Response to discussion Paper on STS Framework for Synthetic Securitisation Under Art. 45 of Regulation (EU) 2017/2402
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One more example can be given to illustrate the impossibility of supervisors to perform their duties when it come to synthetic securitisation: in the rationale for criterion 15, it is said that “Derivatives should be allowed as underlying exposures of a synthetic STS securitisation only where those derivatives are used for the single purpose of hedging the currency and interest rate risk arising from the underlying exposures that are not derivatives”. This rule is not only a perfect example of wishful thinking, but also a school case of a situation that supervisors will never have the possibility to control and enforce. Many other examples of such situations could be given.
One additional point can be added however:
The rationale for criterion 25 mentions that “the audit prior to issuance… should be carried out with a confidence level of a least 99%”. This wording infers that the underlying statistical distribution of synthetic securitised assets is either normal or lognormal, when, as experience has shown, such statistical distributions do not describe properly the behaviour of financial assets during crises, not to mention the behaviour of highly complex securitised assets. Moreover, using a reasoning founded on confidence levels is not conceptually coherent with the tail risk argument developed in § 85. It is essential that policy-makers, if and when they rely on mathematical concepts, be coherent and rigorous, and avoid giving to themselves a false sense of security by the mere fact that they refer to statistical concepts that become meaningless if and when not applied properly.
Question 1: Do you have any comments on this introductory section of the Discussion Paper?
NoQuestion 2: Do you agree with the analysis on the market developments? Please provide any additional relevant information to complement the analysis.
NoQuestion 3: Do you agree with the analysis of the historical performance? Please provide any additional relevant information to complement the analysis.
NoQuestion 4: Do you agree with the analysis of the rationale for the creation of the STS synthetic instrument? How useful and necessary is synthetic securitisation for the originator and the investor? What are the possible hurdles for further development of the market?
NoQuestion 5: Do you agree with the assessment of the reasons that could eventually support a preferential capital treatment?
No. The “originate to distribute” model has demonstrated the danger it represents during the 2007-2009 crisis and nothing can justify a preferential capital treatment of such a model.Question 6: Please provide any additional relevant information on potential impact of the creation of the STS synthetic securitisation on (STS) traditional securitisation, and any other information to complement the analysis.
-Question 7: Do you agree with the criteria on simplicity? Please provide comments on their technical applicability and relevance for synthetic securitisation.
Notwithstanding the fact that the criteria on simplicity are, once again, a contradiction in terms given the level of complexity described (credit risk at two different levels, tranching of credit risk at the first level, interest rate risk, currency risk, legal risk in the definition of an event of default, etc.…), these criteria are characterised by 1) wishful thinking (e.g. criterion 1 “robustness of credit protection”), 2) vagueness of concept (e.g. criterion 4 “homogeneity in terms of asset type”) and, most importantly, 3) an impossibility for NCAs or, as the case may be, ESAs to perform their supervisory duty (e.g. criterion 8 “in the case of securitisations where the underlying exposures are residential loans, the pool of loans should not include any loan that was marketed and underwritten on the premise that the loan applicant was made aware that the information provided might not be verified by the lender”, or criterion 13 “The underlying exposures should have been underwritten on the basis that their repayment was not intended to be predominantly reliant on the refinancing of such underlying exposures or on the resale value of the assets that are being financed by those underlying exposures”). There are two reasons for this impossibility: supervisors have neither the data nor the human resources to perform that duty on the synthetic securitisation market. This is most problematic as a regulation that cannot be enforced at supervisory level is, by nature, useless.Question 8: Do you agree with the criteria on standardisation? Please provide comments on their technical applicability and relevance for synthetic securitisation.
The reasoning given in the answer to question 7 on simplicity applies also to question 8 on standardisation.One more example can be given to illustrate the impossibility of supervisors to perform their duties when it come to synthetic securitisation: in the rationale for criterion 15, it is said that “Derivatives should be allowed as underlying exposures of a synthetic STS securitisation only where those derivatives are used for the single purpose of hedging the currency and interest rate risk arising from the underlying exposures that are not derivatives”. This rule is not only a perfect example of wishful thinking, but also a school case of a situation that supervisors will never have the possibility to control and enforce. Many other examples of such situations could be given.
Question 9: Do you agree with the criteria on transparency? Please provide comments on their technical applicability and relevance for synthetic securitisation.
The reasoning given in the answer to question 7 on simplicity and to question 8 on standardisation applies also to question 9 on transparency.One additional point can be added however:
The rationale for criterion 25 mentions that “the audit prior to issuance… should be carried out with a confidence level of a least 99%”. This wording infers that the underlying statistical distribution of synthetic securitised assets is either normal or lognormal, when, as experience has shown, such statistical distributions do not describe properly the behaviour of financial assets during crises, not to mention the behaviour of highly complex securitised assets. Moreover, using a reasoning founded on confidence levels is not conceptually coherent with the tail risk argument developed in § 85. It is essential that policy-makers, if and when they rely on mathematical concepts, be coherent and rigorous, and avoid giving to themselves a false sense of security by the mere fact that they refer to statistical concepts that become meaningless if and when not applied properly.