PGIM’s Edwin Wilches on securitization regulation

PGIM’s managing director joins AFM to discuss the UK and EU securitization regulatory roadmap

Transcript

SPEAKER_01 0:07

Hello and welcome to another five minutes. I'm Tom Hall, Global Capital's senior securitization reporter. And I am joined by a special guest today, is Edwin Wilches from PGIM. Edwin, do you want to start by giving a little introduction of yourself and what you do at PGIM?

SPEAKER_00 0:25

Absolutely. And first off, thank you so much for having me here today. So as you mentioned, uh Edwin Wilchez help uh co-lead our securitized products business. We are global investors. Uh today we're managing a little bit over $160 billion of assets uh across uh securitization that includes CLOs, CMBS, RMBS, and ABS, increasingly also ABF, which is which is um you know the private form of securitization. So super excited to be here and uh looking forward to the discussion.

SPEAKER_01 0:58

Yeah, good stuff. So uh, you know, it's it's pretty sort of serendipitous timing this podcast. I I got you on to really speak about the sort of regulatory landscape for securitization in the UK and Europe. So maybe uh just just for the listeners, I'll give sort of a brief rundown of what's been happening so far. But for for Europe, you know, we we had those commission proposals back in June, then the the council set out its proposals in December, and uh we're sort of waiting right now for Parliament to present its final amendments on May 5th, according to its own sort of timeline, and then they'll enter the trilogue process. So that's what's happening on the European side. Then on the UK, uh we had the FCA and the PRA uh launched a consultation back in February, that's sort of running till uh May 18th, and then we we should have the the final rules come out in the second half of the year. So uh and I should say we're recording this on uh April 24th. So um, you know, it's uh a bit before we'll see the the kind of next development in the landscape, but maybe starting with the sort of UK outlook, because I think you know it's it's good to get an investor perspective on these things, and I think that's you know probably the the area where uh investors seem sort of more pleased so far. I mean, how how are you feeling about you know the the current UK proposals?

SPEAKER_00 2:19

Yeah, sure. And I think you know, Tom, if we take a really quick step back, you know, asking like the why, why is this important? Why why are we talking about it and and why why is this so um so so so such an important area for investors to really start thinking about and focusing? Taking a taking a quick step back, right? It's it's it's thinking about both for the UK and Europe um how to find additional sources of funding for the real economy, right? And and why is that important? It's important because obviously Europe is looking to grow their GDP. Um, you know, historically they were about 30% of global GDP, today it's below 20. So they're looking to kind of regain some of that momentum. But also perhaps just as importantly and connected is you know, uh there's there's needs for funding the transition, you know, uh in in energy, there is obviously needs for defense, and there's a whole other host of variety of needs, right? So the way that you fund these things is through both debt and equity and you know, if you we look outside of Europe and particularly in places like you know, Australia and the US, a a larger portion of the economy is funded through securitization. Now, I think when we when we peel UK and Europe, um if we look at them separately, the UK has always had a bit more of an advanced securitization market in terms of, you know, we see obviously buy to let and we see other types of securitizations coming through uh the UK market. Post-Brexit, uh the UK has some degree of more independence in terms of how they're gonna develop these markets. So both the UK and Europe have similar ambitions in terms of funding the real economy. The UK, I would say, is closer to delivering on these ambitions through policy. So as you mentioned, there has been some more recent proposals. You know, some of the key things for a securitization program to be successful in order to fund the real economy is, you know, you have to reduce, you know, you know, two things make make an object uh move forward. Uh, you know, one is is is fuel, right? So you you add more fuel to the system, or you reduce friction, right? Uh reducing friction also actually sometimes what holds you back is is is is what's keeping you from moving forward, right? Is as uh as silly as that sounds. So what the what the what the regulator is trying to do is say, let's identify areas where there's unnecessary frictions, uh, right? So there's intentional frictions, like you know, to make sure that the system remains stable, which is which are critical. Uh, but then there were additional frictions that, you know, just created costs either for issuers uh that were thinking about you know funding through securitization, or just as importantly, costs for asset managers or asset owners that are unnecessary. So uh the way I would frame the situation on the ground today is the UK has really been very focused on trying to identify things within the current structure of funding that um allow investors to more freely access securitization. Um, to therefore, right, if if there's more ability to access the product, then there'll be more demand for the product. If there's more demand for that type of funding, uh there will inevitably lead to more supply. And there you get into this flywheel of you know, real economy needing capital. Capital is being met with demand on securitization, and that's the focus. I think as I mentioned, Europe has similar ambitions. However, where we are today is is is is risking of falling short of those ambitions, you know, especially when we look at where the UK is. Uh the UK, um, you know, there's some formal feedback that that that we'll share with with them in a little in a little under a month. Uh, but I'd say, you know, by and large, the blueprint that they share with the market is is quite robust in terms of being able to restart or or said differently, maybe um expand the the existing securitization market.

