Article Category: Research Article
Published Online: May 31, 2023
Page range: 26 - 34
DOI: https://doi.org/10.25143/socr.25.2023.1.26-34
Keywords
© 2023 Irina Cvetkova, published by Sciendo
This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.
At the end of the 20th and 21st centuries, a new institute emerged in the global economy – the institute of securitisation of homogeneous assets, the essence of which consists of refinancing any assets of a company that generates stable cash flow by converting these assets into liquidity through the issue of securities, the payments on which are secured by the transferred assets.
The term “securitisation” was first suggested by the head of Salomon Brothers' mortgage department, Lewis Ranieri, in 1977 when he organised the issue of securities secured by mortgages. This transaction was called the Bank of America issue (Ranieri, 2004).
D.A. Pentsov defines security as a transaction involving the lending of money to another person for the purpose of making a profit, a document certifying such a transaction and the right to buy or sell it (an “instrument”), which is characterised by the following circumstances (Pentsov, 2003):
the seller's motivation to raise the capital required for general use in the seller's business enterprise or to finance significant investments; the buyer's motivation to obtain a profit from the provision of funds; acting as an “ordinary trade item”; the buyer's reasonable expectations of the application to the instrument of federal statutory provisions; the absence of a risk-reducing factor.
According to I.L. Blank, securitisation is the process of converting low-liquid financial assets into liquid securities traded on the capital market (Blank, 2001).
J. Pleaslee and D. Nirenberg point out that in a typical securitisation transaction, the holder of rights of claim pool transfers them, directly or through an intermediary, to a trust or another entity, which, in turn, issues securities backed by that property (Pleaslee & Nirenberg, 2001).
In a technical sense, securitisation is the issuance of marketable securities backed not by the expected capacity to repay of a private corporation or public sector entity but by the expected cash flows from specific assets (Bloomingdale & Hawken, 2005). Securitisations are characterised by a large number of participants, a complex transaction structure and a long lead time to organise the financing process. Securitisation has evolved over several decades from a promising and innovative instrument into a major financing method.
Securitisation is an alternative to borrowing money from a bank and is a legal mechanism for transforming the ownership of real estate market assets for portfolio investment financing. It provides financing and refinancing of income-generating assets of legal entities by increasing their liquidity through the issuance of securities. This has been the traditional way for companies and banks to raise money in the capital market so far.
The development of the securitisation market in global capital markets has developed significantly in recent years. The role of securitisation in transforming financial and capital markets is growing steadily. Globally, asset securitisation is one of the most important ways to finance banks and other institutions.
Since its introduction, the USA has been the global leader in the securitisation market. US banks are actively involved in arranging for the issuance of collateralised securities not only in the domestic market but also in other countries, including Western European countries. Of the top 10 banks in terms of structured finance arrangements, 7 are US banks. Typically, the largest underwriting banks are global players in the global securitisation market. Today, securitisation is generally regarded as a useful tool for maintaining liquidity and economic stability. However, positive effects are only possible with sufficient government control.
Theoretical and methodological aspects of the development of asset securitisation and mortgage lending are presented in the works of scholars such as G. Akerlof, P. Ali, V.K. Bansal, G. fon Bayer, J. Bart, I.L. Blank, A. Ching, G. Gorton, N. Davis, E. Davidson, I. Ertl, F.G. Fabocci, G. Frank, E. Fikes, S. Frost, G. Hardt, L. Hair, K.A. Hill, T. James, A.A. Jobst, V. Katari, M. Koch, T.T. Liksner, Y.D. Lyuu, J.F. Marshall, R.S. Nil, J. Pleaslee, D. Nirenberg, J.J. de Vries Robbe, P. Rose, E. Sanders, G. Sinki, D. Skrabot, and L.L. Wolf.
The research topic is relevant because the financial market is currently developing intensively and credit institutions and organisations are looking for new sources of funding. However, legal regulation of financial instruments that meet the needs of issuers and investors in the financial market environment is becoming more complicated; besides, there is no full-fledged legal regulation of securitisation of assets in Latvia.
