EU Effectively Forces Securitization Reforms on the US

Wow, the EU is increasingly taking steps to force foreign, meaning US and UK firms, to play by its rules or not have access to its investors. The first salvo occurred over private equity funds and hedge funds, where the EU will limit its investors to funds located in the EU, and is also limiting the ability of foreign funds to acquire firms in the EU.

The latest development is that the EU is implementing a rule called 122(a) which will have a significant impact on the private securitization market. EU investors will be penalized (via much higher capital requirements) if they invest in asset backed securities that they cannot understand. And of course, to understand them, the issuer has to make pretty complete disclosure (you can’t assess in a vacuum). That disclosure in turn happens to be higher than the norm pre crisis.

A second element is that Rule 122(a) will also require issuers to retain 5% of their new issues. From :

There is a five percent (5%) retention requirement for the issuer regardless of the type of underlying asset. Even as this article was being written, there is still debate between the regulators and the industry as to the form of the retention. For example, the retention could be a vertical or horizontal slice of the deal.

Much more important than the retention requirement is the disclosure requirement. Issuers are required under Paragraph 7 of Article 122a to “ensure that prospective investors have readily available access to all materially relevant data on the credit quality and performance of the individual underlying exposures, cash flows and collateral supporting a securitisation exposure as well as such information that is necessary to conduct comprehensive and well informed stress tests on the cash flows and collateral values supporting the underlying exposures.”

This appears similar to, but less comprehensive than an FDIC proposal earlier this year which was very much in keeping with what investors needed and therefore died on the vine. IRA contends implementation would not be difficult:

Issuers and the servicers involved in the daily billing and collecting of the underlying exposures are easily able to report all the data fields that they track in their data systems on an observable event basis. Issuers are in the best position to explain each structural element of a security and how they work together. In addition, the information technology exists to provide both the underlying exposure data and the structural features at very low cost. As a result, compliance is easy and several issuers are likely to comply to gain a competitive advantage over those issuers who do not comply and also to ensure ongoing access to the capital markets for funds.

The fact that the EU is muscling the US is a sign of both the US’s weakening authority and a lack of strategic vision. As strange as it may seem now, the reason the US has had the deepest capital markets wasn’t simply the size of our economy, but the perception that we had the most open and fairest regime for investors. The US markets are badly tarnished, yet the authorities continue to take their cues from the very same industry incumbents who created this mess.

The Japanese often would speak of “foreign pressure” as in using foreigners as an excuse to do things that the elite bureaucrats actually wanted to happen but found difficult politically. The worst is our top regulators still seem unable to believe that they can and must be much tougher with their charges.

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33 comments

  1. Lucio

    No more lame excuses from the anglosaxon financial ecosphere… these norms are right on the spot, on either economics and ethics. Brussels bureaucrats? Well, they’re the only ones who are thinking in terms of the soundness of the global economic system, and not in terms of some lobby.

  2. mp

    The EU started to do the same thing several years ago with aircraft maintenance and it’s already taking a lot of jobs away from FAA-licensed mechanics.

    As I’ve said before,…

    Aw, to hell with it. We’ll talk about it when we meet on the breadline.

  3. Francois T

    Hmmm! Think I’m gonna send this article to Clusterstock forums and say, Reason and TownHall.

    Imagine that! Oh my! “Socialist” Europe telling the Masters of the “real, free market” capitalistic Universe what to do.

    3…2…1…NeanderCons Heads Exploding!

  4. dcb

    Please please please when this is all said an done how I can manage to fund my portfolio and leave the entire us financial system behind. I want to buy my stuff out of europe, or other areas that at least try to have some protection for me. I don’t want to get involved with the corrupt treasury, sec, and feeral reserve anymore.

    you won’t say it, but the united states has become one big kleptocracy!!!. I want out

  5. LeeAnne

    The latest development is that the EU is implementing a rule called 122(a) which will have a significant impact on the private securitization market. EU investors will be penalized (via much higher capital requirements) if they invest in asset backed securities that they cannot understand. And of course, to understand them, the issuer has to make pretty complete disclosure (you can’t assess in a vacuum). That disclosure in turn happens to be higher than the norm pre crisis.

    Fascinating that US securities disclosure rules initiated following our great depression to protect investment consumers being revised to reform European investment banking couldn’t be included in our own US financial regulation reform 2010.

    1. sgt_doom

      Even more fascinating is that the EU is set against naked swaps, while our very own Wall Street-run Treasury Department is 100% supportive of naked swaps.

      Hmmmmm?????

  6. rd

    I think that there is a link between this article and the article in the Links on Rich People are Meaner.

    The last three years have made it crystal clear that our global financial class are generally sociopathic in that they only care about their dollars and cents scorecards for their company and house and don’t give a damn about anything else. The globalization of finance has meant that if their own society is collapsing, they just shift their money some place else and invest there without a backwards glance. The massive bonus payouts in 2009 and early 2010 provided us with the information that the US financial sector is incapable of policing itself and ensuring its own survival through any means other than buying the political class.

    It seems like the Europeans get this and are putting limits on bankers ability to do this by putting some limits on moving money into foreign exotic instruments without paying a financial penalty. I don’t know if this is the right move technically, but the thoughts behind it are absolutely necessary and the type of thing that the US should be thinking of doing.

  7. marc fleury

    As I read it, what this says is

    if you are a issuer selling to a EU buyer (this includes US sellers)

    1/ if the deal is opaque, then the buyer has higher capital requirements. Making the deal expensive and less attractive to the buyer.

    2/ the issuer retains 5% of the deal on its balance sheet. Making sure there is skin in the game.

    This is akin to a sarbanes oxley type “disclose your information and stand by it” requirement. No one should really bat an eyelash at this and indeed, in theory, issues should be of higher quality. Of course the question of who is going to audit all the IT information remains open and due diligence will subside when deal volume increases (minsky again).

    The 5% part is interesting from a strictly monetary standpoint as it means it may show up on balance sheets of issuers. If capital ratio are 10-1 then that means a 200-1 ratio of leverage (debt total CDO-capital). This is still a staggering leverage ratio when you consider the total economic system absorbing the debt.

    At the end of the day, it seems we cannot yet escape the monetarist approach. Banks print money and keep on printing it by distributing debt into the system via CDO. We are not limiting the amount of liquidity in the system and that amount is still a function of the banks, at least during the inflationary part of the minsky cycle.

    I like that they have somewhat recaptured the leverage ratio through making sure issuers retain a portion of the issue, but the resulting number (200-1) is still way too high as it seems we blow up at a ratio of 60…

  8. jdmckay

    Your article title would (IMO) be more accurately written as…

    EU enforcing sound financial common sense for investors

    … or something similar.

    Wow, the EU is increasingly taking steps to force foreign, meaning US and UK firms, to play by its rules or not have access to its investors.

    see above comment.

    your statements:

    The fact that the EU is muscling the US is a sign of both the US’s weakening authority and a lack of strategic vision.

    and…

    As strange as it may seem now, the reason the US has had the deepest capital markets wasn’t simply the size of our economy, but the perception that we had the most open and fairest regime for investors. The US markets are badly tarnished, yet the authorities continue to take their cues from the very same industry incumbents who created this mess.

    … seem incoherant to me, self contradicting.

    And as far as “lacking strategic vision” goes, well, I guess that depends on one’s view of the competing strategies:

    a) US: concieved, executed, and run by WS financial class demanding no accountability, which nearly bankrupted the world, and has in review told us: “Who could have known?”

    vs.

    b) requiring the bankers to at least attempt an honest disclosure of the stuff they sell.

    Personally, I think -b- is most certainly a strategy. And as far as that strategy being conceived from “vision”, for my money it’s on the right track… I’ll take it.

    I would also note that you & your fav. front pagers have greatly exaggerated the death of EU/Euro. As I see it (and I’ve been watching very closely for a good while now), despite EU’s flaws, their momentum and intention is moving to and solidifyinjg soundness… I see an intent towards integrity.

    Here (US), well, not so much.

    1. Yves Smith Post author

      In the US “has” the deepest and most liquid capital markets” part, I probably should have been clear as to how much inertia there is. The US unquestionably did have better disclosure and investor regs relative to any other capital markets through (to pick a crude date, the decay was gradual) 1995. And the decay was fastest in the “innovative” products which were un or lightly regulated, namely OTC derivatives and structured credit.

      For instance, a colleague recently had a conversation with a sovereign wealth fund and basically said, “The US is corrupt, Why do you invest here?” And the fund said, “Where are we going to put $100 billion?”

      So people are now using liquidity as their safety mechanism, rather than better disclosure and regs. But that does not work at all in illiquid products like hedge fund investments, PE investments, and a fair bit of structured credit paper. Plus we saw how well liquidity worked in the crisis. It vanished when you want to go to the exits.

  9. ella

    “As strange as it may seem now, the reason the US has had the deepest capital markets wasn’t simply the size of our economy, but the perception that we had the most open and fairest regime for investors.”

