home
login
contact
about
Finance Dublin
Finance Jobs
 
Friday, 29th March 2024
    Home             Archive             Publications             Our Services             Finance Jobs             Events             Surveys & Awards             
Basel II is having minimal effect so far on the securitisation market back

Despite all of the concern originally voiced in respect of the potential detrimental effect which Basel II would have on securitsation transactions, it appears that the securitisation market in Europe and in particular the CDO and CLO markets in Ireland have continued to develop in the first quarter of 2007, write Turlough Galvin and Mark O'Sullivan, adding that, as yet, Basel II does not seem to have dampened the enthusiasm for the creation of or the investment in highly structured products generally.
The much publicised overhaul of the International Capital System for Banks - International Convergence of Capital Measurement and Capital Standards: a revised framework (more commonly known as Basel II) and the impact which it will have on securitisation transactions is now becoming more apparent.

The intention of the new framework adopted under Basel II is to align how banks determine their regulatory capital requirements with the actual economic risk of exposure in respect of the relevant assets and it seeks to reduce the level of regulatory arbitrage prevalent under the first Basel capital accord (Basel I) adopted in 1988. As the Basel I accord did not specifically address securitisation of assets, this led to one of the more frequently criticised forms of regulatory arbitrage with banks divesting their books of higher quality assets (particularly residential mortgages through securitisations), while retaining the riskiest subordinated or first loss position to incentivise deals. In this manner, banks were often able to reduce their Basel I capital requirements while retaining the economic exposure inherent therein.

The impact which Basel II will have, and to an extent already has had, is best explained by the influence which banks have on the European asset backed securities market. The vast majority of European asset backed securities (ABS) issuers are either banks or entities established on the instructions of banks (i.e CP conduits and securitisation companies). Also, nearly two-thirds of the European investor base in ABS comprises banks (according to Kim Slawek of Fitch Ratings in an article entitled 'Asset Backed Securities', published on www.creditmag.com).

Primary effects of Basel II
The primary effects of Basel II on the securitisation market in Europe are likely to be seen in the composition of the portfolios maintained by banks and other investors, the general investment strategies adopted by investors and the tightening of credit spreads on highly rated securities.
One effect of Basel II which has already been witnessed is the marked reluctance of banks to take on junior tranches in securitisation transactions due to the punitive regulatory capital charges for holding such assets under the new regime. Some analysts have predicted that banks will continue to show an appetite for securities rated 'A' and above, due to the risk weighting benefits that the Basel II regime brings to that level of ratings, while more junior tranches may be marketed to asset managers and hedge funds. However, one effect of this shift in banks' investment policies is that as banks seek to offload more junior riskier assets, the secondary market may become less liquid due to the increase in the amount of such assets in the market which in turn could lead to a fundamental lack of liquidity and thus deter hedge funds from active investment in such securities.

It has already been suggested by some commentators (see ISR Nov 2006 'Facing the Basel II endgame', page 24) that as the effects of Basel II and its impending implementation have been known for some time now, the biggest influence of Basel II on investment strategies would have occurred up to two years ago and may already have been one of the primary causes of the tightening of spreads seen over the past two years.

Amongst the securitisation transactions originally said to be most at risk due to the Basel II reforms were collateralised debt obligation (CDO) transactions. However, 2006 and the earlier part of 2007 has not seen a noticeable drop off in CDO and CLO activity. One of the explanations proffered as to why CDO issuances have not been stunted is that funding, rather than regulatory capital advantages, has emerged as the primary motivation for CDOs and securitisations generally (see ISR March 2006 'A bang or a whimper', page 24). Following a period of dramatic spread tightening (as mentioned above), securitisation has emerged as a comparatively cheaper funding mechanism.

The proliferation in collateralised loan obligations (CLOs) over the past few years can probably be linked to banks seeking to offload certain loan portfolios from their books to improve their regulatory capital position in advance of Basel II. In addition due to tightening of spreads in respect of certain asset classes, some of the demand for CLO securities can also be explained by certain investors seeking greater yields from their investments. In any case, the number of CLO transactions being effected in Ireland does not appear to have slowed down for the first part of 2007.

Although it was expected that the change in regulatory treatment of low risk, high grade assets such as those typically securitised in residential mortgage backed securities (RMBS) would lead to a drop off in RMBS activity, early indications are that the predicted drop-off in trade volumes has not occurred. Again perhaps this trend can best be explained by a shift in motivation for such transactions towards low cost financing rather than regulatory capital advantages.
It is anticipated that there will be an increase in project finance debt being securitised, as a result of the implementation of capital management strategies by banks. Some commentators have already pointed to project finance deals being concluded in anticipation of future CDOs of bundles of project finance debt (e.g. Nick Bliss and Victoria Harud in 'Basel II: capital management strategies for project finance loans', IFLR, February 2007). This is seen as providing future flexibility in the form of an additional capital management tool for project financiers.

Conclusion
Despite all of the concern originally voiced in respect of the potential detrimental effect which Basel II would have on securitsation transactions, it appears that the securitisation market in Europe and in particular the CDO and CLO markets in Ireland have continued to develop in the first quarter of 2007. As yet, Basel II does not seem to have dampened the enthusiasm for the creation of or the investment in highly structured products generally.
Home | About Us | Privacy Statement | Contact
©2024 Fintel Publications Ltd. All rights reserved.