Skip to main content
MENU
Subscribe
  • Subscribe
  • Account
  • LOGIN
  • Topics
    • Alternatives
    • Consultants
    • Coronavirus
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Opinion
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Russia-Ukraine War
    • SECURE Act 2.0
    • Special Reports
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • Climate Change: The Inescapable Opportunity
    • Impact Investing
    • 2022 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2022 Defined Contribution East Conference
    • 2022 DC Investment Lineup Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Performance Data
    • P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
    • Future of Investments Research Series
    • Charts & Infographics
    • Polls
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2022 Retirement Income Conference
    • 2022 Managing Pension Risk & Liabilities
    • 2022 WorldPensionSummit
Breadcrumb
  1. Home
  2. INDUSTRY VOICES
May 28, 2018 01:00 AM

Commentary: Regulatory reprieve for European ABS investors

Edward Panek
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print

    We have long held the view that since the global financial crisis, the regulatory environment in Europe has been overly penal to asset-backed securities relative to other fixed-income asset classes. This has impeded the re-establishment of the European ABS market, thereby limiting funding to the real economy and reducing investment opportunities for institutional investors.

    The latest in a number of steps to address this asymmetric regulatory treatment of ABS was announced April 17, with the proposed revision of the capital charge requirements for insurance companies investing in ABS, as set out in the Solvency II regulations. This, coupled with the new securitization regulations approved last autumn and effective Jan. 1, 2019, detailing the requirements for compliance with the "simple, transparent, and standardized" securitizations, will make European secularizations more attractive to European insurance company investors.

    A few more details

    The Solvency II regulations now in place for European insurers divides the ABS universe into Type 1 (senior-most tranches of high-quality assets such as prime residential mortgages or auto loans) and Type 2 (everything else). The capital charges related to these two types of ABS range from penal (for Type 1 ABS) to very penal (for Type 2) compared to other fixed-income asset classes, the underlying securitized exposures and capital requirements for bank investors.

    For example, under current Solvency II regulations, the capital charge on a five-year weighted average life AAA-rated, U.K. prime residential mortgage?backed security with 10% to 12% of credit enhancement, which classifies as a Type 1 ABS, is 10.5%. This is broadly comparable with a BBB-rated corporate bond or covered bond with the same duration, both of which have a capital charge of 12.5%.

    Similarly, a AAA-rated European collateralized loan obligation with 40% credit enhancement or a AAA-rated U.K. non-conforming RMBS with 18% to 20% credit enhancement, which classify as Type 2 ABS, attract a capital charge of 62.5%, which is greater than either a corporate bond or covered bond rated single B or lower (37.5%).

    The new proposed regulations will replace the Type 1 designation with "senior simple, transparent, and standardized securitizations, and non-senior STS," and the Type 2 designation with "non-STS," as well as significantly reducing capital requirements for senior and non-senior STS, as shown in Figure 1.

    By incorporating certain Solvency II requirements related to the structure and quality of ABS into the new regulations, the burden of proof for those provisions and compliance with risk retention requirements shifts from investors to issuers (although prudent investors will still want to complete appropriate due diligence to assure they are comfortable such provisions are being met). We believe this will likely increase the number of issuers meeting all Solvency II requirements, as they will now apply to all investors, via the securitization regulations, rather than just insurance companies.

    Hoping for more

    The new proposed Solvency II regulations, along with the securitization regulations and a related update on bank capital charges are important steps in the post-crisis redevelopment of the European securitization market. However, it does not go as far as, perhaps unrealistically, some market participants had hoped.

    While the new capital regulations certainly make STS securitizations more attractive to insurance company investors, the breadth of their impact is open to debate. The new capital charges for STS transactions are more in line with other fixed-income instruments, but remain marginally penal and non-STS transactions are still significantly disadvantaged.

    For example, when applying the new proposed capital charges, the U.K. RMBS would attract a capital charge of 5% if it qualifies as an STS transaction. This is less than half of the current capital charge (10.5%) and much closer to AAA-rated corporate bonds or covered bonds at 4.5% and 3.5%, respectively.

    Capital charges for non-STS transactions, under the proposed regulations, will be calculated in the same way as they currently are under Solvency II. As such, the capital charge for the AAA European CLO and U.K. non-conforming RMBS, which will be classified as a non?STS ABS going forward, will remain at 62.5%.

    Although, ABS investment now appears relatively more attractive to insurance companies, the absolute return on capital remains in the low- to mid-single digits for insurance companies using the Standard Formula, which calculates capital charges based primarily on the rating, duration, perceived liquidity and seniority in the capital structure of an investment, and is substantially lower than the return on capital banks can earn from ABS investment (see Figure 2).

    Figure 2Absolute returns on capital still fairly low for insurance companies

    Insurance company investors
    PROPOSED SIICURRENT SII
    RatingWAL (years)Spread (bp)STSSII TypeCapitalReturn

    on

    capital

    CapitalReturn on capital
    UK Prime ABSAAA541Y15%8%11%4%
    BBB5153Y240%4%99%2%
    CLOAAA777N288%1%88%1%
    BBB10250N2100%3%100%3%
    Source: JP Morgan, EC, Janus Henderson Investors, as at April 2018.
    Note: STS compliance and Solvency II Type are assumed.   

    Summary

    Although a step in the right direction to the full normalization of the European ABS market post-crisis, the combination of new regulations still leave ABS disadvantaged compared to other asset classes. The new Solvency II regulations will make STS securitizations more attractive to insurance company investors, particularly for non-senior STS tranches (now classified as Type 2), but non-STS transactions will continue to attract significantly penal capital charges. This will contribute to liquidity and pricing differentials between STS and non-STS deals once the new regulations go into effect in January 2019, and is an area of the market we will be watching closely in the coming months and years.

    Edward Panek is head of asset-backed securities investment at Janus Henderson Investors in London. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.

    Related Articles
    Regulatory reforms have had limited impact on markets, SEC finds
    Swaps rule change allows banks to do more swaps activity, GAO report says
    Another MiFID II impact: Best execution of derivatives
    Recommended for You
    Cara Lafond
    Commentary: Allocating to hybrid strategies is a multiple-choice decision
    Paul Rissman
    Commentary: Texas pension participants deserve better than political interference
    Andy Kiehl
    Commentary: The 800-basis-point gorilla in the room
    ESG: Sustainability - Gaining Momentum
    Sponsored Content: ESG: Sustainability - Gaining Momentum

    Reader Poll

    June 6, 2022
    SEE MORE POLLS >
    Sponsored
    White Papers
    Nearing the finish line: Ideas on end-state investing for corporate DB plans
    The Meaning of "Portfolio Intelligence"
    Credit Indices: Closing the Fixed Income Evolutionary Gap
    Forever in Style: Benchmarking with the Morningstar® Broad Style Indexes℠
    Crossroads: Politics, Inflation, & Bonds
    Is there a mid-cap gap in your DC plan?
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    June 20, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2022. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Coronavirus
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Opinion
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Russia-Ukraine War
      • SECURE Act 2.0
      • Special Reports
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • Climate Change: The Inescapable Opportunity
      • Impact Investing
      • 2022 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2022 Defined Contribution East Conference
      • 2022 DC Investment Lineup Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Performance Data
      • P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
      • Future of Investments Research Series
      • Charts & Infographics
      • Polls
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2022 Retirement Income Conference
      • 2022 Managing Pension Risk & Liabilities
      • 2022 WorldPensionSummit