Wednesday, July 02, 2008

Banking and Securities Associations to Develop Securitization Disclosure Guidelines

A consortium of European and global banking and securities associations has transmitted a report to European Commissioner for the Internal Market Charlie McCreevy on improving transparency in the securitization process. Broadly, the report recommends drafting industry good practices on securitization disclosures under Pillar 3 of the EU Capital Requirements Directive and the creation of a new industry quarterly securitization report on the EU and US securitization markets.

Other initiatives set forth in the report are designed to standardize issuer disclosure practices, broaden investor access to transaction information, enhance usability and comparability of information, and strengthen investor good practices. These initiatives are being coordinated on a global basis with recommendations of the Financial Stability Forum and IOSCO. The associations issuing the report include the European Banking Federation; the European Securitization Forum and the Securities Industry and Financial Markets Association.

Pillar 3 of the Capital Requirements Directive was lifted from the Basel II Accord. In the view of the consortium, the subprime crisis highlights the need for more targeted disclosure about securitized products currently beyond the scope of Pillar 3. For example, there must be enhanced disclosure on the securitization exposures of financial institutions.

The consortium has created a Working Group to develop best practice guidelines in this area. The group aims to establish a common understanding on the underlying securitized asset types and exposure types. They will also examine the detail of the quantitative disclosure needed to accurately disclose securitization positions. For example, the requirement to disclose securitization positions by a meaningful number of risk weight bands raises questions as to what constitutes a risk weight band.

While acknowledging that the guidelines will not be binding on financial institutions, the Working Group urged firms to declare whether they had prepared their Pillar 3 securitization disclosures in accordance with the guidelines and if not, why not, essentially importing comply or explain principles into the process.

The securitization disclosures guidelines will have a materiality threshold. The Working Group decided to import the definition of materiality from the Directive into the guidelines. Thus, materiality is defined as information that if omitted or misstated could change or influence the assessment or decision of a user relying on that information for the purpose of making economic decisions. Disclosure would be made annually.

Generally, the Working Group believes that disclosures should provide relevant information about the firm’s business model and business strategy underpinning the securitization activity. Also, a material market-driven change in the business model should be disclosed. All relevant securitization activities should be explained.

The risk management objectives and policies of the institution should be disclosed for each separate category of risk. These disclosures must include the strategies and processes to manage those risks; the structure and organization of the relevant risk management function; the scope and nature of risk reporting and measurement systems; and the policies for hedging and mitigating risk, and the strategies and processes for monitoring the continuing effectiveness of hedges and mitigants.