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Persuading Parliament

Significant risk transfer markets are going from strength to strength, supported by regulatory initiatives ranging from streamlining approvals to optimising structures for lower-risk assets.

But there seems to be much less support for — and even active threats against — the securitisation-as-vanilla-bank-funding market.

The first of these is (hopefully) a drafting error.

The proposed EU securitisation reform package outlined in June had many angles to examine, so the hard cap on the size of an STS-eligible senior tranche initially didn’t attract much attention.

But wind forward a few months and this worry is front of mind. Issuers and bankers dealing with the highest quality asset classes, which spit out triple-A tranches in the mid-90s, face having their structures sabotaged by the cap at a 90% advance rate.

You could put in an illiquid stub of triple-A-ish paper covering 90%-95%, but this would raise costs, reduce liquidity, and lack a natural buyer base.

The hard cap also runs counter to the whole thrust of the new package, which is supposed to point towards greater risk sensitivity. The sizing of the triple-A tranche is already very risk sensitive; it’s the key lever determining the economics of securitising any given asset class. So a hard and arbitrary cap is….hopefully a mistake?

But it’s now causing serious worries, as Richard explores in his report from the TSI Congress here.

And there’s more evidence that the authorities are cooling on the plain vanilla funding markets.

The Chair of the European Systemic Risk Board, Francesco Mazzaferro said to the European Parliament on Monday that the Commission’s proposals could be improved as “regulatory changes should not incentivise banks to remain in the securitisation market as investors, as this runs counter to the goal of transferring risk outside the banking sector and fostering a more diverse and dynamic market”.

Given that most of the investor base for the bank-issued triple-A STS type product is indeed other banks, that’s a pretty damning statement, and one which suggests he’s thinking about securitisation in fairly narrow terms.

If banks are buying each others’ triple-A tranches, he’s right that there’s no risk being transferred outside the banking sector. But that’s largely because there’s not much risk being transferred at all! That’s not the goal! You can tell because the bonds are rated triple-A.

This is securitisation as in, turning whole loans into securities. When a bank turns a whole loan pool into a securitisation and sells the triple-A to other banks (or holds it), the balance sheet gets more liquid. There are probably theoretical limits to how far you can push this, but the European market is a long way from these, and redistributing excess liquidity from big bank treasury desks to smaller bank funding programmes is a totally fine and good thing to do.

More to the point, it’s exactly what covered bonds do, and Mr Mazzaferro doesn’t seem to have the same problem on that score.

He also thinks that “all EU securitisation should be resilient”, to which, again, you have to ask why? It’s possible to build resilience through structure, that’s part of the point of the market, and that serves a useful function. There’s some ropey collateral out there, and securitisation technology makes it possible to efficiency fund it, and even allow funds to make a bit of money doing so.

In other industry-condemning news, he affirmed his opposition to unfunded STS SRTs, as Celeste explores here.

Clearly there’s a lot of lobbying still to do.

Making strides

The art of structuring is all about layering different sets of rules on top of each other, and navigating through them to achieve the desired economic outcome.

Even the most basic deal must achieve a true sale compatible with local securitisation law, securitisation accounting treatment but not derecognition, tax treatment which allows assets to be sold into the structure and bonds to be sold to investors without triggering withholding taxes. If it bakes in a derivative, this may need hedge accounting; the SPV must avoid balance sheet insolvency and comply with corporate governance rules/director’s duties, asset title must be capable of being perfected, liens must be validly registered and interests transferred. Any bonds issued must be dematerialised securities validly created and issued in the clearing systems, freely transferable and distributed according to market abuse and securities regulation.

That’s all securitisation 101 — most deals add a few more layers of rules on top. Structurers must navigate two or three different rating agency methodologies to achieve the most efficient capital structure possible, optimise for bank or insurer regulatory capital, achieve deconsolidation or risk transfer treatment, efficiently price any optionality in the deals and maybe more. Sometimes it’s quite impressive what Excess Spread readers do for a living.

But what if you took this process and layered on another set of rules, drafted some 1,400 years ago, possibly by an angel on Allah’s instruction? Would that make things a bit spicier?