The author poses a number of questions: What is asset securitisation? What are the advantages and disadvantages of asset securitisation? What is the whole loans procedure? How did the 2008 financial crisis affect securitisation of mortgage accounts? What is the regulation of securitisation of assets in Latvia?
The aim of the research is to examine the procedure and regulation of securitisation of assets and the advantages of their use.
The research task is to analyses the legal framework of the securitisation of assets in Latvia and identify the current issues.
As a result of the research, the author draws conclusions about the use of securitisation of assets at present, indicates the lack of appropriate regulation in Latvia and claims that thanks to digitalisation and the widespread use of securitisation around the world, including mortgages, the concept of ownership will be transformed into digital claims rights governed by smart contracts, which will lead to the creation of fundamentally new forms of civil law relations.
Within the framework of the research, the analytical method, descriptive method, induction and deduction method, and logical and legal method have been used.
Securitisation of assets is the issuance of debt securities in which the principal and interest are repaid from the cash flows generated by a defined pool of financial assets. Securitisation of assets helps minimise risks and significantly reduce the cost of borrowing. The main purpose of securitisation is to separate the cash-generating financial asset from the risks of the originator company.
Initially, securitisation of assets was a support measure for the US construction industry and was not a stand-alone financial instrument. This was followed by the securitisation of leasing and the securitisation of car loans, credit cards, retail loans and other asset classes. Market participants quickly recognised all the benefits of this innovative way of financing. For originators, securitisation became an effective way to raise finance and for investors an efficient mechanism to invest in low-risk, secured assets.
A securitisation transaction usually involves the following parties:
a person who is referred to as the originator and who either sells the securitisation company's assets in the form of an actual sale or transfers the risk to the securitisation company (in particular through an artificial transaction); an investor who subscribes to shares and/or debt securities issued by a securitisation company in a private placement or a public placement; a service provider (often the initiator), which, in most cases, has the function of collecting revenue flows; one or more fiduciary representatives who may be appointed to protect the interests of investors; rating agencies that rate securities issued by the securitisation company; a paying agent (a banking institution) for the payment of income flows and interest payments to bondholders.
Cash generated by assets and risks transferred to the securitisation company is redirected to support payments to investors.
Securitisation offers several advantages to both originators and investors. One of the potential benefits of securitisation to the originators is that it is a way of raising non-recourse debt and thus expanding the funding capacity of the originator beyond market constraints and the limits imposed by debt covenants and corporate charters. It also offers access to longer term fixed-rate debt than is affordable through a bank loan or bond issue (Stone & Zissu, 2000).
The benefits of securitisation for initiators include the following:
increasing the return on equity by converting the on-balance sheet lending business into an off-balance sheet fee income flow, which is less capital-intensive; ensuring effective access to capital markets; minimising the issuer's specific limitations with respect to its ability to raise capital; converting illiquid assets into cash (assets can be pooled to create a diversified collateral pool against which bonds can be issued); diversification and targeting courses, investor base structures and transactions: businesses can look beyond the existing bank loans and corporate debt markets to access new markets and investors;
It can also reduce the cost of other types of debt by reducing the volume of issuance, thereby allowing placement with small buyers who are willing to pay a higher price;
generating additional assets to raise additional capital; raising capital while preserving the confidentiality of the protected information on the activities; carrying out more efficient mergers and acquisitions as well as liquidations: this can help create the most efficient combined structure and can be a source of capital for transactions; transferring financial risks on loans or contractual obligations of customers to investors and credit providers.
Benefits for investors include the following:
wide possible combinations of return and risk (a combination of attractive returns by increasing liquidity in the secondary market); higher returns (the ability to achieve a higher return on the invested capital in a particular pool of quality assets backed by loans); a wide choice of repayment terms and security; these assets are paid in monthly coupons.
The main disadvantage for investors is the cost of the borrower's credit behaviour, which can stop payments. In turn, if the borrower pays off the mortgage early, the investor loses part of the profit.
