Return to Treasure Island

Geoffroy Marcassoli, ESG Assurance Leader, PwC Luxembourg, explains how sustainable finance in the EU can benefit from a securitisation market revival.

Europe faces a tough economic landscape: the euro area’s GDP grew by just 0.2% in Q2 2024. On average, the EU’s debt-to-GDP ratio stands at 80.8%, and it exceeds the 100% threshold in several member states. European firms are increasingly struggling to compete globally, as highlighted by former president of the European Central Bank (ECB) Mario Draghi’s recent landmark report.

While the Draghi report is ripe with proposals and points to three key areas to “reignite growth” – namely in innovation, decarbonisation, and supply chain resilience – the road ahead is particularly bumpy. Indeed, to meet the report’s objectives, an eye-watering investment of €750-800 billion is needed annually, of which €450 billion should be directed towards the energy transition between 2025 and 2030.

How to achieve such ambitious investment flows? The long-awaited Capital Markets Union (CMU) must be established, alongside a unified securitisation market in the EU, as this will unlock investment flows, drive growth, and strengthen Europe’s economic resilience.

Securitisation in a European context

Securitisation entails the pooling of income-generating assets – such as loans or mortgages – and selling their cash flows to investors as securities. It turns illiquid assets into marketable ones, spreads risk, and gives lenders fresh capital for further credit. Moreover, it allows banks to move loans off their balance sheets, freeing up capital while providing returns to investors with the risk appetite to purchase the securities. When it gained prominence in the US in the 1970s and 1980s, it helped give the housing sector a much-needed boost amidst sluggish growth.

However, by the mid-2000s, millions of high-risk mortgages – the infamous subprime loans –were bundled into securities without proper risk management, and at the market’s peak, US$2 trillion of securitised products were issued in the US in 2007. As a growing cascade of loans started going sour, rendering the securitised products worthless, the global financial crisis (GFC) ensued, and securitisation’s reputation was badly tarnished.

The GFC continues to cast a shadow. In 2023, the total issuance of the European securitisation market was €213 billion – a figure that has not budged much since 2013, as the graph below highlights.

Figure 1. European securitisation issuance (in billion €)

Source: Retrieved from ‘Securitisation in Luxembourg: A comprehensive guide;’ data from AFME Securitisation Data reports.

Even officials at the European Stability Mechanism have acknowledged that after the financial crisis, “the EU may also have adopted more demanding accounting and prudential rules than the US”. Little wonder then that Europe’s banks have been hesitant about coming to market compared to peers in the US, where costs and complexity are also lower than in Europe’s fragmented markets.

Unifying European capital markets

Since the mid-2010s, the European Commission has been striving to promote stronger, more integrated and resilient European financial markets, with the CMU a central pillar in this endeavour. This integration is crucial for mobilising the substantial investments needed to achieve the EU’s ambitious climate goals and support economic growth.

Between 2011 and 2020, the EU invested an average of €764 billion per year to reduce greenhouse gas (GHG) emissions, although an additional €477 billion is needed annually to meet the 55% reduction target by 2030. Most of this additional investment will be required to decarbonise the transportation sector and boost the energy efficiency of residential real estate.

One promising source of funding lies in retail investors. Currently, European households are sitting on significant savings, with rates at their highest in years. In the second quarter of 2024, the euro area’s saving rate reached 15.7%, up from 15.2% in the previous quarter and notably higher than the pre-pandemic average of around 12%. This high saving rate often reflects economic uncertainty, prompting consumers to prioritise saving over spending or investing. Despite having the means, many Europeans hesitate to invest due to fragmented capital markets and the high costs faced by issuers.

In a bid to move forward with the CMU, a new European regulation on securitisation was introduced in 2017 focused on simple, transparent and standardised (STS) products, along with amendments to capital requirements. The new rules help investors, including retail investors, to better assess risks and make securitisation more accessible. Through such uniform rules, the European policymakers are seeking to propel securitisation forward and unlock new, much-needed financing opportunities to support the continent’s digital and green transformations – but how successful have they been?

The path to revitalisation

There is no denying that the European securitisation market is in stagnation, and as the Draghi report suggested, further revitalisation requires several strategic steps. First, prudential requirements must be adjusted – capital charges for specific STS categories should reflect the actual risk, and the p-factor, which is currently seen as excessive for corporate and SME portfolios, needs targeted reduction. Additionally, transparency and due diligence requirements should be revised to lower the comparatively high barriers that discourage issuance and acquisition.

Establishing an EU securitisation platform, similar to those in other economies, could also help reduce costs, particularly for smaller banks, and promote standardisation, making securitised products more attractive to investors. Finally, targeted public support, such as public guarantees for the first-loss tranche, could incentivise issuance and boost lending in crucial sectors.

Policymakers must also stay ahead of financial innovation. As financial products can become increasingly sophisticated, regulators need the tools to identify and manage emerging risks. This is particularly important for ESG securitisations, which must include enforceable standards to prevent greenwashing and ensure that proceeds are genuinely directed toward sustainability goals.

However, we must remain mindful of the lessons learned from the 2008 GFC. Maintaining a strong focus on transparency and ensuring that disclosure standards evolve in line with market dynamics is crucial, as this will not only protect market participants but also foster a stable and trustworthy securitisation market. If done carefully, this approach can strike three birds with one stone: freeing bank assets for green loans, encouraging investment within Europe, and reducing market fragmentation.

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