In the world economy, the European Union (EU) is often portrayed as a ‘market power’, able to leverage the large size of its internal market and its considerable regulatory capacity to influence international trade negotiations and shape global market regulation. Moreover, the EU often favours stringent regulation for products and production processes. In finance, after the international financial crisis of 2008, the EU also favoured more stringent domestic and international rules on several financial services, with some exceptions in the banking sector. At the same time, the EU’s attempts to ‘trade up’ international financial regulation by acting as a ‘rule-maker’ rather than a ‘rule-taker’ has met with limited success.
The EU’s role in the post-crisis international governance of financial securitization does not sit well within the literature that considers the EU as a ‘paladin’ of stringent regulation as well as a rule-taker in finance. In fact, while the United States (US) promoted more stringent domestic and international rules on securitization in the aftermath of the crisis, comparatively, the EU, has tended to sponsor less stringent domestic and international rules. Securitisation is the process of creating marketable financial instruments by pooling various financial assets (e.g. mortgages, loans) and selling these repackaged assets to investors.
The regulation of securitisation is important because it is part of the shadow banking system and contributed to the 2008 international financial crisis. It also has implications for monetary policy and the provision of funding to the real economy. Furthermore, in the context of the covid-related economic crisis, securitisation can be a way to provide additional funding to struggling companies. Yet, it can also be a source of financial instability. This is because securitisation can be instrumental for the creation of complex and opaque financial products, with poor quality of credit underwriting and monitoring standards. The EU has a relatively large securitisation market, although smaller than the one in the US.
What accounts for the EU’s role as a pacesetter in ‘trading down’ the regulation of securitisation worldwide? An explanation that has been overlooked so far is the pivotal role that the United Kingdom (UK) has played in the international standard-setting process, where it forged a coalition first with the US and then with the EU. The UK, in addition to the EU and US, can be seen as a third power when considering the regulation of global finance. The UK’s power is derived from the fact that it has a very large financial sector, and the City of London is an important international financial centre, also for securitisation. Moreover, the UK has traditionally punched above its weight in international financial fora also because British regulators have advanced expertise on financial matters and well-established contacts within the global financial community. Thus, whether the UK sides with the US or the EU, has implications for strengthening or weakening the negotiating positions of either jurisdiction at the international level.
In the case of securitisation, prior to Brexit, UK and EU regulators had aligned preferences and coordinated their actions at the domestic and international levels. In particular, a powerful alliance was forged by the Bank of England and the European Central bank (ECB), with the support of the European Banking Authority (EBA) and the European Commission. The Bank of England and the ECB produced two influential policy documents on this matter in 2014, noting that securitization, if appropriately structured and regulated, could provide additional funding to the real economy. Furthermore, it could be a source of funding for banks, which could transfer credit risk to non-bank financial institutions. A particular focus was on the promotion of simple structures and transparent underlying asset pools (so-called ‘high-quality’ securitization), while preventing the resurgence of the complex and opaque structures that contributed to the 2008 financial crisis. The European Commission was also supportive of securitization, which was a key component of the Capital Markets Union project proposed by the Commission in 2015. In fact, high levels of securitization were regarded as instrumental to develop Capital Markets Union, which was supported by many EU member states, especially the UK. Capital Markets Union was designed to increase financial sector integration in the EU and enhance the EU’s position in global capital markets.
In international standard-setting fora as well as at the regional (European) level, the Bank of England, the ECB, the EBA and the European Commission, were on the same page and sang from the same script in the attempt to reform the securitisation framework. To revive securitisation markets, two sets of measures were necessary: rules to increase the transparency and standardisation of securitised products, so as to create a label for ‘safe’ securitisation, and less stringent capital rules for this type of securitisation. In response to the EU-UK proposal, the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commission (IOSCO) published Criteria for Identifying Simple, Transparent and Comparable Securitization. At the same time, the BCBS agreed to reduce capital requirements for simple, transparent, and comparable securitization (2016). The same process was subsequently repeated for short-term securitisation (2018). Interestingly, the international discussions concerning the regulation of securitisation and the discussions on Capital Markets Union and the re-launch of securitization in the EU proceeded in parallel and the former were used to legitimise the latter.
Overall, the regulatory pendulum swung back and forth: initially, in the wake of the 2008 crisis, the international regulation of securitisation was traded up following the pace-setting of US regulators. Then, it was traded down as a consequence of the pace-setting of EU and UK regulators. Whereas the financial industry as a whole plauded this regulatory easing, critics (mainly some academics and finance watchers) worried about this development. The explanation – which is elaborated in my JCMS article mentioned below – hinges on the pivotal position of the UK, which first allied with the US and then with the EU on this matter. More generally, the article highlights the crucial role of the UK in making rules for global finance, in particular, whether the UK forges a coalition with the US or the EU. This explanation can ‘travel’ to other cases in finance and has become more important after Brexit because the question of whether the UK will side with the US or the EU in international standard-setting negotiations has come to the fore, especially whenever the EU and the US have strongly misaligned preferences. It takes two to tango in regulating global finance.
This blog post draws on my recent JCMS article: Quaglia, Lucia ‘It takes two to tango: the European Union and the international governance of securitisation in finance’
Short bio: Lucia Quaglia is a Professor of Political Science at the University of Bologna. She has published 10 books, 6 of which with Oxford University Press and over fifty peer-reviewed journal articles. She has also guest co-edited 4 special issues of highly ranked academic journals.