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STATUS OF ASSET BACKED SECURITIES MARKET AND MORTGAGE

BACKED SECURITIES MARKET IN BULGARIA


FINANCIAL & REGULATORY ASPECTS
Vineet Bhansali
Ali Yavar Amerjee
Ankita
Ankur Arora
Ayushi Singh
Geetika Singh
National Law University, Jodhpur (Batch of 2015), Semester IX
Working Paper Series
Faculty Advisor: Dr. Rituparna Das
1


(Words: 15,247)

Abstract
This paper seeks to highlight the financial and regulatory aspects with respect to Asset
backed securities and Mortgage backed securities market in Bulgaria. It discusses the
viability, structure and framework of such instruments in light of the prevailing market
conditions and consumer preferences in Bulgaria. Further, it analyses the ABS and MBS
markets in other jurisdictions such as India and EU Countries as against Bulgaria. The
paper has dealt with several issues pertaining to securitization of these instruments and
the consequent advantages and disadvantages to the issuer and the market as such.
Lastly, it seeks to contribute to the government policy of Bulgaria for maintaining and
managing the ABS and MBS markets within the periphery of legal boundaries and the
banking regulations in the country.

1
We hereby express our sincerest heartfelt gratitude to our faculty Dr. Rituparna Das for his guidance and
supervision. This paper has instilled in us a unique thirst for knowledge in the subject. It could not have
achieved completion without the aegis of Dr. Das.

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TABLE OF CONTENTS
I. INTRODUCTION ................................................................................................................................... 4
II. HISTORY OF ABS AND MBS MARKET IN BULGARIA ................................................................ 5
III. FRAMEWORK ................................................................................................................................... 7
IV. STRUCTURE OF THE ISSUER.......................................................................................................... 8
V. COVER ASSETS .................................................................................................................................... 9
VI. COLLATERAL REGISTER .............................................................................................................. 10
VII. PREFERENTIAL CLAIM ON COLLATERAL ASSETS IN CASE OF INSOLVENCY........................ 10
VIII. LEGAL REGULATION OF BONDS AS SECURITIES ................................................................... 11
IX. VALUATION AND LTV CRITERIA .............................................................................................. 12
X. ASSET BACKED AND MORTGAGE BACKED SECURITIES IN THE EUROPEAN UNION: A
COMPARATIVE ANALYSIS ......................................................................................................................... 12
XI. MORTGAGED BACKED AND MORTGAGE BACKED SECURITIES IN THE EU: A
COMPARATIVE ANALYSIS ......................................................................................................................... 24
XII. MORTGAGE BACKED SECURITIES (MBS) IN INDIA ................................................................. 26
XIII. ASSET BACKED SECURITIES (ABS) IN INDIA ........................................................................ 28
XIV. LEGAL INFRASTRUCTURE FOR ABS AND MBS IN INDIA .................................................... 29
XV. ASSET - LIABILITY MANAGEMENT ............................................................................................. 34
XVI. TRANSPARENCY ........................................................................................................................ 34
XVII. COVER POOL MONITOR AND BANKING SUPERVISION ..................................................... 34
XVIII. SEGREGATION OF COVER ASSETS AND BANKRUPTCY REMOTENESS OF COVERED
BONDS ..................................................................................................................................................... 35
XIX. BULGARIAN MORTGAGE SECURITIES MARKET INFORMATION ........................................ 36
XX. ROLE OF FINANCIAL SUPERVISION COMMISSION ................................................................... 40
XXI. REVIEW OF THE ABS AND MBS MARKET IN FIRST HALF OF 2014 .................................. 41
XXII. THE EU SECURITIZATION MARKET ....................................................................................... 41
XXIII. MEASURES UNDERTAKEN ....................................................................................................... 42
XXIV. REMAINING ROADBLOCKS...................................................................................................... 43

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XXV. REGULATORY TREATMENT ..................................................................................................... 44
XXVI. RELIANCE ON CREDIT RATING AGENCIES ........................................................................ 45
XXVII. TRANSPARENCY AND HARMONISATION ........................................................................... 45
XXVIII. CONCLUSION ........................................................................................................................ 46



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I. INTRODUCTION
MBS and ABS represent a major segment of the global capital markets. The process
of securitization of assets through MBS and ABS route, while complex, has got dominant
place in corporate finance and investment management because it can offer originators a
cheaper source of funding and investors a superior return. With the help of MBS and ABS, an
originator can transfer risk by transferring financial assets and convert illiquid assets into
tradable securities. The assets, once separated from the originator, are employed as backing
for securities. ABS and MBS offer alternative market-based financing, and other benefits like
improved hedging and risk management through diversification, credit enhancement,
enhanced balance sheet management and restructuring and efficient refinancing cost.
2

Innovations and increasing complexity in MBS and ABS warrant a thorough understanding
of the nuances behind these securities.
A market for prudently designed ABS has the potential to improve the efficiency of resource
allocation in the economy and to allow for better risk sharing. It does so by transforming
relatively illiquid assets into more liquid securities. These can then be sold to investors
thereby allowing originators to obtain funding and, potentially, transfer part of the underlying
risk, while investors in such securities can diversify their portfolios in terms of risk and
return. This can lead to lower costs of capital, higher economic growth and a broader
distribution of risk. A more diversified bank liability structure further tends to reduce the
dependency of banks lending decisions on business cycle conditions and to lower the
exposure of debtors to re-financing or liquidity risk, which increases banks resilience and
helps contain systemic risk. Securitization is also uniquely shaped to provide targeted funding
to a variety of economic activities, including by allowing lenders to match the profile of their
funding liabilities with those of the loans they have originated, and to address specific
investor preferences regarding the distribution of risk exposures. And high-quality/simple and
transparent senior ABS can in principle help meet the increasing demand for high-quality
collateral, providing a complement to government debt. Despite its long-term social value,
securitization today suffers from stigma, reflecting both its adverse reputation among
investors and conservatism among regulators and standard-setters. This is the consequence of
misaligned incentives in the years prior to the financial crisis, with many industry participants

2
Madhani, Pankaj M., Mortgage-Backed and Asset-Backed Securities - Concept and Lessons from Subprime
Market (May 23, 2012). ICFAI University Press, 2009. Available at SSRN: http://ssrn.com/abstract=1965856.

5

becoming entwined in a self-reinforcing dynamic between demand and supply of
securitizations.
The potential for securitization markets to damage financial stability was evidenced clearly
during the crisis. The Financial Stability Board (FSB) has adopted a two-pronged strategy
towards ensuring a more resilient shadow banking system, of which securitization markets
are a key building block. First, the FSB has developed a monitoring framework to enhance
national authorities ability to track developments in the shadow banking system with a view
to identifying the build-up of systemic risks and enabling corrective actions where necessary.
Second, the FSB has coordinated the development of policies in five areas where oversight
and regulation need to be strengthened to reduce systemic risks, including policies improving
transparency and aligning incentives in securitization.
3
Official authorities ought to lend their
full support to a successful implementation of this strategy to ensure the benefits of
securitization are fully realized and that the market recovers in a form that adheres to
standards conducive to financial stability.
II. HISTORY OF ABS AND MBS MARKET IN BULGARIA
Until 1989 it was only the State Savings Society that provided mortgage loans. The recipients
of loans were natural persons only and the bank financed the building and purchasing of housing,
the acquiring of shares in real properties for the purpose of their complete buy-out, acquiring of
sites for building. In most cases it was the state or municipalities that were the sellers as they had
the legal obligation to build and sell homes to the population. The complete government control
over the process of building and sales of housing, the financing of the purchases and the return of
credits eliminated the danger of losses resulting from insolvency and abuse. During that period of
time the bank gained substantial experience with clients in mortgage loans made for the purpose of
buying homes. There were also considerable government subsidies expressed in writing off by the
state of part of the debt under certain conditions, crediting mostly long-term customers, etc. Interest
rates were very low (3 per cent simple annual interest). Loans could be paid back within 30 years.
After 1990 the state stopped subsidizing and facilitating natural persons in the purchase and
building of homes both as builder and seller and in terms of financial facilities. The DSK EAD
Bank kept its credit products on offer but the high inflation which resulted in extremely high

3
Strengthening Oversight and Regulation of Shadow Banking - An Overview of Policy Recommendations
and dated 29 August 2013.

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interest on such loans (reaching 300 per cent) reduced substantially demand in the credit market.
The financial stabilization after 1997 stabilized interest rates but the populations buying power was
already too low to bring back demand. The bank was no longer in a position to do long-term
planning and reduced the term of mortgage loans to 9 years. The reason for this can be found in the
structure of the deposits. These are mainly redeemable on sight and it is only thanks to its
empirical experience with non-depreciative remaining assets that the bank can afford to offer such
long-term loans. Following the adoption of the Banks and Credits Act in 1992 commercial banks in
Bulgaria became able to legally finance the commercial activity of businesses. This is actually the
larger mortgage market in the country.
It underwent the same stresses as the home mortgage market. This is generally a very short-term
market.
4
The usual term of business mortgages is between 12 and 36 months. The reasons for this
are the banks inability to make long-term planning because of a changing economic environment
and the rather short term of the deposits used to finance crediting operations. Unfortunately,
Bulgarian National Bank does not require the banks which extend mortgage credits to report
separately on their volume. Additionally, the reporting requirements are being change almost every
year so it is impossible to give comparable data for the period 1995-1999. We can only outline the
development of the housing loans market and give data for 1999 and partially for 1998. Since the
beginning of 1998 (when a tendency towards macroeconomic stabilization was witnessed) the
demand for credits increased significantly. The individuals and firms were willing to take credits
although they knew that their property will be mortgaged in favour of the bank, the interest rate is
relatively high and the bank can increase it unilaterally (such clause is still included in the credit
contracts). On the other hand, as described above, the supply of credits in the Bulgarian banking
system is limited.
5

Currently all housing credits are mortgage credits and no other form of housing financing is being
used. People who are not willing to mortgage their property usually gather money from relatives
and friends and/or use their own savings. The "monopolist" on the housing financing market is DSK
Bank. In 1998 outstanding residential mortgage credit in DSK Bank was 70,709,000 denominated
leva (about USD 42,214.328), which accounted for about 90% of the residential mortgage credit in
the whole banking sector.

