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Modern trends in the digital finance have made some transformations in the existing EU-wide securitization process and regulations. As an important element of well-functioning financial markets, a sound structured securitisation becomes an important channel for diversifying funding sources and properly allocating possible risks within the EU’s financial system.
Background
According the securitization regulation, institutional investors have to observe clearly defined criteria and processes for making investment decisions and ensuring that the risk retention requirement is satisfied. When banks and other credit institutions package loans into securities and then sell them to investors, it’s called “securitization”. It lets banks transfer the risk of some loans to other banks or long-term investors such as insurance companies and asset managers.
This allows banks to use the capital that was set aside to cover the risk in those loans to create and sell new loans.
Thus, securitization is the process in which certain types of assets are pooled so that they can be repackaged into interest-bearing securities; the interest and principal payments from the assets are passed through to the purchasers of the securities.
The EU law treats “securitization undertakings” as business entities which carry out the securitization in full, as well as undertakings which participate in such transactions by assuming all or part of the securitized risks (the acquisition vehicles), and/or by the issuing of securities to ensure the financing.
Generally, securitization is the financial means of taking not-easily-tradable assets, pooling them together, and selling shares to investors. Thus, there are three most common types of securitizations from the perspective of cash flow: collateralized debt, pass-through and pay-through structures.
Presently, securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto-loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling their related cash flows to third party investors as securities.
European securities regulation
The securitisation regulation is a cornerstone of the EU’s efforts to establish a Capital Markets Union: it applies to all securitisation products and includes due diligence, risk retention and transparency rules together with a clear set of criteria to identify simple, transparent and standardised (so-called STS) securitizations.
Under the Securitisation Regulation, securitisation is a transaction or scheme where the credit risk associated with an exposure or a pool of exposures is tranched, and all of the following characteristics are met:
= Payments in the transaction or scheme are dependent upon the performance of the exposure or of the pool of exposures.
= The subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme.
= The transaction or scheme does not create specialised lending exposures.
The Securitisation Regulation confers a number of tasks upon European Securities and Markets Authority, ESMA.
As part of the Capital Markets Union Action Plan, the revised securitisation framework came into application in 2019 with the core objective of establishing an EU securitisation market that helps finance the economy without creating risks to financial stability. The framework consists of: = the Securitisation Regulation, that introduces common rules on due diligence, risk retention and transparency for all securitizations and creates a category of simple, transparent and standardised (STS) securitisation products;
= an amendment to the Capital Requirements Regulation (CRR), that makes the capital treatment of securitizations for banks more risk-sensitive and introduces a specific preferential treatment for STS securitizations;
= the prudential rules concerning insurer’s investments in securitization set out in the Solvency II directive and the amended Commission Delegated Regulation 2015/35.
On regulation (from 2017) in;
https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32017R2402
On FISMA
The Directorate-General for Financial Stability, Financial Services and Capital Markets Union (DG FISMA) has launched in the beginning of October 2024 a targeted consultation to assess the effectiveness of the EU securitisation framework, which was introduced in 2019 with the aim to promote an EU securitisation market that finances the economy without creating risks to financial stability. Securitisation can play a crucial role in the development of the capital markets union and the savings and investment union.
For example, by freeing up balance sheets, banks and non-bank lenders can increase lending to households and corporate entities, while also providing another set of assets for the interested investors. The Eurogroup statement of March 2024 and the European Council conclusions in April 2024 on the capital markets union highlighted the need to relaunch the European securitisation market. Presently the EU and the member states wish to seek feedback from relevant stakeholders on the current EU securitisation framework and identify potential areas for improvement.
DG FISMA develops and carries out the Commission’s policies on financial services in the following directions: = regulation and supervision; = capital markets union and financial markets; = banking in the EU and the banking union; = insurance and pension funds; = sustainable and digital finance; = consumer finance and payments; = financial crime; and = the EU finances in the world.
More in: https://commission.europa.eu/about-european-commission/departments-and-executive-agencies/financial-stability-financial-services-and-capital-markets-union_en
Digital finance
Synthetic data enables national authorities to make their financial data publicly available. In September 2020, the European Commission adopted the digital finance strategy to foster a more competitive and innovative European financial sector.
The digital finance platform initiative is part of this effort to support innovation in finance and build a true single market for digital financial services. This platform is aimed at developing closer relationships between financial companies/firms and supervisory authorities.
The platform is a collaborative space that offers practical tools designed to facilitate the scaling up of innovative firms among the EU member states. It features the new data hub, cross-border services, a fintech mapping, an overview of the latest policy news, as well as organising digital finance events.
More in: https://finance.ec.europa.eu/news/digital-finance-2024-04-10_en
EU Digital Finance Platform
The European Commission launched in March 2024 the data hub (with the addition of synthetic datasets), a new digital finance platform with the objective of facilitating the exchange of data between supervisory authorities and financial companies/firms.
The data hub is a part of the EU Digital Finance Platform, which facilitates data exchange between financial companies and supervisory authorities. Its aim is to provide companies with access to synthetic supervisory data for testing new applications and training AI/ML models.
The technology used for data sharing on the data hub is known as synthetic data, which is artificially generated to resemble real-world data in terms of statistical properties, without including real individuals or identifiable information; it is using algorithms, simulations and/or machine learning models.
The process of creating synthetic data involves three steps. First, a machine learning model analyses real customer data to understand relationships between factors, such as how income level affects loan default risk. Then, this analysis is used to train an algorithm to replicate these trends. Finally, the model generates new data that mirrors the patterns of the original data but does not represent any actual person. For instance, it might create a synthetic “customer” with certain financial characteristics, but this customer doesn’t exist.
There are several reasons for using synthetic data. One major benefit is privacy protection, as the synthetic nature of the data removes the risk of revealing real customer information, ensuring compliance with privacy regulations. It also enables data sharing, as central banks and national authorities can share synthetic data with external partners or researchers without privacy concerns. Additionally, the synthetic data retains enough quality to train models effectively, meaning there is no significant loss in accuracy.
Synthetic data offers a way for supervisors to participate in the project without having to make the real data they hold accessible to any third party. In short, synthetic data ensures full “anonymization” while preserving the characteristics of the original data that make it relevant for testing purposes. At no point will any real data leave the premises of the respective supervisors, nor will any external user gain access to it.
The synthesis methodology was tested by the joint research centre (JRC), the research and innovation directorate general of the European Commission. The purpose of this testing was to ensure that the new datasets maintain the properties of the original datasets while also protecting privacy and confidentiality.
This allows financial companies to test algorithms without the need for real customer data, making the process safer and compliant. A recent report by the Commission’s Joint Research Centre (JRC) reviews the use of this synthetic data technology in the Data Hub, comparing the statistical characteristics of the original and synthetic datasets. The report evaluates the efficiency of the data creation process and addresses privacy concerns. Tests show that the synthetic data replicates key patterns from the original data while ensuring the confidentiality of sensitive information.
The JRC report concludes that the synthetic datasets are comparable in value to real data while meeting privacy requirements, contributing to the EU’s digital finance goals by supporting innovation without exposing real data to third parties.
Reference to: https://finance.ec.europa.eu/news/digital-finance-2024-04-10_en