On 5 May, the European Systemic Risk Board (ESRB) published a report on the impact of STS on-balance-sheet securitisation on financial stability in the EU. The analysis indicates that the market is growing, with an increasing number of banks using synthetic STS securitisations to transfer credit risks. The ESRB concludes that the market is currently functioning well and does not pose a threat to financial stability. However, the report also highlights some limitations. One key reason given for the currently low risk is simply the small market size. The ESRB also raises concerns about extending STS to synthetic structures that involve unfunded credit protection.
ESRB recognises potential and rates risks as limited
The ESRB considers synthetic STS on-balance-sheet securitisations as an effective instrument for diversifying credit risk. Such transactions enhance banks’ resilience of banks and support regulatory capital relief, enabling increased lending to the real economy. The report emphasises:
- Transparent structures: STS rules ensure clarity and reliability in structuring.
- Contribution to financial stability: SRT securitisations, the majority of which are synthetic securitisations, reduce the burden on bank balance sheets and improve capital planning.
- Professionalisation of the market: The market is growing steadily, with experienced players involved.
Positive view on securitisation markets – with some caveats
Although the ESRB report draws positive conclusions, it also highlights potential risks:
Firstly, during severe economic downturns, the associated sharp rise in default rates for corporate loans might lead to losses filtering through to the senior tranches – which would once again materialise risks in the banking sector.
Secondly, the ESRB is critical of the lack of transparency due to the non-mandatory ESMA reporting to a securitisation registry – which would leave supervisors without an overview on where the risks ultimately lie. The ESRB categorises these risks as non-systemic – but in particular due to the small size of the market segment.
Thirdly, the ESRB is critical the role of insurers as protection sellers for unfunded structures under STS.
Limitations of the ESRB report not comprehensible
As TSI, we do not share the above-mentioned restrictions in this form.
- European securitisations had low default rates during and after the financial crisis. A study by the EBA from 2020 confirms this. The good performance of synthetic on-balance-sheet securitisations was one of the main reasons why such securitisations were also made STS-eligible. In addition, synthetic securitisations deliberately transfer only part of the credit default risks and are comparable to the role of reinsurers for primary insurers.
- The above-mentioned study shows further that supervisors have sufficient data, even if ESMA reporting certainly has to be optimised in the sense of monitoring, see our statement on the ESMA consultation in March 2024.
- Insurers hedge risks from a wide range of asset classes that have a low correlation. They therefore contribute to risk diversification. Granting STS-status to protection sellers in unfunded structures could help promote a more diversified and robust market for synthetic securitisations.
Bottom line, the European market for synthetic securitisations also works for larger volumes and represents a reliable instrument for risk diversification, as the risks are effectively transferred to private investors and thus out of the banking sector.
Outlook: Eagerly awaiting the EU Commission’s legislative proposal
A lot is happening in the regulatory environment for securitisations. The ESRB report adds to the ongoing discussion. It should be an argument for the European Commission to lower the regulatory hurdles, so that, in particular, more experience investors enter the market. A balanced regulatory framework promotes trust and growth. The time until the European Commission’s legislative proposals, announced for 17 June, is not long anymore.