    This is not strange. Regulation, not free markets kept our markets safe from fraud and predation. It is really simple absent regulation, no one has any protection. That is the kind of protection that cannot be bought and that is rigged in favor of the few or the kind of protection that is not passed along to the market participants and the taxpayer. Those costs have been estimated to be in the trillions of dollars.

    Many are leaving the markets and with good reason. It is a zero sum loser’s game unless you can front run with HFT. Unfortunately, most of us do not have that capability. We cannot trust to the government to guarantee our debt so our profits are risk free, as demanded by Pimco along with the big banks.

    We cannot even depend on the government to pay our Social Security even though we have contributed 15% of our income during our working years. We can no longer afford our health insurance premiums without cutting expenditures elsewhere, in spite of all of the Administration promises. Health care costs are still rising along with deductibles.

    Fortunately, the EU is wising up and maybe just maybe their regulations with help us here in the USA.

  10. jake chase

    EU investors will be penalized (via much higher capital requirements) if they invest in asset backed securities that they cannot understand?

    Gosh, there goes the free market system. What’s next, penalizing executives and accountants for freehand fantasy? Penalizing regulators for reading Keynes? Penalizing directors for falling asleep during monthly luncheon presentations?

    Don’t you ever tire of parsing this idiotic extend and pretend ponzi finance?

  11. anonymous

    I nominate Yves, again, as regulator-in-chief. The most annoying thing about the current debacle is the fact that even I could make better decisions than the clowns in charge. Remember a certain general warning that the invasion of Iraq wasn’t going to be as simple or easy as Cheney and company were saying? Didn’t stop them spending several fortunes poorly and the continued year after year expense of waging two wars forever.

    Romer has been scapegoated for making a similar prediction. Again, the political operators determined that Romer’s package came at too high a political cost. Just chew on that little nugget. Folks making millions out of political office decide that protecting US jobs just isn’t worth the political cost to the ruling party.

    The result? The zombie corpse of George Bush has been pretty much resurrected and given a fresh coat of paint. Bush beats President They Call Me a Cur hands down in Ohio, when all Republicans should be giving Americans are fleas.

    Thoroughly enjoyed the Michael Moore piece. He’s right about the role unions played in the US economy and completely wrong about union and UAW greed. I know lots of UAW folks and the stories about workers parking vans full of beer and dope in company parking lots for use during breaks are true. Or used to be. The union turned a blind eye to rampant drug and alcohol abuse by workers throughout the eighties and nineties.

    I belong to a union and have to say that a number of unions give collective bargaining a bad name. Look for rampant protectionism under the new Republican administration. It’s going to be interesting watching Wall Street tempt the new Puritans of the Tea Party. Old GOP types will take the money without missing a step.

    Yves for regulator in chief!

  12. tyaresun

    If the EU is so great why didn’t they design better stress tests? Why did they fail to see and counteract the credit bubble?

    1. Yves Smith Post author

      This is halo effect thinking, that if a party or group is good on one axis, it must be good or bad on all. Organizations can be good on one and bad on another, just the way people can be pretty and stupid.

      Halo effect is a cognitive bias, see:

      The structured credit matter is less politicized than the bank stress tests. Those are to paper over issues not easily resolved, just as in the US.

  13. Jim the Skeptic

    President George W Bush’s administration called the regulatory dogs off of Microsoft, the Europeans continued to increase regulation of Microsoft.

    Now the Europeans are trying to regulate financial systems which our financial regulators say can not be effectively regulated.

    The Europeans don’t trust us and I don’t know why they should!

    But think of it this way, we win, the jobs in the riskiest securitization industries will migrate to the US. (They were threatening to migrate to Europe.) What a triumph!

    And when the next collapse comes, the Europeans will see the market for their exports dry up! By God, we will show them.

  14. Mikey

    No this is complete rubbish and a straw man. I’m always surprised with how people accept EU nonsense as its some sort of moral and ethical role model. Are you people insane?

    All the EU wants to do is reduce the hedgies in UK and US, in order to capture more of the business. This type of so-called “regulation” is just about jurisidiction control and money. The hedgies had nothing to do with the financial crisis, other than exposing some of those banks like Lehman which needed to be exposed. They did the jobs EU, US and UK regulators should have been doing all along.

    The EU stress tests were a total joke and everyone knows it. Wake up and smell the bullshit folks…

    Dissapointed in Yves, very poor one sided analysis of EU’s intent and motives.