The benefit for borrowers is improved credit conditions. The availability of credit and the simplification of credit conditions are improved for them.
Securitisation often reduces funding risk by diversifying funding sources. Financial institutions also use securitisation to eliminate interest rate mismatches. For example, banks can offer long-term fixed-rate financing without significant risk, by passing the interest rate and other market risk to investors seeking long-term fixed-rate assets. In addition to these benefits, securitisation has also been used successfully to give effect to sales of impaired assets (Davis, 2000).
The securitisation of bank loans is the conversion of mortgage loans into securities. A bank lends a loan, fixing it as an asset on its balance sheet, receiving principal and interest. The bank's funds in these loans are locked up, and securitisation is a way of unlocking these locked up funds. If the bank needs funds, it can issue bonds backed by these loans and sell them to an investor. The borrowers would then no longer owe the bank that originated the mortgage, but the new owner of the liabilities, the investor. In addition, securitisation relieves the bank of the risk of default.
Classical and synthetic securitisation involve several stages of transaction in a specific sequence. At the stage of asset selection and segregation, the procedures are identical. However, further on, significant differences arise.
A classic mortgage asset securitisation scheme involves the following steps:
The initiator of the transaction (originator) issues loans to natural persons (borrowers) by obtaining real estate as collateral (mortgages). The rights of claim on the mortgages are sold by the bank to a specially created legal entity – special purpose vehicle (SPV) (What is a Special Purpose Vehicle, 2022). An SPV issues securities (mortgage bonds) secured by mortgage loans. Investors purchase these securities by paying funds to the SPV for them. The funds received from investors upon the placement of the securities are paid by the SPV to the originator, thus paying for the acquired claim rights. The originator maintains the securitised assets, receives, manages and, if necessary, enforces the collection of receivables through legal proceedings. The receivables service function may also be performed by another person, the so-called servicer. The funds received by the originator from the borrowers are transferred to the SPV to be settled with the investors; The SPV pays the investors the interest on the mortgage bonds and the principal amount by the due date. Implementing an asset securitisation transaction through a specially created legal entity (SPV) makes it possible to separate the assets that secure payments on the securities acquired by investors from certain risks.
In a traditional true sale, the originator sells a pool of assets (a true sale) to the buyer (in which the rights to receive the debt are transferred to the new owner of the asset (the investor)). The company finances the purchase by issuing bonds that can be rated by a rating agency. As a result, the investor obtains legal and beneficial ownership of the underlying assets.
In synthetic securitisations, the originator buys protection through a series of credit derivatives, instead of selling the asset pool. Such transactions do not provide the originator with funding. They are typically undertaken to transfer credit risk and reduce regulatory capital requirements.
An asset owner transfers the credit risk of a portfolio of assets to another person or directly to the capital markets. Although the credit risk of the portfolio is transferred, the actual ownership remains with the buyer.
Credit risk can be transferred in several ways:
the buyer can issue bonds with an embedded default swap to the seller or directly to investors. The terms of the bonds will provide for a reduction of the buyer's redemption obligations on the bonds in the event of default or other credit events arising in connection with the portfolio; the buyer can make credit default swaps, aggregate income swaps or other credit derivative transactions with the seller; the seller agrees, in return for certain payments, in the event of a default or other credit event in respect of the portfolio to pay a certain amount to the buyer. This amount is calculated based on the amount of the defaulted payment or a reduction in the market value of the defaulted portfolio.
The subject of securitisation of leased assets is a portfolio of leasing contracts. This transaction is a classic case of securitisation, in which there is an assignment of rights of claim under the leasing agreement and the actual sale of the lease object.
Trust companies play a special role in the securitisation of leased assets. Leasing companies sometimes finance leases whose value may exceed the amount of the company's equity, which causes the assignment of leasing contracts to the trust company, carried out at a certain discount by the methods of assignment, novation and sub-participation. A peculiarity of the procedure of assignment of leasing contracts is that no change of the proprietor, which remains the originator, considerably simplifies the securitisation mechanism (Leshchinsky, 2007).
The first securitisation of non-mortgage loans was conducted only in 1985 by Sperry Lease Finance. The transaction was secured by the cash flows of computer equipment contracts. Over the past 15 years, the value of leasing asset securitisations in the USA have been $124.4 billion, or an average of $8 billion per year. The most developed leasing asset securitisation market in Europe is Italy. Each year in Italy, about 10 such deals are concluded, with an average value of €828 million. The securitisation objects are leasing contracts with different types of assets. The share of equipment is 60%, real estate 25% and motor vehicles 15% (Gazman, 2011).
Securitisation, which emerged in the USA in the late 1960s and until the mid-1980s, was only done with mortgages. In many ways, it was this instrument that made the so-called “long” mortgages affordable and widespread.
Whole loans is an American term used to distinguish between original mortgages (mortgage loans) and pass-through securities. Mortgage-backed securities (MBS) are mortgage-backed bonds and mortgage participation certificates.
Whole loans generally carry the risk of default, have no guarantees and no insurance and may not meet the standards by which the mortgage pool is formed for classic securitisation. That is, for whole loans,
borrowers may have low credit ratings; loan amounts can be either small or very large; the loan-to-value (LTV) ratio can exceed 100%; in the secondary market, such loans can be traded in retail and wholesale, being bundled into portfolios for subsequent structuring, resale or securitisation.
The mortgage debt market has become an increasingly important component of the US capital market in the past two decades. MBS in particular, which are created through securitisation of mortgage loans made by financial institutions such as commercial banks, savings and loans and mortgage companies, have come to dominate the mortgage debt markets in recent years (Xu & Fung, 2005).
US federal agencies such as Fannie Mae, Ginnie Mae and Freddie Mac work with pools of mortgage loans, while individual loans and whole loans are handled by private companies: banks and financial and insurance companies. Securitisation of bank assets is backed by mortgages. For banks, mortgage securitisation is profitable because of the rapid repayment of loans secured by real estate:
It enables quick turnover and further financing of borrowers, It protects against the risk of loan default, It increases balance sheet liquidity.
The securitisation algorithm is as follows:
The consumer takes out a mortgage loan from the bank; The bank initiates the securitisation procedure and becomes the originator organisation; The originator evaluates the assets and forms the portfolio it wants to sell; The portfolio may be divided into several parts – tranches. Generally, they are formed according to the degree of risk. Usually the lowest-risk debts become the senior (higher priority) tranche, and debts with the lowest or no rating become the junior tranche; The portfolio is bought by a special issuing company, which issues bonds backed by mortgage loans; The issuer sells the securities to investors.
In the USA, most MBS are issued by one of the three government-sponsored enterprises or agencies known as Ginnie Mae (GNMA), Freddie Mac (FHLMC) and Fannie Mae (FNMA), although there is a growing trend towards MBS being issued directly by large mortgage lenders. Mortgage securitisations had been completed in the 1970s by the Government National Mortgage Association (Shenker & Colletta, 1991).
Mortgage-backed securities have become very popular as an investment vehicle among individual and institutional fixed-income investors. Key reasons for this popularity are that MBS offer attractive yields, have little or no credit risk and trade in a liquid secondary market (Longstaff, 2005).
In 1999, a law prohibiting banks from engaging in investment activities was abolished in the USA. After that, banks started massively issuing substandard (subprime) mortgages. Those who took them out could not actually afford them but hoped that a growing economy and a favourable housing market would allow them to refinance the loan on favourable terms in the future.
The banks then securitised these mortgages and sold them to investors. The popularity of US mortgage bonds was enormous – investors from all over the world bought them.
The securitisation market reached an annual volume of around US $2 to US $3 trillion from 2001 to 2007, before the mortgage crisis, and from 2008 to 2015. This significant volume was driven by two main factors: strong growth in the US mortgage market and the securitisation of mortgage assets accumulated in previous periods.
