Minimize legal ambiguities related to rights and obligations between servicers, trustees, and investors.
  - Implement a secure, transparent, and automated claims transfer system.
- Credit ratings and disclosure
  - Standardized definitions of securitization characteristics and full disclosure of the ratings process for bonds would increase transparency.
  - Rule makers should provide guidance on granular loan data information disclosure.
  - The process of ratings shopping should be disclosed (and possibly prohibited).
  - Removal of reference to external ratings in the European Union and under the BCBS should be accelerated as fast as reasonably possible.
- Capital charges and cliff effects
  - Address remaining cliff effects and inconsistent application of capital charges (across borders and asset classes) to restore investor participation.

### Granular risk classification (para 31)
- Aggregate risk labels can:
  - encourage investor “shirking” of due diligence,
  - precipitate forced buying and selling pressure irrespective of investor tolerances for different risk dimensions,
  - create fragmented markets with significant pricing discontinuities.
- Recommendation: apply consistent industry standards to classify risk at a granular level (e.g., duration risk, credit risk, collateral fungibility) to preserve benefits of standardization while mitigating crisis-era problems.

### Diversified institutional investor base (para 32)
- Securitization markets could be strengthened by a diversified institutional investor base (beyond just banks) with long-term capital.
- For continental Europe, making securitization more attractive to European institutional investors could help diversify financing sources and contribute to broader growth objectives, though not a panacea.

### Remaining open issues and regulatory priorities (Table 1 summary)
- Include Maximum loan-to-value (LTV) and debt-to-income (DTI) ratios in QRM, QM, and similar measures.
- Introduce counter-cyclical macroprudential policies (for instance, variation of LTVs or DTIs across the cycle).
- Standardized definitions of securitization characteristics and full disclosure of the ratings process for bonds.
- Provide guidance on granular loan data information disclosure.
- Accelerate removal of reference to external ratings in the EU and under the BCBS as reasonably as possible.
- U.S. regulators should implement rules preventing ratings shopping in accordance with DFA 939F.
- Address possible capital arbitrage and cliff effects.
- Avoid unfavorable treatment of securitizations compared to products with similar risk features.
- Adopt a more realistic definition of maturity; authorities should consider use of the actual cash flow waterfall.
- BCBS and local authorities should coordinate to ensure formulae, assumptions, and implementation of capital charge estimates are consistent across jurisdictions.
- U.S.: Provide relief for securitization vehicles from compliance with swap clearing rules.
- Promote securitization structures of low complexity.
- Minimize legal ambiguities related to rights and obligations among servicers, trustees, and investors.
- Implement secure, transparent, and automated claims transfer.

### Selected regulatory measures and numeric policy parameters (from Table 1 and Box 1)
- EU: Issuers to retain material net economic interest of at least 5%. (CRR Art. 405)
- BCBS (Revision of securitization framework, Dec. 2014; coming into effect in January 2018):
  - Reduction of reliance on external ratings through formula-based approaches.
  - Minimum Risk Weight floor 15%.
  - Increased Risk Weights for highly-rated exposures, reduced ones for low-rated ones.
- EU: Remove all references to CRAs for regulatory purposes by 2020. (CRA3 Art. 5c)
- BCBS new hierarchy of approaches (Box 1):
  - Securitization-IRB Approach (SEC-IRBA) where allowed and approved.
  - Securitization-External Ratings-Based Approach (SEC-ERBA) if SEC-IRBA not available and jurisdiction allows ratings.
  - Securitization Standardized Approach (SEC-SA) if neither SEC-IRBA nor SEC-ERBA can be used.
  - All approaches include a risk-weight floor of 15 percent for any securitization tranche.
- SSFA (Simplified Supervisory Formula Approach) inputs:
  - (i) capital charge of the underlying pool;
  - (ii) tranche thickness;
  - (iii) credit enhancement;
  - (iv) supervisory adjustment factor p.
- Supervisory adjustment p:
  - Under SEC-IRBA, p is subject to a 0.3 floor and is determined by inputs including number of loans in the pool, loss given default of underlying loans, and tranche maturity.
  - Under SEC-SA, p is uniformly set to one.
- SEC-ERBA requires one eligible credit rating for securitization exposures and distinguishes between senior and nonsenior tranches, reflecting maturity and tranche thickness.
- Note: “Retained securitization” refers to a securitization that remains 100 percent with the originating bank; maximum capital charge for a retained securitization is not supposed to exceed the exposures of the pool of underlying assets.

### Illustrative capital-calculation context (Appendix 1 summary)
- Example conventions used in illustrative tables:
  - U.S. High-Quality Mortgage example: A US$100 million transaction; risk weight of underlying loans set at 50 percent, implying total capital charge for underlying loans of 4 percent (i.e., 50 percent of 8 percent), or US$4 million.
  - Consumer securitization example: A US$100 million transaction; risk weight of underlying loans set at 75 percent, implying total capital charge for underlying loans of 6 percent (i.e., 75 percent of 8 percent), or US$6 million.
- Tables show weighted average risk weights and aggregated capital charges under:
  - Standardized Approach (SA) and Ratings-Based Approach (RBA) under Basel II;
  - New BCBS framework approaches: IRBA, ERBA, and SA;
  - U.S. Simplified Standardized Formula Approach (SSFA).
- The last row in the illustrative tables displays the multiple of the capital charge on the deal vis-à-vis the capital charge of the underlying loan portfolio.

