Capital Markets Union – Breakdown of EU Roadmap (Part 1)

9 Apr

Despite several EC studies stating that capital adequacy and liquidity ratio requirements do not decisively curtail bank lending, they are often associated with a pro-cyclical effect. And the fact remains that the percentage of SME bank loan requests denied rose a not insignificant 2%, from 11% to 13% of applications made between 2013 and 2014.

jigsaw EU Flag

Building a better form of Capital Integration

The major motive the EC is lauding as its principal argument for instigating a Capital Markets Union by 2019 is that the level of SME finance is not sufficient to meet smaller, innovative companies’ potential rate of growth.

Europe lags behind the US in the provision of loans and rights issuances for medium and micro business. In the USA, “medium-sized companies, the engines of growth in many countries, receive five times more funding from capital markets than they do in the EU.” Deepening European capital markets integration is projected to yield an additional €90billion in funding.

Not a New Problem

The problem is one the EU has been pontificating over for some time, as records of a speech made in 2013 demonstrate. ECB Executive Board member Benoit Coeure, in a speech ‘Assessing Liquidity in a Global Framework’ to a Korean Audience on 3 June, said of the transnational loan market pre-crisis:

“We now know that risk was neither well assessed nor well monitored, and that unchecked cross-border lending supported projects with low intrinsic profitability, such as in the housing sector. Moreover, the structure of these flows, (i.e. wholesale interbank credit, rather than direct loans to firms or capital market investment) was inherently fragile.”

In a rather indiscreet admission, he continued: “Another salient feature of the recent wave of financial globalisation is the role of cross-border banking and the interaction between liquidity cycles and the leverage of global banks.”

The somewhat draconian, and occasionally contradictory, legislation enacted to prevent irresponsible securitisation structures itself then became the target of criticism. This became the subject of discussion at an OECD Financial Roundtable on ‘Non-bank debt financing for SMEs: the role of securitisation, private placements and bonds’ in 2014.

It is recorded that “Particularly institutional investors who are suffering from a dearth of yield due to the low interest rate environment would like to see regulatory barriers removed that, as they claim, inhibits their participation in a safer securitisation market.”

Far from being the scapegoat responsible for systemic instability, securitisation can equally act as a credit risk transfer mechanism which offers substantial returns to investors who assume that risk. In the case of SME loan securitisations, the problem is the lack of transparency and availability of credit information on the borrower companies.

How good is their credit?

The only country which had an institution specifically dedicated to collating credit information on SMEs was France, whose “Fichier Bancaire des Entreprises” (FIBEN) is a database containing the credit risk records which all credit institutions under French jurisdiction are required to admit to a central repository. This includes on and off-balance sheet credit risk. The risk reporting thresholds, since January 2002, are respectively €76,000 for reporting institutions in metropolitan France and French overseas territories; and €45,000 for reporting institutions in the French overseas departments (Guadeloupe, Martinique, Guyana and Reunion, and several other smaller territories.

A universal set of easily comparable metrics has been proposed by the Commission, which would be made available to non-bank credit institutions. Currently banks have the monopoly on the loan history of smaller companies, and while they will share this information between institutions in the interest of fraud prevention and to ensure new loan applicants have the means to repay their debts, this information is not distributed to retail investors as a matter of course.

The EC reports that “Work on credit scoring has started and received broad support from Member States”. But evidently this is still a work in progress, as it concedes that in Europe currently 25% of companies – and 75% of owner-managed companies – do not have a credit score. It means to hold a workshop in 2015 to consult stakeholders on how to improve this ratio.

Restructuring the Securitisation Market

The EC Capital Markets Union Green Paper cites measures like the LCR (Liquidity Coverage Ratio) Directive as a positive step toward freeing up the degree to which certain risk-weighted securities can be used as a ‘liquidity buffer’. This enables banks to hold a wider range of assets, including auto loan receivables, RMBS (retail mortgage-backed securities), consumer, and SME asset-backed securities, on balance sheets without being penalised.

Of course, consumer loans and SME loans are subject to a 35% minimum haircut requirement, higher than the other two categories which have a risk-weighted value threshold of 25%. To earn a place in the liquidity buffer, the loan tranche must comprise the most senior of the total liabilities; as well as having a remaining weighted average life of 5 years or less, and having an issue size of at least €100m value. So any long-term or unsecured debt – the conditions most forgiving to a start-up of limited means – are still not classed as sufficiently liquid assets for regulatory capital purposes.

Securitisations comprising mixed asset pools are not allowed in the liquidity buffer, presumably because of the difficulty in taking a standardised approach towards assessing the quality and value of the underlying loans. But SME loans are characterised by their lack of homogeneity, something that has been commented in the afore-mentioned OED roundtable discussion: “Contrary to other capital market products, standardisation of SME-related issuances could be counter to the very nature of SMEs, which are inherently diverse.”

The EC observes that securitisation issuance in Europe is still far below the level that could be desired, totalling just €216billion in 2014 vs €594billion in 2007. On top of Solvency II and Liquidity Coverage Ratio acts, it proposes new EU-wide initiative which would “ensure high standards, legal certainty and comparability across securitisation instruments. This framework should increase the transparency, consistency and availability of key information, particularly in the area of SME loans, and promote the growth of secondary markets to facilitate both issuance and investments.”


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: