FACING EUROPE'S
FINANCING GAP
The time is now for a new era of securitization.
A version of this article first appeared in VIEWS the EUROFI Magazine on February 21, 2024. It is republished here with permission.
The European Union (EU) has ambitious goals in green development, new technologies (such as digital and distributed ledger/blockchain) and small and medium-sized enterprise growth. These goals require closing a funding gap estimated by some market sources to be as high as €700bn per annum for Europe’s planned green and digital transition alone.
Yet traditional bank lending does not have the capacity to satisfy that need. Securitization can play a much greater role in Europe’s future economic landscape.
The potential role of securitization
International Monetary Fund data show under one-third of economic financing in Europe derives from Capital Markets compared to banks, versus over two-thirds in the United States.1 In its Securitization Data Snapshot for 2022, the Association for Financial Markets in Europe (AFME) identified that total European securitization issuance was less than 10% of the size of U.S. securitization issuance, compared to 85% in 2008.2
Regulatory action and investor appetite in the United States have helped securitization flourish and provided financing beyond traditional consumer-facing asset classes to receivables arising from, among others, data centers, fiber optics, mobile phones and infrastructure, solar and wind farms.
A new European legislative cycle provides an opportunity to close this gap. As such, now is a critical moment to make securitization a reliable mechanism for capital diversification. Doing so could deliver benefits such as investment diversification, credit risk distribution, market resilience and balance sheet efficiency.
The structural challenges
Policy makers and market participants learned many lessons from the events of 2008. More discipline around underlying assets and structures and more robust risk controls have already come into play. There is also a deeper understanding of the operationally stabilizing effects provided throughout the investment lifecycle via the role of trustees, agents and other similar institutional providers.
Further strengthening securitizations' post-crisis credibility — and realizing its benefits — requires action from public entities and private market participants to achieve greater clarity and stability without limiting innovation.
Simple, transparent and standardized (STS) criteria are one such mechanism. STS disclosure rules have already improved investor perceptions and will continue to spur confidence among investors. However, issuing parties must carefully manage their minimum risk retention requirements. Documentation and data quality also need to be addressed to avoid undue operational stress on issuers and their service providers.
Another relative European success story in recent years, helped by regulation including STS, has been the increasing use of significant risk transfer (SRT) mechanisms by banks. As more banks and investors explore this approach, policymakers may wish to consider ways to streamline the current supervisory assessment process to manage increasing volumes, albeit without diluting standards.
The path forward
Forward momentum for securitization hinges on further work from public authorities and private stakeholders.
- Policy-making: Action on building a Capital Markets Union (CMU) is essential. The lack of an integrated market that explicitly supports securitization is a significant gap. Securitization and its regulatory framework should be high on the list of CMU priorities of the next European Commission.
- Issuance: Aside from disclosure templates, private market stakeholders should also consider whether more should be done to standardize rules, harmonize transaction documents and rationalize post-issuance reporting and compliance. Doing so may alleviate complexities and expedite the issuance process while lowering the operational barriers that create friction for issuers and investors. Participants across the securitization value chain should find agreement and put it into common practice.
- Investor access: Investors need smoother inroads into securitization. Institutional investors face stringent capital controls (e.g., Solvency II) that impact their participation. The critical question is how to recalibrate the capital framework without undue risk exposure. Expanding participation routes for individual investors (as envisaged by some regulators) may also help increase the size of Europe’s capital market. However, retail investment creates challenges in managing amendments or defaults; it may be difficult to balance the interests of individuals and sophisticated institutional players. Both investors and trustees will need greater clarity on how to make this work.
The power of shared commitment
The potential future benefits from new and bolder policy changes are significant. Rebuilding market confidence is essential for making securitization a larger element in Europe’s capital markets. Important public policy steps have already been taken. The role of trustees and agents in providing confidence and operational stability for investors should also be recognized and supported. A larger role for securitization can help drive sustainable growth and stability across the bloc.
