(Bloomberg) -- The European Central Bank is seeking clarity on how investors use borrowed money to buy significant risk transfers, as it tries to ensure the increasingly popular structure helps mitigate exposures rather than shift them across the banking sector.
The supervisor sent a questionnaire to a small group of the top European banks, asking about policies and conditions they attach if investors want to buy their SRTs with borrowed money, according to people familiar with the matter. The ECB also seeks to assess terms under which lenders are willing to provide leverage against investors’ SRT holdings, the people said.
A representative for the ECB declined to comment.
SRTs allow banks to transfer some of the risks on their balance sheet to outside investors, freeing up capital for new business. While the ECB is trying to give banks a faster and simpler route to do that, it also seeks to ensure that risk is not being shifted elsewhere in the system.
The International Monetary Fund has flagged financial stability concerns, because the source for much of the leverage employed by SRT buyers is often just another bank.
If SRT buyers use leverage, “substantial risk” remains within the banking system, the IMF said in a report released in October.
The ECB sent the questionnaire last month and is expecting the answers in the coming weeks, said the people. While the watchdog is still in fact-finding mode, it’s possible that the information it gathers will lead to a debate on whether regulatory guardrails are warranted, said the people, asking not to be identified discussing the private information.
At the same time, the ECB is working to accelerate its approval process for SRTs, in a sign that the watchdog isn’t opposed to their use as such.
Under new proposals, banks will be allowed to submit information for their SRT transactions with a shorter notice period and fewer details, other people familiar with the matter have said. A pilot of the simplified process is due to start in January and run for around six months, they added.
Adding leverage is more common in the US than elsewhere, because buyers there have to insure larger portions of the debt. That makes the securities yield less, and additional leverage can boost returns.
Bloomberg reported last month that US banks including Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. are asking investors to disclose whether they plan to use additional debt to invest in SRTs, as regulators step up scrutiny.
Bank of America is not allowing its SRT investors to take leverage from other US banks, a person familiar with the matter said at the time, adding that such an approach is consistent with what other major American lenders are doing.
The debt tends to come in the form of repurchase agreements as well as other types of credit options such as net asset-value loans. The latter are popular with private equity firms, which secure the debt against a portfolio of their holdings.
One worry by watchdogs is the mismatch between repos and SRTs. While repos are typically short-term loans that are regularly adjusted to market prices, SRTs are by nature longer term and harder to value because there isn’t much buying and selling of the securities.
Loans tied to SRTs have reached about $1 trillion this year as deals are running at the fastest pace on record, according to data compiled by Chorus Capital Management.
--With assistance from Arno Schütze and Carmen Arroyo.
(Updates with details of simplified approval plan from eighth paragraph.)
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