4
Balzs Horvth and Istvn P. Szkely, The Role of Medium-Term Fiscal Frameworks for Transition Countries:
The Case of Bulgaria, Emerging Markets Finance & Trade, Vol. 39, No. 1, The Role of Fiscal Reforms in the
Transition (Jan. - Feb., 2003), pp. 86-113.
5
Ibid.

7

The other very active player on the market is Bulgarian - American Credit Bank. The volume of
housing loans extended by other banks is negligible
III. FRAMEWORK
In Bulgaria, the legal basis for the issue of covered bonds is the Mortgage-backed Bonds
Law issued by 38
th
National Assembly on 27 September 2000, published in the State Gazette
(Darzhaven vestnik) issue 83 of 10 October 20001.
6
Ordinance No 8 of Bulgarian National Bank on
the Capital Adequacy of Credit Institutions treats the risk weighting of other types of covered
bonds.
A. Mortgage-backed bonds
Mortgage-backed bonds shall be securities issued by banks on the basis of their loan
portfolio and secured by one or more first mortgages on real estate in favour of banks
(mortgage loans).(2) The real estate under paragraph 1 shall be insured against destruction
and may be of the following types:
1. housing units, including leased out;
2. villas, seasonal and holiday housing;
3. commercial and administrative office space, hotels, restaurants and other similar real
estate;
4. industrial and warehousing premises.
7


B. Mortgage Bonds Collateral
Mortgage bonds collateral are mortgage credits /main collateral/ or assets with zero risk
weight in accordance with the classification set in a regulation of BNB /substitute collateral/. The
substitute collateral should not exceed 30 per cent of the issuing bank's liabilities on the outstanding

6
Amended; issue 59 of 2006; in force on the date of entry into force of the Treaty of Accession of the Republic
of Bulgaria to the European Union; amended; issues 52 and 59 of 2007; amended; issue 24 of 2009; effective as
of 31 March 2009
7
Law on Mortgage-backed Bonds(Issued by the 38th National Assembly on 27 September 2000; published in
the Darjaven Vestnik, issue 83 of 10 October 2000; amended; issue 59 of 2006; in force on the date of entry into
force of the Treaty of Accession of the Republic of Bulgaria to the European Union; amended; issues 52 and 59
of 2007; amended; issue 24 of 2009; effective as of 31 March 2009)

8

mortgage bonds. Mortgage loans are used as collateral up to 60-80% of the mortgage appraisal
value of the real property (the exact per cent depends on the type of the property).
The purpose of these limitations is the collateral risk minimization. The credits are used as collateral
at a value lower than the mortgage appraisal value. The main collateral/substitute collateral ratio
requires a better management of the maturity structure of the bank's claims on mortgage loans and
the liabilities on mortgage bonds in terms of decreasing the risk evolving from the temporary
misbalances in cash flows and worsened liquidity.
8
The law envisages that mortgage bonds will be
issued under the existing legislation.
9
Additional requirements are set to the prospectus/the offer to
subscribe to the issue including internal rules of the issuing bank as well as the main characteristics
of the collateral portfolio.
IV. STRUCTURE OF THE ISSUER
Pursuant to the Mortgage-backed Bonds Law, the mortgage-backed bonds shall be securities
issued by banks on the basis of their loan portfolio and secured by one or more first in rank
mortgages on real estate in favour of banks (mortgage loans).
10
Only banks may issue bonds called
mortgage-backed bonds. The real estate under the previous paragraph shall be insured against
destruction and shall be of the following types:
Housing units, including leased out;
Villas, seasonal and holiday housing
Commercial and administrative office spaces, hotels, restaurants and other similar real estate;
and
Industrial and warehousing premises.
The issuing bank shall adopt internal rules on conducting and documenting mortgage appraisals of
real estate which shall comply with the requirements of Article 73, paragraph 4 of the Bulgarian
Law on Credit Institutions. Securities issued under procedures other than the one laid down by the
Mortgage-backed Bonds Law may not referred to with, or include in their appellation, the extension
mortgage-backed bond, or any combination of these words.

8
Mortgage Financing in Bulgaria:Developments, Housing Market and General Backgroundi, Tzveta Dimitrova,
IMEDaniela Vladimirova, DSK BankDr. Krassen Stanchev, IME (editor)Martim Dimitrov, IME.
9
Alexandru Minea and Christophe Rault, Some New Insights into Monetary Transmission Mechanism in
Bulgaria, Journal of Economic Integration, Vol. 24, No. 3 (September 2009), pp. 563-595.
10
Ibid.

9

V. COVER ASSETS
The outstanding mortgagebacked bonds shall be covered by mortgage loans of the issuing
bank (principal cover). To substitute loans from the principal cover that have been repaid in full or
in part, the issuing bank may include the following of its assets in the cover of mortgage-backed
bonds (substitution cover):
Cash or funds on account with the Bulgarian National Bank (BNB) and/or commercial banks;
Claims on the Government of the Republic of Bulgaria or the Bulgarian National Bank, and
claims fully secured by them;
Claims on governments or central banks of states as determined by the Bulgarian National Bank;
Claims on international institutions as determined by the Bulgarian National Bank;
Claims fully backed by government securities issued by the Government of the Republic of
Bulgaria;
Bulgarian National Bank, the Governments, Central Banks or international institutions;
Claims secured by gold; and
Claims fully backed by bank deposits denominated in Bulgarian levs or in a foreign currency for
which the BNB quotes daily a central exchange rate.
The substitution cover of mortgage-backed securities shall not exceed 30% of the total amount of
liabilities of the issuing bank under that issue. Mortgage-backed Bonds cover from any issue (the
sum total of the principal cover and the substitution cover) may not be less than the total amount of
liabilities towards the principals of mortgage-backed bonds from that issue which are outstanding
and in circulation outside the issuing bank. The claims of the bondholders under mortgage-backed
bonds from each issue shall be secured by a first pledge on the assets of the issuing bank included in
the cover of that issue. The pledge is a subject of entrance in the Central Registers of Special
Pledges, with the respective issue of mortgage-backed bonds being indicated as a pledge creditor.
The issuing bank shall request an entry and submit to the Central Register of Special Pledges all
data required for the entry of the pledge within one month after executing a mortgage-backed bonds
issue and shall update that data at least once every six months thereafter. The pledge shall remain in
force until the full redemption of the liabilities of the issuing bank under the respective issue of
mortgage-backed bonds without the need for any renewal. Deletion of the pledge entry shall be

10

made upon the full redemption of the issuing banks liabilities under the respective issue of
mortgage-backed bonds on the basis of a document issued by the banks auditors.
11

VI. COLLATERAL REGISTER
The issuing bank is obliged to keep a register of the issued mortgage bonds collateral. The
bank constitutes a special pledge1 on the claims stemming from the credits included in the register.
The register includes different pools of credits used as collateral for separate mortgage bonds issues.
The access to the register is set in bank's internal regulations, which do not insult the bank secret.
The bank is obliged to manage and report separately the assets included in the collateral register and
may not impose any other burdens on them. The purpose of these regulations is to secure the claims
of the mortgage bonds creditors and to assure them accurate information for the collateral's
composition and its quality. The separate reporting of the collateral isolates these assets of the bank
from the others and decreases this portfolio's risk for it is composed of claims with lower risk
(collateralized with a real property).
VII. PREFERENTIAL CLAIM ON COLLATERAL ASSETS IN CASE OF INSOLVENCY
The draft law sets preferential regime for claims of mortgage bonds creditors in accordance
with the usual European practice. In case of insolvency of the issuer the claims on credits included
in the collateral register are separated from the common assets of the bank. A trustee, appointed by
the courts, separately manages these claims. He or she acts simultaneously to the assignee that is
appointed by the court in case of insolvency of the bank. The trustee has the rights and obligations
of the assignee in respect of the assets included in the collateral register. The law does not change in
any way the existing legislation in respect of the mortgage regime, the regulations of the Bulgarian
National Bank or the common order of bond issuing .Moreover, the creation of this instrument
known for more than 200 years in the European practice is possible because of the good regulation
of mortgages and the application of supervisory requirements which are unified with EU standards.
The purpose of the law is the minimization of risks born by the banks in their credit activity and
respectively risks born by bond creditors as well as decreasing costs of mortgage financing and

11
Adopted by the Bulgarian National Bank, published in the Darjaven Vestnik, issue 106 of 27 December 2006,
in force as of 1 January 2007; amended, issue 62 of 2007; amended, issue 38 of 2008, effective as of 11April
2008; amended, issue 21 of 2009; amended, issues 20, 85 and 102 of 2010; amended, issue 95 of 2011
(http://www.bnb.bg/bnbweb/groups/public/documents/bnb_law/regulations_8_credit_instit_en.pdf).

11

allowing easy access to mortgage credits as a long-term source of financing for a broader range of
people and companies.
12

VIII. LEGAL REGULATION OF BONDS AS SECURITIES
Bonds are regulated by the Commerce Act and the Public Offering of Securities Act and are
subject to obligations and material law. Under the law, securities are transferable rights or
documents, which materialize transferable rights. The Commerce Act does not provide a definition
of bonds but its characteristics can be deducted from the texts of this law:
The bond as a security materializes the right to receive principal and interest.
The bond may be backed by funds available or not. When it is backed by property it
gives rise to both an obligation and a material legal relationship: the right of
ownership of its holder.
The bond may be issued to bearer or to a named individual.
The bonds issued by a company may have various face values.
The Commerce Act provides regulation of the general requirements in respect to the
issuer which make him eligible to issue bonds. Of all commercial companies, only the
joint stock company can issue bonds. There are requirements in respect to the amount
of the companys capital and the volume of the bonds as a percentage of the
companys own capital.
Exceptions can also be made for issues guaranteed by the state or by banks (under the
Commerce Act) and such issued by banks (the Banks Act).
The history of the company. At least two annual accounting reports approved by the
general meeting are required.
The manner of resolving to issue bonds.
13



12
Mortgage Financing in Bulgaria:Developments, Housing Market and General Backgroundi, Tzveta
Dimitrova, IMEDaniela Vladimirova, DSK BankDr. Krassen Stanchev, IME (editor)Martim Dimitrov, IME.
13
Ibid.

