## _sdn1507

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### EXECUTIVE SUMMARY — Context and Rationale
- SMEs account on average for "99 out of every 100 businesses", "2 in every 3 employees" and "58 cents of every euro of value added of the business sector (industry, construction, trade and services) in the EU (European Commission 2014a)".
- SMEs are highly dependent on bank finance; banks remain focused on raising capital and are weighed down by impaired assets, constraining long-term funding for SMEs.
- A well-functioning and liquid securitization market is a promising avenue to enhance banks’ lending capacity and permanently broaden funding options for SMEs while supporting greater integration of European capital markets and advancing a Capital Markets Union (CMU) objective.

### EXECUTIVE SUMMARY — Key Findings on SME Financing and Securitization
- Bank vs bond financing:
  - "Bank loans represent 80 percent of euro area companies’ debt", while "U.S. companies use bond financing (accounting for 75 percent of their debt)".
- Leverage:
  - "The average debt-to-equity ratio in the euro area is close to 70 percent", "above the U.S. average of 60 percent".
- Market size and composition:
  - "European securitization market outstanding stock is about €1.5 trillion" (end-2014).
  - "Private-label U.S. market €2.6 trillion" (excluding RMBS issued by Fannie Mae and Freddie Mac).
  - RMBS dominance: "about €875 billion (about 60 percent of all collateral types) at end-2014".
  - "SME loan-backed securities constitute only less than one-tenth of the total market (€121 billion)".
- Concentration and issuance:
  - Transactions from Netherlands, Italy, Spain, Germany, and Belgium accounted for "about 81 percent of the securitization market in the euro area in 2014".
  - "More than three-quarters of outstanding SME securitization transactions in the euro area have been issued by entities in Spain, Italy, and Belgium".
  - Stock contraction: "outstanding securitization has contracted by about one-third since the start of the crisis".
  - New placements dropped to "about one-fourth of their earlier size" and "amounted to less than €80 billion in 2014".
  - RMBS contracted by "approximately €531 billion (about one-third) since 2009".
- Retention patterns:
  - "For SME securitization, almost 95 percent were retained in 2014".
  - "Of new issuances generally, about two-thirds remain on banks’ books".
  - In 2004, "just above five percent of euro area banks’ outstanding SME loans were securitized".
- Potential monetary policy and collateral benefits:
  - SME securitization could "enhance monetary transmission" and "deepen the supply of high-quality collateral for securities financing transactions (SFTs)".

### IMPEDIMENTS — Summary of themes
- Regulatory framework, including liquidity risk standards and capital requirements, does not provide the right incentives for high-quality securitization (HQS).
- Fragmented national insolvency and debt enforcement regimes and lack of harmonized credit information across EU countries raise issuance costs and limit the investor base.
- These impediments hamper development of a vibrant SME securitization market and limit potential benefits for SME funding and financial stability.

### PROPOSED STRATEGY TO REVITALIZE SME SECURITIZATION
- Comprehensive, multi-faceted strategy combining:
  - Encouraging greater regulatory differentiation among securities of varying underlying asset quality and structures.
  - Developing market infrastructure and facilitating cross-border investment through EU frameworks for harmonized credit reporting and insolvency regimes.
  - Enhancing the scope of current EU initiatives for SME finance and introducing a more nuanced treatment of SME-related collateral for refinancing with the Eurosystem.
- Underpinning measures with a pan-European definition of high-quality securitization (HQS) comprising simple, transparent, and efficient asset structures that can receive preferential regulatory treatment and official-sector support.
- Targeted and time-bound official sector support to complement regulatory reforms and infrastructure development.
- Potential benefits:
  - Broader access to finance would limit SMEs’ exposure to banking-sector difficulties.
  - SME securitization could mobilize additional funding now, while longer-term development of private equity, venture capital, and direct SME access to capital markets proceeds.
  - Financial-stability gains by enabling risk transfer from banks to a wider pool of investors beyond the banking sector.
  - Enhanced integration of European capital markets and progress toward a Capital Markets Union.

### RESILIENCE AND PERFORMANCE DURING THE FINANCIAL CRISIS (Chapter 6 highlights)
- Default statistics:
  - Defaults ranged "between 0.6 and 1.5 percent on average for European securitization transactions" and were "0.1 percent for European SME ABS (ECB 2014c)".
- Default concentration:
  - European defaults were heavily concentrated in non-investment grade tranches; U.S. impairments affected even highest-rated tranches.
- Supporting factors for resilience:
  - Conservative loan origination standards with high-equity participation and continuous servicing by originator.
  - Adequate post-issuance performance monitoring and issuer due diligence.
  - Securitization treated as part of ongoing balance sheet operations with funding linked to real economic activity.
- Caveat:
  - Some SME loan-backed transactions with non-granular portfolios and unsecured (mezzanine) loans experienced significant downgrades and defaults, though they were a small part of the market.

### EU INITIATIVES TO FACILITATE SME SECURITIZATION (Chapter 6 overview and limits)
- Initiatives and resource figures:
  - "EIB Group standing facility to guarantee SME securitization": typical annual use "€0.5-0.8 billion".
  - EIF credit enhancement facility: allows zero risk weight on tranches guaranteed by the EIF (Triple-A).
  - EU SME Initiative combining EU structural funds and EIB/EIF resources.
  - COSME Loan Guarantee Facility (Securitization Option): "€1.3 billion available over 2014–20".
  - EFSI: "€21 billion fund backed by €8 billion EU resources and €5 billion contribution from the EIB"; aims to boost investment by "€315 billion over 2015–17", of which "€75 billion should be allocated to SMEs and mid-cap companies"; "€5 billion is earmarked to support SME risk finance, including SME securitization".
  - National example: French Euro Secured Note Issuers scheme: five French banks issued notes worth "€3.65 billion via an SPV".
- Reasons initiatives have not jumpstarted the market:
  - Capacity constraints: resources are limited relative to banks’ SME loan portfolios; committed amounts are small with overlap across initiatives.
  - Scope limitations: support focused narrowly on bank lending and does not sufficiently solicit non-banking funding sources or provide direct capital market access.
  - External impediments: lack of coordinated effort to address regulatory differentiation, market infrastructures, debt enforcement and insolvency differences, and fragmented credit information.

