The asset-backed securities market: Experts discuss trends and opportunities

9 August 2023
The asset-backed securities market has slowed in the last year due to rising interest rates, consumer stress and other factors.

Few doubt the market will achieve significant growth in the long term, but there are indications of short-term recovery as well. To take the US as an example jurisdiction, this summer Tesla, Hilton Grand Vacations Trust, and Flagship Credit Auto Trust all announced plans to enter into ABS deals ranging from USD300 million to USD1 billion.

There are other indicators that the ABS market is poised to surge. One of its prime industry events is the annual Global ABS conference, which held its 27th edition in Barcelona this summer. It attracted a record number of attendees, with thousands of issuers, investors, banks and other industry professionals convening.

We asked three of those experts — each of whom attended the recent Global ABS conference — to talk about the state of the asset-backed securities market now and where it is headed. 

Navita Yadav is Vistra’s managing director and global head of capital markets and is also responsible for loan market solutions. Sven Haase is commercial director, capital markets (Luxembourg and Germany), and Stephen Birkwood is commercial director, capital markets (UK and Ireland). Together, they have decades of experience working in the ABS industry.

High interest rates, inflation and other related factors are leading to uncertain markets. How have these headwinds affected the asset-backed securities market?

Stephen: UK inflation has finally started to abate following relentless interest rate increases. The Bank of England has been criticised for not acting as quickly as the US’s Federal Reserve, but hindsight is a wonderful thing, and these are not clear-cut decisions. Interest rates in the UK are expected to rise again, but it’s starting to feel like we’re close to the end of hikes, as inflation appears to be under control.

Against this backdrop, we have seen banks and non-bank lenders utilising the asset-backed securities space in private markets for a number of reasons, including to improve their capital efficiency ratios by securitising existing assets or to increase lending to existing clients. We’ve also seen several innovative structures, as lenders look to continue to service their clients (that is, the borrowers) during challenging economic times.

Many ABS transactions are now concentrated in real estate-backed loans or SME loans, and we expect that to continue. Lenders are taking action, and the volume of deals has increased over the summer months, historically a quiet time.

Sven: Uncertainty has generally slowed the ABS market, but as Stephen notes there are opportunities for those who act quickly. In this environment, we’re seeing more private — and I think in general smaller — transactions, as well as deals with established players that know each other. These transactions are quicker to bring to market. Public transactions, such as automotive and consumer loan asset-backed securities, are also going ahead, as they’re well-established deal types with standard documentation and stable investor bases. Public transactions may, however, be more difficult to price in volatile markets.

Regulatory requirements in the securitisation industry, particularly in the EU, can be stringent and difficult to understand and follow. How can firms and investors best position themselves to address changing compliance requirements in all relevant jurisdictions?

Navita: Regulatory requirements in the securitisation markets are ever-changing and can be challenging for participants. Take for example compliance with the EU’s STS regulation, which requires originators, sponsors and securitisation SPVs to make information on the transaction and underlying exposures available to investors and authorities. It applies to all securitisation products and includes adherence to due diligence requirements, capital requirements and risk weightages. All participants must also adhere to ESMA reporting requirements.

There are of course other regulations governing the industry, inside and outside the EU, including forthcoming ESG regulations that require disclosures for mortgages, auto and leasing assets. Ultimately, more regulation means increased administrative burdens and risk, and rising investor costs.

It’s important to remember that there are ways to mitigate regulatory risks and costs. Lenders and borrowers should build and maintain compliance teams with internal stakeholders and third-party experts to keep abreast of and follow new and changing regulations. The recent Libor transition is a great example of collaboration between issuers and third parties to solve for the change affecting the industry as a whole.

I also recommend building tech capabilities, including platforms that can streamline the compliance process, particularly around reporting. Given costs, data security challenges and the need for ongoing tech expertise, it’s often most efficient to outsource technology capabilities to corporate service providers. This is really an extension of working with experts to understand and follow applicable regulations — the regulatory and tech environments are so volatile, and the related risks so high, that outsourcing is increasingly attractive.

One final point that’s often overlooked is to engage with regulatory authorities on a consistent basis. This will help you understand the rationale behind changes and their potential effects on the industry.

Fintech is changing the securitisation process, from creating reporting efficiencies to widening the pool of potential originators. What do you see as the most overlooked or underappreciated benefits of technology in securitisation?

Sven: Technology can bring the many transaction parties closer together and enable a secure means to collaborate. Historically, these parties worked in various segregated workstreams, which led to inefficiencies and poor communication. Secure platforms that promote communication reduce the time to market and reduce costs. This technology can also lead to standardising certain work-streams — potentially with the help of AI — and that can lead to even greater time and cost savings down the line.

These emerging technologies can also help collect and analyse huge amounts of data, and that data can be made available to the relevant parties in a transaction.

These benefits may ultimately provide access to new players who may previously have been restricted from using securitisation as a financing tool because of their relatively lower securitisation volumes.

Private securities are popular with sellers in part because they carry fewer regulatory obligations. What are some of the benefits and risks in this area and what related trends are you seeing now?

Navita: Private securitisations are a relatively recent development in capital markets, basically since the global financial crisis. The key is that the business mix of a company must generate assets over which security can be granted to the note-issuing vehicle, or SPV. These assets can take the form of loans, invoice receivables, units of manufacturing or engineering production, residential and commercial property, and any other assets that generate a revenue stream and can be charged as a security.

Private placement securities are offered to a defined group of professional investors, such as pension funds, family offices, or insurance companies and other professional parties that can analyse the risks associated with the investment. 