12

IX. VALUATION AND LTV CRITERIA
A. Valuation
Mortgage appraisals of property shall be performed by officers of the issuing bank or by
physical persons designated by it having the relevant qualifications and experience. For appraisals
of the property the comparative method, the revenue method and the cost-to-make method shall be
used for the purposes of the law. The mortgage appraisal shall explicitly specify the method or
combination of the above methods used with the relative weight of each method in the appraisal, as
well as the sources of data used in the analysis and calculations.
Subsequent mortgage appraisals of property used as collateral on the loans recorded in the register
of mortgage- backed bonds cover shall be made at least once every twelve months for loans which:
Have outstanding liabilities exceeding 1% of the issuing banks own funds; or
Have not been consistently classified as standard risk exposures throughout that period.
B. LTV criteria
LTV criteria are generally defined in the banks own lending policies depending on their risk
appetite and other internal rules.
14
No specific legal requirements are imposed by the local banking
law.
X. ASSET BACKED AND MORTGAGE BACKED SECURITIES IN THE EUROPEAN UNION:
A COMPARATIVE ANALYSIS
A. The European ABS market: evolution and current size
The Asset backed security (ABS) market peaked in Europe before the sub-prime
crisis, with a total of $1.2 trillion in new ABS issuance in 2008. By 2013, total new issuance
was only $239 billion (Figure 1).
15
Demand for these assets plummeted after 2008 because of
the deterioration in the rating of the collateral behind the various types of ABS, leading to a
major market price correction of ABS products.

14
Balzs Horvth and Istvn P. Szkely, The Role of Medium-Term Fiscal Frameworks for Transition
Countries: The Case of Bulgaria, Emerging Markets Finance & Trade, Vol. 39, No. 1, The Role of Fiscal
Reforms in the Transition (Jan. - Feb., 2003), pp. 86-113.
15
Carlo Altomonte & Patrizia Bussoli, Asset-backed securities: The key to unlocking Europe's credit
markets?, BRUEGEL, July 24, 2014, available at http://www.bruegel.org/publications/publication-
detail/publication/842-asset-backed-securities-the-key-to-unlocking-europes-credit-markets/

13

Figure 1: New issuance in the EU ABS market, 1999-2013 (2014Q2)

Source: SIFMA (July 2014).
Moreover, the freeze in European inter-bank lending reduced demand for these assets as
collateral for repurchase (repo) agreements (in other words, agreement to sell an asset and
buy it back at a later date).
16
In particular, after the start of the financial crisis in 2007-08, the
ECB progressively tightened the rating and structural requirements for ABS it would accept
as repo collateral, with the result that using ABS as repo collateral became expensive, in
particular compared to covered bonds. Hence, after 2008, the amount of eligible ABS
declined by 38 percent while covered bonds increased by 14 percent, until in mid-2012
covered bonds overtook ABS as delivered repo collateral for the first time since 2007.
17

A final blow to the ABS market during the crisis came from the insurance sector. Insurance
funds, traditionally large buyers of ABS products, were also negatively impacted by the
introduction of more restrictive regulation in response to the crisis, and consequently limited
their ABS purchases.
18

Country-by-country, the smallest players in the market (eg Belgium and Ireland) saw a
decrease in new issuance of more than 95 percent from the peak, while, among the main
issuers, new issuance in Italy, the Netherlands and Spain dropped by about 73 percent. In
Germany, the decline was 80 percent.
19
It is interesting to look at the United Kingdom: here,

16
Id.
17
Id.
18
Id.
19
Id.

14

new issuance represented almost a third of total European issuance on average until 2008, but
after the peak, UK flows dropped by 90 percent, with new issuance in 2013 representing less
than 20 percent of the European total. Considering this change in the UKs role in the
structured product market, new issuance in the euro area rose to 73 percent of total European
new issuance in 2013, from 63 percent in 2008. However, in volume terms, euro-area
issuance was slashed from $766 billion to $175 billion.
Interestingly, the collateral behind the ABS products also varied during the crisis, with the
collapse in the issuance of Real Mortgage Backed Securities (RMBS) and European
Collateralised Debt Obligations (CDOs), with issuance of both dropping by 90 percent
between 2008 and 2013 (Figure 2). The composition of overall issuance thus changed, with a
(relative) increase in ABS with consumer credit as collateral, and a marginal increase in ABS
backed by loans to small and medium-sized enterprises.
Figure 2: Breakdown of ABS issuance per type of collateral, various years

Source: SIFMA (July 2014).
Another indication of the reduction in the liquidity of this product is the amount of new
issuance placed on the market relative to ABS retained by originators, such as banks that
package securitised products (Figure 3). Before the crisis, almost 70 percent of new issuance
was placed on the market, and the remainder retained by originators. After 2008, the share of
new issuance placed on the market dropped to below 10 percent, signalling virtual market

15

refusal of these securities. More recent figures point to a market placement rate of about 40
percent, though at much lower overall volumes.
20

Figure 3: Retention rate of ABS products, various years and type of collateral

Source: SIFMA (July 2014).
However, originator retention rates vary by type of instrument. Despite the dramatic
reduction in issuance of CDO and Commercial Mortgage Backed Securities (CMBS),
currently around 90 percent of their new issuance is placed on the market, probably because
of demand from specialised investors, who could no longer find these securities on the
market. By contrast, there is weaker market demand for RMBS, generic ABS (car loans,
leases, etc) and SME ABS. In particular, almost all new SME ABS are retained on banks
balance sheets, with only 10 percent placed on the market.
B. Potential for increase in size
The outstanding amount of European securitisation, at the end of 2013, was
approximately 1 trillion, of which roughly half was placed on the market (Table 1 on the
next page). For comparison, at its peak in 2008, the overall outstanding amount of the ABS
market reached more than 2.2 trillion. About 60 percent of the market (637 billion) is made
up of mortgage-backed securities (residential and commercial), followed by standard ABS
(car loans, leases, etc) with a volume of 150 billion, and SME ABS for 102 billion. CDOs
stood at 113 billion.
21


20
Id.
21
Id.

16

Table 1: Total outstanding amount of EU securitised products

Source: SIFMA data Q1-2014.
The quality of these securities varies in terms of collateral type, with about 77 percent of the
amount outstanding rated above BBB, and therefore eligible for collateral transactions with
the ECB3 (Figure 4). The highest presence of high-rated securities is in France and Germany,
while Italian and Spanish ABS are more concentrated in the single A category, in line with
the evolution of the sovereign ratings in these countries. In terms of collateral type, SME
ABS are the lowest quality, probably due to the heterogeneity of the collateral and the
deterioration of companies balance sheets during the crisis. Moreover, in the case of SMEs
the quality of financial information reported in balance sheets is in general less regular and
accurate, an issue that also impacts negatively on the rating, because it implies a more
negative assessment of the probability that loans will be repaid. From 30 to 40 percent of
SME ABS are currently estimated to be sub-investment grade or not rated. Italy and Spain are
also the countries with the main outstanding volumes of SME ABS.


17

Figure 4: Rating of ABS products per type of collateral and country, 2013

Source: SIFMA
Given these figures, what potential for growth does the ABS market have overall, on the
basis that potential ECB purchases could create sufficient demand to revitalise the market?
Looking at the markets for collateral, data from monetary financial institutions shows (Figure
5) that the outstanding amount of mortgages for house purchases (thus secured lending)
stabilised at about 3.8 trillion in 2013 in the euro area, while the outstanding amount of bank
loans to non-financial corporations (NFC) in the euro area reached about 4.2 trillion. Figure
5 also compares the trend in the mortgage market to that in the RMBS market (left panel),
and NFC loans to SME ABS (right panel).

In both cases, there has been an evident fall in volumes of both types of securitised product,
with SME ABS performing relatively worse. The reason is the contraction of credit demand

18

coupled with bank deleveraging, leading to a contraction of NFC loans, compared to relative
stability in the volume of mortgage loans outstanding. Hence, collateral for SME ABS
operations has been squeezed relatively more compared to RMBS. Moreover, one has to
consider the negative regulatory impact on capital requirements associated with the issuance
of this type of product.
The question is, then, how much of these outstanding volumes of loans to NFCs or mortgage
loans worth 8 trillion could be translated into new issuance of RMBS and SME ABS. In line
with Batchvarov (2014), we make estimates on the basis of mortgage loans to households and
loans to non-financial corporations, for the countries that represent 80 percent of the total
portfolio of outstanding loans in the euro area (Germany, France, Italy, Spain, Ireland and
Portugal). The share of SME loans in total NFC loans, as estimated by the OECD (2013),
varies between these countries. Applying these shares to the euro area, the implied euro-area
SME ABS share is approximately 25 percent of total outstanding NFC loans.
On the basis of the conservative assumption that only 50 percent of the 8 trillion of existing
loans is ultimately eligible for securitisation (eg for reasons of maturity or loan
characteristics), we then introduce a different haircut so that the securitised products attain an
investment grade rating (to be eligible as a collateral for the ECB). Unlike the standard
assumption of a homogeneous 10 percent haircut for subordination for all categories of assets
(Batchvarov, 2014), we apply a more prudential and differentiated haircut for the three main
categories of assets selected, as retrieved from updated statistics for these securities
(SIFMA): 35 percent for SMEs loans, 30 percent for ABS backed by loans to large
corporations, and 15 percent for mortgages.
Based on this, we estimate a maximum amount of securitisation of roughly 3 trillion
(compared to 4 trillion estimated by Batchvarov, 2014), broken down as shown by Figure 6
on the next page. It should be noted that SME ABS would represent the smallest fraction
(about 10 percent) of this market.


19

Figure 6: Estimates of potential ABS market for the euro area ( billions)

Source: Bruegel.
Table 2 on the next page shows that the estimated breakdown of the potential overall ABS
market by country will vary according to the size and composition of each countrys
underlying market for collateral5: Germany, France and Italy would each represent almost 20
percent of the total NFC-loan ABS, while in terms of SME ABS, Spain would count for a
fifth of the whole amount, with Germany and France accounting for about 17 percent each.
The role of Germany is also significant in the RMBS market, representing about 26 percent
of the outstanding amount, followed by France, Spain and Italy.


