Clayton Utz Insights
22 December 2011
By Louise McCoach and Alex Chernishev.
APRA has outlined current concerns with securitisation and its future regulatory actions.
On Monday 21 November 2011, Charles Littrell, Executive General Manager of Policy, Research and Statistics of the Australian Prudential Regulation Authority addressed the Australian Securitisation Forum Conference. In his keynote address, Mr Littrell provided an overview of recent securitisation events pre- and post-financial crisis and APRA's approach to securitisation.
Mr Littrell also outlined:
- key concerns from APRA's perspective given the recent events in the global economy; and
- the reforms that APRA has introduced, and will continue to roll out, in an attempt to address investor and depositor disquiet, particularly in relation to securitisation.
Mr Littrell made the following key points:
A positive take on securitisation: Despite the collapse of investor demand for securitised paper following the global financial crisis, APRA remains of the view that securitisation is more useful than it is dangerous. There was, however, a cautionary statement that securitisation should not become over-complicated.
Displeasing practice: Mr Littrell voiced his displeasure with some securitisation practices adopted by ADIs which he described as trying to push the boundaries of "what the rules allowed" as opposed to "what was economically sensible" – in particular following the roll-out by APRA of the revised APS 120. Mr Littrell went on to highlight the following practices of concern to APRA:
- some ADIs were progressing securitisations and claiming capital relief without meeting the basic documentation requirements associated with self-assessment;
- ADIs were assessing compliance with the self-assessment requirements and APS 120 as a legal matter and relying on legal opinions as opposed to their financial judgment as to matters such as effective risk transfer;
- some ADIs retained all of the junior tranches in their securitisations (and therefore did not transfer much, if any, credit risk) and also claimed balance sheet relief. Mr Littrell observed that ADIs that do not claim capital relief when they retained junior tranches were adopting a more sensible approach; and
- some issuers were placing junior tranches in a non-commercial fashion, for example with related entities or by arbitraging with other ADIs.
B notes: During the course of 2010 APRA released interim arrangements to address some key industry issues to allow ADIs to continue securitising even if they could not sell their B notes. These arrangements left originating ADIs which held B notes with two options:
- not claim a capital benefit (ie. pursue funding-only securitisation arrangements); or
- seek capital relief but deduct from Tier 1 the value of the B notes held.
In addition, APRA recently clarified that ADIs can pursue funding only securitisations and proposed the introduction of anti-arbitrage rules to prevent ADIs from avoiding a capital deduction by trading their B notes.
APRA now proposes to commence a more complete review of APS 120 in 2012 and adopt a simpler approach to securitisation, with more supervisory flexibility. Mr Littrell indicated that this new approach will emphasise ADIs complying with the spirit of APS 120 over black-letter interpretation.
Current issues facing APRA
In addition to the above, Mr Littrell also provided certain personal insights into current issues facing the regulator. These include:
- co-ordination of APS 120 alongside global reforms such as the "skin in the game" requirements introduced in the US and Europe;
- regularising the funding-only approach to securitisation;
- addressing the perceived practise of some ADIs of placing junior tranches with less informed investors;
- considering the possibility of securitisation structures having no more than two tranches in light of various levels of credit risk;
- addressing the perceived existence and trading of re-securitisation structures that arguably fail safety tests for securitisation structures;
- adopting a less complicated approach in relation to prescription of risk weights to ADIs holding securitised paper that complies with Basel III reforms;
- ensuring that recent amendments to capital treatments reflect the view that APRA does not favour ADIs buying junior tranches from other ADIs;
- working to provide a prudential framework that will support funding-only securitisations and develop the securitisations for capital relief, while ensuring that imitations of true risk transfer structures do not work;
- in relation to covered bonds, that the covered bond trustee does not dispose of assets at fire sale prices; and
- clarifying that assets pledged above the 8% limit in relation to covered bonds will attract an equity deduction.
As a final observation, Mr Littrell commented on the recent global reforms which he saw as positioning banks as institutions pledging significant quantities of collateral (eg. in order to collateralise central counterparty exposures) as opposed to being mainly unsecured borrowers. Mr Littrell observed that although the recent initiatives may provide ADIs cheaper funding options or better trading terms, an entire industry with large quantities of collateral pledged is most unlikely to make the remaining depositors and unsecured creditors safer. This final point, Mr Littrell confirmed, is an issue that APRA will have to carefully consider over the next several years.
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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.
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