EU law could boost ‘safe’ securitisation

Jonathan Hill

Jonathan Hill launches Green Paper consultation on the Capital Markets Union (CMU), Brussels, 18 February 2015 [European Commission]

The European Commission will consider reducing how much capital banks must hold against risk for a new class of asset-backed securities, a process of packaging and selling loans blamed for the financial crisis.

EURACTIV understands the most likely route to achieve that would be through new legislation proposed by the executive, which would have to be scrutinised by the European Parliament and EU Council before entering into force.

Brussels wants to create a new market for safe, simpler, more transparent and high quality securitisation products, it said today (18 February), as it launched a three month consultation paper on its plans for a Capital Markets Union.

Capital Markets Union is the Commission’s flagship project to unlock funding for Europe’s businesses by creating a single market for capital. It is designed to create alternative sources of finance to bank lending, which is the dominant form of European company credit. Since the crisis, bank lending has dropped significantly.

The plan is to unify markets by 2019 and make it easier for companies to raise cash on stock and bond markets.

Securitisation is when a lender pools and repackages a set of loans or other assets. The lender will sometimes organise those assets into tranches of products tailored to the risk and reward appetite of different kinds of investors.

The US subprime crisis was caused by bad mortgage debts underpinning such tranches. The lower quality of the credit, obscured by the complex layers of tranches, ultimately caused massive defaults, which in turn hit the financial institution that invested in the securities.  

The subsequent loss of confidence contributed to a global credit crunch and taxpayer bank bailouts on both sides of the Atlantic, with ongoing ramifications for European growth today.

The stigma of the crash has stultified the securitisation of loans to small and medium sized firms. The Commission said such securitisation was still at half pre-crisis levels and could generate €20 billion of funding for businesses.

Securitisation can help free up banks’ balance sheets, allowing them to increase their lending to businesses and households, the Commission said.

How will it work?

Banks would issue the new securitisation instruments, pooling and repackaging their loans to households and businesses, which would then be sold in tranches to institutional investors such as pension funds.

The quality of the underlying debt would be guaranteed by a standardised set of rules. How this new framework would work and its form has been put out for consultation.

A standardised system would create the conditions to encourage the new products and guarantee their quality. EU sources said they would be “extremely prudent” because of the role securitisation played in the crisis.

“This is not a return to the bad old days of the subprime market,” Financial Stability, Financial Services and Capital Markets Union Commissioner Jonathan Hill told reporters at a Brussels press conference.

Experts told EURACTIV that investors would be interested in such a product, if it offered attractive rates of return.

Hill, who is British, said that the Bank of England, the European Banking Authority (EBA), the European Central Bank and global standard-setter the International Organisation of Securities Commissions (IOSCO), had looked at safe securitisation.

“This is not some kind of maverick solo run the Commission is making,” he said, “”It is part of a broader conversation.”

“Lots of brainy people, who think about securitisation a lot of the time, think it is possible to come up with a framework that will be more transparent, and more stable and enable people to see more clearly where the risk is,” he added.

The Commission, through its work on the Solvency II capital law for insurers, IOSCO and the EBA, currently have differing definitions of “high quality” securitisation. Although they have much in common, they will need ironing out before the new framework becomes a reality.

New legislation?

The Capital Requirements Directive sets the levels of capital that banks must hold against risk. The rules were part of the response to the crisis and designed to shore up the EU’s banking system’s ability to withstand financial shocks.

But critics blame the CRD for disincentivising banks’ lending to business. A lack of access to finance for businesses is one of the reasons for the EU’s sluggish return to growth.

To support that, EU sources said they would consider reducing the risk calibration for the new safer, simpler and more transparent securitisation instruments.

Currently there is no distinction in the treatment of securitised products. That distinction for products within the new framework would be introduced.

EURACTIV has learnt this would be achieved most simply with a new legislative proposal for transparent securitised products that would apply for all financial institutions, including banks, pension funds, and other institutional investors. 

Hill hinted at some regulatory flexibility in his Brussels press conference. During the crisis, policymakers were forced to legislate at speed “with the flames lapping at their feet”, he said.

“It makes sense to look at the effect of that regulation over time,” he added.

British Banking Association deputy chief executive Sally Scutt said, “EU policymakers have worked to make Europe’s banks safer in recent years but now is the time to focus on measures that will help boost growth for citizens across Europe.  A fully functioning Capital Markets Union, with banks playing a central role, could be an important part of that programme.”