SPEAKER_01 6:08

Yeah. I mean, I guess it's it's kind of interesting, you know, thinking about the sort of the UK and Europe divergence. I mean, it it feels like I think there was certainly on on the investor side kind of more positivity around the the more recent uh UK news than perhaps, you know, I I know one of the things that keeps coming up around you know Europe is sort of the sanctions framework around, you know, are they sort of being too punitive and is is that gonna you know sort of discourage investors who don't already you know invest in ABS assets from joining the market? I mean, do you do you have sort of you know any any kind of general thoughts from an investor perspective on how the the kind of EU regulatory roadmap is going so far?

SPEAKER_00 6:55

Yeah, so so um it's it's it's moving in the right direction. Again, it's kind of like when we when we uh you know there was a Draghi report in 24 that really was a catalyst for kind of um you know mobilization of of and and focus in this initiative. I'd say those those ambitions were quite high. And you know, as we've rolled through, I think those ambitions remain. Uh, however, we we probably have had a little bit of a slowdown in terms of like uh you know ensuring we we meet all of these ambitions, right? So so I think it's positive progress, but definitely a lot more work to do. Uh I think one really fascinating piece, and I think you open this way, is the UK has seemed to really move forward quite well. Uh so we're hopeful that once the UK framework blueprint uh is out there, perhaps it helps the the European teams consider some of those updates, if you will, to the regulation. Now, I think with regards, you asked about sanctions, and I think you're talking about third-party sanctions. I I think of it this way, Tom, right? Like what we're talking about here is we're looking to expand GDP. Uh, we're looking to invest in in growth, right? So what that means by definition is there is going to be, you know, if if the pie is, you know, uh X big, uh, maybe, you know, if if we think about it in the future, it's one and a half times as big or two times as big. Um, what's important and critical is to remember that, you know, it's not just about supply. So a lot of the regulation focus has been on banks, which I think is appropriate in part because banks are a very large part of funding today, right? It's nearly 80%. However, if we think about the need for the need for additional funding being, you know, uh multiples of that, or or maybe not multiples, but a high degree of existing funding, unless we want to grow the banking system, and you know, that has its own kind of pitfalls in terms of just financial stability in the future, uh, you need to grow securitization. Right. So when we think about that, uh, you know, how do you grow securitization? You need two things, right? One, you need more issuance, which which I think, you know, if there's demand, the the issuance will inevitably come. Um, and you know, these things take time. But then how do we build demand, right? We need to have investors at the core in terms of how we build the regulation. Now, I think how do you do that for investor portfolios? I mean, we've been you know managing assets, securitize assets for for decades. Uh personally we've been at it over two decades uh here at PGEM. You know, market size matters a lot, right? When we look at, you know, even existing securitizations like something like CLOs, uh, right, you you good folks will often report, you know, some some you know large investors out of Asia, for instance, that that invest in European securitizations. And, you know, obviously a lot of US firms will invest as well. And the reason for that is because those markets are large, right? I think part of the hang up today is this idea of if I have um a European investor, I want to keep all their cash, all their all their assets here. Um, and I think longer term, that's not the best approach. One, because then effectively you're gonna crowd out foreign investment, which I think is critical and quite large. And two, for those investor portfolios, you know, I could tell you that as I speak to our investors in Europe, you know, one of the things that, you know, they are focused on is delivering for their, you know, for for their asset owners, for their, for their, you know, ultimate investors. And, you know, diversification is critical. You know, there is a need to diversify, you know, not just in asset tech, but even just away from the local economy. Ultimately, you know, a pension holder, you know, what they really want to know and and feel is that they have confidence that when they retire, uh those payments that are promised to them that they expect to be able to sustain themselves on in retirement are there. And how they get there, you know, obviously is important. Uh, but also the end outcome will be that they spend the money locally. Um, so all that to say, Tom, that you know, we think that expanding the the box, not making these punitive third country sanctions, uh, really kind of trying to disincentivize investors from investing outside of Europe, but then also what the consequence of that is, is it crowds out foreign investment in Europe because then the you know uh local investors are the only ones that are really focused on it, um, I think is critical, right? So it's it's one of these things where you almost need to take a step back in in in my opinion and say, you know, financial like longer term what result in a better um funding source and market, it's it's is you know, casting the widest net you can. And the way you do that is by you know uh ensuring that foreign investors can participate. And and and the way that that that happens is by allowing you know the local investor base also have a global universe to invest. And you know, we do think that ultimately uh that will produce better investor outcomes, asset owner outcomes, uh in terms of just risk and return, right? A larger universe uh will usually mean that you could find more assets uh to achieve similar returns with with less risk, right? That's kind of um you know, just just diversification and and kind of portfolio construction uh you know theory, modern portfolio theory, if you will.

