Appendix I: the regulatory treatment of asset securitisation--the bis proposals on securitisation.

Author:Jobst, Andreas A.
Position:Collateralised Loan Obligations (CLOs
  1. Introduction

    Following a protracted effort to address topical regulatory issues involved in the developments of structured finance, such as synthetic asset-backed securitisation, on 28 October 2002 the Basle Committee issued the Second Working Paper on the Treatment of Asset Securitisation (augmented by the Consultative Document to the New Basle Accord of April 2003) in order to sound out the viability of new, more risk-sensitive elements of the securitisation framework it had already set forth in the First Working Paper on Asset Securitisation of October 2001--after a series of consultative papers augmenting the Basle 1988 Capital Accord.

    Essentially, the current Basle regulatory framework falls short of providing guidance on the comprehensive treatment of synthetic securitisation structures, liquidity facilities and securitisation transactions of revolving credit exposures containing early amortisation features. Besides improvements to the standardised and the internal-ratings based (IRB) treatment as well as the supervisory formula approach (SFA) in context of capital adequacy in securitisation, the Second Working Paper on the Treatment of Asset Securitisation also requests input from financial institutions concerning the supervisory review component ("Pillar 2", see Basle Committee, 2002a and 2002b). (49) It was mainly put forward in the effort to solicit feedback from banking organisations on the need of future modifications to the existing proposal or adjustments to the way minimum capital requirements are calibrated in asset-backed securitisation. Notwithstanding its tentative nature, it reflects a purposeful attempt to address present gaps in the regulatory treatment of asset-backed securitisation. Given the rapid growth of securitisation markets around the world, adopting a comprehensive regulatory policy in this matter is critical to a viable securitisation framework under a revised Basle Accord. Failure to do so would certainly miss the objectives of financial stability set out by the Basle Committee.

    The Second Working Paper on the Treatment of Asset Securitisation and the Consultative Document to the New Basle Accord were preceded by a series of consultations in the effort to develop uniform capital treatment for securitisation exposures (see Exhibit 30). The First Consultative Paper, released by the Securitisation Group of the Basle Committee in June 1999, introduced a general securitisation proposal, which was later expanded upon in the Second Consultative Paper on securitisation in January 2001. At this stage, the drafting of common regulatory policy focused primarily on the standardised treatment to traditional securitisation transactions (see section VII.A. 1 below), where banks were required to assign risk weights to securitisation exposures based on few observable characteristics, such as an issue rating. However, it also presented an initial distinction of sponsoring and investing banks, revolving asset securitisation, cash advancement and liquidity facilities as well as risk transfer requirements for traditional securitisation.


    After consultation with the industry and further analyses, the Basle Committee issued the First Working Paper on the Asset Securitisation, which comprised an in-depth internal-ratings based (IRB) treatment of securitisation exposures in addition to the standardised, "one-size-fits all" approach. It also sought to initiate further consultation on a concrete treatment of synthetic securitisation, liquidity facilities and early amortisation features, which finally culminated in the Securitisation Framework (Credit Risk--Securitisation Framework, [section]IV of the QIS 3 Technical Guidance) before yet another round of consultation talks commenced to fine-tune the quantitative criteria of higher risk-sensitivity in the determination of minimum capital requirements for issuers and investors of securitisation transactions. The outcome of this latest regulatory effort were the Second Working Paper on the Treatment of Asset Securitisation of October 2002 and the Consultative Document to the New Basle Accord of April 2003, which--among many new qualitative aspects of securitisation regulation, such as supervisory review (Pillar 2) and market discipline (Pillar 3)--also proposed a more ratings-based approach (RBA) for securitisation transactions in line with the distinction of the standardised approach and the internal ratings-based (IRB) approach to the computation of general minimum capital requirements.

    We now explain the contents of the First Consultative Paper and the Second Consultative Paper of 2001 before we move on to the specification of the supervisory formula approach (SFA) and the ratings-based approach (RBA) as the proposed foundations of regulatory policy for asset-backed securitisation in the light of the Second Working Paper on the Treatment of Securitisation (Basle Committee, 2002a and 2002b) and the Consultative Document to the New Basle Accord (Basle Committee, 2003).

  2. The "Consultative Package"

    On 16 January 2001 the Bank for International Settlements (BIS) issued a revised proposal for capital requirements in securitisation. This proposal for an adjustment of regulatory capital and supervision by financial regulators on financial institutions includes a separate 32-page chapter on the securitisation as a comprehensive effort to codify a regulatory framework for structured finance in the funding process of financial intermediaries and firms alike.

    It warrants mentioning that the revised proposal does justice to the increasing popularity of synthetic transactions by devoting a separate section on this recent structural innovation of securitisation. The earlier proposals in June 2000 were completely silent on synthetic securitisation. Moreover, besides the critical issue of information disclosure requirements with respect to securitisation transactions, the revised proposal also draws an important distinction between implicit/residual risks and explicit risks in securitisation, the latter being separately dealt with in an additional section. In this context, implicit risk refers to residual risk that is thought of not being legally assumed by an originating or sponsoring bank; however, due to an obligatory commitment to safeguard investors' interests it might still be tacitly recognised to that extent that actions in defiance of this understanding might prejudicially affect the reputation of the bank.

    The subsequent...

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