### REGULATORY AND STRUCTURAL HURDLES (Chapter 6 & 13)
- Insufficient regulatory differentiation and capital charges:
  - Regulatory framework tends to impose high capital charges on securitization instruments relative to other funding instruments of similar credit risk.
  - Effects:
    - Proposed capital charges for even highly rated transactions would reduce balance sheet leverage so that insurance companies, and to a lesser extent banks, may not achieve sufficient return on equity based on current profitability.
    - Regulatory cost of securitization remains too high relative to holding underlying SME loans or investing in alternative fixed income instruments with comparable risk-return properties.
  - Sector impacts:
    - Banks: BCBS 2014 RWA definitions for securitization exposures raise capital intensity even for simpler securitization transactions.
    - Insurers: Solvency II capital charges for securitization transactions are higher than for other assets with comparable risks.
- LCR and HQLA treatment (Chapter 13):
  - LCR implementing legislation includes SME, auto and consumer loan ABS in HQLA but "only up to a cap of 15 percent" and with "haircuts of 25 to 35 percent (European Commission 2014c)".
  - Covered bonds can constitute "up to 70 percent of HQLA, at a 7 percent haircut (European Commission 2014b)", disadvantaging securitization.
- National investment restrictions:
  - EU Life Insurance Directive allows national authorities to adopt more stringent criteria.
  - IORP Directive remains deficient in reining-in national restrictions on cross-border diversification.
  - Examples of national restrictions: obligations to buy only domestic government bonds; limits on investments in nongovernment debt with high minimum credit-rating requirements.
  - Consequences: weakly diversified asset allocations and skewed demand away from alternative investments.

### MARKET INFRASTRUCTURE OBSTACLES (Chapter 13)
- High upfront and structuring costs:
  - Sunk IT costs for granular information, pooling, legal documentation, due diligence, credit ratings, and credit enhancements (high subordination, overcollateralization, interest reserve accounts).
- Pooling and pooling-size challenges:
  - Clean credit history, sufficient tenor, clarity on collateral, and sectoral diversification needed; achieving critical mass is difficult for SME loans due to heterogeneity and relationship lending.
- Commoditization and rating protection:
  - SME loan uncertainty typically requires higher credit enhancement for senior tranches, raising costs; small pools are comparatively costly.
- Interest margin constraints:
  - Banks face difficulty creating high-yielding assets with adequate tranche differentiation from heterogeneous SME loan pools that are costly to securitize and often yield relatively low returns.
- Weak enforcement and collateral access:
  - SME ability to grant security interests and debt enforcement vary widely across EU countries, affecting recovery rates and securitization viability.
- Data and reporting fragmentation:
  - Heterogeneity of SME portfolios and national credit registries limit standardized, comparable financial data necessary to boost investor interest and enable cross-border SME securitization.
- Crisis-era collateral demand effect:
  - Many transactions were structured primarily as collateral for central bank refinancing, with large retained mezzanine and junior tranches supporting a small senior tranche, limiting genuine credit risk transfer.

### POLICIES TO REVITALIZE SME SECURITIZATION (Chapter 13 recommendations)
- Ensure greater regulatory differentiation for HQS:
  - Promote simple, transparent, and comparable securitization structures guided by clear principles.
  - Define HQS on principles of simplicity, transparency, and comparability with SME-specific criteria.
- Proposed HQS key requirements:
  - Strict rules and enforcement on asset eligibility and quality, conservative loan origination standards, risk-retention rules (“skin in the game”), avoidance of “originate-to-distribute” models, strong funding relation to real economic activity, and requirement that the cash-flow generating reference portfolio is self-funded and homogeneous (only one type of asset).
  - Scope to include non-senior tranches of robust structures, supported by improved data and analytics.
  - Rigorous disclosure requirements at asset and transaction levels, with standardized documentation and reporting at inception and post-issuance.
  - SME-specific eligibility criteria regarding diversification, cash flow, and track record to limit underlying risk.
- Regulatory treatment recommendations:
  - HQS transactions should receive more lenient regulatory treatment than non-HQS transactions to reflect lower risk and greater transparency.
  - Reduce capital charge on HQS for non-bank investors to encourage issuance while maintaining safeguards.
  - Greater differentiation in haircuts for eligible HQS in liquidity risk management to increase banks’ appetite.
  - Revise investment restrictions for institutional investors (insurance companies, pension funds, mutual funds) once supervision and regulatory framework are strengthened, to prudently encourage alternative investments that benefit SME financing.

### HIGH-QUALITY SECURITIZATION (HQS) — Attributes and Implementation (Chapter 21 Box 4)
- General Criteria — Asset characteristics (underwriting and eligibility):
  - Sound underwriting practices: assets selected as part of ongoing balance sheet operations (seasoned, senior, fully disbursed loans only); prohibition of self-certification; no originate-to-distribute.
  - Strong funding relation to real economic activity; exclusion of re-securitization.
  - Eligibility determined by materiality to originator’s business, homogeneity of cash flows, restricted use of derivatives, requirement of full funding and enforceability, exclusion of encumbered/nonperforming assets, availability of borrower payment record.
  - Quality of assets and transaction determined by external assessment; minimize tranche retention above regulatory minimum to enable credit risk transfer.
- Structural features:
  - Asset transfer: legal separation and bankruptcy remoteness; no severe claw-back provisions; obligor rights compliance with consumer protection; legal validity.
  - Continuous servicing via retained obligation or pre-determined agent; sufficient material net economic interest of originator/issuer in contractual performance (“skin in the game”).
  - Replacement of derivative counterparties/liquidity providers upon default or insolvency.
  - Transparent, pre-determined payment process: self-liquidating asset portfolio, "pass through" payment structure for non-revolving assets, "early determination triggers" for revolving portfolios, no circularity of support mechanisms.
- Documentation and reporting:
  - Regular reporting of asset quality and transaction performance in investor reports; initial disclosure consistent with RTS for CRA3 Regulation.
  - Distributed tranches required to be listed on a regulated exchange or admitted to trading on another organized venue.
- SME-specific additional criteria:
  - Obligor definition: obligors meet "European Commission’s definition of SMEs".
  - Conformity with "European Investment Bank -intermediated lending" terms.
  - Types of SME lending defined to include financing leases, credit lines/guarantees, promissory notes, debentures, concessionary loans, and other loans serving a real investment purpose.
  - Portfolio characteristics: sufficient diversification/granularity; limits on aggregate outstanding balance of securitized assets without scheduled principal payments; creditor track record of "at least one annual reporting period".
- Regulatory treatment and classification:
  - HQS should not substitute granular risk assessment; capital charges should reflect standardized classification of risk dimensions: duration risk, prepayment risk, asset correlation/concentration risk, collateral fungibility, and track record of credit performance.
- Implementation:
  - European Commission to define high-level principles, with Regulatory Technical Standards (RTS) specifying operational details and governance for HQS designation; accountability and due diligence rules for market participants and supervisors.