SPEAKER_01 12:15

Yeah, yeah. You know, it is interesting kind of when when you look at these regulations. I mean, you know, obviously being fair to the regulators, they they do have to obviously consider it from lots of different angles, whether you, you know, tailor it to helping investors or whether you tailor it to helping issuers more to enter the market. You know, whether uh you know, you're you're mentioning versus you know bank issuers versus specialist lenders and like the the Australian market's obviously a very interesting one because it's so uh you know dominated by specialist lenders and you know that that obviously makes kind of intuitive sense because they don't have access to deposit funding. So securitization obviously is a a sort of natural you know funding source for those issuers. I mean, is is there kind of a difficulty of when when they come up with these sort of regulatory regimes trying to capture the interests of all the the many kind of different parties involved, you know, when you look at the securitization markets?

SPEAKER_00 13:12

Yeah, and look, I think I think it's it's a it's challenging, right? Because when we talk about and and perhaps this helps explain a little bit in terms of what seems to be a bit of a a leapfrog in outcome, if you will, or maybe not outcome because it's still being written, but uh, you know, in kind of current state of affairs between the UK and Europe, it is challenging, right? There's there's 27 member states. I think each of those representatives are quite keen to ensure that any changes to this regulation are are being done thoughtfully. You know, I think it's important to definitely keep all the lessons learned from the great financial crisis, right? In terms of it forefront, in terms of making sure that there's no um uh you know, other by by by trying to get more capital, you you end up introducing different risk. I don't think that's what what will happen. I think it's important to keep in mind all the other regulations and that that have been put in place, you know, away from securitization that I think really have changed the way that lending occurs in the economy. Uh, but but listen, I think each individual member state, you know, also has an obligation to its local citizens to ensure that any updates to regulation um you know have a benefit for for for their constituents. So I appreciate it's it's not an easy process. Obviously, as you mentioned, there's uh upcoming trilogues coming. Uh you know, so so just just to kind of highlight how how difficult this is. I'm hopeful that you know the the North Star uh remains and and maybe the the the UK kind of kind of leadership here in terms of where where what what what good uh policy uh looks like might help be a catalyst for for for moving the ball forward even even quicker. Uh but Tom, to answer your question, it is tough. And I think it's important to remember, right, there's not every member state has a securitization program. So, you know, there's some places like you know, whether that's that's Italy, France, Spain that, that, you know, have used securitization, used securitization, you know, have seen, obviously have experienced some of the pitfalls uh from from from from decades ago, but but also have have been beneficiaries uh or have seen the benefits um to their economies, to their banking system. Uh so they're gonna be much more open and focused and and and um and and thoughtful, you know, in terms of of you know what what the trade-offs are between different things within the securitization regulation. And then there's other places that that don't have that development in part maybe because their economies aren't as large, or simply because they've been relying on banks, right? So so there's there's a bit of education as well that I think is is happening in parallel. And and look, I think, you know, again, the the GFC was was something that was quite quite difficult. And many folks, you know, uh outside of just simple education, you know, will also need to be, for lack of better terms, convinced uh that the the rules that will be put in place are robust to ensure that you know that doesn't happen again. I'm hopeful. I I think again, there's a lot of other regulation that that has really limited, you know, the fraud, increased transparency, you know, the uh increased credit quality to make securitizations, you know, uh be fairly robust. But but again, that takes time. So so look, um, I you know, to answer your question, it's it's it's uh it's not surprising, I suppose, um that that the pace, you know, the ambitions are high and the pace is a bit slower. Uh but again, we're we're hopeful that um, you know, and we're we're doing our best to educate and uh and and and help uh the member states uh with anything that we you know we could share based on our experience. But it'll take some time. It'll take some time. And I think it's it's important. Like it's like you know, uh happiness is is is in part kind of kind of where you set your expectations, right? And I think it's important to set have high expectations, but also understand that and you know, uh have high expectations coupled with with a lot of patience to know that it's it's gonna take some time, right? Both from an education, both from a re-education, and and and and even just uh you know, just an understanding of what what's in the art of possible. Yeah, yeah, absolutely.