In 2005, there was a boom in the whole loan market in Europe. The number of originators (those who do not issue mortgages) of mortgages grew on the supply side, for whom whole loans became a fast and efficient way to increase financing and write-off assets from their balance sheet. Many purchasers of whole loans, who previously became originators of mortgages, are now purchasing additional portfolios of mortgages to diversify the assets on their balance sheet.
After reaching its peak values in 2003, the US securitisation market stagnated as the MBS market declined, while the asset-backed securities (ABS) market continued to grow until the start of the mortgage crisis during 2007–2008 (What is ‘MBS).
In 2008, the mortgage market bubble burst, property prices went down and borrowers stopped paying their loans. The number of outstanding and overdue mortgages and the amount of mortgage payables rose rapidly and uncontrollably on a massive scale. Investors were left without mortgage payments and with severely cheapened and idle housing.
Impaired MBS led to the worst stock market crash since the Great Depression and massive bankruptcies of investment banks and insurance companies around the world, triggering a global crisis, the effects of which have not been resolved to date. In 2008, securitisation volumes more than halved to less than USD 1 trillion. Investors subsequently reassessed the risks considerably.
The US mortgage crisis reached enormous proportions, aided by speculators who saw secondary securities (derivatives) as a source of endless profits. The following factors contributed to the collapse:
MBS ceased to be associated with specific properties and began to exist autonomously. Endless issuances and the emergence of new options encouraged traders to keep speculating, while statistics on the increase in the actual number of defaulters did not interest anyone. The same forecasting and analysis models were applied to MBS as to conventional equities and futures, despite their significant differences. Mortgage risk rating methodologies have not been sufficiently developed due to the short historical period in which they have existed, allowing trading strategies and hypotheses to be fully tested. Banks and large hedge funds colluded with leading rating agencies – Standard & Poor's and Moody's, triggering a global financial crisis (Heinsvort, 2009).
As the US Commission of Inquiry subsequently found, the agencies deliberately inflated the investment attractiveness of any bonds and mortgages. In fact, the rating agencies did not evaluate the securities at all – they simply put the price offered by the issuers on the securities.
Rating of securities appears to be much more important, and this is the line of business that increased dramatically: the dollar value of originations of subprime mortgages alone rose from $65 billion in 1995 to approximately $600 billion, and Moody's profits tripled between 2002 and 2006 (Bolton, 2009).
In the summer of 2007, the mentioned rating agencies failed to manage the ratings of the structured finance products, possibly due to weak reputational initiatives or unreliable information sources, or both (The Financial Crisis Inquiry Report, 2010).
The US government Financial Crisis Inquiry Commission concluded that the three main credit rating agencies – Standard & Poor's, Moody's and Fitch Ratings – acted as major enablers of the financial crash, largely due to positive ratings on high-risk securities backed by residential mortgages.
It is important to note that almost on the eve of the mortgage crisis, in September 2006, the US Congress accepted the Credit Ratings Agency Reform Act (Credit Ratings Agency Reform Act), which came into force in July 2007, i.e. during the mortgage crisis. This document paid particular attention to increasing competition between credit rating agencies, managing conflicts of interest, transparency and openness of their information.
Mortgage crisis ( bankruptcy of banks and insurance companies; a decline in private savings of citizens; real estate taken away from debtors has returned to the real estate market, causing prices to fall; from the real estate market, the crisis has spread to other economic areas; financial losses in the crisis amounted to about $450 million, equivalent to 3.5% of US GDP; an outflow of foreign investment from the US economy; declining dollar stability for investments.
Following the USA, the mortgage crisis came very quickly to Europe. English banks were the first to suffer: interbank lending problems in the USA led them to run out of money to repay their current debts. The information about a large loan to an English bank led to panic: bank customers rushed to withdraw their deposits fearing bankruptcy. In a short time, the British banks lost more than 2 billion pounds sterling, and the pound/dollar exchange rate fell below two dollars per pound. European banking stocks began to fall in value, and interbank lending rates, on the other hand, jumped sharply. At the beginning of the crisis, Iceland found itself on the verge of bankruptcy. It had to ask for help from the International Monetary Fund and nationalise its three biggest banks. Iceland's economy was only able to emerge from recession in the second half of 2010.