### STRENGTHENING MARKET INFRASTRUCTURE (Chapter 21)
- Harmonized reporting and credit data:
  - Collect SME credit information based on Eurosystem collateral taxonomy.
  - ECB loan-level data initiative requirements as preconditions for ABS acceptance as Eurosystem collateral.
  - European Datawarehouse (EDW) collects detailed borrower and loan characteristics; scope could be expanded to include non-securitized loans for pricing and benchmarking.
  - Single Supervisory Mechanism (SSM) could adapt same reporting requirements for supervisory purposes.
- Make SME credit information available to investors:
  - SSM-generated standardized and continuous credit quality information paired with harmonized credit registries and reliable SME financial reporting.
  - Consider development of an EU-wide credit register building on ECB efforts toward gradual formation of a credit register for banking union countries; consider private-sector European credit bureau.
- Debt enforcement convergence:
  - Functional convergence, mutual recognition and cooperation (European Insolvency Regulation), and nonbinding recommendations for pre-insolvency/out-of-court restructuring can help.
- Market innovations:
  - Mutual issuance platform (national or euro area-wide) to allow SMEs to issue securitization transactions without bank intermediation (mini-bonds and other instruments).
  - Explore nonbank-intermediated securitization and equity finance where securitization impediments are high.
  - Consider widening eligible asset classes for covered bonds to include SME loans to encourage standardized origination and loan pricing.

### VALUATION HAIRCUTS AND DISCLOSURE (Chapter 32)
- Rationale:
  - Securitization transactions carry greater market risk due to lower liquidity and should face higher valuation haircuts for Eurosystem refinancing.
  - Current haircut schedule provides limited differentiation other than a broad ratings-based distinction; HQS threshold currently set to the lowest investment grade rating "BBB–" (or CQS ranking of "three (3)" under the temporary collateral framework).
- Use of loan-level data and EDW:
  - EDW reports composition and asset quality monthly; this could be used for valuation if overcollateralization is sufficient to reduce daily valuation frequency.
  - Expanding EDW to include non-securitized loans and credit claims used for repos could support differentiated haircut calibration.
- Policy proposals for haircut differentiation:
  - Valuation haircuts should differ according to scope and quality of disclosure requirements; set consistently across asset types and funding instruments.
  - Better information could allow valuation haircuts calibrated to LGDs for non-securitized SME loans.
  - Consider calibrating haircuts to disclosure quality and frequency (e.g., loan-level EDW reporting), overcollateralization levels, portfolio composition changes, and LGD estimates.
- ECB Asset-Backed Securities Purchase Program (ABSPP) facts:
  - ECB started purchasing ABS on "November 21, 2014".
  - As of "May 1, 2015", "€5.8 billion of ABS had been purchased under ABSPP" after five months at an average weekly run-rate of "€300 million".
  - Assuming same pace, annual volume would be about "€13 billion (or about 0.6 percent of the ECB’s current balance sheet)".
  - ECB eligible ABS "universe" about "€485 billion" versus "€975 billion in covered bonds" (falls to "around €700 billion" if smaller transactions ("<€500 million") excluded).

### TARGETED OFFICIAL-SECTOR SUPPORT (Chapter 21 recommendations)
- Integrate and reconcile existing initiatives to exploit synergies and scale:
  - Example impact estimates: securitization option under EU SME Loan Initiative could generate about "€28–35 billion in new SME lending" if all EU member countries participated with the maximum amount ("€13.4 billion"), compared to a market for SME loans currently around "€1.4 trillion" outstanding.
  - With Spain’s participation of "€0.8 billion", expected impact would be about "€3.2 billion".
- Expand role of European institutions:
  - Act as guarantors or strategic investors with most tranches distributed to nonbank investors to achieve diversification.
  - Enhance capacity to provide official-sector guarantees ("wrappers") to mezzanine tranches (building on EIF Credit Enhancement Program).
  - Direct co-investment in senior tranches as strategic investor would boost ratings and reduce subordination needs.
  - Public sector support should be "risk-sensitive and time-bound" to limit long-term distortions.
- Eurosystem collateral framework considerations for eligibility:
  - Entire underlying asset structure should satisfy HQS criteria and current loan-level ECB disclosure standards plus extra requirements.
  - Aim to support transparent, standardized transactions with most tranches distributed rather than transactions structured primarily for central bank funding with sizeable retained tranches.
  - Tranche-level requirements:
    - Most senior tranche must receive the highest possible external credit rating by at least two external credit assessment institutions (ECAIs).
    - Structural subordination supporting the senior tranche should receive an external credit assessment consistent with minimum credit quality for collateral assets accepted by the Eurosystem.
    - Minimize voluntary tranche retention above regulatory minimum: any voluntary retention in excess of the greater of the minimum retention requirement (CRR) and the notional amount of the most junior tranche would need to be "equal to or less than the notional amount transferred or sold to third-party investors, net of the senior tranche".
    - Require comprehensive disclosure at issuance and periodic performance reporting, including non-performance, to facilitate price discovery and risk monitoring.

*International Monetary Fund — Revitalizing Securitization for Small and Medium-Sized Enterprises in Europe (excerpts from _sdn1507_).*

### EXECUTIVE SUMMARY ......................................................................................................

### EXECUTIVE SUMMARY

### Context and Rationale
- Small- and medium-sized enterprises (SMEs) account on average for 99 out of every 100 businesses, 2 in every 3 employees and 58 cents of every euro of value added of the business sector (industry, construction, trade and services) in the EU (European Commission 2014a).
- SMEs are highly dependent on bank finance; banks still focused on raising capital and weighed down by impaired assets, constraining long-term funding for SMEs.
- A well-functioning and liquid securitization market is a promising avenue to enhance banks’ lending capacity and permanently broaden funding options for SMEs while supporting greater integration of European capital markets and advancing a Capital Markets Union (CMU) objective.