SPEAKER_01 17:08

And you know, there I think there's definitely you know still reasons to to be hopeful about you know it sort of spreading into other you know member states. We obviously we had VIIs last year, the first sort of Polish securitization is also I think there's been like uh a Lithuanian uh CMBS that came out you know towards the end of last year. So I mean there there's obviously hopes that you know it will spread to to other member states and they'll they'll be able to you know unlock the the benefits of you know that that kind of different funding models through securitization.

SPEAKER_00 17:41

Exactly. This it's been it's been uh uh a deep freeze for some and it's slowly thawing uh to your point on on the Polish and Lithuanian um securitization. Yeah, yeah.

SPEAKER_01 17:52

I guess my my last sort of question is as we're saying, there there's still you know, we we haven't even started the the trilogue process for you know the EU securitization uh regime. So there's still plenty of time for sort of you know changing things if if there's areas where you know they they perhaps haven't you know done enough to really kind of move the needle and sort of unlock the you know the full potential of securitization, perhaps in the same way that you know the the UK sort of you know appears to be doing. I mean, do you do you think in the you know the under the sort of current proposals they they would lead to much of a sort of you know change in strategy and either PGIM's investments or do you think they would really help you know bring in a lot of those investors that you know perhaps haven't you know felt comfortable sort of entering the securitization market, partly because you know there's obviously quite a high complexity premium for entering the market. You need quite a big you know team if you're you're an asset manager and want to start investing.

