EU may allow European asset-backed securities to be included as liquid assets for the liquidity coverage ratio. France & Germany push for delay to 2018, much to the chagrin of the UK.

An article in Bloomberg on January 20, 2012 by Esteban Duarte caught our eye. The reporter wrote that the EU may allow European asset-backed securities (ABS) to be included as “liquid assets” for the liquidity coverage ratio (LCR). The LCR requires banks to hold certain liquid assets such that they cover 30 days of outflows. We have noted that the LCR requirement severely constrains the time honored lend long/borrow short repo strategy that is the bread and butter of many repo desks and has been a driver for the greater appetite for term funding. We wrote extensively about the LCR in Finadium’s October 25, 2011 paper “Capital Charges for Margin, Securities Lending and Repo: A Guide for Banks, Their Clients and Counterparties”. A link to the synopsis is here.

In between the ECB loosening the collateral requirement for their repo activities and the potential LCR change, it seems like there is an intensified focus in Europe on the collateral market. Recognizing the impact of regulatory changes and market stress has on collateral supply and demand and tweaking policy accordingly is certainly a good thing. Sources have told us that the knock-on impact of some of the regulatory change was never thought out very well by the regulators. The Banks have spent a lot of time explaining the consequences to the Regulators and it seems like they have made some progress.

Including asset backed securities may breathe life into a market which evaporated along side the sub-prime market in the US. The Bloomberg article said, “Issuance of asset-backed securities have tumbled in Europe after bonds linked to U.S. subprime debt slumped, prompting investors to shun the hard-to-value securities. Sales of the debt fell to 74 billion euros ($96 billion) last year from as much as 510 billion euros in 2006, according to JPMorgan Chase & Co data.” The purpose of the LCR is for banks to have a reserve of liquid assets they can sell if their other funding sources evaporate. We wonder exactly how the European Banking Authority will test for liquidity? Just because a security is safe, it doesn’t mean it is liquid.

UPDATE: An article in the FT today reported that France and Germany are pushing to have LCR reporting pushed back 3 years to 2018 and a re-jiggering of the definitions. This is setting up a showdown between Germany and France on one hand, and the UK — who are pushing for strict adherence — on the other. A link is here (although it may be behind the paywall….sorry)

We earlier posts on the LCR in are here and here

A link to the Bloomberg article is here. A link to the EC paper is here.


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