### Key Findings on SME Financing and Securitization
- European firms rely heavily on bank financing: bank loans represent 80 percent of euro area companies’ debt, whereas U.S. companies use bond financing (accounting for 75 percent of their debt).
- Euro area companies have higher leverage: the average debt-to-equity ratio in the euro area is close to 70 percent, above the U.S. average of 60 percent.
- The European securitization market outstanding stock is about €1.5 trillion—more than half the size of the private-label U.S. market (€2.6 trillion), excluding RMBS issued by Fannie Mae and Freddie Mac.
- The European market is dominated by RMBS: about €875 billion (about 60 percent of all collateral types) at end-2014.
- SME loan-backed securities constitute only less than one-tenth of the total market (€121 billion).
- Market concentration: transactions from the Netherlands, Italy, Spain, Germany, and Belgium accounted for about 81 percent of the securitization market in the euro area in 2014; more than three-quarters of outstanding SME securitization transactions in the euro area have been issued by entities in Spain, Italy, and Belgium.
- The stock of outstanding securitization has contracted by about one-third since the start of the crisis; new placements dropped to about one-fourth of their earlier size and amounted to less than €80 billion in 2014.
- RMBS segment contracted by approximately €531 billion (about one-third) since 2009.
- Securitization retention patterns: for SME securitization, almost 95 percent were retained in 2014; of new issuances generally, about two-thirds remain on banks’ books.
- In 2004, just above five percent of euro area banks’ outstanding SME loans were securitized.
- SME securitization could enhance monetary transmission by strengthening the link between market interest rates for securitization instruments and the policy rate and deepen the supply of high-quality collateral for securities financing transactions (SFTs).

### Impediments to SME Securitization (summary of themes)
- Regulatory framework, including liquidity risk standards and capital requirements, does not provide the right incentives for high-quality securitization (HQS).
- Fragmented national insolvency and debt enforcement regimes and lack of harmonized credit information across EU countries raise issuance costs and limit the investor base.
- These impediments hamper development of a vibrant SME securitization market and limit potential benefits for SME funding and financial stability.

### Proposed Strategy to Revitalize SME Securitization
- A comprehensive, multi-faceted strategy combining:
  - Encouraging greater regulatory differentiation among securities of varying underlying asset quality and structures.
  - Developing market infrastructure and facilitating cross-border investment through EU frameworks for harmonized credit reporting and insolvency regimes.
  - Enhancing the scope of current EU initiatives for SME finance and introducing a more nuanced treatment of SME-related collateral for refinancing with the Eurosystem.
- Underpinning measures with a pan-European definition of high-quality securitization (HQS) comprising simple, transparent, and efficient asset structures that can receive preferential regulatory treatment and official-sector support.
- Targeted and time-bound official sector support to complement regulatory reforms and infrastructure development.

### Potential Benefits
- Broader access to finance would limit SMEs’ exposure to banking-sector difficulties and help ensure the flow of credit to viable firms.
- SME securitization could mobilize additional funding now, while longer-term development of private equity, venture capital, and direct SME access to capital markets proceeds.
- Financial-stability gains by enabling risk transfer from banks to a wider pool of investors beyond the banking sector.
- Enhanced integration of European capital markets and progress toward a Capital Markets Union.

*International Monetary Fund, Executive Summary (selected content).*

### 6.      Simple, transparent, and comparable securitization instruments, in line with existing

### 6.      Simple, transparent, and comparable securitization instruments, in line with existing practice in Europe

### Resilience and performance of European securitization during the financial crisis
- Defaults since the start of the financial crisis ranged across different studies between 0.6 and 1.5 percent on average for European securitization transactions and were 0.1 percent for European SME ABS (ECB 2014c).
- European defaults were heavily concentrated in non-investment, grade-rated tranches, unlike in the United States where impairments affected even tranches with the highest credit ratings.
- Factors supporting resilience in Europe:
  - Traditionally conservative loan origination standards with high-equity participation and continuous servicing by the originator.
  - Adequate post-issuance performance monitoring and issuer due diligence.
  - Securitization treated as part of ongoing balance sheet operations with funding linked to real economic activity.
- Caveat: Some SME loan-backed transactions with non-granular underlying reference portfolios, especially those including unsecured (mezzanine) loans, experienced significant downgrades and defaults, but these represented only a small part of the market.

### EU initiatives to facilitate SME securitization and their limitations
- Overview of initiatives:
  - European Investment Bank (EIB) Group standing facility to guarantee SME securitization (used regularly for credit enhancement of senior and mezzanine tranches; €0.5-0.8 billion annually in past years).
  - European Investment Fund (EIF) credit enhancement facility that allows zero risk weight on tranches guaranteed by the EIF (Triple-A rating).
  - EU SME Initiative combining EU structural funds and EIB/EIF resources.
  - COSME Loan Guarantee Facility (Securitization Option) with a total of €1.3 billion available over 2014–20.
  - European Fund for Strategic Investments (EFSI): €21 billion fund backed by €8 billion EU resources and €5 billion contribution from the EIB; aims to boost investment by €315 billion over 2015–17, of which €75 billion should be allocated to SMEs and mid-cap companies; €5 billion is earmarked to support SME risk finance, including SME securitization.
  - National example: French Euro Secured Note Issuers scheme—five French banks have issued notes worth €3.65 billion via an SPV.
- Reasons initiatives have not jumpstarted the market:
  - Capacity: Available resources are limited compared to banks’ SME loan portfolios; committed amounts are small and there is some overlap across initiatives (COSME, Horizon 2020, EIB/EIF).
  - Scope: Support is focused narrowly on bank lending and does not sufficiently solicit non-banking funding sources or provide direct capital market access.
  - External impediments: Lack of coordinated effort to address insufficient regulatory differentiation, incomplete market infrastructures, differences in debt enforcement and insolvency regimes, and fragmented credit information—these reduce the effectiveness of support.
- Specific program resource figures (as presented):
  - EIF Credit Enhancement / EIB Group Risk Mandate (EREM): €6 billion available from the EIB/EIF to support SMEs over 2015–21, of which €1.95 billion is earmarked for the ABS Credit Enhancement program; annual volume of guarantees on SME securitization typically €0.5–0.8 billion.
  - EU SME Initiative (Securitization Option): If all EU countries participated, ESIF could provide €8.5 billion, EU funds €0.36 billion, and EIB/EIF €36-49 billion (fully leveraged).
  - COSME LGF (Securitization Option): €1.3 billion available for COSME’s Equity and Loan Guarantee Facilities.
  - EFSI: €21 billion fund, backed by €8 billion EU funds and €5 billion from the EIB/EIF; €5 billion earmarked to support SME risk finance.

### Role in Capital Markets Union
- SME securitization could be an important element of a more developed and integrated EU capital market (Capital Markets Union).
- Many obstacles to cross-border long-term investment (limited access to credit information, differences across securities laws, national debt enforcement and insolvency regimes) also impede SME securitization; EU actions to promote SME securitization and Capital Markets Union objectives are mutually reinforcing.

### Impediments to SME securitization: regulatory and structural hurdles
- Key categories of impediments:
  - Regulatory hurdles: capital and liquidity requirements for banks and insurers do not sufficiently differentiate credit quality and type of underlying asset structures, weakening the investor base.
  - Structural market factors: high issuance costs; cross-border investment barriers (differences in debt enforcement and fragmented national insolvency regimes); lack of harmonized credit information across EU countries.
- Consequence: These hurdles prevent SME securitization from being priced to meet issuers’ and investors’ needs.

### Insufficient regulatory differentiation and capital charges
- Persistent problem: insufficient regulatory differentiation of securitization instruments allows opaque, leveraged, and complex structures that exacerbate systemic vulnerabilities.
- Positive steps taken:
  - Use of the High-Quality Securitization (HQS) concept in Solvency II and in implementation of LCR and leverage ratio for EU banks.
  - European Commission consultation on legislative proposals encouraging HQS (Green Paper on the Capital Markets Union).
  - Uniform risk retention (“skin-in-the-game”) requirements since 2011 (Articles 394-399 of CRR).
  - Enhanced disclosure and transparency standards for structured finance instruments (ESMA 2014).
  - Loan-level information as a pre-condition for ABS eligibility as central bank collateral (Bank of England; ECB).
- Remaining issue: Current regulations tend to impose high capital charges on securitization instruments relative to other funding instruments of similar credit risk, maintaining a regulatory imbalance that narrows the investor base.
- Effects of high capital charges:
  - Proposed capital charges for even highly rated transactions would reduce balance sheet leverage to levels where insurance companies, and to a lesser extent banks, may no longer achieve a sufficient return on equity based on current profitability.
  - Regulatory cost of securitization remains too high relative to the cost of holding the underlying SME loans as originators or investing in alternative fixed income instruments with comparable risk-return properties.
- Sector-specific impacts:
  - Banks: The revised Securitization Framework by the Basel Committee on Banking Supervision (BCBS 2014) defining RWAs for securitization exposures raises capital intensity of even simpler securitization transactions relative to other forms of structured finance held by banks, undermining differentiation based on actual market performance.
  - Insurers: Capital charges under the Solvency II Directive for insurers investing in securitization transactions are higher than those for other assets with comparable risks.

*Source: Excerpt from the IMF chapter "6.      Simple, transparent, and comparable securitization instruments, in line with existing practice in Europe" in the PDF content unit provided.*

### 13.      EU regulations affecting the liquidity risk management and investment demand of

### 13.      EU regulations affecting the liquidity risk management and investment demand of

### Regulatory effects on HQLA and investment demand
- Liquidity coverage ratio (LCR) aims to ensure banks hold enough high-quality liquid assets (HQLA) to cover expected net cash outflows over a 30-day stressed period.
- The EU’s implementing legislation for the LCR:
  - Includes an expanded range of HQS instruments in HQLA (SME, auto and consumer loan ABS in addition to RMBS), but only up to a cap of 15 percent and with haircuts of 25 to 35 percent (European Commission 2014c).
  - Still disadvantages securitization relative to covered bonds, since highly rated covered bonds can constitute up to 70 percent of HQLA, at a 7 percent haircut (European Commission 2014b).
- Net effect: even well-designed securitization transactions remain unattractive relative to covered bonds due to quantitative caps and materially higher haircuts.

### Indirect national investment restrictions and investor base impacts
- EU Life Insurance Directive defines eligible assets (including SME-backed securities) and maximum limits, but EU countries may adopt more stringent criteria for particular asset classes.
- For pension funds, the IORP Directive remains deficient in reining-in national restrictions on cross-border diversification.
- National restrictions observed include:
  - Obligations to buy only domestic government bonds.
  - Limits on investments in any nongovernment debt, often combined with a high minimum credit-rating requirement.
- Consequences:
  - Statutory limits have encouraged weakly diversified asset allocation strategies and skewed demand away from alternative investments.
  - High fixed costs (reporting, research) for a limited supply of difficult-to-value assets demand a critical scale of investment, further deterring investment in SME securitization.

### Impact of capital regulation: banks and insurers (cost-benefit analysis)
- Analytical assumptions used for market-implied regulatory capital charge calculations (as of end-December 2014):
  - Average yield of European benchmark AAA-rated ABS.
  - Average net interest margin of SME lending in the euro area after provisioning: 20%.
  - Average EU benchmark government bond yield as of end-December 2014 (risk-free interest rate): 0.64%.
  - Return on equity (RoE) is taken after taxes (35%).
  - For insurers’ capital charge, a maturity tenor of five years and compliance with “Type 1 securitization” criteria (high-quality securitization, HQS) was assumed.
- Key quantified observations (as of end-December 2014):
  - For banks: the intersection of feasible regulatory capital charge and RoE curves implies investment in highest-rated senior tranches of ABS would result in an RoE of less than 12 percent, which is only slightly above the current benchmark RoE for banks and far below the RoE from holding the SME loan on their books.
  - RoE benchmark referenced for large banks, mid-2013: 11.2%.
  - For insurance companies: the regulatory incentives favor holding covered bonds rather than securitization transactions on the same credit risk; break-even RoE for covered bonds lies significantly below the current benchmark RoE for large insurers.
  - RoE benchmark referenced for large insurers, end-2012: 7.5%.
- Conclusion: current regulatory incentives and proposed capital charges are stacked against securitization, impeding broadening of the potential investor base. Current monetary easing and low risk-free yields (0.64%) influence results but do not alter the overall outcome.

