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Article 122a: Protectionism and a Shift from "Service" Economies

Way back in May, you may recall the EU limiting local investors to Private Equity & Hedge Funds located only within the EU.  Well, the EU has taken steps to implement a little directive know as Article 122a.  While everyone is focused on Basel III as the next wave to rock our ship, Article 122a could be an even more decisive ebb.  Courtesy of Institutional Risk Analytics:
…[Article 122a] requires European credit institutions that invest in structured finance securities to know what they own. It lays out explicit penalties if a European credit institution does not obtain sufficient data regarding an ABS…

There are two basic requirements: retention and disclosure.
There is a five percent (5%) retention requirement for the issuer regardless of the type of underlying asset. Even as this article was being written, there is still debate between the regulators and the industry as to the form of the retention.

Much more important than the retention requirement is the disclosure requirement. Issuers are required under Paragraph 7 of Article 122a to ensure that prospective investors have readily available access to all materially relevant data on the credit quality and performance of the individual underlying exposures, cash flows and collateral supporting a securitisation exposure as well as such information that is necessary to conduct comprehensive and well informed stress tests on the cash flows and collateral values supporting the underlying exposures

I find this an ironic directive for two reasons.  First, the FDIC attempted at a similar initiative in the best interest of consumers, which, therefore, failed to launch here in the US.  Second, Meredith Whitney somehow still finds a microphone at her beckon call, and she was on C-SPAN this weekend talking about ‘the “Wall Street Ponzi Scheme” of keeping investors in the dark by telling them they won’t understand their investments.’  Even though I think Ms. Whitney misremembers what a Ponzi scheme is, her commentary syncs neatly with the EU’s apparent ABS qualms.

I have a few takeaways from the Article 122a move.  The US financial system has certainly taken a hit to its goodwill.  We packaged subprime loans into ABS like hotdogs, then sold them as if they were venison sausage.  But, any crises goes hand and hand with fraud, so nothing to see there.

More importantly, given the developed world’s touted shift toward “service” economies, finance & financial services sectors have taken a larger and larger slice of the GDP pie.  We talk about a reversion toward protectionist economic models as a potential cure for global imbalances and waning local demand.  That’s a politically touchy subject, but a compelling one nonetheless.  The EU limiting investors to local funds was certainly a veiled protectionist move—maybe a knee-jerk reaction having watched the UK take a body-shot from Icelandic banking crisis?  Article 122a, therefore, either ends as a protectionist measure, or a political push to affect US financial regulation from the outside.

Disclosure: no positions