24 January 2014

AFME: Securitisation report argues for broad approach to liquidity

This paper aims to provide a new perspective on the relative liquidity of two important European asset classes, covered bonds and ABS. It focuses on evidence from bid-ask spread data, a data source neglected in the recent EBA analysis of asset class liquidity.

EBA has analysed the liquidity of different asset classes as part of its work for the Commission on definitions to be employed in a European implementation of the LCR. AFME‘s report critically examines the EBA analysis, focusing on the exclusion of bid-ask spread data from the evidence employed. Using bid-ask spreads, the report shows that Asset-Backed Securities (ABS) and Covered Bonds (CB) do not exhibit radically different levels of liquidity in recent years. Furthermore, the data show that, based on bid-ask spreads, some non-residential-mortgage-backed ABS (excluded from the LCR in the EBA proposals) have been more liquid than CBs.

As AFME points out, the EBA analysis is almost exclusively based on a single transactions database that omits the most obvious source of information on liquidity, namely bid-ask spreads. The AFME paper provides evidence on the relative liquidity of two important asset classes: Covered Bonds and Asset Backed Securities (ABS). It found that:

1. On average, Covered Bond bid-ask spreads are narrower than those of ABS. But, for much of the sample period, spreads for the more liquid ABS are narrower than those of Covered Bonds, especially in the period of 2011-2012 when significant fears about sovereign solvency (and hence the prospects for Covered Bond bailouts) gripped the market.

2. Some short maturity non-mortgage-backed ABS such as auto-loan-backed ABS have liquidity as measured by bid-ask spreads that is generally comparable to that of Covered Bonds and indeed is markedly superior for non-Pfandbriefe Covered Bonds. This finding is in stark contrast to the conclusions of the EBA since they regard all non-mortgage-backed ABS as of very low liquidity.

3. The analysis presented in the paper provides a warning against reliance on a single dataset and the use of methods (such as those employed by the EBA) which depend heavily on frequency of trading and turnover rather than trading cost measures such as spreads. To understand why these approaches lead to very different results, one may focus on auto-loan-backed ABS. These are short maturity and hence rarely traded. However, when during the crisis holders wished to dispose of these securities, they were able to do so at a small cost.

4. As well as examining bid-ask spreads directly, AFME measured the discounts evident in the prices of securities that are relatively illiquid. These can be significantly greater than immediate bid-ask spreads as market participants price in trading costs that might be encountered in a future crisis. These measures suggest that the differences in price discounts between high- and low-liquidity securities between Residential Mortgage Backed Securities (RMBS) and Covered Bonds are comparable.

Full AFME report

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