Concerns and support

Sony Kapoor, managing director of the think tank Re-Define, warned the challenges of integrating fragmented capital markets run on different legal principles should not be underestimated.

“Some ideas, such as encouraging securitisation for SME loans, make a lot of financial sense but the proof will lie in the pudding,” he said.

Kapoor, a former Lehmann Brothers trader, added, “This is very different from the kind of dodgy securitisation that contributed to the crisis and should have an overall beneficial impact.”

Finance Watch is an organisation that campaigns to make “finance serve society”. It wants tranching banned from any future framework.

Frédéric Hache, head of policy analysis at Finance Watch, said, “”Recent initiatives to define transparent and simple securitisation go in the right direction but are not tight enough to make securitisation become again truly simple and robust.

“This practice [tranching] generates model uncertainty, additional complexity and conflicts of interests,” he added.


The City of London would play a fundamental role in the creation of the new market, with much of the product design originating from the EU’s leading financial centre, EU sources said.

If UK Prime Minister David Cameron wins May’s general election, he has promised to hold a referendum on Britain’s membership of the EU before 2017.

Quizzed over whether the plan could help encourage the UK to stay in the EU, Hill said the Capital Markets Union would be drafted with all 28 member states in mind.

Pressed further, he said, “The UK is traditionally a champion of the single market and this is a classic single market initiative.”

Britain is the EU’s biggest capital market and could benefit from such initiatives to increase trading turnover.

Hill did not mention a new  “super-regulator” to hold sway over the City of London financial centre.

>> Read: European Commission mulls super-regulator for capital markets

Capital Markets Union

In the United States stock and bond markets generate most of the cash for the economy but Europe’s fragmented capital market has a stock market capitalisation that is only half that of the US.

In the eyes of the EU executive, the CMU should be seen as “the first structural initiative” adopted under the €315 billion investment plan put forward by Jean-Claude Juncker last year.

>> Read: Divided EU leaders give nod to €315bn Juncker plan

“If EU venture capital markets were as deep as the US, as much as 90 billion euro more in funds would have been available to companies between 2008 and 2013,” the Commission said in a statement, explaining that the current environment was “tough for businesses that remain heavily reliant on banks and relatively less on capital markets”.

Hill’s CMU plan includes making it easier and cheaper for smaller companies to list on stock markets and tap money directly from investors. He wants fast progress involving as little new legislation as possible and instead to tweak existing EU rules and rely on industry initiatives.

“I don’t think there are any quick wins,” said Lachlan Burn, a financial services lawyer at Linklaters, saying the key would be to rework some existing EU rules, but it will not be easy.

Hill said the CMU was not a threat to banks but would widen choice for companies who need cash to grow.

Andy Baldwin of EY consultancy said Hill’s plans do not address cultural and historical barriers to CMU and it could take a generation to stimulate demand for more funds from markets.


In the European Parliament, the Liberal ALDE group called for expediting the CMU proposal, urging the Commission to “adopt a much more ambitious timetable”.

“What we need is a fast-tracked legislative package that will help deliver economic growth in the short to medium term,” said Sylvie Goulard, a French Liberal MEP. "The majority of European companies remain dependent on bank financing and there is evidence this is hampering the recovery. We need to create a fully integrated capital market as soon as possible, to provide more diversified financing at lower costs to companies, especially SMEs."

"If we had had a more diversified financial system, the economic crisis may not have hit Europe as hard as it did,” added Cora Van Nieuwenhuizen, another Liberal MEP from the Netherlands. “Certainly, the recovery would have been quicker and less painful, like in the United States."

The European Conservatives and Reformists Group (ECR), hailed the Lord Hill’s CMU plan, saying the proposals are “crucial to the long-term economic recovery of the EU”.

“If the past five years were about new financial services regulations then the next five must be about removing barriers to kick-start investment, capital, growth and eventually new jobs,” said Kay Swinburne, a UK Conservative party member.

Swinburne was also satisfied that the Commission did not propose a central ‘super-regulator’ to verse the CMU. "Lord Hill is right to not want to create a centralised Capital Markets Union, but to create the right conditions for a Capital Markets Union to thrive. Investors and businesses must do the rest and this paper by the commission should now be taken up as a challenge to industry.”

The Greens/EFA group encouraged the Commission to seize the CMU opportunity to reform financial markets in a way that is "compatible with European values".

"The financial sector needs to focus on long-term investment guided by not just economic but also environmental and social responsibility criteria," said Sven Giegold, a German MEP who is economics and finance spokesperson for the Greens. "The Capital markets union is the perfect opportunity to ensure these sustainability criteria are integrated in risk analyses, investment products and ratings reports."