The German government's anti-crisis measures included government provision for interbank lending and direct investment to increase banks' own capital. These measures cost Germany half a trillion euros; France, for example, allocated just over 10 billion euros to support the banking system.
The securitisation market has been recovering slowly since 2009, but annual securitisation volumes have remained around 40%–50% lower than before the crisis. However, whole loans carry default risk, have no guarantees and no insurance, and may not meet the standards by which the mortgage pool is formed for classic securitisations. That is, under whole loans, borrowers may have low credit ratings, loan sizes may be small or very large and the LTV ratio may exceed 100%. In the secondary market, such loans can be traded both retail and wholesale, bundling them into portfolios for subsequent structuring, resale or securitisation.
In 2010, Michel Barnier, a European Commission (EC) member for internal market issues in J.M. Barroso's Commission, considered the possibility of creating an EU rating agency. The proposal to create such an agency was made by Markus Krul, a former partner of the German consulting firm Roland Berger. The future rating agency would be constituted as a fund with a capital contribution of 10 million euros from each of 30 investors active in the financial market. However, Krull was unable to find investors, and the idea of a pan-European rating agency was abandoned (EU rating Agency Buried).
In 2016, the European Group of Valuers' Associations developed and accepted European Valuation Standards (European Valuation Standards, 2016). It provided recommendations for Property Valuation for Securitisation Purposes:
Where the valuation will be used to secure a loan on a property or a portfolio of properties intended to back a securitised instrument, this will normally be on the basis of the market value of the property. In some jurisdictions, the mortgage lending value may also be used. When undertaking a valuation for securitisation purposes, valuers should focus on the market and property-related risks relevant to the property or properties being mortgaged so that interested parties can understand:
the market value (and/or the mortgage lending value) of the individual properties; the net asset or sustainable asset values for a portfolio; the associated market and property risks, facilitating the development of mortgage loan portfolios, portfolio ratings and investor decisions. It is essential that the client and the valuer agree before the start of the valuation on the extent of the valuer's instructions – is he/she simply to determine the market value of the property at the valuation date, or is he/she also required to prepare a property risk profile? In some cases, he/she may also be asked to play a role in determining the sustainable asset value. The written terms of engagement should clearly set out the extent of the valuer's instructions. It will be assumed for this paper that the valuer is asked both to determine the market value and prepare a property risk profile. In this case, TEGoVA recommends valuers to undertake their task in two stages: first, the conventional valuation of the property and then an assessment of the specific property risk profile. Where a portfolio of properties is being assessed, the valuation and risk assessment should relate to the whole portfolio (European Valuation Standards, 2016).
Today, the whole loans market is most developed in America; American companies have become the largest players in this sector of the mortgage market in Europe. The current market structure is the result of the liberalisation of the financial sector in Europe.
The largest group of specialised institutions are mortgage banks. Mortgage banks dominate the market in Denmark and Sweden (90% and 80%, respectively) and are highly influential in Germany, France, Austria, the Netherlands and Finland. However, with the entry of non-specialised institutions into the market, deregulation has begun, resulting in a significant strengthening of the position of universal banks (40% of all loans).
In addition, there are secondary market mortgage investors and other strategic investors who are not originators but also actively buy these mortgage products to use them in refinancing. These loans are often included in subordinated bond tranches with low ratings but high yields.
Mortgage whole loans trading in Europe has been increasing in recent times. This part of the secondary mortgage market dominates in the UK and has good growth potential in Germany and the Netherlands, with the participation of US investors. Deposits play a major role in financing mortgages in Europe (62% of residential mortgages).
The second place is taken by the issuance of mortgage bonds. The importance of mortgage lending varies markedly from country to country. For example, in Denmark, the Netherlands, the UK and Germany, the ratio of residential mortgages to GDP is 50% or more, while in Italy, Greece and Austria, it is less than 10%. The marked differences in the size of mortgages and their role in the economy are related to the national and historical characteristics of each country.
