| Industry is at beginning of a new phase of development |
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By: Dermot Hardy, Dermot Hardy
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| The increasing importance of third party fund managers, hedge funds and standalone credit funds in the European securitisation market is impacting on the Irish industry writes Dermot Hardy, who believes that the traditional dominance of banks as investors is waning, which is leading to a new phase in the development of the industry in Ireland. |
This year is proving to be another challenging year for investors as credit spreads on securitised products remain at historically light levels. We are currently faced with the twin prospects of low returns at a time of increased volatility in the underlying markets. The newspapers have been full of talk of the problems associated with the US housing market and particularly with sub-prime borrowers. In Europe the focus has been on the Spanish housing market and UK non-conforming borrowers. The European market remains fundamentally sound and the structural protections embedded in securitisation transactions means that the bond ratings should be stable.
Given these market conditions investors are turning to more sophisticated strategies which involve additional leverage to increase the level of income. A lot of these strategies are built around synthetic structures which employ leverage based off indices and credit default swaps. Employing more sophisticated products involves more complex risk embodying not only credit risk but also correlation and model risk. The existence of experienced personnel with the relevant skills to analyse these risks has been one of the factors that has contributed to the growth of this sector in Ireland over the years.
Another development over the past twelve months has been the emergence of more fund activity or off-balance sheet activity by banks. Many funds are in fact quasi-banks lending in the international wholesale capital markets and funding through the commercial paper, repo or medium term note markets. I believe that we are at the beginning of a new phase in the development of the industry in Ireland. Traditionally the main ABS investors and issuers in Ireland, as well as the rest of Europe, have been banks but this trend is changing globally with the increasing importance of third party fund managers, hedge funds and standalone credit funds.
The European credit sector is experiencing an explosive growth in the number of new investment vehicles. Many are the subsidiaries of existing US funds or asset managers who want to establish a European base while others are entirely new entities. The growth of non-bank sponsored asset managers is a natural progression and is following the same path as in the US. In the securitisation world Europe tends to play catch-up with the US which has traditionally been the market leader and innovator. This is not always the case however, the development of the CPDO product last year was a European innovation spearheaded by a European bank.
These innovative vehicles are an increasingly important element of more mature markets. Dublin is still a relatively young market in terms of development and in order to reinforce itself as a securitisation hub we need to reinforce our position by encouraging more of these entities to locate in Dublin. For international banks establishing a securitisation centre in Europe, Dublin is one of the main centres. We need to ensure that Dublin is first on the list of preferred destinations for funds or investment vehicles being established in Europe.
In Ireland we are familiar with the idea of banks allocating capital based on expected default risk. The implementation of the Capital Requirements Directive (CRD) has introduced a more complex capital allocation process depending on the approach adopted by the financial institution. Banks are still assessing the impact of these changes. From an Irish perspective the whole process was greatly facilitated by the establishment of the CRD Securitisation Working Group under the joint auspices of he CRD Implementation Forum and the ISF, the aim of the process was to promote a greater understanding of the implications of the CRD and to identify and compile a list of issues for submission to the Financial Regulator. The benefit of this process was that there was an industry forum to ensure a consistent approach by industry to the CRD. Those issues where no common understanding could be found were submitted to the Financial Regulator for comment.
Funds which hold the same assets as banks do not allocate capital on the same basis, they use market risk or market value. This is a more dynamic form of measurement, these different regulatory platforms present challenges and indeed opportunities. Banks in Ireland are becoming more involved in the establishment and management of investment vehicles and funds as a way to leverage their risk weighted capital. These vehicles can provide capital efficient solutions for banks as they are not governed by the same capital rules.
At present there is considerable support from the public sector for non-residents who wish to establish funds and vehicles in Ireland. There is, I believe, a pressing need to support potential new ventures in this area which are sponsored by Irish based businesses through the provision of risk/seed capital, funding and other fiscal incentives. A major factor in Ireland's economic development has been our ability to grow our own indigenous enterprises - businesses that are grounded in value-added products and services. This proposal is in line with the policy of supporting new, innovative start-ups that are considered high potential start-ups.
As well as physical capital there is also a need to further enhance our intellectual capital. In an international survey carried out by the Centre for the Study of Financial Innovation in London, 'a pool of skilled labour is perceived as the most important attribute in determining the competitiveness of a financial centre'.
There is an urgent need to deepen the domestic pool of financial sector expertise to support the immediate development of the ABS sector and to ensure that there are sufficient qualified people to fuel the long-term development of the industry. Although initiatives such as the Securitisation Skillnet training programme have started to address some of the educational gaps in the sector, this programme is aimed at the entry level and we need to develop this further, particularly at a senior level where we need to address the development needs of senior executives working in the sector. The aim is to develop Dublin as a leading educational centre and one that fosters an environment that encourages innovation and research and development. This will further enhance our status as a leading internationally competitive financial centre and help us become a hub for financial knowledge, innovation and learning in the securitisation sector.
Over the past 12 months the industry has continued to prosper and grow, over the next twelve months there is a need to progress these issues. Both the ISF and the IFSC Clearing House Group provide platforms to progress these initiatives with the support of the public and private sectors and ensure that we maintain the joint approach which has ensured the success of the IFSC to date. |
Dermot Hardy is head of treasury at Aareal Bank AG, Dublin Branch. He is the chairman of the investor/issuer working group of the Irish Securitisation Forum and is a member of the banking and treasury working group of the IFSC Clearing House Group.
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