20

Table 2: Potential availability of ABS per country (%)

Source: Bruegel estimates based on MFI data (March 2014) and OECD
C. The revival of the ABS market: options
Our estimates show that the euro-area securitisation market has the potential to build
significant volume and to be sufficiently liquid for use in possible non-conventional monetary
operations. However, a number of trade-offs must be considered relating to the timing of
ABS market measures, and the underlying size of the market at that moment: the earlier that
measures are taken, the more restricted will be the type of ABS product that can be targeted
for direct purchase (eg SME ABS only), reducing the impact of potential ECB operations on
credit markets.
These trade-offs arise because the current securitised products on the market differ in terms
of underlying characteristics, ie collateral type and thus rating, borrowers quality and
geographic distribution, loans residual maturity, frequency of repayment, cost of credit, type
and amount of interest (fixed or variable), prepayment rates and possible credit enhancements
built into the structure6. Because of these heterogeneous characteristics, only a fraction of
existing ABS products are ready to use, if ever, by the ECB. Moreover, within the existing
range of products, there are different implications of the ECB targeting for direct purchase
only SME ABS rather than RMBS. Undertaking specific regulatory steps aimed at
standardising the characteristics of securitised products in different countries might allow the

21

full activation of the estimated 3 trillion in potential ABS market volume, but reaching such
a figure would require time for implementation.
In the following sections we detail the ECBs options.
Option 1: Act small and fast
Option 1 would involve the direct purchase of very simple (plain vanilla) existing
ABS products with corporate credit exposure7. By pursuing this option, the ECB could act
immediately, but would have a limited direct impact on credit markets. Existing ABS
products limited to SMEs loans amount to 102 billion (Table 1). If the lease component of
generic ABS is included, one could add a further 15 billion. With respect to these figures,
the volume of securitised products available for immediate use with a rating above
investment grade is 60 percent of SMEs ABS and 50 percent of the lease components. As a
result, with these constraints, the maximum theoretical size of the ABS market for immediate
ECB intervention is about 68 billion. This is probably not enough to generate a direct impact
on credit conditions in the euro area.
This does not imply, however, that there is no role for an ABS market backed only by
corporate
Option 2: Act large and slow
Option 2 essentially implies reviving, deepening and integrating the euro-area ABS
market so it can be used as a new tool for non-conventional monetary policy. The ECB and
the Bank of England (2014b) point at improving the regulatory environment for ABS
products to better differentiate the necessary prudential requirements for relatively simple,
robust and transparent ABS products (eg consumer finance ABS, RMBS and SME ABS)
from more complex and potentially illiquid instruments. By revamping this market, these
instruments could be used effectively as a direct vehicle through which non-conventional
monetary operations could be run. Clearly, the trade-off here is that developing the latter
would require a number of changes to underlying regulation, and would thus take time.
To achieve a high-quality, simple and transparent European ABS product, two areas of
regulatory change should be developed: one on collateral rules, for the corporate loan market
in particular; the other on ABS product characteristics, ie the format to be applied to various
types of ABS10.

22

D. ABS product characteristics
Two issues also need to be addressed in terms of the format of securities:
Common guidelines on ABS structure
The risks of ABS are embedded not only in the type of underlying collateral that is
securitised, but also in the way collateral is sliced and packaged (see Box 1 for an overview
of the basic elements constituting an ABS product).
A common structure for each type of collateral would ease the origination process and imply
that the spread between different bonds in each rating category would depend only on
differences between collateral characteristics (such as geographical distribution, maturity or
the legal framework applying to default). Common structure could tremendously boost
market liquidity. Also, the cost of creating the instruments should decrease, as pan-European
banks will be able to leverage the size of their loan pool across European markets. With a
common structure, the rating framework should become more homogeneous as well, cutting
the cost of providing ratings and making the European ABS market much more similar to the
US market. Ratings will become more closely related to collateral characteristics and less to
the sovereign rating of the originator, and monitoring by rating agencies during the life of the
product will focus more on collateral evolution. A straightforward way of achieving this
result would be to build on the idea, already hinted at by the ECB, that only an ABS format
with a plain vanilla structure would be eligible for purchase by the ECB.
Common guidelines on the setup of SPVs within national borders
Another key factor in the underlying heterogeneity of the securitisation process is also
related to the different role that the Special Purpose Vehicle (SPV) might acquire (see Box
1). The SPV is a unique entity the role of which is the acquisition of an identified pool of
assets. The SPV is the holder of the collateral within the securitisation. The owner of the
SPV, whether it is the originator or a pool of originators, bears the risk of the SPV. A
possible guideline is that an originator could establish only one SPV for all the transactions of
the same type to be issued, instead of one SPV for each transaction. In the case of a single
SPV for all transactions, since the vehicle is immediately available, transaction costs will
diminish and the process of securitisation will speed up.

23

In cases in which a group of originators considers creating a common SPV for the ABS
market (whether or not specialised by type of collateral) the risk will be borne by the owners
of the SPV. A Banque de France initiative to re-start the securitised SME loan market has
worked along these lines.
The creation of a joint SPV within national borders allows for sharing of set-up and operating
costs. Standardised legal documentation used by the originators will also reduce costs and
operational frictions, and make the SPV a very efficient credit claims mobilisation tool.
Whether such a set-up is legally compatible with each country's legal framework, and
whether such a choice could be more efficient from the market point of view, are however
open questions. The answer in part would depend on the risk weighting assigned to the
shareholders of the SPV.
Another reason for the creation of a joint SPV is that, once a common ABS structure with the
same collateral type is defined ex ante, there will be less flexibility or creativity in the
structuring phase, so that certain type of collateral, if available in volumes that are
insufficient to respond to the structuring requirements (such as over- collateralisation
criteria), could not be used. While in the past the lack of assets to create credit enhancement
in the form of over-collateralisation was compensated for by other forms of internal or
external credit enhancement, the absence of this choice in the new system could place a limit
on the participation of small and medium players in the ABS market, because of lack of
collateral. The problem could however be circumvented through the creation of an SPV at
national level, or jointly created by small originators. This would stimulate more
consolidation of the banking sector within countries.
In summary for option 2, we can conclude that, under the Single Supervisory Mechanism
headed by the ECB, there is ample room to refine all the existing regulation, as we have
discussed, in order to create a large pan-European market for simple, robust and transparent
ABS products. However, it is also clear that, because of the time it will take to implement the
necessary regulatory changes, these developments might only be relevant for the next
business cycle, unless this process is accelerated.
Option 3: Act bold
If direct outright purchases in the ABS market are really meant to significantly
enhance the functioning of the monetary policy transmission mechanism within the next few

24

months (ie working immediately, and not just as potential amplifiers of the TLTRO), there is
a third alternative to the fast/small versus slow/large options we have analysed. A further
option, already suggested by Claeys et al (2014), is the direct purchase of RMBS.
In fact, the improvement in banks balance sheets would be marginal (given the lower capital
absorption of these instruments), while clearly a careful assessment should be made of the
need to minimise the impact of RMBS purchases on house prices (and the ensuing wealth
effects for households) in the euro area, in order to avoid new bubbles, or to stop the
correction of existing ones. While the monitoring exercise now routinely carried out as part
of the Excessive Imbalance Procedure can be deployed to avoid such a risk, the fiscal
implications of these actions should nevertheless be carefully assessed.
XI. MORTGAGED BACKED AND MORTGAGE BACKED SECURITIES IN THE EU: A
COMPARATIVE ANALYSIS
A. I ntroduction
The bulk of outstanding European RMBS issuance is from the UK, Spain, the
Netherlands, and Italy. As one shift focus from one country to another, RMBS dynamics
change dramatically, and thus, a good grasp of the differences is required for any proper
analysis.
22
A very important distinction is that most mortgage lending in the United States is
treated as asset-based, meaning that if a borrower defaults, the lender typically can only
foreclose on the mortgaged property to recover any losses (even in the judicial foreclosure
states, lenders rarely choose to file for a deficiency judgment).
23
In Europe (and most of the
rest of the world), mortgage lenders typically have full recourse to the borrower and in case
of default, the lender can file a lien against the borrowers other assets and future income
streams. This creates a much larger incentive in Europe to repay the mortgage, whereas US
borrowers can default on their loan and abandon their home, with the main impact being a
negative mark on their credit score. In addition, the US government plays a much larger role
in the mortgage market, indirectly holding the credit risk of more than 50% of outstanding
US mortgages via Government Sponsored Enterprises (e.g., Fannie Mae, Freddie Mac, and

22
Hikmet Sevdican & Mike Li, European Residential Mortgage-Backed Securities: Key Considerations,
DYNAMICCREDIT 2 (2014) available at
23
UK Prime MT vs. US Jumbo RMBS, Banc of America/Merrill Lynch, August 20, 2009

25

Ginnie Mae), and guaranteeing approximately 85% of new mortgage production, whereas the
private sector holds most ofthe mortgage credit risk in Europe.
B. Securitisation structure
The typical securitisation is a standalone transaction where a pool of assets backs a
single RMBS transaction and its tranches. US and Dutch RMBS are structured in this format.
However, the US predominantly has pass-through transactions, where payments are filtered
through the cash flow waterfall to be paid to the note investors. Dutch transactions typically
feature the loan originator acting as a swap counterparty, which receives all of the mortgage
payments and in exchange pays the required amounts to the noteholders and guarantees an
amount of excess spread (net mortgage interest less coupons due on the notes) in the
transaction. Given an equivalent level of defaults and most all else being equal, Dutch RMBS
will perform better relative to US RMBS. However, Dutch RMBS performance becomes
much more aligned with the health of the institution sponsoring the transaction, potentially
impacting cash flows as well as market perception of risk. This is a double-edged sword as it
adds a layer of support to the transaction while introducing an additional element of risk.
24

In contrast, U.K. Prime RMBS are largely structured in a master trust format, similar to credit
card securitisations, where a pool of mortgages supports several securitisations having
various currencies, maturities, coupons, and redemption dates. The first key difference is that
master trust pools are revolving pools, where the pool composition changes on a month-by-
month basis as old loans amortise and new loans are added to the trust, making issuance
vintage less meaningful than in static transactions. The second is the complicated system of
rules governing the trust payment waterfall as trust cash flows are allocated to pay different
notes depending on the delinquency rate, mortgage prepayment speed, and upcoming tranche
redemption dates.
A common focus when valuing most European RMBS is assessing the likelihood of the
transaction being redeemed on its expected time call date3. This assessment is based on a
number of factors, the most important of which are: the capacity of the sponsoring institution
to do so, either via taking the mortgage loans back onto the balance sheet or through a new
bond issuance; its motivation to retain access to the securitisation markets as a future funding
option, and the performance of the transaction.