    1. Yves Smith Post author

      Mikey,

      With all due respect, exactly what does this article have to do with the stress tests? See response to tryaesun above re halo effect thinking and related Wikipedia link ().

      And your comment is all wet re hedge funds and PE funds. The EU has very little in the way of a native hedge fund and PE fund business. It seems you are so deeply invested in a finance centric world view that you are unable to recognize that some societies don’t buy that model (indeed, it’s widely depicted abroad as “Anglo-Saxon”).

      And you are wrong re the politics. The big impetus for tougher rules on private equity funds was that they were kevering uo companies and too often, the result was bankruptcy and job loss. Funny that we think that sort of locust like behavior is acceptable in the US.

    2. sgt_doom

      You appear to be unaware, Mikey, of the legislation passed within Denmark and Germany over the past several years placing serious restrictions on the raiding of their companies and economies by private equity firm leveraged buyouts?

      Which is along the same lines as this post’s subject.

    3. Yves Smith Post author

      One point I should clarify (and I’ve been big time remiss in not clarifying) is that while the UK is in the EU, these reforms are being driven very much out of continental Europe. There have been repeated instances of EU officials basically saying they don’t give a damn about hedge fund jobs in London.

  15. Rick Halsen

    “The worst is our top regulators still seem unable to believe that they can and must be much tougher with their charges.”

    Hah. This is quite funny only for its singular stick in the eye obviousness. Our top regulators ARE the flaming charges.

    1. Yves Smith Post author

      Here I mean charges in the sense of “person or thing entrusted to the care of someone else.” The babysitter watched over her charges.

  16. Yves, nice post and just a few comments should suffice as a response to other posts as well.

    The CRD amendments that became 122a were passed in May 2009 and shepherded through by the former commissioner for Internal Markets and Services, Charlie McCreevy.

    The political brilliance of McCreevy’s vision is that the rules are written to safeguard the EU banking system so that structured finance never again requires massive taxpayer support to bail out the banking system. By focusing the penalties on the purchaser, who according to the Association for Financial Markets in Europe (AFME) welcome greater transparency, the EU regulation diminishes the lobbying power of the sell side to soften the regulation.

    The regulation now leaves three bodies in the U.S. with important questions as to how to proceed:

    1. The SEC has been in the process of a substantial rewrite of Reg AB. What should they do? Should they simply adopt 122a and have global coordination of regulation or do they go their own way and effectively require that U.S. issuers comply with two sets of regulations where a securitization is sold in both the U.S. and the EU (a fairly normal event).

    Will U.S. investors be treated differently by issuers and sellers in the U.S. versus those based in Europe? Will EU purchasers be accorded more protection than U.S. purchasers through access to better loan-level data? These are troubling questions for all participants.

    Essentially, the question is whether 122a has become the de facto global standard.

    2. The FDIC sought to reform securitization through its Safe Harbor provision. Now it must decide whether that Safe Harbor provision should embody 122a or move in a separate direction.

    The EU believes that if a purchaser has no usable information to perform due diligence on the underlying assets of a securitization, then higher capital requirements approaching 100% must be imposed to protect the system. The FDIC Safe Harbor provision is to serve a similar protective purpose.

    How the FDIC decides to respond should be interesting to watch.

    3. The Federal Reserve has been purchasing structured finance securities and taken them as collateral during this crisis. Will there be any effect of 122a on its operations or that of the ECB and BoE for that matter?

    The May 2009 amendments to the Capital Requirements Directive represent a watershed event in financial regulation. Journalists may be a little late to the subject, but nothing focuses attention like a looming deadline or effective date and January 1, 2011 is less than four months away.

    The entire Q&A in Whalen’s IRA should be read by anyone who wishes to be informed on this subject.

    1. Ginger Yellow

      Gary, do you not think the disclosure requirements in the new Reg AB (assuming they aren’t watered down in the final rulemaking) won’t satisfy 122a? Most lawyers I speak to think they will.

      Incidentally, Yves describes this as “muscling” the US and is a bit surprised by that. I don’t read it that way. For one, this was the handiest tool the EU had to regulate securitisation, so it’s almost coincidental that it affects US issuers. There was no framework for them to (comprehensively) regulate issuers directly, so they did it through the buy side instead (which I happen to think is a good idea, but it only covers bank investors at the moment). It’s a bit similar to how the SEC regulated securitisation issuers through the rating agencies with 17(g)5. As for the muscling issue, the US has done similar things – 17(g)5 for example theoretically applies even to foreign issuers who don’t want to sell to US investors. Or it did until the temporary waiver was granted. Similarly, in its Reg AB revisions the SEC made a rule change barring revolving securitisations of non-revolving assets (ie mortgage master trusts) from shelf issuance. The SEC rather pointedly said that this would only affect a handful of issuers, all from the UK. Well, yes, but they are by far the largest issuers in the UK, a substantial portion of the European securitisation market, and before the crisis the most frequent issuers into the US.