"Moreover, the harmonisation of capital markets could function in Europe, if it is accompanied by the strengthening of the EU supervisory authorities (ESMA, EBA and EIOPA). The EU capital market must not lag behind in the supervision of cross-border actors and consumer protection," Giegold said.



The European Fund and Asset Management Association (EFAMA), an industry association represnting investment fund managers, insisted that the CMU proposal should stay “primarily focused on investors”.

“EFAMA believes that investors are the cornerstone of the asset management industry and that an integrated capital market in the EU will help unlock capital, shift it towards investments in long-term projects, and ultimately reduce the cost of investment funds and pensions savings for investors,” the association said in a statement.

EFAMA also believes a single market for personal pensions will play an important role in broadening capital markets in Europe. “In particular, a pan-European pension product would help overcome the current fragmentation of the European pension systems by stimulating cross-border market integration.”

The IFRS Foundation, which is responsible for the governance and oversight of the International Accounting Standards Board (IASB), said it supports the goal of the proposed CMU to increase the role that capital markets play in financing the European economy.

“A single set of financial reporting requirements can play a fundamental role in the creation of a CMU, providing comparable and transparent information that allows investors to make informed investment decisions without acting as an impediment to companies wishing to raise capital,” the IFRS Foundation said in a statement.

Dörte Höppner, European Private Equity & Venture Capital Association chief executive, said the Commission recognised private equity, venture capital and infrastructure funds as sources of financing to be promoted through a Capital Markets Union.

"To unlock more of this essential financing, the EU should aim to free up the enormous pool of capital sitting with institutional investors, enabling it to flow across borders to companies that desperately need it. With this critical initiative to enhance the single market, the Commission is taking a key step to growth,” she said. 

BusinessEurope director general Markus Beyrer said, "We welcome many of the initiatives set out in the Commission’s paper, including unlocking alternatives to bank finance, such as equity, corporate bonds and venture capital, and are ready to work with the Commission in translating them into concrete steps to boost business investment, growth and jobs.”

Olav Jones, deputy director general of Insurance Europe, said, “The consultation covers several key areas of importance for insurers, a primary example being the prudential treatment of long-term investments. As Europe’s largest institutional long-term investors, insurers are particularly hopeful that progress can be made to reduce barriers and disincentives to making long-term investments that are so important to ensuring growth and stability in Europe.”

Aviva, a British multinational insurance company headquartered in London, applauded the Commission's Green Paper on CMU, saying "a continued focus on long-termism is crucial" to the financial sector's sustainability.

“Not being sustainable could be the biggest market failure of all. So we all have a responsibility to look to the long-term," said Mark Wilson, CEO of Aviva. "That’s just good business. So we welcome the Commission’s Green Paper on Capital Markets Union. It is a landmark moment. Now we must all back this initiative – and make it a reality.”

Aviva particularly welcomed initiatives aimed at making credit information on SMEs more widely available in order to help open new lines of lending to them. It also supports "embracing digital advances" in order to make it easier to sell products across border to consumers.

However, Aviva said more could be done to promote long-term sustainability, for example by "boosting the green bond market, improving corporate governance and financial literacy.

Jason Piper, Association of Chartered Certified Accountants Business Law Manager, said,“The development of a common market for capital across the Union can be expected to pay dividends beyond the direct impact on businesses which access the new funding. The governance and reporting disciplines which support the market for investors will benefit creditors and suppliers more generally. Trade creditors will take comfort from the confidence of investors, while the process of supply chain due diligence will be eased where their partners have been through the rigour of a placement or listing.”

Jonathan Hill, the EU's new financial services commissioner, announced he will set out his plans for a pan-European capital market by the middle of 2015.

The objective is to create an integrated market for raising money through bonds, shares and other financial instruments over the next five years.

Officials say a capital markets union would also mean the EU moving beyond public subsidies and loans to coordinate financing for companies and infrastructure through project bonds, public-private partnerships and infrastructure funds.

Hill said his first steps would be to push a proposal for European long-term investment funds for infrastructure and businesses, to develop a framework for securitisation and to carry out analysis of private placements - the sale of securities to a small number of chosen institutional investors.

>> Read: EU finance chief to announce capital market plan in 2015

  • By 13 May 2015: All interested parties are invited to submit their views on the CMU (consultation page here).
  • By summer 2015: Jonathan Hill expected to lay out "Action Plan" on CMU for the next five years
  • 2020: End of CMU action plan

Subscribe to our newsletters