### Market infrastructure and obstacles to cross-border investments
- High upfront and structuring costs for SME securitization:
  - Sunk costs for IT systems to handle granular information and collateral heterogeneity.
  - Costs for pooling, legal documentation, due diligence, credit ratings, and credit enhancements (high subordination, overcollateralization, interest reserve accounts).
- Pooling challenges:
  - Necessary conditions include a clean credit history, sufficient maturity tenor with predictable cash flows, clarity on collateral and availability, and sufficient sectoral diversification.
  - Achieving critical mass of suitable SME loans is more difficult than for residential mortgages due to heterogeneity and relationship lending.
- Commoditization and rating issues:
  - Higher uncertainty in credit risk assessment of SME loans typically requires greater investor protection (higher credit enhancement) for senior tranches, raising costs.
  - Larger pools reduce per-transaction cost ratios; small pools are comparatively costly.
- Interest margin constraints:
  - Banks find it difficult to create high-yielding assets with adequate tranche differentiation from heterogeneous SME loan pools that are costly to securitize and often yield relatively low returns.
- Weak enforcement and collateral access:
  - SME ability to grant security interests varies widely across EU countries.
  - Debt enforcement regimes range from out-of-court enforcement to lengthy judicial processes, producing large differences in speed and recovery rates.
  - Weak collective enforcement regimes and plurality of creditors in insolvency reduce expected recovery rates on underlying SME loans, negatively affecting securitization viability.
- Data and reporting fragmentation:
  - Heterogeneity of SME loan portfolios and national credit registries limit standardized, comparable financial data necessary to boost investor interest and enable cross-border SME securitization.
- Crisis-era collateral demand effect:
  - Transactions often structured primarily as collateral for central bank refinancing, with large retained mezzanine and junior tranches supporting a small senior tranche, limiting supply of transactions involving meaningful credit risk transfer and skewing away from SME loans.

### Policies to revitalize SME securitization
- Ensure greater regulatory differentiation for high-quality securitization (HQS):
  - Promote simple, transparent, and comparable securitization structures guided by clear principles to broaden the investor base.
  - Define HQS on principles of simplicity, transparency, and comparability with specific criteria for SME securitization.
- Proposed HQS key requirements:
  - Strict rules and enforcement on asset eligibility and quality, conservative loan origination standards, imposition of risk-retention rules (“skin in the game”), avoidance of “originate-to-distribute” business models, a strong funding relation to real economic activity, and requirement that the cash-flow generating reference portfolio is self-funded and homogeneous (only one type of asset).
  - Scope to include non-senior tranches of robust structures, supported by improved data and analytics.
  - Rigorous disclosure requirements at both asset and transaction levels, with standardized documentation and reporting at inception and post-issuance.
  - SME-specific eligibility criteria regarding diversification, cash flow, and track record to limit underlying risk.
- Regulatory treatment recommendations:
  - HQS transactions should receive more lenient regulatory treatment than non-HQS transactions to reflect lower risk and greater transparency.
  - Further reducing the capital charge on HQS for non-bank investors could encourage greater issuance while maintaining financial stability safeguards.
  - Greater differentiation in setting haircuts for eligible HQS for liquidity risk management purposes would increase banks’ appetite for a wider range of securitization structures of sufficient credit quality.
  - Revising investment restrictions for institutional investors (insurance companies, pension funds, and mutual funds) once supervision and the regulatory framework are strengthened, to prudently encourage alternative investments that benefit SME financing.

*Source: IMF staff summary of chapter 13, _sdn1507_*

### 21.      A well-designed HQS regime would enhance, rather than supplant, the relevance of

### _sdn1507 - 21.      A well-designed HQS regime would enhance, rather than supplant, the relevance of

### Role of HQS and prerequisites
- A well-designed HQS regime would enhance, rather than supplant, the relevance of granular risk assessment of securitization transactions for regulatory and prudential purposes.
- Comprehensive risk analysis and disclosure requirements at both the asset and transaction level should be a prerequisite for HQS certification.
- HQS should be a complement rather than a substitute for current regulatory standards, promoting greater transparency and comparability.
- Enhanced disclosure and assessment would facilitate risk assessment by investors and help enhance the marketability of securitization transactions by overcoming pitfalls (misaligned incentives, insufficient risk management, lack of due diligence).

### Proposed attributes of High-Quality Securitization (Box 4)
- The proposal offers a principles-based definition of high-quality securitization (HQS) as the regulatory foundation of a safer securitization market, and introduces criteria for SME loans as securitized assets.

- General Criteria
  1. Asset characteristics―underwriting process and asset eligibility:
     - (1) sound underwriting practices (that is, assets selected as part of ongoing balance sheet operations (with seasoned, senior, and fully disbursed loans only) and without impacting the risk management and control of the originator (“no originate-to-distribute”) and prohibition of self-certification;
     - (2) strong funding relation to real economic activity (that is, satisfies credit demand by nonfinancial corporations and households) and exclusion of re-securitization;
     - (3) the eligibility of assets (determined by materiality of assets to originator’s business, the homogeneity of cash flows (without ex ante exclusion of a particular asset type), the restricted use of derivatives/transferable financial instruments, the requirement of full funding and enforceability, the exclusion of encumbered and/or nonperforming assets, and the availability of a payment record of the borrower); and
     - (4) quality of assets and transaction (determined by an external assessment and criteria that ensure the marketability of the asset structure and minimize tranche retention above the regulatory minimum to enable credit risk transfer).
  2. Structural features:
     - (1) asset transfer (legal separation and bankruptcy remoteness, no severe claw-back provisions, obligor rights in compliance with applicable consumer protection legislation, legal validity of the transaction, and no transfer of risk that are unrelated to the risk profile of securitized assets);
     - (2) continuous servicing (via retained obligation by the issuer or pre-determined agent) and sufficient material net economic interest of originator/issuer in contractual performance (“skin in the game”);
     - (3) replacement of derivative counterparties/liquidity providers upon default or insolvency; and
     - (4) transparent and pre-determined payment process (self-liquidating asset portfolio without reliance on borrowings and asset sales, “pass through” payment structure of non-revolving and “early determination triggers” of revolving portfolios, and no circularity of support mechanisms due to contingent credit/liquidity arrangements with related parties).
  3. Comprehensive documentation and reporting requirements:
     - (1) scope of disclosure (regular reporting of asset quality and transaction performance in investor reports, initial disclosure consistent with the RTS for the CRA3 Regulation), and
     - (2) requirement of distributed tranches to be listed on a regulated exchange or admitted to trading on another organized venue.