Ireland's SPV securitisation market grew more than 9% in the past year, despite COVID, with collateralised loan obligation (CLO) transactions being a key growth driver. Of the 4579 securitisation vehicles reported in 2020 across the euro area, 29.8% were domiciled in Ireland. The country is now recognised as the leading jurisdiction for domiciling CLO SPVs following the changes in VAT legislation in the Netherlands, which saw the migration of the majority of Dutch CLOs to Ireland (European Securitization Trends, 2021).
The Dutch residential mortgage-backed securities (RMBS) and related buy-to-let space are attracting interest from foreign parties and private equity-backed non-bank financial institutions (NBFIs) searching for yield.
The main disadvantages of securitisation are currently considered to be the following:
the risk of developing a financial bubble, acceleration of inflation, their low accessibility to medium and small market players. Securitisation of companies (WBS) and small businesses (SME) has become popular in Europe in recent years, but MBS, particularly RMBS – their share in 2017 was 52.02%, but in 2018, already 42.06% – have also taken a major share in securitised securities, and countries in Europe have been trying to reduce their reliance on such securities for years.
To create a more risk-sensitive prudential framework for simple, transparent and standardised securitisation of ABS, to clearly define what constitutes a securitisation of ABS and to align the interests of originators, sponsors, original lenders involved in the securitisation and investors, Regulation (EU) 2017/2402 “Securitisation Regulation” was adopted in 2017 (Securitisation Regulation). It has been applied since 1 January 2019, and it lays down a general framework for the regulation of in-scope securitisation activity. In doing so, it sets out certain requirements that apply to all forms of in-scope securitisation issuance, such as risk retention, investor transparency, a ban on re-securitisation and criteria for credit granting. It also creates a specific framework for simple, transparent and standardised securitisation. Due diligence, requirements also apply to “institutional investors” in securitisation.
It should be noted that in Europe, market participants have only now gained sufficient experience in loan structuring and have understood the fundamentals of the mortgage lending and securitisation mechanism: credit risk, liquidity and relative value pricing – which has pushed the market forwards.
European originators of mortgages are looking for new sources of funding in diversified capital markets. This serves as an impetus for the development of the secondary market. This instrument needs to be monitored as securitisation is seen as one of the causes of the 2007–2009 financial crisis due to the generation of substandard assets by US mortgage rating agencies (Dekua, Karab & Zhouc, 2019).
Through the securitisation of mortgages, the concept of ownership as the totality of the powers of possession, disposition and use has changed considerably, and other property relationships have also undergone changes. Rights in rem and rights of obligation on the real estate market are being transformed into digital rights of claim and will, in the future, be governed by smart contracts. This will undoubtedly lead to new forms of civil law relations.
A full-fledged legal regulation of securitisation still does not exist in Latvia. The Financial and Capital Market Commission originally pledged to remedy this situation and study legislation to introduce securitisation (Dekua, Karab & Zhouc, 2019).
Estonia, Latvia and Lithuania have agreed to create a pan-Baltic capital market to strengthen their economies and stimulate investment to create jobs with support of the EC and the The European Bank for Reconstruction and Development (EBRD). In 2019, the Ministers of Finance signed a Memorandum of Understanding (Memorandum of Understanding, 2016). The parties have agreed to cooperate in the following fields:
promoting the pan-Baltic asset class; developing a regional legal and regulatory framework for covered bonds and other structured products, like securitisation; supporting the development of new capital market instruments – as an alternative to the banking sector – including equity, derivatives and other listed vehicles and other.
In 2019, the European Bank of Reconstruction and Development Introduction of a Covered Bond and Securitisation Legal and Regulatory Framework in Latvia (Introduction of a Covered Bond and Securitisation Legal and Regulatory Framework in Latvia). It is addressed to the European Bank for Reconstruction and Development and the Ministry of Finance, in the context of the reform of the legal and regulatory framework of covered bonds and securitisations in Latvia.
