Or maybe not. At the outset, let’s give credit where credit is due. It was gratifying to read a governmental missive on the capital markets that made sense, showed an actual grasp of how markets function and an awareness of the issues confronting capital formation. Best damn thing I ever read coming out of the swamp.
The Treasury Report on the capital markets published in early October is indeed pretty fantastic stuff. The Report covers the Treasury’s recommendation on re-centering many of the rules around the capital markets over a wide range of regulatory issues important to securitization and capital formation.
Let’s focus on the provisions in this Report that are central to securitization.
These can be summarized as follows:
- There should be one agency with the responsibility for the Risk Retention Rule and we should dispense with the committee-of-committee that’s been running the clown car for the past couple of years. The old saw that “a camel is a horse built by a committee” is certainly proven by the risk retention experience.
- Regulatory bank capital requirements treat investment in non-agency securitized instruments punitively.
- Regulatory liquidity standards unfairly discriminate against securitized products.
- Sponsor risk retention as set out in the Risk Retention Rule represents an unnecessary cost imposed upon securitization.
- Some of the new and improved (read: expanded) disclosure requirements under Dodd-Frank are unnecessarily burdensome.
In other words, our regulatory regime needs a certain amount of recalibration to achieve its goals of safety and soundness in the financial market place while not impeding capital formation.
The Treasury found a general hostility to securitization and securitized products in the existing rule structure which they attribute to an overreaction to the excesses of the financial crisis which “negatively colored popular opinion of securitized products.”
The Report goes on to tick off most of the problems the industry has identified over the past several years. The Report criticized the risk rating for securitized products which makes it less attractive to hold securitized products than the underlying assets directly. It criticizes the notion that capital charges should follow accounting treatment rather than the realities of risk transfer. I really love this. It is a poke in the eye to some of the whacky FASB rules that have caused financial institutions to continue to recognize assets they don’t own and liabilities for which they are not contractually liable. Such a wonderful breath of common sense.
The Report criticizes the Fundamental Review of the Trading Book Rule (FRTB) as an unreasonable layering of capital on capital and imposing undue burdens on liquidity. It acknowledges, something we all know to be true, that the FRTB will make secondary market activities uneconomical for many banks and fundamentally impair the securitization business model since liquidity is at the heart of the value proposition of securitization.
It gently criticizes the Comprehensive Capital Analysis and Review (CCAR) as imposing “outsized costs” on market makers for securitized products and discouraging the development of the securitization market. Once again, it recommends recalibration.
Bless my heart, this is fun to read. It goes on then to criticize both the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio Rule (NSFR) as other examples of piling capital on capital for no real purpose. The Report proposes that non-agency securitized products should not be excluded from the calculation of High Quality Liquid Assets (HQLA) for LCR purposes. Note, however, that while this report was being released, the Federal Reserve moved forward with the NSFR rules which will have a huge negative impact on liquidity in the capital markets. So, what’s that about?
On risk retention, the Treasury doesn’t have much good to say. It points out that the banking agencies “do not appear to have undertaken a sufficiently robust economical analysis on the impact…” You think? It opens up the possibility of broadening the definition of “Qualified Assets” which would reduce the need for retaining a risk retention securities position. (This is particularly important in the CRE space where the Agencies have put the rabbit in the hat and made it virtually impossible to structure securitized deals around Qualified Commercial Real Estate loans.) It suggests that it’s possible that robust disclosure and strong representations and warranties could take the place of retaining risk retention securities. Note that this modality of meeting risk retention was included in the Dodd-Frank Act but was summarily dismissed by the regulators when the Risk Retention Rule was published. The Report also suggests reconsidering the length of the hold period.
With respect to the CLO market (which, by the way, performed pretty damn well through the Credit Crisis), the Report notes that the imposition of risk retention on CLO managers was an unduly blunt instrument to enhance risk mitigation and it made little sense. It suggests a broad qualified exemption for CLO risk managers.
Finally, near and dear to my heart, the Treasury recommends that the SEC should not attempt to expand registered deal-type disclosure requirements to unregistered 144A offerings. To my eye, this threat was included in the Risk Retention Rule as a warning to the industry to behave and not push back too hard. It has haunted the markets ever since.
I think we all agree that almost everything in this Report makes sense and if it was done tomorrow, it would be terrific. We would then have a regulatory regime that actually respects common sense and reflects a reasonable balance between achieving regulatory goals and fostering capital formation. Just great.
If, however, you have given up believing in the tooth fairy (jury is out in my case), you should be a bit careful about getting too excited about all this. Sorry to say, but I think we need to curb our enthusiasm here.
First, the Report feels a little precatory; just like the Treasury talking to its regulatory neighbors over the back fence and saying, “Hey, I had a couple of stray thoughts about these issues. Just saying.” It does not have the feel of a call to action or a directive to the agencies to hop to it and get in line. Remember that all of the criticized rules are in the purview of one or any number of prudential bank regulatory agencies (and the SEC) and not the Treasury. The banking agencies are, at least nominally, independent of the administration.
But people are policy and perhaps as the current administration fills key seats in the agencies, a consensus will develop around the conclusions in this Report. That hasn’t happened yet and the current administration’s ability to fill out its key policy team has proved to be somewhat challenged at best.
Then, if a consensus actually does develop around the Treasury’s recommendations, are we good? Remember that the Treasury is in the middle of publishing four separate and lengthy sets of recommendations on regulatory change. This Report is the second. It can’t all happen at once. Are the things that affect commercial real estate capital formation, the things that are central to this Report, on the top of this administration’s to do list? I don’t know, but I rather doubt it.
Moreover, it remains troubling to see the Fed moving forward with the NSFR and Basel continuing to pump out guidance such as the recently released and thoroughly looney “Identification and Management of Step-In Risk,” a piece of foolishness that I thought had been dead and buried. (For those of you who have nothing better to do, it makes an interesting read as it addresses the possibility that notwithstanding all the existing and elaborate bank capital rules, in some cases a bank might just feel like it sort of wants to support a non-consolidated entity, just because. And if so, then it should hold capital in those instances. Really. I’m not making this up.)
So net-net, there’s a lot to like here and reading this report is at least a feel good experience. It certainly high-fived my confirmation bias. But, I don’t see material relief on the key regulatory issues on the horizon. Even if this process continues to move forward in a relatively linear way, all of this would require extensive notice and comment through rule-making, which could consume most of 2018. In some cases, congressional action would be necessary and we all know how likely that is.
So, enjoy the pleasurable frisson of reading a report that truly gets our industry and instills confidence in our government (I can hardly believe I just wrote that). Enjoy knowing that someone in government seems to get it, but stand by for a hell of a ride. All of us should be prepared to help our trade organizations move this dialogue forward and while I cannot tell you I’m sanguine about material change, it’s better than a stick in the eye.