24
Id.

26

As the sponsoring institution will take the mortgages and the reserve fund, a cash account
established for the securitisation to absorb losses not covered by excess spread, onto its
balance sheet (at least temporarily), the effect on its capital adequacy ratios is of paramount
importance. Based on current secondary market spreads, calling a transaction and transferring
the remaining portfolio into a new issuance is likely to be an expensive proposition with
regard to funding costs.
However, the size of the reserve fund can often determine whether it is economically feasible
for the call option to be exercised. If losses are expected to be less than the projected
cumulative excess spread, then calling a transaction would generally result in the
improvement of the sponsors capital. The reserve fund is typically greater than the risk-
weighted capital charge of the mortgages in a performing securitisation and the benefit to the
capital ratios would help mitigate the impact of the higher funding costs. However, a
transaction which has already begun or is expected to use its reserve fund to offset losses is
likely to have a negative impact to a banks capital ratios if it is called (as the risk-weighted
capital charges relating to the poorly performing mortgages overtake the benefit from the
remaining cash reserves). Particularly where bonds are priced to the call date, greater than
anticipated pool deterioration can result in higher required yield for both the additional risk of
principal loss and the potential extension of cash flows. The latter issue has a much greater
impact on required yields in the case of a time call as opposed to a clean-up call, because it
affects senior bonds severely as well.
While a framework has been described by which to analyse these types of securities, it is far
from a definitive guide to European RMBS. Accurately valuing European RMBS is not a
simple task, even for many familiar with the asset class. Inconsistent information reported by
servicers, the difficulty of finding historical data points, significant differences between
mortgage markets within the European Union, and the difficulty of appropriately pricing the
bonds make the analysis process a challenging proposition. However, for those who can
navigate the obstacles, investing in this asset class can be a lucrative endeavour.
XII. MORTGAGE BACKED SECURITIES (MBS) IN INDIA
The beginning of Mortgage Backed Securities (MBS) in India was made in August 2000,
when National Housing Board (NHB) issued the first MBS with issue size of INR 59.7
crores, originated by HDFC Ltd. Till October 2004, NHB has made 10 MBS issues in the

27

secondary market with total issue size of INR 512.27 crores and comprising of 35,116
housing loans, shown in exhibit 1.
While the number of housing loans has increased, the number of MBS issued so far has
remained more or less constant for all the years since 2000, on the basis of total issue size.
Also, while the volumes of securitisation in general have continued to zoom, the RMBS
activity remains limited. The MBS issued so far has been for an aggregate outstanding
principal of INR 663.91 crores, shown in exhibit 2. The aggregate principal outstanding
against the MBS issued till 2003 was just 0.5% of the total disbursements made over these
years. On an annual basis the percentage of loans converted into MBS of the total
disbursements made in that year has declined from 0.96% in 2003 to 0.34% in 2003. While
2004 has seen comparatively better performance with MBS of issue size INR 144.75 crores
already issued, the performance of India with regard to developing the secondary market for
home mortgages is far from satisfactory.
One possible explanation for the declining interest in issuing mortgage backed securities is
the fact that the spreads in mortgage lending have come down drastically over time. Interest
rates have declined, and there is stiffening competition. Housing finance has suddenly
become the coveted asset class for a bank to house on its balance sheet which has been
responsible for squeezing the spreads. If the spreads are thin, will mortgage originators
securitize? Essentially, the question is one of mindset. There is a notion that securitisation
transactions were driven by a gain-on-sale motive
25
. If gain-on-sale is the driving motivation,
it is understandable that where spreads have dwindled, the extent of gain-on-sale will become
less significant. However, the gain-on-sale is one of the many motivations in securitisation.
The most predominant motive is the reduced cost of funding in any mature securitisation
market, a securitisation transaction must result into lower weighted average cost of funding.
If it does not, it is a clear signal that either the rating agencies are dictating too high credit
enhancements, or that the investors are demanding too high premiums possibly due to lack of

25
Gain on sale is the profit that is booked, upfront, when a portfolio of assets is securitized. In accounting as in
legal parlance, securitisation is a sale, and the sale might result into a gain or loss on sale. Usually, securitisation
transactions result into a gain on sale, if there is a positive difference between the rate of return inherent in the
mortgage pool and that in the issuance of securities which is obviously expected. Even if the pool is sold at
par, but with a contractual right to derive profit in future in form of service fees or any other retained interest, if
conditions of off-balance sheet accounting are met, accounting standards will permit profit booking by bringing
on books the fair value of the retained interest.

28

understanding of the inherent risks in RMBS. Both these factors are signals of market
inefficiency inefficiency is necessarily transient, if the extraneous hurdles to development
of the market are removed. So, we expound in this article that the reduced interest in
securitisation is in fact the product of inefficiencies of the system, which have set in process a
vicious cycle inefficiency breeding inefficiency.
XIII. ASSET BACKED SECURITIES (ABS) IN INDIA
(a) Auto loans:
Though securitisation was made popular by housing finance companies, it has found
wide application in other areas of retail financing, particularly financing of cars and
commercial vehicles. In India, the auto sector has been thrown open to international
participation, greatly expanding the scope of the market. Auto loans (including installment
and hire purchase finance) broadly fulfil the features necessary in securitisation. The security
in this case is also considered good, because of title over a utility asset. The development of a
second hand market for cars in India has also meant that foreclosure is an effective tool in the
hands of auto loan financiers in delinquent cases. Originators are NBFCs and auto finance
divisions of commercial banks.
(b) Investments:
Investments in long dated securities as also the periodical interest instruments on
these securities can also be pooled and securitised. This is considered relevant particularly for
Indian situation wherein the FIs are carrying huge portfolios in Government securities and
other debt instruments, which are creating huge asset-liability mismatches for the institutions.
Government securities issued domestically in Indian Rupee can be bundled and used to back
foreign currency denominated bonds issues. It would more be of the nature of derivative.The
subordinated Government securities are intended to absorb depreciation in the value of the
rupee thereby protecting to certain extent the senior securities that the Government securities
back. The senior securities are directed at the international capital markets and are structured
using offshore SPVs by countries like Mexico.
Similarly, under the STRIPs mechanism, the interest coupons on the Government dated
securities are separated and traded in the secondary markets. Such interest instruments can
also be bundled and securitised in the normal asset securitisation method.

29

(c) Others:
Financiers of consumer durable, Corporates whose deferred trade receivables are not
funded by working capital finance, etc are Originators of other asset classes amenable to
securitisation. Corporate loans, in a homogeneous pool of assets, are also subject to
securitization There is virtually no known instance so far in the United States or in other
countries of an ABS transaction having failed. This is despite the fact that the markets for
ABS are exceptionally large. Industry experts attribute this to three main factors. ABS
transactions are always planned, prepared and carried out with great care. Second reason is
the intrinsic valueof the paper and in particular the high level of transparency on the quality
of the underlying assets. Third, ABS transactions are sponsored generally by large and well
known institutions which can't afford to jeopardise their reputation with investors, the
majority of which are institutional investors.
XIV. LEGAL INFRASTRUCTURE FOR ABS AND MBS IN INDIA
By far, the most significant barrier to development of securitisation in India is the
presence of certain antiquated laws that date back to the 19
th
century and are completely out
of place with the present market reality. Unfortunately, these laws are stumbling blocks to the
development of securitisation in the country. It is not that this paper brings those issues to the
notice for the first time this has been done by every single committee that went into the
matter, starting from the Andhyrujina panel to the several consulting groups of the Asian
Development Bank. However, no concrete measures have been taken by the government to
resolve the issues.
A. The Securitisation Act a futile exercise
To many, it might sound surprising that there is an enactment called the Securitisation
and Reconstruction of Financial Assets and Enforcement of Security Interests Act
(SARFAESI) enacted in 2002. The long title suggests that the Act does something about
securitisation in fact, the Act is focused on enforcement of security interests, and whatever
skeletal provisions it had enacted about securitisation have been completely useless in
practice. The whole scheme of the Act was flawed it envisaged the concept of a
securitisation company, supposedly a company in the business of securitisation, which will
be licensed and regulated by the RBI. No such companies have come into existence, and
therefore, the provisions of the Act on securitisations have been of no avail whatsoever.

30

Perhaps in realization, the Finance Minister announced as a part of the Budget Speech
presenting the Union Budget 2005 that the government will appoint a high-powered
committee to examine all aspects of securitisation transactions.
B. Problems of the existing legal system
The existing legal system, as far as it relates to mortgage backed securitisation, suffers
from two basic legal infirmities. It was easy to resolve both of these without involving any
Centre-State issues and it is only surprising as to why this has not been done.

