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A Tax on Securitization

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A Tax on Securitization BASEL II respect to losers as regulatory capital burdens increase. Basel II losers include lower-rated A tax on bank, corporate and ABS exposures, OECD sovereign exposures rated below AA- (although banks might hold them for liquidity purposes anyway), non-bank equities, and non-core, high operating cost securitization activities such as asset management. Among its many effects on banks’ regulatory capital, Basel II Portfolio rebalancing might prove to be an additional capital tax on securitization Depending on the extent to which lending margins change to align themselves with rom January 1 2010, Basel II will be in standardized banks, capital requirements will revised regulatory capital burdens, Basel II full effect. The new rules are scheduled vary from a 20% risk weight for the most might also prompt banks to rebalance their to come into effect for all EU banks creditworthy exposures (that is, €1.60 of portfolios by shedding losers and keeping on January 1 2007. One year later, capital for each €100 of exposure) to a 150% winners. Fadditional rules for advanced banks will come risk weight for the least creditworthy Banks might be more willing to retain into effect, with a two-year transition period. exposures (€12 of capital for each €100 of high-quality corporate exposures on their These rules will make highly-rated asset classes exposure). Securitization exposures held by balance sheets because their capital costs more popular, could lead to the restructuring of standardized banks will vary from a 20% risk would be lower than the cost of securitizing many conduits and will act as an additional weight for the most creditworthy exposures to them while retaining the capital-heavy lower capital tax on securitization. a 1,250% risk weight for unrated positions tranches. Banks might also be less willing to Basel II will align bank regulatory capital and other positions such as unearned interest- extend credit to lower-quality borrowers. It is requirements with the risk of exposure, only strips (effectively €100 of capital for possible that the lending market for small to reducing the amount of regulatory arbitrage each €100 of exposure). medium-sized enterprises (SMEs) will be that occurred under Basel I through Compared with standardized banks, IRB tiered: standardized banks would extend transactions that did not change a bank’s risk banks will have lower capital requirements for credit on a relationship basis to SMEs while profile but reduced its capital requirements. the most creditworthy exposures but higher IRB banks would extend credit on a credit Basel II will, for the first time, permit banks requirements for the least creditworthy score basis. to calculate required capital on the basis of an exposures. The most creditworthy non- Lastly, Basel II could trigger divestitures of exposure’s rating. Advanced banks (those securitization exposures will require as little as regulatory capital-intensive businesses such as using their own, internal ratings-based (IRB) €0.15 of capital for each €100 of exposure, insurance and asset management. approach rather than the standard risk and the most creditworthy securitization weightings) will also be permitted to calculate exposures will require as little as €0.48 of Effects on securitization capital based on internal determinations of capital for each €100 of exposure. At the As long as liquidity covers 100% of the assets risk for all exposures except securitization. other end of the spectrum, a risky exposure of an asset-backed commercial paper conduit, Securitization exposures will be subject to such as unlisted equities might require up to and the conduit holds assets rated AA- or separate rules. Banks taking the standardized €40 of capital for each €100 of exposure better, Basel II eliminates the regulatory capital approach will generally determine capital on depending on the model used, and an unrated benefits that an IRB bank sponsor obtains by the basis of ratings for most securitization junior securitization position to which operating such a conduit. If the conduit’s assets exposures. IRB banks can also determine neither the supervisory formula nor the are rated lower than AA-, a conduit might still capital using this ratings-based approach, but internal assessments approach applies will provide regulatory capital benefits depending they will also have access to a special formula require €100 of capital for each €100 of on the nature of the assets and how the conduit for securitization exposures known as the exposure. is structured. supervisory formula and an internal ratings For most conduits, the IRB bank sponsor capital calculation method known as the Winners and losers must hold at least 56 basis points of capital internal assessments approach. Basel II is expected to create classes of winners against its liquidity support for the conduit, In each case, under Basel II a bank will and losers. Some asset classes will gain and more capital for its programme-wide assign a risk weight to each