- Additional Criteria for SME Securitization
  4. Definition of asset class:
     - (1) obligors meet the European Commission’s definition of SMEs;
     - (2) conform to the terms and conditions of European Investment Bank -intermediated lending; and
     - (3) type of SME lending defined as financing leases, credit lines/guarantees, promissory notes, debentures, concessionary loans, and other loans that serve a real investment purpose.
  5. Portfolio characteristics:
     - (1) sufficient diversification/granularity and no credit-specific differences to originator’s overall loan portfolio;
     - (2) limits on the aggregate outstanding balance of securitized assets without scheduled principal payments; and
     - (3) creditor track record of at least one annual reporting period.

### Regulatory treatment and capital charges
- Regulatory endorsement of HQS should not engender investor complacency.
- Capital charges for investment in HQS should require sufficient nuance beyond current use of rating categories and tranche thickness as quality criteria, reflecting all relevant structural features through a standardized classification of individual risk dimensions.
- Recognize different degrees of risk within HQS by standardized classifications at the level of:
  - duration risk,
  - prepayment risk,
  - asset correlation/concentration risk,
  - collateral fungibility, and
  - track record of credit performance.
- This encourages investor due diligence, enhances risk assessment based on compliance with granular risk dimensions, and mitigates risk of creating a fragmented market with significant pricing discontinuities.

### Implementation issues and operationalization
- European Commission’s intended draft legislation would define high-level principles for operationalization of HQS, to be specified in detail by Regulatory Technical Standards (RTS).
- RTS would include accountability and governance framework for designation of HQS and due diligence required by market participants and supervisors.
- The process could be modeled after the European Commission’s implementation of uniform risk retention requirements for securitization in 2011.

### Strengthening the infrastructure for SME securitization
- Harmonized reporting requirements and improved access to credit data would facilitate SME securitization by lowering transaction costs, facilitating credit risk assessment, and ensuring comparability of SME loan performance across Europe.
- Collect SME credit information based on the taxonomy of the Eurosystem’s collateral framework:
  - ECB’s loan-level data initiative established requirements for transparency and standardization as preconditions for acceptance of ABS as collateral for Eurosystem refinancing operations.
  - European Datawarehouse (EDW) collects detailed borrower and loan characteristics; scope could be expanded to include non-securitized loans for pricing and benchmarking.
  - Single Supervisory Mechanism (SSM) could adapt same reporting requirements for supervisory purposes.
- Make SME credit information available to investors:
  - SSM-generated standardized and continuous credit quality information should be paired with development and harmonization of credit registries and reliable financial reporting by SMEs.
  - Consider development of an EU-wide credit register building on ECB efforts toward gradual formation of a credit register for countries in the banking union; consider private-sector European credit bureau.
- Functional convergence of debt enforcement regimes across EU countries would facilitate collateral access and cross-border investment; full harmonization is politically difficult, but mutual recognition and cooperation (European Insolvency Regulation) and nonbinding recommendations for pre-insolvency regimes/out-of-court restructuring can help.
- A mutual issuance platform, national or euro area-wide, would allow SMEs to issue securitization transactions without bank intermediation and could be used for mini-bonds and other instruments; nonbank intermediated securitization and equity finance should be explored where impediments to asset securitization are high.
- Consider widening the range of eligible asset classes for covered bonds to include SME loans to encourage standardized origination and loan pricing processes.

### Providing targeted official-sector support
- Greater and more targeted official-sector support is needed to restart SME securitization markets: integrate EU initiatives, enhance catalytic role of institutions, introduce differentiation in collateral treatment within Eurosystem, and widen asset purchase program to foster disclosure, signal to investors, and boost issuance.
- Reconciling and integrating existing initiatives would exploit synergies and scale:
  - Example numbers: securitization option under the EU SME Loan Initiative could generate about €28–35 billion in new SME lending if all EU member countries participated with the maximum amount (€13.4 billion), compared to a market for SME loans currently around €1.4 trillion in outstanding loans.
  - With Spain’s participation of €0.8 billion, the expected impact would be only about €3.2 billion.
- European institutions could expand support by acting as guarantors or strategic investors in transactions with most tranches distributed to nonbank investors to achieve genuine diversification of credit risk:
  - Enhance capacity to provide official-sector guarantees (“wrappers”) to mezzanine tranches (based on the existing EIF Credit Enhancement Program) to reduce cost of subordination and provide capital relief.
  - Direct co-investment in senior tranches as strategic investor would boost ratings, provide incentives to decrease subordination, and make asset structures more efficient.
  - Public sector support should be risk-sensitive and time-bound to limit long-term distortionary effects.
- Eurosystem collateral framework considerations:
  - For any tranche to be eligible as collateral for refinancing with the Eurosystem, the entire underlying asset structure should satisfy all relevant HQS criteria, meet current loan level disclosure standards of the ECB, and satisfy extra requirements.
  - Aim to support development of transparent, standardized transactions with most tranches distributed, rather than transactions structured primarily to meet central bank funding eligibility with sizeable retained tranches.
  - All tranches above the lesser of the applicable minimum retention requirement and the most junior tranche would need assessment by two or more external credit assessment institutions (ECAIs) and comply with the following criteria:
    - Ensure marketability of entire asset structure: the most senior tranche must receive the highest possible external credit rating by at least two ECAIs; structural subordination supporting the senior tranche should receive an external credit assessment consistent with the minimum credit quality for collateral assets accepted by the Eurosystem.
    - Minimize tranche retention above regulatory minimum: any voluntary tranche retention in excess of the greater of the minimum retention requirement (required under the CRR) and the notional amount of the most junior tranche would need to be equal to or less than the notional amount transferred or sold to third-party investors, net of the senior tranche.
    - Require comprehensive disclosure at issuance and periodic performance reporting: standardized reporting on securitized and non-securitized assets—including non-performance—would facilitate price discovery, enhance consistency of risk control measures relative to credit claims as Eurosystem collateral, and enhance risk monitoring.

