Reform proposals bring fresh hope of deeper ABS market

Blog posts about regulation rarely trouble our most-read charts, but on this occasion we think the payback on time invested looks more compelling.

The European Commission this week published its much anticipated (and recently leaked) official proposal for reform of securitisation regulation, which is intended to overhaul the European Union’s framework for asset-backed securities (ABS) issuers and investors.

Enhancing European capital markets and the transmission of lending to the real economy was one of the key pillars of Mario Draghi’s September 2024 report on European competitiveness, which among other things called for an easing of certain regulatory burdens on ABS if the region was to unlock economic growth to keep up with the US and China.

The broad context of this reform is to improve the existing regulatory framework which was put in place in the aftermath of the 2008 financial crisis. As the Commission highlighted in its proposal:  

“The experience with the [existing] framework indicates that it is too conservative and limits the potential use of securitisations in the EU. High operational costs and overly conservative capital requirements keep many issuers and investors out of the securitisation market.” 

To put the potential impact into context, Morgan Stanley suggests the European securitisation market could grow to €1.2 trillion over the next five years from €550 billion today. We are also optimistic on the positive momentum the reforms should create for the market, though we recognise that some hurdles exist in the text which serve to temper our expectations somewhat. Either way, this is a material and welcome development.

We will spare the finer details here (there will be more to follow in a longer format), but below we briefly outline the likely impact for market stakeholders.

For all investors, due diligence requirements will become more principles-based, removing elements of duplication and prescriptive rules and making them more proportionate to the risk of the investment (ABS remains the only investment market we are aware of where investors have detailed regulatory due diligence requirements). 

For banks, there are improvements to the capital treatment of securitisations, particularly for high credit quality securitisation instruments. Currently, bank treasuries invest less than 1% of their high-quality liquid assets (HQLA) bucket into securitisation, despite being able to own up to 15%. Here, Morgan Stanley estimates the proposed improvements could attract €800bn of demand from banks. A deeper market could also mean broader use of securitisation for optimising banks’ balance sheets, which could boost profitability. However, these proposals come with a vastly increased level of complexity in banks’ calculations of the capital charges, which somewhat contradicts the Commission’s stated aim of simplification.

For insurers, the Commission will be publishing draft amendments to the insurance prudential rulebook in the coming weeks. The details are not yet known, but a meaningful improvement in the capital treatment of securitisation could finally tempt European insurers to enter the market. Insurers in the US hold 17% of their investment portfolios in ABS, while the equivalent European number is virtually zero. Even increasing insurers’ exposures by 5% in Europe would create €400bn of new demand, according to Morgan Stanley.  

For issuers, reporting requirements will be less prescriptive although the specifics depend on the transaction type. This will likely lessen the burden on issuers, which could open more doors for new issuers to join the market although the exact quantum of the appeal is difficult to assess at this stage.

In terms of timing, the proposal will now be submitted to the European Parliament and European Council for consideration and adoption – this is never a quick process and is likely to take well over a year. There are further consultations ongoing, and we await more detail on the prudential rules for insurers. As a result, we expect this is 2027’s business.

In the UK, a second round of consultation on securitisation regulations is expected in the second half of 2025, which will be an opportunity for the UK regulator to address any divergence between the two regimes.

The need and motivations for the proposed changes are clear. Barriers to entry for ABS issuers and investors are currently too high. Assuming the hurdles are overcome, the hope is that banks and insurers will become large buyers of AAA rated high quality ABS, facilitating growth of the market and generating greater funding for the European economy.