SPOTLIGHT KEY POINTS The liquidity crisis of summer 2007 reversed the growth trend that the European Spotlight securitisation market had enjoyed from the beginning of the decade. Why have Asset-Backed Commercial Paper (‘ABCP’) conduits played a key role in the growth of the securitisation market and in its recent crisis? What market trends for the near future can be advanced based on recent events? Is there a hope for recovery? Author Carlos Echave Securitisation: the end of the beginning SECURITISATION: FEATURES, This article takes a close look at the European securitisation market before and RATIONALE AND TYPES OF through the liquidity crisis. What is the future of this market in the light of recent TRANSACTIONS events? Although it is very difficult to make predictions, one thing is certain: the The term ‘securitisation’ normally same forces that caused the success of this product in the past will shape its future. refers to a broad array of structured finance transactions with different features, purposes and participants. diversification of portfolio by asset Spain, The Netherlands and Italy, were A paradigm securitisation structure (see class and structure, rather than simply by also significant contributors. In recent figure 1 overleaf) however, normally includes corporate issuer name, and normally higher years, however, an increasing number some basic features such as: (i) a portfolio of spreads as compared to non-ABS securities of countries were beginning to see some illiquid assets/debts transferred via true sale of comparable rating. issuance activity, including certain (bankruptcy remote) by its original holder For the financial market as a whole, nascent markets in Eastern Europe (originator) to a special purpose vehicle securitisation is beneficial insofar as it (Russia, Ukraine and Kazakhstan). (‘SPV’); (ii) the SPV finances the acquisition increases the capacity of the overall market by by issuance to the market of securities backed providing an alternative source of funding, in While issuance in the third quarter of by the portfolio (asset-backed securities particular necessary for amounts of funding 2006 amounted to €113.5bn, it declined to – ‘ABS’); (iii) the ABS are tranched into layers and tenors (in some cases up to or more than €89.5bn in the third quarter of 2007. It is of securities with different risk profiles and 20-25 years) exceeding the capacity of the well known that the US ‘subprime mortgage’ rating, so that junior tranches absorb losses banking system. crisis of last summer caused an ‘investor without interrupting the flows of payments to strike’ in the financial markets which led to a the senior tranches. MARKET PERFORMANCE: liquidity crisis and, ultimately, to this issuance Though not strictly securitisations, other GROWTH, DIVERSIFICATION AND slowdown in European term securitisation. structured products share some of their LIQUIDITY CRISIS As market turmoil continues, it seems now features. For instance, synthetic securitisations From the beginning of the decade and that these new credit market conditions hedge, rather than transfer, the credit risk until July 2007, European securitisation characterised by reduced investor risk using credit derivatives. In collateralised debt issuance had enjoyed spectacular growth tolerance, global repricing, increased volatility obligations (‘CDOs’) and repackagings, the and increasing diversification in asset and funding costs and lower liquidity are here portfolio is normally comprised of tradable classes and originators’ jurisdictions. to stay for some time. securities or debt instruments. ABCP According to data published by the What is the future of European conduits have certain distinctive features European Securitisation Forum, European securitisation under these market conditions? which are described below. securitisation annual issuance rose from Although it is not possible to ascertain how The objectives of the originators are the €78.2bn in 2000 to €474.5bn in 2006. precisely securitisation will evolve, as many main drivers of securitisation business. For In the second quarter of 2007, issuance uncertainties remain, some market trends may instance: reached €164.8bn, of which: be predicted with the appropriate caution. But It is a good economic capital management a majority, €102.8bn, consisted of we must first examine the role and importance tool, insofar as it improves Return on mortgage-related assets (residential of the key ABCP conduit sector to understand Equity (‘ROE’) by reducing the cost of and commercial mortgage-backed such trends, as it was the first to be hit by the capital. securities, ‘RMBS’ and ‘CMBS’), liquidity crisis. For regulated institutions such as banks but other asset classes such as CDOs or insurance companies, securitisation (€40.9bn), collateralised loan obligations ABCP CONDUITS AND STRUCTURED further allows for regulatory capital relief. (‘CLOs’) (€8.2bn), auto loans (€6bn) INVESTMENT VEHICLES (‘SIVS’) For originators with low ratings, and corporate receivables (€2.9bn) were Main features securitisation aims to improve their all-in beginning to take a significant share of ABCP conduits normally have the following cost of funds or the amount of funding the issuance volume; characteristics: that they can raise. excluding CDOs (€123.9bn), roughly They are SPVs often incorporated as half of issuance volume was originated limited liability companies with very little But it also provides benefits for in the UK alone (€62.1bn), whilst other capital base in tax-friendly jurisdictions. investors. In particular, they achieve credit Western European countries, notably These conduits issue ABCP in the money Butterworths Journal of International Banking and Financial Law March 2008 115 Spotlight SPOTLIGHT markets to invest in long-term, highly normally set up by their sponsoring banks conduits, leveraged ten to 15 times through rated receivables/loans and/or securities. to provide off-balance sheet funding to their the issuance of ABCP and Medium Term ABCP has short maturity (typically customers with lower capital costs. For Notes (‘MTNs’). SIVs are required to up to 270 days in the US and 365 days European banks, the introduction in the mark-to-market their assets and monitor in Europe), like ordinary commercial EU of International Accounting Standard their performance regularly to determine paper, but it is secured by the conduit’s (‘IAS’) 39 forced a number of sponsor banks compliance with specific tests in order to assets. to recognise their sponsored-conduits’ limit their exposure to the different risks Unlike term securitisation SPVs, their assets on balance sheet. On the other hand, that they face (investment risk, hedging risk liabilities are not tranched. All ABCP is regulatory capital costs of liquidity and and funding/liquidity risk). How a SIV’s pari passu, although subordinated credit credit enhancement providers in ABCP assets perform relative to its benchmark enhancement in the form of a letter of conduits are expected to increase as a result will determine its operating state, from the credit, a loan or a financial guarantee of the implementation of the 2004 Basel ‘normal’ operating state to ‘the below normal’ policy is normally provided to protect Accord (‘Basel II’). states (restricted investment, restricted investors and liquidity providers against Up until the second quarter of 2007, the funding and enforcement) which the SIV losses in defaulted assets. size of outstanding European ABCP had will fall into if its Net Asset Value (‘NAV’) Their key feature is the liquidity support grown to $281bn (source: Merrill Lynch) declines below certain thresholds. These provided by one or various highly rated issued by an increasing diversified conduit features are specially designed to preserve the banks designed to cover the maturity base which included: (i) single seller and ABCP and MTN holders’ interests, as losses mismatch between short-term assets multi-seller conduits; (ii) arbitrage conduits, will be absorbed first by capital note holders, and long-term liabilities. The liquidity which invested in rated securities and other and, crucially, have made it possible for support is normally sized to backstop marketable debt, rather than customer- SIVs to operate without 100 per cent bank 100 per cent of the conduit’s maturing generated receivables/loans; (iii) hybrid liquidity support. debt, excluding defaulted assets, so as to conduits, which invested in a combination allow the conduit to continue purchasing of receivables/loans and securities; and (iv) The importance of ABCP conduits assets and repaying the maturing ABCP repo/TRS conduits, which funded their for securitisation. in a scenario of liquidity shortage within assets through repo and total return swaps. Future prospects the structure. In recent years, up to 25 SIVs and ABCP conduits and SIVs have been integral three SIV-lites, a subset of ABCP issuers, to the growth in securitisation insofar ABCP normally gains the highest had emerged in the liquidity-rich credit as they have reinvested in securitisation short-term ratings thanks to a combination markets. SIVs have a capital model which bonds the proceeds raised in money of liquidity support, credit enhancement allows them more flexibility than conduits markets which money market investors and good-quality underlying assets (AAA- to vary their mix of assets and liabilities could not have invested directly due to rated ABS among them). These conduits are over time. Their capital base is greater than legal constraints.