*International Monetary Fund — Revitalizing Securitization for Small and Medium-Sized Enterprises in Europe (excerpt)*

### 32.      Valuation haircuts should differ according to the scope of disclosure requirements.

### 32.      Valuation haircuts should differ according to the scope of disclosure requirements.

### Rationale and current shortcomings
- Securitization transactions carry greater market risk due to lower liquidity and thus should be subject to higher valuation haircuts for refinancing with the Eurosystem.
- Under the current “haircut schedule” (ECB 2013b), securitization transactions are generally assigned the lowest “haircut category,” which provides no detailed differentiation other than a broad ratings-based distinction between high investment grade (AAA to A–) or low investment grade (BBB+ to BBB–) determining the initial margin.
- The HQS threshold is currently set to the lowest investment grade rating of BBB– (or credit quality step [CQS] ranking of three (3) under the temporary collateral framework).
- Widening the scope of the HQS concept beyond the senior tranche to the quality of the securitization process would avoid potential overlap of credit risk assessment with existing regulatory capital standards at the tranche level.

### Use of loan-level data and EDW reporting
- Changes in the composition and asset quality of the reference portfolio underlying securitization transactions are reported to the EDW monthly; this information could be used for valuation purposes if the overcollateralization of posted transactions is deemed sufficient to reduce the daily valuation of collateral to a lower frequency.
- Expanding the mandate of the EDW to include data collection of non-securitized loans (for pricing) and credit claims used for repos with the Eurosystem could also be considered.
- Better information on credit risk parameters would warrant exploring options for (and greater flexibility in the calibration of) more differentiated valuation haircuts for collateral in Eurosystem refinancing operations.

### Policy proposals for haircut differentiation
- Valuation haircuts should differ according to the scope and quality of disclosure requirements; haircuts could be set in a manner that is consistent across asset types and funding instruments—for example securitization transactions, covered bonds, secured whole loan portfolio funding, and whole loan sales, among others.
- Better information could provide the basis for greater flexibility in setting valuation haircuts based on loss given default (LGDs) for non-securitized SME loans.
- Consider calibrating haircuts to:
  - Disclosure quality and frequency (e.g., loan-level reporting to the EDW).
  - Overcollateralization levels and portfolio composition changes.
  - LGD estimates and other loan-level credit risk parameters.

### Box (ECB Asset-Backed Securities Purchase Program) — key facts and implications
- The ECB introduced a private asset purchase program of securitization transactions and covered bonds in late 2014 with a policy focus on easing credit conditions for SMEs.
- The ECB started purchasing ABS on November 21, 2014, one month after implementation of CBPP3.
- Eligibility: eligible ABS would be purchased in both primary and secondary markets over a period of at least two years, subject to detailed eligibility criteria that exceed those set out in the General Documentation for refinancing operations with the Eurosystem, with some derogations for Greek/Cypriot issuers subject to additional requirements.
- As of the May 1, 2015, reference date some €5.8 billion of ABS had been purchased under ABSPP, after five months of purchases at an average weekly run-rate of €300 million.
- Assuming the ABSPP continues at the same pace, purchases would lead to an annual volume of about €13 billion (or about 0.6 percent of the ECB’s current balance sheet).
- After considering the stipulated limit on maximum purchases of 70 percent per transaction, the ECB eligible ABS “universe” is about €485 billion—compared to just €975 billion in covered bonds, which would fall to around €700 billion if smaller transactions (<€500 million) are excluded.

### Conclusions and recommended official-sector actions
- Further development of securitization could help mitigate structural constraints on credit supply to smaller firms in Europe by providing alternative funding sources for SMEs, enhancing resilience, supporting cross-border investment, and improving transmission of monetary policy.
- Official sector support would be required, at least initially, to promote securitization as a viable market-based source of long-term finance for SMEs. Elements of support could include:
  - Raising the capacity of European development institutions to support SME finance.
  - Amending the Eurosystem collateral framework (including differentiated valuation haircuts linked to disclosure scope and credit information).
  - Incorporating any changes to collateral eligibility in the current private asset purchase program.
- These measures should be combined with greater regulatory differentiation of HQS transactions and structural reforms to enhance the attractiveness of SME finance for non-bank investors.

*Source: _sdn1507 - 32.      Valuation haircuts should differ according to the scope of disclosure requirements.*

### 14. https://www.coveredbondlabel.com/pdf/Covered_Bond_Label_Convention_2015.pdf

### 14. https://www.coveredbondlabel.com/pdf/Covered_Bond_Label_Convention_2015.pdf

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- Lam, W. Raphael, and Jongsoon Shin. 2012. “What Role Can Financial Policies Play in Revitalizing SMEs in Japan?” IMF Working Paper 12/291, International Monetary Fund, Washington. https://www.imf.org/external/pubs/ft/wp/2012/wp12291.pdf.  
- Segoviano, Miguel, Bradley Jones, Peter Lindner, and Johannes Blankenheim. 2015. “Securitization: Lessons Learned and the Road Ahead.” Staff Discussion Note 15/01, International Monetary Fund, Washington. http://www.imf.org/external/pubs/ft/sdn/2015/sdn1501.pdf.  
- _______. “Securitization: Lessons Learned and the Road Ahead.” IMF Working Paper 13/255, International Monetary Fund, Washington.   http://www.imf.org/external/pubs/ft/wp/2013/wp13255.pdf.  
- Shin, Hyung Song. 2009. “Securitization and Financial Stability.” The Economic Journal 119 (536): 309–32.  
- Van den Heuvel, Skander J. 2007. “The Bank Capital Channel of Monetary Policy.” Unpublished, Department of Finance, The Wharton School, University of Pennsylvania.  
- Wehinger, Gert, and Iota Nassr. 2015. “SME Debt Financing Beyond Bank Lending: The Role of Securitization, Bonds and Private Placements.” Organisation for Economic Co-operation and Development, Paris.  
- World Bank. 2014. Doing Business Survey 2014—Understanding Regulations for Small and Medium-Size Enterprises. (Washington: World Bank Group).

*Source: Excerpted reference list from the PDF chapter "Revitalizing Securitization for Small and Medium-Sized Enterprises in Europe."*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2015/_sdn1507.pdf_