*Source: CONCLUSIONS, _sdn1501 - CONCLUSIONS_*

### REFERENCES

### _sdn1501 - REFERENCES

### Policy papers, regulatory frameworks, and supervisory documents
- Bank of England and European Central Bank. 2014. “The Case for a Better Functioning Securitisation Market in the European Union.” Discussion Paper, May.
- Basel Committee on Banking Supervision (BCBS). 2006. "International Convergence of Capital Measurement and Capital Standards - A Revised Framework - Comprehensive Version." Bank for International Settlements, Basel.
- Basel Committee on Banking Supervision (BCBS). 2013. “Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools.” Bank for International Settlements, Basel.
- Basel Committee on Banking Supervision (BCBS). 2014a. “Basel III: The Net Stable Funding Ratio.” Bank for International Settlements, Basel.
- Basel Committee on Banking Supervision (BCBS). 2014b. “Revisions to the Securitisation Framework.” Bank for International Settlements, Basel, December.
- Basel Committee on Banking Supervision (BCBS). 2014c. Consultative Document “Criteria for Identifying Simple, Transparent and Comparable Securitizations.” Bank for International Settlements, Basel, December.
- Board of Governors of the Federal Reserve Board. 2013. “Agencies Revise Proposed Risk Retention Rule,” 28 August. http://www.federalreserve.gov/newsevents/press/bcreg/20130828a.htm.
- European Banking Authority. 2014. “Discussion Paper on Simple Standard and Transparent Securitizations,” 14 October. https://www.eba.europa.eu/-/eba-consults-on-simple-standard-and-transparent-securitisations-and-their-potential-regulatory-recognition.
- European Commission. 2014. “Communication from the Commission to the European Parliament and the Council on Long-Term Financing of the European Economy,” 27 March. http://ec.europa.eu/internal_market/finances/docs/financing-growth/long-term/140327-communication_en.pdf.
- European Insurance and Occupational Pensions Authority (EIOPA). 2013. “Standard Formula Design and Calibration for Certain Long-Term Investments.” Technical Report, December. https://eiopa.europa.eu/Publications/Reports/EIOPA_Technical_Report_on_Standard_Formula_Design_and_Calibration_for_certain_Long-Term_Investments__2_.pdf
- European Insurance and Occupational Pensions Authority (EIOPA). 2014. “Financial Stability Report,” May. https://eiopa.europa.eu/fileadmin/tx_dam/files/publications/fin-stability/Reports/may_2014/EIOPA_Financial_Stability_Report_-_May_2014.pdf.
- European Parliament. 2011. “Pension Systems in the EU – Contingent Liabilities and Assets in the Public and Private Sector,” October. http://www.europarl.europa.eu/document/activities/cont/201111/20111121ATT32055/20111121ATT32055EN.pdf.
- Hill, Jonathan. 2014. “Capital Markets Union – Finance Serving the Economy.” Speech in Brussels, 6 November. http://europa.eu/rapid/press-release_SPEECH-14-1460_en.htm.

### IMF publications and working papers
- International Monetary Fund (IMF). 2014a. Global Financial Stability Report, October. World Economic and Financial Surveys (Washington).
- International Monetary Fund (IMF). 2014b. “Euro Area Policies: Selected Issues from Article IV Consultation.” IMF Country Report No. 14/199. International Monetary Fund, Washington.
- Jones, Bradley A. 2014. “Identifying Speculative Bubbles: A Two-Pillar Surveillance Framework.” IMF Working Paper 14/208. International Monetary Fund, Washington.
- Segoviano, Miguel, Bradley Jones, Peter Lindner, and Johannes Blankenheim. 2013. “Securitization: Lessons Learned and the Road Ahead.” IMF Working Paper 13/255. International Monetary Fund, Washington.

### Industry reports, research notes, and market commentary
- Prime Collateralised Securities. 2013. “The Label.” http://www.pcsmarket.org/the-label/pcs-eligibility/.
- Standard and Poor’s. 2014. “EIOPA’s Revised Solvency II Calibration Still Risks Turning European Insurers Away From Securitizations,” Structured Finance Research (March).
- Towers Watson. 2014. “Global Pension Assets Study,” January. http://www.towerswatson.com/en-US/Insights/IC-Types/Survey-Research-Results/2014/02/Global-Pensions-Asset-Study-2014.

### News, press releases, books, and legal/industry guidance
- Gallagher, Dan. 2007. “Citigroup Says It Will Absorb SIV Assets.” MarketWatch, 13 December. www.marketwatch.com/story/citi-plans-to-absorb-49-billion-in-siv-assets-onto-balance-sheet.
- Muolo, Paul, and Mathew Padilla. 2008. Chain of Blame. Hoboken, NJ: John Wiley & Sons, Inc..
- National Conference of State Legislatures. 2014. “National Mortgage Settlement Summary.” http://www.ncsl.org/research/financial-services-and-commerce/national-mortgage-settlement-summary.aspx.
- State Street. 2009. “State Street Announces Common Stock Offering.” Press Release, May 15. pr.statestreet.com/us/en/20090518_1.html.
- Stroock & Stroock & Lavan. 2013. “CFTC Staff Provides Informal Relief for Securitization Vehicles from Compliance with New Swap Clearing Rules,” May.

*International Monetary Fund — _sdn1501 - REFERENCES_*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2015/_sdn1501.pdf_