C. Mortgage debt regarded as immovable property
The first problem is that a mortgage backed security, being an interest in a mortgage,
is treated by law as an immovable property. This may be resolved by providing, that a
receivable which as the security of a mortgage will not be deemed to be an immovable
property, thus taking mortgage receivables out of the domain of the Transfer of Property Act,
a law with its foundations in the 19
th
century.
D. Stamp duty issue
The other issue is the issue of stamp duty. The stamp duty also originates from an
archaic concept of English law whereby a receivable (actionable claim) is treated as a
specific form of property, for the transfer of which a written instrument is required. This
principle is enshrined in sec. 130 of the Transfer of Property Act. If this provision was
deleted or amended, obviating the need for a written instrument, one would not need a
conveyance to transfer a mortgage debt, and therefore, the whole issue of stamp duty could
be resolved in one stroke.
Currently, the system works under an extremely inefficient structure of stamp duty
concession notifications. Several states have issued such notifications, notably, Maharashtra,
Gujarat, Tamil Nadu, West Bengal, etc. As could be expected, the language of the
notifications is different, and interpretations are mind-boggling. It is easy to understand why
securitisation pools have been restricted to those states where these notifications exist, thus,
keeping the borrowers from the rest of the country outside the securitisation framework.
The stamp duty issue is being made to look like a Centre-State issue, but in fact it is not.
None of the States would have projected huge revenues out of securitisation stamp duties in
States which have not made the stamp duties practical enough, there are not any securitisation

31

transactions at all. So the options are clear either make it practical, or the transactions do
not happen at all.
E. Mortgage foreclosure laws
Another difficulty commonly cited so far was the lack of mortgage foreclosure laws.
Under traditional civil law (sec. 67 of the Transfer of Property Act), mortgage foreclosure
necessarily required the decree of a civil court, which could take anywhere between years to
ages.
This problem has substantially been addressed in terms of legal infrastructure - only requires
institutional structure to handle foreclosures. The SARFAESI Act made it permissible for
banks (and notified finance companies) to foreclose mortgages (and other security interests)
without approaching a Court. While the legal provision therefore exists, all that is required is
development of institutions that could carry out the law and logistics inherent.
F. Clarity on taxation
Securitisation structures are going on without any clarity whatsoever on the tax treatment of
special purpose vehicles. Securitisation SPVs are created as trusts, and it is believed, without
any precedent or basis, that they will be tax transparent and that the tax will be imposed on
the ultimate investors.
Given the fact that the pass-through rules in the US taxation are quite complicated and not
every transaction qualifies for pass-through or see-through treatment, believing securitisation
SPVs to be tax transparent may be quite dare-devilish. In fact, with the kind of recycling,
reconfiguration of cash flows and stripping of inflows, it is quite likely that the transactions
are not treated as pass-through.


32

Exhibit 1: MBS Issued by NHB in India
NHB
SPV Originator
Date
of
Issue
Pool Size
Issue
Size
(in
crores)
Pricing
Structure
MBS
Coupon
Credit
Enhancement
Rating
(with
Agency
Name)
No. of
Loans
Principal
Outstanding
HP1 HDFC Ltd
Aug-
00 8329 88.32 59.7 Par 11.85%
A-B Structure
& Guarantee
of Rs. 1.10 Cr
AAA
(So) by
CRISIL
LP1 LIC HFL
Aug-
00 2777 47.54 43.84 Par 11.85%
A-B Structure
& Cash
Collateral
AAA
(So) by
CRISIL
LP2 LIC HFL
Apr-
01 4292 74.22 46.84 Par 10.25%
A-B Structure
& Collateral
AAA
(So) by
CRISIL
CP1 Canfin Ltd
Apr-
01 4257 63.4 44.85 Par 10.25%
A-B Structure
& Cash
Collateral
AAA
(So) by
CRISIL
CP2 Canfin Ltd
Jun-
02 4256 85.35 58.19 Par 8.90%
A-B Structure
& Cash
Collateral
AAA
(So) by
CRISIL
BP1 BOB HFL
Apr-
03 3548 77.15 59.65 Par 6.89%
A-B Structure
& Cash
Collateral
AAA
(So) by
CRISIL
CP3 Canfin Ltd
Jun-
03 2007 64.13 54.45 Par 6.25%
A-B Structure
& Cash
Collateral
AAA
(So) by
CRISIL
DP1
Dewan
HFL
Mar-
04 3155 69.79 61.83 Par 6.98%
Bank
Guarantee
@2% of PTC
A Rs. 1.24
crore at time
of issue
AAA(So)
by
FITCH
and
CARE
AB-1
Andhra
Bank
Mar-
04 1437 50.36 42.95 Par 6.15%
A-B Structure
& Cash
Collateral of
Rs.68 lakhs
AAA(So)
by
CRISIL
BH-1 Birla HFL
Mar-
04 1058 43.65 39.97 Premium 6.60%
A-B Structure
& Cash
Collateral of
AAA(So)
by ICRA

33

Rs.9.81 crore
Total 35116 663.91 512.27

Note: All amount in INR Crores
Source: National Housing Banks Annual Reports and www.nhb.org.in

Exhibit 2: Issuance of MBS in India (Year wise consolidation)
S.No. Year
No. of
Issues
No. of
Loans
Principal
outstanding
Issue
Size
Total
Disbursement
% of loan
issued as
MBS
1 2000 2 11106 135.86 103.54 14110.29 0.96%
2 2001 2 8549 137.62 91.69 19058.68 0.72%
3 2002 1 4256 85.35 58.19 23858.43 0.36%
4 2003 2 5555 141.28 114.1 42026.86 0.34%
5 2004 3 5650 163.8 144.75
TOTAL 10 35116 663.91 512.27

Source: National Housing Bank


34

XV. ASSET - LIABILITY MANAGEMENT
Article 6 of the Law on Mortgage-backed Bonds stipulates that mortgage loans shall be
included into the calculation of the principal cover at the value of their outstanding principal but at
no more than 80% of the mortgage appraisal value of the real estate as housing units, including
leased ones, and at no more than 60% of the mortgage appraisal value of the real estate as villas,
seasonal and holiday housing units used as collateral on mortgage loans. Substitution cover of
mortgage-backed bonds from any issue may not exceed 30% of the total amount of liabilities of the
issuing bank under that issue.
Mortgage-backed bonds cover from any issue (the sum total of the principal cover and the
substitution cover) may not be less than the total amount of liabilities towards the principals of
mortgage-backed bonds from that issue which are outstanding and in circulation outside the issuing
bank. In making calculations under the previous paragraph for mortgage-backed bonds and assets
constituting their cover denominated in different currencies, the official foreign exchange rate for
the Bulgarian levy to the respective currency quoted by the Bulgarian National Bank of the day of
the calculation shall apply. A loan recorded in the register of the cover of mortgage-backed bonds
from a particular issue may be repaid at any time by bonds of the same issue at their face value.
XVI. TRANSPARENCY
Banks (the only eligible issuers of mortgage bonds) produce regular reporting to Banking
Supervision authority Bulgarian National Bank (BNB), and provide and publish financial
information on a monthly basis. The public banks are reporting issuers and submit all required
information to the regulated market Bulgarian Stock Exchange Sofia (BSE), as well as to the
Bulgarian Financial Supervision Commission (FSC). No additional specific measures in respect to
the mortgage bonds are currently announced.
26

XVII. COVER POOL MONITOR AND BANKING SUPERVISION
Cover pool is managed by the issuing bank which should have adopted internal rules for
maintaining the cover pool, the rules for access to the cover pool data base and the regularity of the

26
Taylor, J, "The Monetary Transmission Mechanism: an Empirical Framework", Journal of Economic
Perspectives, 9, pp. 11-26.

35

update of the cover. Bulgarian National Bank carries out general assessment of the banks, including
issued mortgage bonds as part of general banking supervision.
27

XVIII. SEGREGATION OF COVER ASSETS AND BANKRUPTCY REMOTENESS OF COVERED
BONDS
After the record of the assets in the register as a cover of mortgage-backed bonds of a
particular issue may be used as collateral solely for the liabilities of the issuing bank on that issue.
The issuing bank may not allow any encumbrances on its assets constituting the cover of
outstanding mortgage-backed bonds. The issuing bank accounts assets recorded in the register of
mortgage-backed bonds cover separately from the rest of its assets.
The issuing bank shall keep a public register of the cover of mortgage-backed bonds issued by it as
the register is kept separately by mortgage-backed bonds issue. In case of declaring the issuing bank
bankrupt, the assets recorded as of the date of declaring the bank bankrupt in the register of the
mortgage-backed bonds cover shall not be included in the bankruptcy estate. Proceeds from the
liquidation of assets recorded in the register as a cover on a particular issue of mortgage backed
bonds are distributed among the bondholders from that issue in proportion to the rights under their
bond holdings. Any funds remaining after settling the claims under mortgage-backed bonds from a
particular issue is included in the bankruptcy estate.
The asset pool under the above mentioned paragraphs are managed by a holders trustee of
mortgage-backed bonds which is appointed by the bankruptcy court when it has been established
that the bank has outstanding liabilities under mortgage-backed bonds. The trustee is managing the
assets by individual mortgage-backed bonds issue.
The Trustee shall be a person who meets the requirements of Article 217, paragraphs 1 and 2, items
1-3 of the Public Offering of Securities Act and is not engaged in any relationship with the issuing
bank or any of the holders of mortgage-backed bonds which give reasonable doubt as to the
formers impartiality. The Trustee shall have the powers of an assignee in bankruptcy in respect of
the asset pool described above, as well as in respect of any outstanding liabilities of the issuing bank
under mortgage-backed bonds.

27
Orlowski, L, "Monetary Policy Regimes and Real Exchange Rates in Central Europe's Transition
Economies", Economics Systems, 24, pp. 145-66 (2000).

36

The Trustee shall manage the above mentioned assets separately for any mortgage-backed bond
issue. The Trustee shall sell the above described assets under the procedure set forth in Articles
486-501 of the Civil Procedure Code and shall account any proceeds to an escrow account opened
for each issue with commercial banks as determined by the Bulgarian National Bank.
28
The Trustee
shall publish in the State Gazette (Darzhaven vestnik) and in at least two national daily newspapers
the place and time for the tender for the sale of assets under the procedures of previous sentence not
later than one month prior to the date of the tender. The bondholders of any issue of mortgage-
backed bonds of a bank which has been declared bankrupt shall have the right to obligate the
Trustee to sell loans included in the issue cover to a buyer specified by them and the Trustee shall
follow precisely the decision of the Bondholders General Meeting under the previous sentence.
The liabilities of the issuing bank under a mortgage-backed bonds issue shall be deemed repaid
when the amount of outstanding principals of the sold loans becomes equal to the total amount of
liabilities on principals and interest accrued on the bonds prior to the sales.
XIX. BULGARIAN MORTGAGE SECURITIES MARKET INFORMATION
Since the adoption of the Bulgarian Law on Mortgage-backed Bonds in 2000 the mortgage
bond issues in Bulgaria total 28. There were no new issues in 2012. The volume of issued
mortgage-backed bonds is EUR 268.3 m originated by 11 issuing banks.
A. Market Demand for Securities
Currently the bond market in Bulgaria is equal to the government securities market. So far,
only few companies dared to issue corporate bonds. These are Prosoft AD, Kaolin AD, Energija AD
and the Black Sea resort Albena. All of the bonds are issued on the domestic market and are not
traded on the stock exchange (they were placed privately). Additionally, on the domestic market
were issued bonds of the Svistov Municipality and on the foreign market - small issue of eurobonds
of the Sofia Municipality.
Here are two examples of issues, which were placed successfully:
Prosoft AD issued 5-year corporate bonds in nominal value of BGL 300,000. The issue value is
equal to the face value of the bonds (the company took over all charges for the Securities

28
Amended; issue 59 of 2006; in force on the date of entry into force of the Treaty of Accession of the Republic
of Bulgaria to the European Union; amended; issues 52 and 59 of 2007; amended; issue 24 of 2009; effective as
of 31 March 2009.