  17. Slartibartfas

    I am a bit confused. Maybe a look at a map could help as UK firms are not “foreign” at all, unlike US firms. Last time I checked the UK was part of the EU and its single market. While some anti EU guys may hate that, it is still a fact.

    1. John Reilly

      Thank you Slartibartfas. Someone else who knows that the UK is actually in the EU. It is not in the Euro Zone (like several other EU countries), but is in fact in the EU.

      It’s not clear to me reading the article what the scope of the new rule is and who will enforce it. Will it be enforced only in euro zone countries (via ECB?) or will it apply to all EU countries?

      1. John Reilly

        To answer my own question, I searched around a bit. First time round I missed the explanation in the linked article stating it is an amendment to the EU Capital Requirement Directive. states this is legally binding in all EU member states, not just eurozone.

  18. sgt_doom

    Hmmmm…..this may put a crimp in that Global Financial Virus managed by the top 5 banksters in American (controlling over 90% of those credit derivatives).

    My oh my!

  19. skippy

    Structured Financial Instrument’s a la Derivatives ewwwwww.

    What a unholy frankenstein melding of Calculus and Caligula like individualism…cough Randian dopamine hyper imbalance syndrome aka wheres today’s high! high!! high!!!

    *Theoretical* face values of the underlining, traded on markets before their expiration date as if they were assets is a sure fire recipe for achieving critical economic mass, using theoretical laws of motion / cosmos for fk sake, added and abetted by advances in computational power…cough computers (for all you climate model detractors{@least its based on observable / measurable empirical facts}, your real ire should be directed here[!] {models fudged to fit expediency…cough bonus babies).

    Yes they’ve been around since the 1700s but, at least friction still existed (PLC finite state logic), where today we have computer boosted numeric values approaching our view to the night sky’s (PLC infinite state logic). Today we have retail investors, dark pools (parlor tricks), all in a adversarial relationship with algorithms, flash, HFT, generating unforeseeable / reinforcing / looping, back sums and call it the largest most important part of our economy? The means by which we make our bread, lay our children down to bed, view our neighbors, plan for the future, look inside our very selves!

    Too what end, too whom, do we thank for this state of affairs, the financial Popes and their pontificate[?], hell Bernanke does resemble Pope Nicholas III..lol.

    This is a form of *Financial Simony*. Dante in The Inferno talks briefly to Pope Nicholas III, who was condemned to spend eternity in the Third Bolgia of the Eighth Circle of Hell, reserved for those who committed Simony, the ecclesiastical crime and personal sin of paying for offices or positions in the hierarchy of a church. In Dante’s story, the Simoniacs are placed head-first in holes, flames burning on the soles of their feet (Canto XIX). In these pits, Nicholas III was the chief sinner, which is demonstrated by the height of the flames on his feet. At first he mistakes Dante for Pope Boniface VIII. When the confusion is cleared up, Nicholas informs Dante that he foresees the damnation (for simony) of not only Boniface VIII but Pope Clement V, an even more corrupt pope, as well.

    Skippy…I wonder if Dante’s Hell has room for all these sinners…maybe their occupancy rate will preclude my checking in for past crimes…I can only hope to arrive only to see the blinking *NO VACCACY* sign.

    PS. regulate the hell out of these time bombs, unwind the agents of our demise, invest in people again and not hording of resources in the name of the select individual over the commons.

  20. ChrisPacific

    Definitely a shot across the bows of US capital markets.

    Cynic that I am, I doubt that it will prevent investors from buying things they don’t understand, but it will at least provide an unambiguous evidence trail if (and when) things go bad, which is a useful function in and of itself.

  21. Tim Ingham

    “The fact that the EU is muscling the US is a sign of both the US’s weakening authority and a lack of strategic vision” or, simply that the US is controlled by an oligarchy of bankers, whereas the EU is not.

    If the second is really true, why is that? Is the governance structure of the EU more resistant to private influence? Something to do with extremely short “term limits,” no election funding and kickbacks?

    The only flaw of democracy is the use of other people’s money to buy votes. Just maybe incorporating certain specifics of the EU management/placement structure/procedures would provide us some relief from that.

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