Be that as it may, here we are in 2025, the UK government is actively promoting Islamic securitisation, and StrideUp is out with the first public Islamic RMBS since 2018’s Tolkien RMBS from Al Rayan Bank.

There have been private transactions in the intervening period, notably Offa’s BTL RMBS, placed in private last year, and a private Islamic facility provided to Gatehouse Group by ColCap and MUFG earlier this year, structured to facilitate future takeout.

The particular difficulty in Islamic deals is that they are rendered Islamic by structures that look a little like equity instead of debt; mortgages become Home Purchase Plans, with ‘borrower’ and ‘lender’ partnering up to buy property together.

That works for Islamic purposes, but makes it harder to handle these plans for debt-packaging purposes.

There’s a stamp duty issue to solve (selling homes traditionally incurs stamp duty). There are exemptions in the tax code to stop this applying to the sale of housing debt into an SPV, and a more robust exemption was added in the last Finance Act to explicitly smooth the path for Islamic finance (where it isn’t exactly housing debt, but kind of is).

We’re not tax experts, and it’s almost certainly fine (the government wants Islamic securitisation to happen, it’d be a weird thing for HMRC to start chasing) but investors are still advised (in the OC) to seek their own advice.

The deal also comes in certificate form, rather than your regular bonds — these are trust certificates giving a beneficial interest in the SPV and a beneficial entitlement to receive payments, rather than financial instruments with a contractual right to seek payments. This is very much one for the lawyers, we’re stumped here, but the point is, it’s a little out of the ordinary.

The structuring adventures continue across other aspects of the deal: there’s a “profit rate swap”, which functions like an ordinary interest rate swap but without “interest”, and with a murabaha structure (there’s an embedded commodities transaction to make it sharia-compliant). Even the account bank, normally a less exciting counterparty role in a structured finance deal, generates interest not through the traditional mechanisms but through a commodities-based murabaha structure).

The more important thing for most investors is likely to be the collateral and the leverage. If you can get past the legal/religious structuring, Islamic finance is a great niche to be in, high quality borrowers co-purchasers who are willing to pay lots of interest rent.

The pool here isn’t prime AF high street: there’s a lot of first time buyers, a little interest-only, a little BTL in the mix, and the deal structure is something like “specialist-lender flexible” — a big slug of pre-funding, lots of product switch flexibility, vertical risk retention. But if you examine the comp table, the interest rate shines out — 6.42% average, 80bps higher than the highest comp they have (Aldermore’s Oak No. 5) and more than 200bps north of some specialist owner-occupied transactions.

We the People

Speaking of historic documents with no mention of securitisation, do you know what the US constitution has to say on the matter?

“We the People of the United States, in order to form a more perfect Union, do hereby declare that loan pools can be securitized to Promote the general Welfare, and that no Skin in The Game shall be required.”

Not really, but the US is looking at binning risk retention, on the grounds that it is unconstitutional!

OK, it’s a couple of steps back from there; the argument is, according to the executive order granting authority, that various executive agencies and their regulatory powers are not properly constituted according to the constitution, and can therefore be rolled back. So there’s a broad effort underway to attack the “administrative state”, of which risk retention is but a small part.

The market has learned to live with risk retention in its current variant — it’s another structuring needle to thread — and investors do appreciate it on some level.

There’s widespread acknowledgement that a vertical retention (holding 5% of each class of notes, leaving open the possibility of selling the equity) is less debt-friendly than horizontal (holding 5% via junior exposures), though you’d be hard pushed to isolate any pricing effect in the statistics.

Horizontal retentions are far more common in pure bank funding deals, which are more debt-friendly because they have stronger sponsors who are more likely to call deals, whereas verticals are more common in hedge fund deals or thinly capitalised and highly levered specialist lender transactions — and there’s plenty of reason to distinguish between these categories on pure credit grounds, which muddies the waters.

Still, although the industry has grown used to it, there’s a decent argument that risk retention as it stands in Europe was implemented for confused reasons and doesn’t really achieve its stated purpose.

The basic idea which grew into risk retention was to protect securitisation markets by stopping banks from cherry-picking their bad assets to ship off to unsuspecting investors, essentially a fix for the “designed to fail” synthetic CDOs of ABS. If deal sponsors have to hold a piece of their deals, they have to make sure it’s going to perform.