37

Commission, marketing, etc.). A "buy-back" option is included in the contract. The interest rate is
the base interest rate of the Bulgarian National Bank + 6p for the first three years and the base
interest rate of the Bulgarian National Bank + 6.5p for the last two years.
Kaolin AD issued bonds with total volume of BGN 2,500,000 and 10% interest rate. The issue of
Svistov Municipality was not very successful. The total volume is BGL 371,000 and only about half
of it was placed. 18% of the issue were acquired by municipal firms which actually had to gain
from the money collected by the Municipality from the issue.
So, the main issuer of bonds in Bulgaria is still the Government. Investors in Bulgaria could acquire
government securities on the primary or the secondary market. On the primary market they can buy
securities on the auctions organized by the Bulgarian National Bank. Only the so-called "primary
dealers" (approved by the Bulgarian National Bank and the Ministry of Finance) may participate in
the auctions. These are banks or investment intermediaries (as defined by the Law on Public
Offering of Securities). Investment intermediaries may participate with:
Competitive orders for their account or for the account of their clients
Non-competitive orders on the account of their clients, which are not banks or investment
intermediaries.
The Bulgarian National Bank determines before the auction the share of the government bonds
offered for competitive and non-competitive orders.
The Bulgarian National Bank buys back the government securities before its day of maturity on
decision of the Minister of Finance on auctions, too. The issue which is to be bought back could be
replaced by a new issue of government securities or the face value and the interest could be paid to
the holder. Only competitive offers are being accepted. Main players (buyers) on the market are the
banks, the insurance companies, the newly created Fund for bank deposits guarantee, pension
companies, and individual investors.
29

B. Terms and conditions
Banks have largely unified the terms and conditions of the mortgage loans. This is the result
of substantial legal regulation by means of laws and regulations of this aspect of the operations of
the banking institutions. The regulatory provisions of the Law on Banks and the regulations issued

29
Nenovsky, N., Chobanov, P., Mihaylova, G., Koleva, D.(2008), "Efficiency of the Bulgaria Banking System:
Traditional Approach and Data Envelopment Analysis", AEAF Working Paper, No. 1/2008.

38

by the Bulgarian National Bank are mandatory for the crediting businesses. The goal set in the
restrictive provisions is to limit risks to banks in the course of their crediting operations. It should
be noted though that the provisions are most liberal in respect to first mortgage on a piece of real
property with appraisable market value which exceeds by 25 per cent the amount of the loan. These
mortgages have a risk weight of 50 per cent and are included in the risk component of the balance
sheet in an amount equal to half of their balance sheet value. Of lower risk weight are only the
assets of the bank invested in available (cash) funds, on sight funds in the banks checking
accounts, receivables from the government and receivables from foreign banks, organizations and
countries on the special list of the central bank.
In order to get a mortgage loan approved by the bank, the credit applicant should generally meet the
following requirements:
1. Good creditability: It is assessed by the ability of the applicant to fulfill his obligations in respect
to the loan transaction under the terms of the contract so as not to threaten his financial situation and
not to affect the interests of other persons. Natural persons prove their creditability by indicating the
sources and amount of their incomes for a preceding period of time and the anticipated sources of
income for the period of payback of the loan. The individual should have sufficient funds left to
ensure his support after deducting the monthly mortgage payments from his income.
The credit rating of businesses is proven by an analysis of the information in their accounting
documents for a past period of time and an analysis of the forecast cash flows expected from the
expansion of operations or the development of a new operation.
2. Positive rating of the individual credit risk of the applicant, i.e. the likelihood of him failing to
fulfil or of him getting into a situation where he cannot fulfil the terms of the credit contract.
3. The value of the collateral should match the amount of the loan. There is no legal regulation of
the methodology of the appraisal. The law does place, however, certain requirements in respect to
the persons who are doing the assessment. They should possess licenses to engage in such activity
and should operate independently of the bank. The appraisal of the property must also provide
indication of the methodology used. It is often the practice of banks to have their own experts re-
examine appraisals made by outside assessors.
4. A mandatory element of the mortgage contract is the requirement that the client provides
supplementary collateral if the market value of the real property used should drop below the
required minimum corresponding to the amount of the loan.

39

5. There is a practice in the Bulgarian banking market for banks to allow credit users early
redemption of loans. There are just a few banks, which charge fees for early redemption of loans,
and such fees cover a portion of the loss of interest by the bank.
C. Pricing
The elements, which form the price of the mortgage credit are as follows:
1. Interest costs
As credits carrying the lowest risk of loss mortgage loans have the lowest interest rates. It is
usual practice for banks to set interest rates of loans depending on the purpose of these loans. The
interest rate covers the price of the monetary resource deposited increased with the profit required
from the credit transaction. A risk supplement is added to this base interest rate which in the case of
mortgages is the lowest possible.
Two approaches are used in everyday practice for assessing interest on loans: compounded interest
(redemption by annualized instalments) and simple decursive interest (redemption of principal and
interest on the loan calculated by the staircase method). With the staircase method interest is
accounted on the remainder of the loan whenever there is a change in the amount of that remainder
or whenever there is a change in the interest rate.
In the event of the principal becoming overdue or some other violation of the contract, the bank
accounts penal interest on the amount overdue until the elimination of the violation. The penal
supplement is a percentage added to the regular interest rate.
2. Fee for examination and appraisal of the collateral
This is a one-time fee collected upon submission of the application for the loan, which
covers the banks expenses for studying the client, the purpose of the loan, for appraisal of the
collateral, for obtaining the opinion of a credit expert and other costs.
30



30
Alexandru Minea and Christophe Rault, Some New Insights into Monetary Transmission Mechanism in
Bulgaria, Journal of Economic Integration, Vol. 24, No. 3 (September 2009), pp. 563-595

40

3. Loan service fee
This is usually an annual fee collected at the beginning of every period and covers the
costs of the bank incurred for monitoring the current creditability of the client, his compliance with
the provisions of the credit contract and for subsequent appraisals of the collateral.
4. Costs of property insurance
It is a usual requirement for the real property serving as collateral to be insured in favour
of the bank against all insurance risks that could bring about its destruction or a depreciation of its
market value. The insurance should be able to cover all receivables of the bank in respect to the
loan. The insurance is renewed every year until full redemption of the loan.
5. Costs of instituting collateral
These costs include state fees for notarization and registration of the transaction and
lawyer fees for preparing the deed.
D. I nterest rates
Generally, interest rates on loans in the Bulgarian banking system depend on the base interest
rate of the Bulgarian National Bank. The base rate is determined on the basis of the income from
short-term treasuries. Treasury auctions are held weekly and changes in their interest rates result in
changes of the base rate. The stability of the financial system during the last two and a half years
has resulted in stability (evidenced by the insignificant changes in treasury return) of the base rate.
For the entire period it has fluctuated between 3.5 and 5 per cent. This has enabled banks to refrain
from significant changes in the interest they charge on loans, or at least to refrain from changing
rates as a result of changes in the base interest rate. Stability has also resulted in a reduction of the
supplementary charges for general financial risk. The base rate charged by banks is now between 10
and 15 per cent. Various risk premiums are charged and can reach 10 per cent.
XX. ROLE OF FINANCIAL SUPERVISION COMMISSION
The Primary mission of the Financial Supervision Commission (FSC) is to assist with the
legal, administrative and IT resources to maintain the stability and transparency of the non-banking
financial system in Bulgaria as well as to protect the interests of investors and insured persons. By
general and financial supervision of the regulated entities, it monitors compliance with the legal
requirements. It also keeps a track of the financial position of the companies and credible

41

information about the same. Commission monitors activity through remote monitoring and spot
checks on the licensed market participants. The purpose of the activities performed by the FSC
control activities is to prevent and stop the offenses to ensure protection of the interests of investors
and insured persons.
XXI. REVIEW OF THE ABS AND MBS MARKET IN FIRST HALF OF 2014
In the first half of 2014 the market dynamics is characterised by maintenance of the record
low interest rate levels, in combination with minimal changes in the activity and volumes during the
period. The market showed some increase in the activity in the segment of the deposit lending deals,
while the secured trade is more limited than in the first half of the previous year. The trade between
banks and their clients grew in the first half of 2014 compared to the same period of 2013 by EUR
281.7 million. FX sales exceed purchases by EUR 1 645.1 million.
31
Like the same period of the
previous year, in 2014 the structure of the traded currencies remained almost unchanged as EUR
deals occupied almost 90% of foreign currency transactions. There were no secured deposit lending
deals in August and the repo-deals share was 36.6 per cent of the total interbank money market
transactions volume (BGN 1242.4 million); this share decreased compared to July, when it
amounted to 37.6 per cent (BGN 1377.2 million).
XXII. THE EU SECURITIZATION MARKET
The outstanding amount of ABS in the EU is currently about EUR 1,500 billion (see
Chart 1), or around one quarter of the size of the US ABS market. Since its peak in 2009, the
outstanding amount has decreased by a third, or EUR 750 billion. Residential Mortgage
Backed Securities (RMBS) form by far the largest securitisation segment, accounting for
58%; SME ABS is second, but account only for 8% of the market. The largest jurisdictions in
terms of outstanding ABS are the UK, Netherlands, Spain and Italy. In 2006, all primary
issuances were placed with end-investors and other banks; by 2009, almost all deals were
retained by the originating banks and many were placed as collateral with central banks.
Despite some small improvements since, public issuance volumes remain very low in the EU
and continue to be mostly originated in a small set of countries such as Germany, Netherlands
and the UK. The deals that have emerged from the more stressed economies either involve
short maturities, high yielding assets or SME transactions with specific support from the