Private placements are typically used for the placement of unlisted securities for amounts of up to about EUR300 million and placed with one or more investors. Private placements benefit from simpler regulations and annual disclosure requirements, which means that the issuer can go to market more quickly. Normally, in the EU, the issuer is exempted from the requirements under the Prospectus Regulation and will not be required to prepare a prospectus — a simplified private placement memorandum will suffice.

Private placements are also exempted from credit rating requirements, further reducing funding costs. This makes private placements particularly attractive for new issuers, small and medium enterprises, the fintech industry and venture capital funds. Issuers benefit from a more economical, more rapid recycling of capital. Meanwhile, investors benefit from an established security framework with a calculable risk profile — they’re being compensated well relative to risk while there’s a general lack of liquidity.

Private securitisations are an option for issuers in other circumstances, for instance when a subset of a portfolio is more challenging to securitise publicly due to a limited performance history or for assets where there is not yet a developed rating methodology. 

Of course, there are risks associated with private securities. Private securities are less liquid and more challenging to sell compared to publicly traded securities. Investors may face difficulties in exiting their investments before the agreed-on maturity. Furthermore, investors may have limited access to financial information and face challenges when trying to assess the issuer’s creditworthiness and performance. Finally, with fewer regulatory obligations and disclosures than public securitisation, private securities may be relatively opaque and subject to less oversight, increasing the risk of fraud and mismanagement.

This brings us back to the earlier point about regulatory complexity — along with the general complexity of securities — and the need for third-party expertise to lower risk and create efficiencies. Lenders and borrowers need to work with an expert that fully understands private placements and their underlying transactions and has a platform to support the lifecycle of the transaction, from issuances to repayments.

One of the most surprising aspects of opening any operation in a new country is the time and effort it takes to open a bank account, and this holds true for special purpose vehicles. What are the primary challenges with opening bank accounts for SPVs, and are there alternatives to traditional bank accounts?

Stephen: This is a topic that doesn’t get as much attention as it deserves, given how many transactions are affected on a yearly basis. Not all jurisdictions or client types pose the same challenges. There’s a difference, for example, between opening a bank account in the UK for a large, established financial institution — which is relatively easy — and opening an account for a smaller, less established party.

The primary challenge for a smaller firm will typically relate to know-your-customer and anti-money laundering checks. And if the firm is not regulated, the onboarding process at a traditional bank can be time-consuming, which is unavoidable as banks have regulatory duties to fulfil.

There are alternatives for an organisation that needs to transact within a few weeks, however. It can engage with a neobank or challenger bank, offered by a fintech, which can operate quickly. Neobanks have proved extremely valuable to the smaller firms that need to operate at speed. This nicely illustrates that the securities market is not a one-size-fits-all space.

Investors and regulators around the world are pressuring various markets to conform to ESG principles. What are the key ESG themes you are seeing in the market? 

Navita: I’d start with sustainability disclosure. The International Sustainability Standards Board (ISSB) has issued its inaugural standards, ushering in a new era of sustainability-related disclosures in capital markets worldwide. This will bring about a renewed emphasis on the concept of financial materiality and the interplay between sustainability and financial value creation. 

Next, I think there will be a reset for ESG integration and sustainable finance. As market participants become more sophisticated and regulatory frameworks become increasingly stringent as to what qualifies as a sustainable investment, I believe heightened attention to quality and integrity will temper greenwashing concerns and drive further innovation in the sustainable finance market.

Finally, I see a growing market for transition finance. Virtually all countries regard energy independence as a critical national security priority. There’s also a growing recognition that some of the most promising opportunities to decarbonise can be found in the highest-emitting sectors of the economy. All of this will lead to an increased focus on projects that do not align with a pure “green” framework as we think of it now, but will be instrumental in helping to reach net-zero by 2050.

Ultimately, I believe the world is headed towards not just issuance of green instruments, but transformation into green companies, which will greatly uplift the standards of sustainability in our global geo-political economy.

How do you see securities market participants adopting the various ESG frameworks?

Navita: 2022 was a record year for large public companies publishing corporate sustainability reports, known as CSRs, and taking steps to align their organisations with external ESG frameworks and standards. While the major uptick in transparency is driven in part by stakeholder expectations for greater visibility into ESG metrics, it’s also a sign of increased ESG maturity among leading companies, particularly those in the S&P 500.

This is a large subject — there are five leading ESG frameworks or sets of standards (including SASB, CDP, TCFD, GRI and SDGs) adopted by S&P 500 companies, for instance. But basically, ESG reporting framework adoption by a particular company depends on the metrics that are material to the company’s industry and operations, as well as to external forces, such as customer data requests and investor expectations.

ESG frameworks are multiple, then, and adoption is not uniform across industries or company size. Companies are also going through something called “framework fatigue” due to numerous requests from various parties. Smaller companies have in general been slower to adopt ESG frameworks, but they may still report ESG-related data, such as a sustainability webpage or a brief narrative report. However, best-practice ESG reporting generally includes reporting to at least one framework so data can be easily compared.

Many countries are undergoing significant rises in the cost of living, which may lead to consumer-loan delinquencies and new regulations to protect consumers. How can issuers and investors put themselves in a good position to thrive now and in the future in the unsecured consumer finance space?

Sven: Issuers should follow the industry closely, in particular industry regulatory trends, and try to prepare for expected changes. This will typically require working with a third-party compliance expert and remaining nimble as an organisation so you can quickly respond to new obligations and reduce the negative effects that come with being unprepared. Issuers should also provide investors with accurate data that helps them accurately assess the risk-return profile.

As for investors, they should ensure that the consumer-loan platform is following best practices even in the absence — or especially in the absence — of tight regulations. If regulation kicks in, these platforms are less likely to suffer compared to some more aggressive platforms. Finally, analyse the data diligently and ensure that you thoroughly understand the risk profile of the tranche you’re investing in.