SPEAKER_00 18:54

Yeah, so so let's um let's let's unpack that super quickly. So a few things, right? From from an investor perspective, you know, there's different types of investors today that are that are that that that buy you know securitizations, let's just say, or that that incorporate these these assets into portfolio construction. Uh and if we break it down almost too simply, uh, but just uh you know relative to what's what's in the rulemaking, um, there's insurance, right? And we saw some changes in solvency too. And that obviously unlocks quite a bit of, or potentially unlocks, quite a bit of capital. Um and I'll share a little bit, you know, give you some insight there in terms of what we're seeing. And it's early days, and again, these things will take some time. Uh, but that is something that that I think it feels more immediate than than than not. And then the other is is usage funds, right? Uh so this is the European retail market um that that also has capital that may be invested in securitization. And and we think again, um securitization is is a is a pretty important, and I'd say core building block and portfolio construction and fixed income portfolios that that is underutilized in Europe largely due to some of the regulation, right? So if we think about uh insurance for a sec, because that that's been you know kind of moved forward quite early, uh what we're seeing today is is to your point, right? So asset owners and some of these are large institutions have because of you know regulatory capital, um, haven't really been able to think about, you know, uh, and I'd call it non-STS securitizations in their portfolios because the capital charges were were quite high, making these assets really not feasible in terms of portfolio construction. As some of these investors are are also just large institutional investors, as a general statement, some of those big investors, you know, for instance in CLOs, you know, can uh now start to think about how do I incorporate CLOs into my portfolio. And some folks are starting to think about that. What has been interesting is the number of large institutional investors that now say, okay, uh I've been keeping an eye on the CLO market. It has, you know, especially at the AAA level, performed quite well. However, to your point, I need a team, right? I need a team to be able to analyze the collateral, I need a team to be able to model the tranches, I need a team to be able to, you know, do the surveillance once I own it. I need to do kind of all the due diligence that I need to do. And I've never invested in that team, you know, to your point, the complexity. And it's, you know, it's it's just any asset is complex. It's just you need you need to have some resources to make sure you can you can you can underwrite it appropriately. I've never made that investment because I didn't think I could or I didn't have to. And you know, we are seeing, you know, folks reach out to many, including ourselves, to say, hey, you know, uh, we'd like to start considering these assets for our balance sheet. Is that something you could help us do while we get up to speed? Right. So so there is, I think, a very real, tangible, you know, anecdote there where, you know, now that the regulation looks like it's going to change and allow for investment in in something like a CLO, uh, some folks that have the that have the scale uh can turn it on, but many never have. That scale because there's a barrier of entry, right? So it goes back to even like the sanction point, right? If if you don't give investors the incentive or if you don't remove the disincentive from right, the friction from investing, then people simply won't, you know, build a team and allocate the capital, uh, the human capital, to to think about these investments. So I do think that, you know, again, going forward, it'll take time, right? It's not gonna be an immediate, you know, the stroke of the pen occurs, and then, you know, in the morning there's all this demand and supply comes online and we fund things overnight. It's gonna take time because people that have underinvested in in teams to look at these assets will need to find folks to help them look at these assets. In the meantime, you know, they'll probably look at, you know, uh, you know, help from existing asset managers to to to to both get them up to seed and get them invested. And candidly, we've seen this even in Asia, right? I mean, um, you know, a lot of the Asian investors invest themselves and many um alongside the the internal investment teams also outsource uh right to help them get scale in in the product and also just get information and knowledge. So I suspect that'll that'll that'll happen. And then with regards to usage, really, really quick, you know, there is some regulation there that, you know, again, kind of maybe unintentionally, maybe not, uh, you know, uh limits the ability of of a usage fund uh to purchase you know securitizations in in a certain type of size. Uh that is uh you know something that is um being focused on today. Uh but again, the the the high level, you know, taking a step back is where are the pools of capital? Where's the savings, right? So there's gonna be usage, there's gonna be insurance, there's gonna be pensions. How do we incentivize or or remove disincentives uh to help um move these assets, these pools of capital that today are are are largely in in savings into more investments? And I think you know, taking that perspective is is critical, right? So I think all this regulation has been trying to do is say, what can we do differently to help investors regain focus? But to your point, in terms of teams and barriers, um, it's gonna take some time. And I think the quicker we get there, it's it's interesting, you know, you you mentioned we we you know the trilogues have not started and there's time. I think the challenge, Tom, and I think that's that's that's fair. I think the challenge is the world doesn't wait. Right. Um there's there is a critical need for defense. There's gonna be a critical need for investment in AI. There is a critical need to continue to grow GDP, right? Uh the pension system in in Europe, as you know, uh the population has grown uh from immigration and everything else, right? It's kind of critical for all these economies to get moving. Uh so while the process suggests that you have time, I think the the facts on the ground, I think that was Draghi's purpose back in 24 to to inject some energy into the debate and say, yeah, you know, it always feels like we have time, but it's been about you know two decades now since since we've talked about this. We really need to focus now.

SPEAKER_01 25:05

Yeah, yeah. Well, excellent. I think we've uh we've covered quite a lot then. I guess uh we'll we'll just have to uh have to wait and see how it all uh all plays out then.

SPEAKER_00 25:15

We're very hopeful. Yeah, uh we're very excited to be part of the discussion. And yeah, I I agree. You know, I think this is critical for for Europe, for our employees, for our investors there. Uh and that's kind of been our North Star trying to help you know educate and move the ball forward as much as we can.

SPEAKER_01 25:29

Yeah, yeah, excellent. Well, uh, thank you so much for coming on the podcast, Edwin. I think it's been really interesting. So uh I guess all that all that's left to say now is uh goodbye.

SPEAKER_00 25:40

Thank you. It's it's been a privilege as an active listener. It's it's it's quite an honor to be on, so thanks again.

SPEAKER_01 25:45

No worries. All right, thanks so much, then goodbye.