31
Bulgarian National Bank, Market Review, No.8/2014.

42

European Investment Bank (EIB)/European Investment Fund (EIF) (e.g. via purchases of
senior or mezzanine tranches and/or via guarantees). Despite the low issuance and the modest
take-up by investors, most European structured finance products performed well throughout
the financial crisis, with low default rates. According to an analysis by Standard & Poors, the
cumulative default rate on European structured finance assets from the beginning of the
financial downturn, July 2007, until Q3 2013 has been 1.5%. Some asset classes such as
consumer finance ABS, SME Collateralised Loan Obligations (CLO) and RMBS have
experienced default rates well below this average and the performance of European structured
finance products has also been substantially better than US peers.
32
By way of comparison,
ABS on US loans experienced default rates of 18.4% over the same period, including
subprime loans.
XXIII. MEASURES UNDERTAKEN
To address earlier flaws in the securitization market, several financial regulations and
other initiatives have already been implemented in the EU. These are focused on removing
misalignments of interests and information asymmetries between issuers and investors,
including creating greater transparency to support accurate pricing of credit risk. The new
regulations include, amongst others, the following:
Risk Retention Rule (originators to maintain some skin-in-the-game), introduced in
2011;
measures that address information asymmetry with the securitization process by
increasing transparency of the securitization structures (the due diligence
requirement);
EU Credit Rating Agency legislation in 2013, making rating agencies more
transparent and accountable.
There have also been a number of public sector initiatives to improve the functioning of the
EU securitization market.
33
For example, significant steps have been taken to introduce

32
The corresponding default rates for European consumer finance ABS, RMBS and SME CLO are 0.04, 0.1 and
0.4% respectively.
33
The loan-level information also facilitates central banks risk assessment of ABS that counterparties use as
collateral in central bank credit operations. In fact, due to the increased level of transparency and standardization
in structured finance markets, the Euro system decreased its haircuts on ABS in July 2013, from 16% to 10% in
the permanent framework.

43

consistently-recorded loan-level data in all major ABS asset-classes throughout Europe via
the Euro system's and the Bank of Englands loan-level data initiatives.
34
Market participants
now have access to comprehensive asset level data, which helps prevent originators, seeking
to clean up their balance sheets, from off-loading through securitisation their lowest quality
assets. More broadly there are initiatives to ensure that information on asset performance,
transaction documents and cash flows associated with deal structures is publicly available.
This high level of transparency is an important first step towards restoring investor
confidence in European ABS. In 2013 the EIB and EIF launched a European-wide scheme to
increase their involvement in securitisation. The EIB Group ABS initiative for SMEs
provides credit enhancement for senior and mezzanine tranches of securitisations backed by
SME loans, including guarantees, and facilitates their execution.
35
Finally, there have also
been pan-European and national initiatives from the private sector to enhance transparency
and standardization in securitization markets.
XXIV. REMAINING ROADBLOCKS
The new regulations to protect investors, as well as policy makers and authorities efforts
to reduce the perceived regulatory stigma of ABS and to clarify their support for simple and
more transparent securitisations have so far failed to kick-start the EU securitisation market.
In large part, this may reflect current conditions, including: the availability of cheap funding
from other sources, deterring issuance of ABS; ongoing macroeconomic weakness in several
European countries, aggravating investors concerns about future asset quality deterioration
of the ABS collateral pools; and low demand for loans, making it difficult to build collateral
pools providing sufficient income to support the coupons and credit protection investors
demand. On this latter point, often referred to as deal economics, a sustainable recovery in
stressed euro area jurisdictions will only be possible as credit risk gradually recedes on the
back of structural reforms, strengthening economic fundamentals and unlocking profitable
investment opportunities. Still, while these shorter-term factors decrease, there are a number
of remaining structural roadblocks that may prevent investors and issuers from returning to

34
For the Euro system, this began in January 2013 for RMBS, SME ABS and CMBS. In January 2014, the
reporting requirements began for the other asset classes - auto, leasing and consumer ABS transactions and in
March 2014 for credit card ABS. For the Bank of England, reporting requirements were introduced in December
2011.
35
SME Loan Securitisation 2.0 Market Assessment and Policy Options, Working Paper 2013/19, EIF
Research.

44

the market. By addressing these issues now, the authorities can help to catalyse the return of
asset backed securitisation to support monetary and financial stability and economic recovery
XXV. REGULATORY TREATMENT
Regulatory initiatives have been designed to address the shortcomings highlighted during
the crisis. However, the proposed changes arguably treat ABS in ways that might be
perceived as unduly conservative, both relative to their performance in the European context
and more particularly relative to other forms of long-term wholesale funding such as covered
bonds. One reason is that the proposed changes do not appear to distinguish sufficiently
between the actual performance of simple and prudently structured ABS for example,
including some of those predominantly issued in Europe and of more complex, opaque
structures. In addition, there appear to be inconsistencies across different regulatory
initiatives in a number of different fields such as capital charges and liquidity requirements.
The proposed changes in the regulatory treatment and the current uncertainty about their final
outcome affect investors willingness to participate in the market. The December 2013
consultation papers from the Basel Committee on Banking Supervision (BCBS) on proposed
revisions to the securitization framework affecting banks and from EIOPA affecting
insurance companies (Solvency II), although including a less adverse treatment than
previously discussed, still propose capital charges that may be perceived as high for high-
quality ABS, particularly when compared with similar asset types. Similarly, a key issue
would be the relative treatment of securitisation and covered bonds in the forthcoming EU
implementation of the Liquidity Coverage Ratio (LCR). Banks, insurers and pension funds
that are affected by these regulations are the major players in the securitisation market, and
their ongoing participation is vital to its ongoing functioning.
For the market to recover in a meaningful way, further measures may be needed. One way of
achieving this would be to take into account the simplicity, structural robustness and
transparency features of ABS which have meant that low risk and well-structured ABS issued
in some markets have displayed strong performance and minimal losses through a period of
severe financial stress. In this respect the latest EIOPA proposal for Solvency II as of
December 2013 to introduce a distinction between Type A and Type B securitization
36
as

36
Under the latest proposal, EIOPA has introduced two types of risk factor, based on structural, collateral and
transparency standards of each investment. Type A securitisation needs to meet tighter criteria compared with
Type B securitisation.

45

well as the communication on 27
th
March 2014 from the European Commission to the
European Parliament and Council
37
are welcome first steps.
XXVI. RELIANCE ON CREDIT RATING AGENCIES
Credit rating agencies influence the ABS market via three important channels. First, as a
result of weak economic conditions, rating agencies now require far greater levels of credit
enhancement to achieve a given rating, which consequently makes it more costly to issue
structured finance assets (supply side effects). Second, rating actions taken on sovereigns
indirectly lead to ABS downgrades. In some EU countries, rating agencies currently also
apply maximum rating caps to ABS that are not related to the underlying collateral quality
itself, but to sovereign rating levels. In those EU countries affected, an AAA rating the
benchmark in ABS markets is no longer achievable without a guarantee from a super-
national institution like the EIF, regardless of their credit support. Third, ratings on ABS
transactions drive regulatory capital charges incurred by many ABS investors. The reliance
on ratings by credit rating agencies may thus lead to unwarranted pro-cyclicality effect.
XXVII. TRANSPARENCY AND HARMONISATION
Whilst significant effort has been expended to create standards for quality, transparency
and simplicity and therefore help to boost investor trust, market participants continue to cite
the lack of transparency and standardisation of ABS and related data on underlying assets as
a key constraint. The central banks loan-level data reporting templates and market -led
initiatives are encouraging steps towards more transparency and harmonisation of reporting
standards. Over the long run, the Single Supervisory Mechanism might also influence
transparency and underlying underwriting standards. Nevertheless, further improved and
standardised data availability may be needed to enable investors to assess the credit risk
inherent insecuritised assets and to help restore investor confidence in the securitisation
market.

37
The Commission will work on the differentiation of high quality securitisation products with a view to
ensuring coherence across financial sectors and exploring a possible preferential regulatory treatment
compatible with prudential principles.

46

XXVIII. CONCLUSION
This analysis suggests that revitalising publicly-distributed ABS issuance on any
meaningful scale would require concerted policy action in various fields, involving a range of
official entities. Standard-setters and legislators being responsible for the regulatory treatment
can change incentives to participate in the ABS market. It would be important that the
authorities seek to ensure that new regulations at global and EU levels do not act to the
detriment of the securitisation market.
To this end, the plans of EU and international regulators such as the BCBS and IOSCO to
review developments in securitisation markets and promote the concept of so-called high-
quality securitisations should be helpful. These efforts should be reinforced and accelerated
without delay to reduce the current regulatory uncertainty that is impeding the reactivation of
the market. A key question is the actual criteria to distinguish high-quality transactions
relative to the wider ABS universe. In this regard, central bank eligibility criteria aiming at
ABS with simple structures and well-identified and transparent underlying asset pools with
predictable performance could form a useful guide. These criteria have already been
demonstrated to filter undesirable ABSs (proven by default performance), are set in a manner
free from conflicts of interest, and are widely accepted by market participants. As regards the
next questionactual treatmenthigh-quality securitisations should receive treatment
commensurate with these reduced risks, in contrast to the currently-proposed catch all
regulatory treatment for all ABSs.
The high-quality segment of the securitisation market should aim to be more resistant to
market stress, thereby providing banks with a resilient form of funding. But it is also
important to support more junior tranches of safe and robust securitisation markets. In this
regard, authorities should continue to help improve the availability of data and analytics and
seek to ensure that these are delivered as efficiently as possible. This will help improve
general standards applied to even the riskiest securitisation transactions and should facilitate
investment in all ABS across a broader base of investors, also implying greater degree of
credit risk transfer between bank and non bank sectors.

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