of its exposures popularity with bank investors because the credit enhancement support. One conduit and must hold 8% capital against all of its new rules impose lighter capital burdens than sponsor can achieve a capital charge of 48 risk-weighted assets. In the case of off- Basel I, and some asset classes will lose favour basis points as a result of the EU’s proposed balance-sheet exposures (including all because they are subject to heavier capital 6% risk weight for super-senior positions commitments), the bank must assign a credit burdens. ranking senior to a AAA-rated tranche, but conversion factor (CCF) to the exposure. The Spread tightening is expected to occur with other conduits do not qualify for this CCF converts an unfunded commitment into respect to winners as regulatory capital preferential treatment. a funded exposure for regulatory capital burdens fall. Basel II winners will include However, depending upon the credit calculation. For example, a CCF of 100% securitization exposures rated BBB and means that the bank must hold regulatory higher, corporate exposures rated BBB or capital against the unfunded commitment as higher, and non-OECD sovereign exposures if it were fully funded. rated higher than BB+. For non-securitization positions held by Spread widening is expected to occur with “Such a broad attack on asset substitution would throw many active securitization markets into disarray” 18 IFLR/December 2006 www.iflr.com BASEL II in jurisdictions that have more favourable capital rules, while at the same time applying Unfortunately, there are now almost as to their regulators for changes to their own “ more burdensome rules. This assumption certainly depends on the many views of what significant means as magnitude of the differences in national rules. there are regulators It is also possible that, due to differences in ” capital rules, some banks might become market leaders in certain products. Given that a thorough understanding of the national quality of a conduit’s assets, an IRB bank available to IRB banks from January 1 2010. rules is required to know just how big the might even have lower capital charges (15 But these floors could create opportunities national differences are, this issue is one to basis points if the assets are corporate that will not exist after the transition period. watch. exposures held on balance sheet). The bank It is expected that Basel II capital will have the same 56 basis point capital requirements will be lower than the floor, Risk transfer charge anyway, if the conduit holds only the requiring banks to hold more capital than The Basel II rules require an originator to most creditworthy securitization exposures they need given their portfolios. As a result, it transfer significant risks to third parties before (such as ABS). So in some cases banks will might make sense for banks to invest in moving from the non-securitization rules to need more capital to securitize assets than to higher-yielding assets during the transition, as the securitization rules. During the Basel II hold them on balance sheet. the cost of incremental capital will be zero. negotiations, the meaning of the term Bank sponsors are expected to continue to significant risk transfer was not clear, except in operate conduits for reasons other than Late adoption Canada (where rules already contained such a regulatory capital arbitrage, but it also seems The industry has raised a number of requirement), whose regulators said that it was likely that there will be a series of conduit complaints about various aspects of the Basel II designed to enable them to ignore sham restructurings over the next few years, as well rules for a number of years, both with the Basel transactions in which no risk was transferred. as an exploration of structured investment Committee and with the EU and member state Most securitization transactions executed vehicles as the preferred mechanism for regulators during implementation. by originators for funding purposes transfer obtaining arbitrage profits. Restructurings With the deadline for implementation only only catastrophic risk (that is, unexpected will focus on reducing liquidity requirements, months away, a surprising number of losses that are highly remote). Most of these such as finding liquidity in the assets rather jurisdictions within the EU have not yet securitizations would satisfy the Canadian than a capital-heavy bank commitment, published their proposed capital rules. These analysis, however, because the catastrophic placing liquidity with non-banks, providing regulators have presumably been coordinating risk transferred is certainly not insignificant liquidity with instruments that attract lower with the banks they regulate, but distinctions and so not a sham. capital requirements (such as issuer extendible between national rules will be important (see Unfortunately, there are now almost as commercial paper, investor extendible below) and can only be evaluated once the many views of what significant means as there commercial paper, repos, or total return swaps rules are publicly available.
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