Both covered bonds and securitisations have the ability to provide significant benefits for Latvia including improvements to the funding of the real economy, increasing the stability of bank funding and generating a group of high-liquidity and credit quality investments for domestic investors. Also, the development of both securitisations and covered bond markets is key objectives of the EC's Capital Markets Union initiative. To realise these benefits, enabling legislation will be required, and in the case of covered bonds, a supervisory framework will need to be established.
As the covered bonds and securitisations involve the legal transfer of rights related to residential mortgages, then after the transfer, under the current regulation, the SPVs might fall within the scope 40 of licenced activities (consumer lending, debt recovery, etc.) This could be solved, according to the European Bank for Reconstruction and Development, in one of the following approaches:
Any licencing requirement for the SPV could be avoided, if it is ensured that the activities subject to licencing remain with the bank at all times. Special licences could be introduced for SPVs, if such licences are needed for the performance of any actions related to the transferred assets. However, this approach would not be the best solution for securitisation since in general, issuing of securitisations should be possible for any types of entities, whereas in the case of covered bonds, which are more strictly regulated, a one-off licencing might be feasible, provided that the licencing has as simple as possible procedure and reasonable costs. The licencing procedure should be introduced in the New Covered Bond and Securitization Law. The actions subject to licence could be outsourced by the SPV to a licenced entity. The latter approach has been used in practice in Latvia, e.g. when commercial loans are transferred to a non-licenced entity. In this case, the actions requiring licence, namely, debt collection, are outsourced to an entity, which is licenced for the debt recovery services. In this case, the law should oblige the bank to only transfer the assets to a servicer that has sufficient licenses in place. This approach might necessitate amendments in the Consumer Rights Protection Law and the Law On Extrajudicial Recovery of Debt (Introduction of a Covered Bond and Securitisation Legal and Regulatory Framework in Latvia, 2019).
The European Bank for Reconstruction and Development points out that the specific method of moving the assets into the SPV is the conclusion of a sale–purchase agreement between the issuer (bank) and the SPV. Under Latvian law, the sale–purchase of claim rights is possible just like the more traditional sale–purchase of tangibles (goods) (Civil Law Article 2002, 2005). However, the law should be more specific and recognise the peculiarities of the sale–purchase of claims for the securitisation and covered bonds purposes, e.g. provide the concept of the “true sale” of assets.
The European Bank for Reconstruction and Development proposes to accept in Latvia a New Covered Bond and Securitization Law, at least the following issues should be analysed in relation to current Latvian legislation whether additional amendments to specific Latvian laws need to be introduced or specific regulations should be included in the New Covered Bond and Securitization Law (which as special law will prevail over general Latvian laws), if the SPV model is chosen for the covered bonds and securitisations programmes.
Securitisation allows a higher rating than that of the borrowing company by separating the securitised assets from the other assets of the organisation, and hence reducing the cost of debt financing.
Despite the mortgage crisis in 2008, securitisation of mortgages accounts for more than half of all securitisation transactions.
The disadvantages of securitisations are currently seen as the risk of a financial bubble, accelerating inflation and their low availability to the medium and small market participants.
The development of this institution in Latvia is due to the absence of regulations governing the securitisation of any homogeneous assets other than mortgages.
To fully shape the development of securitisation of financial assets in Latvia, it is necessary to do the following:
finalise the basic regulatory framework for the securities market (including mortgages); provide opportunities for large investors to invest in MBS; develop measures of state support; expand the list of the types of assets that can be used for securitisation purposes; define the requirements for the issuers of the securities being issued in securitisations; develop an infrastructure for the activities of mortgage agents, trustees, etc.
Thanks to digitalisation and the widespread use of securitisation around the world, including mortgages, the concept of ownership as a set of powers of possession, disposition and use, as well as any other property relations, rights in rem and rights of obligation in the property market will be transformed into digital claims rights governed by smart contracts, which will logically lead to the creation of fundamentally new forms of civil law relations.