That’s intellectually at odds with the idea that securitisation should be a useful tool of risk transfer. If the point of the market is to efficiently move risk out of the banking system, then banks may indeed want to select their bad assets to securitise! That’s a good thing (and the idea behind the state-backed GACS and HAPS programmes for NPLs).

The actual sweet spot is assets which are good but which also consume a lot of regulatory capital — but we’re talking general high-level principles here. Transferring risk means freedom to transfer risk, rather than to retain it.

Even in the minimal and possibly strange goal of “get the deal sponsor to retain deal risk”, it’s not clear the risk-retention rules succeed. A full-stack securitisation with a vertical risk retention held by a third party is perfectly legal, normal and market-standard, and doesn’t involve the deal sponsor committing to retain anything.

So the Founding Fathers were potentially right on this one. In practice, the EU and UK aren’t abolishing risk retention any time soon, so the practical effect of a US repeal is likely to be more market fragmentation, as EU investors won’t be able to look at non-RR US deals at all.

The CLO market has always been more transatlantic than other securitised products (you spell ‘CLO’ the same way wherever you are!) but it’s also been a non-risk retention market in the US for a long time, and there’s still a few US platforms which structure European-compliant deals, suggesting that there could be some voluntary compliance.

It also opens the door to the relatively efficient ‘random sample’ version of EU risk retention. That’s when a bank keeps a random sample of whole loans from the same portfolio and securitises the rest; all you need to do to get an efficient risk-retention structure for a securitisation of €100 is draw the portfolio perimeter so it covers €105.27.

This isn’t allowed under US risk retention rules, but if they go in the bin, that’s a win for European banks distributing their transactions into the US.

Why-FC

It’s IMF Meetings week, and Celeste is on the ground digging into development bank risk transfer, global regulation and more.

The IMF jamboree was also an excuse for a round of promotion of the International Finance Corporation’s new emerging markets CLO, IFC Emerging Markets Securitization 2025-1. It’s not a brand-new concept (the first deal of this kind emerged more than 30 years ago!) but it is the first in potentially a new wave of capital optimization transactions across public development bank institutions.

The Trump administration isn’t pulling out from the IMF and the World Bank, but a speech from treasury secretary Scott Bessent on Wednesday made clear that it wants to see a lot of Trump-aligned change from the IMF.

That means no climate and gender work, funding for nuclear power, no support for China (and ideally some research slapping China on the wrists), more burden sharing (recalitrant creditors are apparently being treated too kindly), less spending on staff, a tougher line on supporting state-owned enterprises — and a new quota formula. You get the idea.

But Trump or no Trump, there’s definitely a need to do more with less in the MDBs.

Enter the new CLO! It’s an unusual structure from the point of view of traditional capital optimisation — Richard has all the details in a good piece here.

A minority equity position was sold to Mobilist, a UK government programme (the acronym stands for Mobilising Institutional Capital Through Listed Product Structures).

The UK government is already a large IFC shareholder, so there’s a bit of left pocket-right pocket going on.

The mezzanine tranche is where the heavy lifting of risk transfer appears to be taking place, and it wasn’t sold at all, instead being insured by a consortium of four credit insurers.

Placing the senior is the strangest decision. It’s a great deal for the bondholders. Quite apart from the structural support built into the deal, it’s hard to imagine a flagship transaction like this being allowed to fail.

Arguably, therefore, you’re getting IFC risk, usually bought at a single digit Treasury spread, at SOFR+130bps (wide of US BSL CLO new issue).

It’s less obvious why IFC would want to place such a deal. It doesn’t need the funding! Distributing risk out of the supras seems worthwhile, and it’s encouraging that the credit insurers have rallied around it. But is a cash structure with a distributed senior tranche really the right instrument?

Welcome to Miami

I’m packing up my linen clothing for my first trip to FT Live’s ABS East — give me a shout if you’re in town next week. I’ve never been to Miami but I gather it’s full of tanned gym bros flexing on the beach. Looking forward to fitting right in!

Excess Spread is our weekly newsletter, covering trends, deals and more in structured credit and ABS — subscribe to this newsletter here.