Building a stage for the comeback

Credit markets and particularly structured credit products are undergoing major changes in 2008


 Issuance is predicted to fall to €272 bn in 2008 a 41 percent decline from 2007 according to the European Securitisation Forum’s (ESF) 2008 Forecast Report. Products that are expected to see the greatest differences in issuance in 2008 are residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) and collaterised debt obligations (CDO). Despite dire predictions the market is not expected to be routed completely, but the originate and distribute model which was at the heart of the growth in recent years is under severe scrutiny.

  • The list of factors affecting the issuance outlook is well known:
  • Global credit market uncertainty;
  • Evolving risk repricing;
  • A de-leveraging trend as illustrated by hedge funds unable to meet margin calls;
  • Softer mortgage markets in certain jurisdictions;
  • Squeeze on structured investment vehicles (SIVs) and their funding model based on assets with long maturity funded by liabilities in the short-term;
  • Flight to quality for asset backed commercial paper (ABCP)
  • Diminished liquidity (a wait-and-see attitude on whether the latest action by the US Federal Reserve’s $200bn liquidity boost coordinated with other central banks will work);
  • Heightened investor risk sensitivity.

At the moment Europe is not generally experiencing credit quality issues at the same level as in the US. However, investor risk perception has had a marked effect on the securitisation markets – at its most basic – less investors means less liquidity.

While lack of disclosure is not the cause of market turmoil, the opacity of some complex instruments, it is fair to say have contributed to it. The ESF, an affiliate of the Securities Industry and Financial Markets Association, has been working on transparency an important piece of the puzzle to reassemble the securitisation market through a number of practical initiatives which aim to boost investor confidence and to restore normal market conditions. An integral step is to ensure that investor faith is rebuilt so that when the market returns investment opportunities are selectively determined.

Accessibility of pre- and post-issuance information
The transparency action plan will improve information about securitisation and enhancing data accessibility for public term ABS deals.  Since September 2007 the ESF is working on a number of industry initiatives for the current structured products market environment. These include industry measures to improve functioning of market such as recommending transparency of ABCP Funded Vehicle Holdings; clarification of various definitions including subprime and non-conforming and disclosure as well as the standardisation in valuation methodologies. In addition, the ESF is putting greater emphasis on investor education of structured finance. The emphasis is focused on transaction surveillance, risk monitoring and valuations.

At the beginning of this year a few of the initiatives on transparency and disclosure were taken a step further with seven other industry associations and the European Commission. The commitment letter outlined three main initiatives with relevant work streams and a delivery deadline of end of June 2008. Different associations will be jointly responsible for particular areas of work. The ESF will work on two particular streams: the first project is an industry market data report and the second one deals with investor information initiatives which does not have a specific deadline. This is because the ramifications of the changes under consideration are far wider and imply changes in the current business practices with specific costs and benefits.

Beginning in June 2008 a report, which will be produced on a regular basis will aggregate existing data that is presently available from different sources into one consolidated report. The report will provide information on aggregate basis for the main asset classes for Europe and the US.

The goal is to include information on a wide variety of instruments, including ABCP, term ABS and CDOs. Information will include aggregate data on primary activity by type and location of investors as well as by region and asset class. The purpose of the report is provide the European Commission as well as other authorities with statistical information and a brief description of the market trends to be able to monitor the evolution of the markets.

Also the report is not static and over time market participants, regulators and the European Commission will identify other potential areas of coverage.

The ESF is also working on the accessibility and investors understanding of product structures.  Investors require upfront disclosure information on each public transaction structure and initial portfolio as well as ongoing data on the performance of the pool assets as well as other information such as rating changes. Generally this information is available but not openly accessible.

The industry is working to increase transparency to investors and interested parties in the securitisation market. There are a few hurdles which necessarily need to be overcome such as ensuring there is a legal and technical feasibility review to make sure that the proposed changes comply with the existing EU Directives such as the Prospectus Directive, the Transparency Directive and the Market Abuse Directive. The amendments under consideration will not affect existing transactions.

Standardised definitions
The ESF together with other associations are planning three questionnaires covering the main asset classes for securitisation: RMBS, CMBS and CDO. The purpose of the questionnaire is to come up with globally accepted definitions that can be used going forward in the offering documents and also in the context of the Capital Requirements Directive. Standardised definitions will also be key to have a better understanding of the statistical representations and the data included in the research reports.

While the task of creating global definitions is impossible due to the existing differences in the mortgage markets a related objective is to be able to better compare standards. A typical example is the relevance of the credit quality of the borrowers that is determined by country court judgements (CCJ) in the UK while the FICO scores in the US are predominant.

The securitisation industry is working hard to building back the confidence in its market and laying the foundations for the return of this important fixed income instrument.