This study aims to examine changes to securitisation regulations in the United States(US) and the European Union (EU) since the global financial crisis and draw implications of the findings for better securitisation regulatory framework in Korea.
Inadequate regulation of securitisation has been cited as one of the factors amplifying the global financing crisis. More specifically, the relevant disclosure regimes were not enough to capture ABS risks, and no regulatory tools were available to address conflicts of interest in ABS transactions, and no regulation was in place to curb excessive securitisation. On top of that, investors relied overly on credit rating agencies as a source of information regarding ABS because ABS information was often limitedly available.
Following the global financial crisis, the US and the EU have revamped their regulatory frameworks for ABS transactions. When looking at regulatory developments relating to ABS disclosure, the US revised Regulation AB in 2014, thereby tightening asset-level disclosure and introducing new requirements for certain asset classes to disclose standardized asset-level information in order to help investors better understand the characteristics of underlying assets. In addition, the revisions include expanded disclosures about underlying assets and transaction parties, and several changes to the content of disclosures so as to enable investors to conduct their own analysis of underlying assets and securitisation structures without reliance on credit ratings. Meantime, the EU strengthened the disclosure of information on ABS transaction parties to ensure that investors have a sufficient understanding of transaction structures and characteristics, and adopted specific reporting requirements for underlying assets. Notably, the EU introduced disclosure templates per asset class to provide investors with more detailed information about the assets underlying ABS by asset type, and imposed requirements on issuers, originators and sponsors to publish jointly information on the underlying assets and the structure of the securitisation transaction sufficient to conduct stress tests, if needed, to assess the creditworthiness of the underlying assets.
The major difference in the changes to ABS disclosure between the US and the EU is that the US adopted more detailed disclosure requirements only for the retail finance sector whereas the EU adopted disclosure templates for diverse asset classes, especially applying disclosure requirements to ABCP. Another difference can be found in shelf-registration. The US put shelf-offering process for ABS and shelf-registration forms for ABS issuers in place but the EU has no relevant requirements. This is attributable primarily to differences between the US and European ABS markets in terms of market size and structure, and different regulatory frameworks in the two regions.
The US and the EU introduced new regulation that requires originators to retain at least 5% of the credit risk of the underlying assets in order to address conflicts of interest in ABS transactions. The US and EU risk retention rules are slightly different. The US allows originators to use various risk retention methods, and impose more lax risk retention requirements on or provide exemptions from the requirements for any ABS backed by qualified assets, such as residential mortgages, commercial real estate loans, commercial loans, and auto loans that meet certain criteria, and mortgages acquired by government agencies issuing MBS. The EU has more stringent regulation that allows investments in ABS only if originators have explicitly disclosed that it will retain at least 5% of the securitised exposure.
The existing Basel II risk-weighted assets computation for securitisation exposures shows mechanistic reliance on credit ratings given by external credit rating agencies, and assigns relatively low risk weights to high-rated securitisation exposures and relatively high risk weights to low-rated securitisation exposures. Furthermore, the existing calculation may lead to so-called cliff-effects that refers to substantial increases in capital requirements resulting from deterioration in the credit quality of the underlying assets. To solve this problem, Basel III requires banks to conduct their own internal assessments if the securitisation exposures have an external credit ratings, eliminating certain cliff-effects associated with credit risk mitigation activities, and introducing higher capital requirements for complex securitisation transactions.
The tightening of ABS regulation had large impacts on the ABS markets. The stronger regulation and weaker investor confidence in ABS resulted in a significant market contraction. ABS issuance volumes in the US and the EU dropped by about half immediately after the global financial crisis. Since 2015, however, the US ABS market has recovered gradually whereas the European ABS market has remained sluggish.
One reason for the stuttering EU ABS market is an increase in issuance costs resulting from more stringent regulation. Discussions have been underway in Europe on how to revive the ABS market. Part of the efforts are the adoption of a single, uniform regulatory framework for all securitisations in the EU, and the introduction of a differentiated regulatory regime for simple, transparent and standardized(STS) securitisations. The EU defined the basic concept of STS securitisation, and introduced implementation mechanism based on the definition of STS securitisation. In the meantime, the Basel Committee on Banking Supervision made revisions to its securitisation framework to reduce risk weights for STS securitisations in the belief that because STS securitisation is a low-risk transaction in a relatively simple structure, a lower risk weight can be applied to a STS securitisation transaction than a complex securitisation transaction. STS securitisation has been introduced only recently and its concrete implementation plan has yet to be finalized, which make it somewhat difficult to assess its effects. Nevertheless, in the long term, STS securitisations is expected to help reduce regulatory costs and enhance incentives for investors to make investments in securitisation products.
Korea’s ABS market is different from the US or EU market in terms of the way the market was created. The US or EU ABS market sprang up and developed on the back of existing securities-related laws. Conversely, the Korean ABS market was created by the government. The enactment of the Asset-Backed Securitization Act(ABS Act) laid a legal and institutional foundation for the ABS market along with relatively stringent regulatory framework in place. The Korean market is also a far cry from the US or EU market in terms of market structure. Various securitisation structures and relatively complex structures can be seen in the US and European ABS markets. Moreover, a high proportion of securitisation transactions in these markets seek to obtain risk transfer. On the other hand, fund-raising is the primary purpose of securitisation in Korea.
Such differences should be reflected in drawing out implications of the changes to securitisation regulations in the major countries. Most importantly, revisions to the ABS Act are required to promote sound development of the ABS market in Korea. The ABS Act should be amended not only to enhance the soundness of the market but also to increase regulatory flexibility, thereby enabling the adoption of various securitisation structures. In addition, Korea needs to push for better ABS disclosure regime after looking into the improved ABS disclosure regimes in other countries. Among other things, stronger ABCP disclosure is needed. From a short-term perspective, it is worth considering the introduction of an integrated data system that provides ABCP issuance information along with rating summaries from credit rating agencies. From a long-term perspective, it should consider the adoption of a comprehensive disclosure regime for securitized products including both ABS and ABCP.
Furthermore, it is necessary to improve the domestic ABS disclosure regime in response to global regulatory changes and to consider the adoption of a regulatory framework to tackle conflicts of interests of originators. It should be noted, however, that the adoption of regulation on conflicts of interest has to be preceded by assessment of ABS characteristics and review of potential conflicts of interest. If the analysis results support the adoption of a requirement to have originators hold the subordinated tranches of a securitisation, a phased introduction of the risk retention requirement is worth considering together with measures to minimize its negative effects.