European ABS reform: A game-changer for institutional investors

Background: From crisis to contraction

Following the 2008 global financial crisis, securitisation became synonymous with systemic risk. However, the sweeping regulatory backlash did not distinguish between the poor underwriting practices of the US subprime mortgage market and the structurally sound, low-loss performance of European ABS.

In the US, lending excesses included:

• Loan-to-value ratios exceeding 120-130%.
• Minimal or no employment and income verification.
• Non-recourse lending allowing borrowers to “walk away” from mortgages.

European markets, by contrast, were characterised by:

• Full-recourse lending frameworks.
• Conservative underwriting and stricter borrower vetting.
• Significantly lower leverage and loss experience.

Despite this, European policymakers responded with an overcorrection – introducing layers of new requirements through the Securitisation Regulation, Solvency II, and CRR, all of which raised the cost and complexity of both issuing and investing in ABS.

As a result:

• We estimate the European ABS market has contracted by 16% since 2013, while the US market has grown by 65% over the same period (see Exhibit 1).
• Insurance allocations to European ABS have fallen from an estimated 7–9% pre-2008 to virtually zero.
• The European residential mortgage-backed securities (RMBS) market has shrunk from €350bn to under €150bn.

Only the European collateralised loan obligation (CLO) market has bucked the trend, having grown steadily to comprise more than half of all European securitisations, supported by its strong performance profile and institutional investor familiarity.

The case for reform

In the wake of the Covid-19 pandemic and the end of quantitative easing, European banks face a renewed need for more diversified sources of funding.

Policymakers have recognised that a healthy securitisation market can act as a critical transmission channel between bank lending and capital markets, lowering costs and unlocking more financing for the real economy. In 2022, securitisation issuance in Europe was equivalent to 0.3% of GDP, versus 4% in the US.

The historical credit performance of European ABS strongly supports the case for reforming its regulatory treatment. As Exhibit 2 shows, investment grade (IG) tranches of European ABS have outperformed equally rated corporate bonds across market cycles. Even during the global financial crisis, IG ABS loss rates peaked at 0.19% versus 0.41% for IG corporate bonds.

The European Commission’s 2025 reform initiative builds on two central themes:

1. Proportionality – aligning regulation with empirical credit risk rather than legacy perceptions.
2. Competitiveness – ensuring European capital markets can compete with the US on depth and efficiency.

This reform agenda sits within the broader European Savings and Investment Union (SIU) initiative (formerly the Capital Markets Union), which is intended to mobilise institutional capital into productive sectors and strengthen the region’s financial sovereignty.

Key elements of the ABS reform package

The reform package¹ encompasses six interrelated areas:

Implementation timeline

• 2025–26: EU Parliament and Council review and amendment.
• 2026–27: Trilogues and final adoption.
• Early to mid-2027: Expected implementation across EU jurisdictions.

While the process remains bureaucratically complex, there is clear momentum. Privately, senior EU officials are known to be pushing for a more ambitious approach, reinforcing market confidence that reforms will not be diluted.

It is worth stating that while securitisation market participants have long lobbied for what they see as fairer regulatory treatment for the asset class, these efforts are not the primary driver of the reforms. The political impetus behind the reforms is driven purely by European policymakers’ desire for deeper, more efficient capital markets and an expansion of funding to the real economy.

Expected market impacts

Reduced capital charges and higher potential returns

From the investor standpoint, the biggest impact of the reforms is improved return on regulatory capital for banks (under LCR and CRR) and insurers (under Solvency II).

The European Commission’s focus has been on the senior (predominantly AAA rated) part of the securitisation capital structure (see Exhibit 3). The biggest impact on investor capital charges is for senior Simple, Transparent and Standardised (STS) tranches, which will be more aligned with those for covered bonds. There is also a meaningful reduction in investor capital charges for non-STS senior tranches, with AAA CLOs being a considerable beneficiary.
 

For insurers, under the proposed Solvency II recalibration:

• AAA rated STS tranches will see a 43% reduction in capital requirements, while capital charges on AAA CLOs will be 4.6 times lower (see Exhibit 4).
• Standard RMBS/ABS will also experience a material uplift in return on regulatory capital.

This shift better aligns the capital treatment of these securitisations with their empirical risk data, correcting the distortions of the current framework which treats some demonstrably safer assets as being more risky than corporate bonds.

Reinvigorated institutional demand

• Insurers: Even a modest allocation increase to 5% could add €400bn in demand.
• Banks: Reduced risk-weighted assets (RWAs) will incentivise issuance and balance sheet recycling.
• Pension funds: Expected to participate more actively as the market broadens and transparency improves.

Market depth and liquidity

Increased issuance frequency and a larger investor base will naturally improve secondary market dynamics:

• More regular primary issuance enables consistent price discovery.
• Greater diversity of investors (including non-bank institutions) enhances bid/ask stability.
• Existing liquidity mechanisms such as Bids Wanted in Competition lists (BWICs) will scale with broader participation.

Comparative performance: Europe vs. US ABS

European ABS has consistently outperformed European corporate bonds and demonstrated resilience across market cycles.

Key distinctions include:
 

The comparative dearth of European ABS issuance is not driven by risk but by regulation – a central rationale for reform. Comparing historical losses in the European and US markets (see Exhibit 5) highlights the overcorrection that European regulators enacted following the global financial crisis, with the sound lending and structuring practices of European ABS erroneously associated with the excesses in US subprime.

The US ABS experience post-crisis demonstrates that well-calibrated regulation supports market expansion without compromising investor protection.

Strategic implications for investors

For institutional investors, the reforms signal a potential paradigm shift in asset allocation strategies, driven by:

Capital efficiency

Lower capital charges improve relative value versus other fixed income segments. AAA ABS may deliver superior post-regulatory risk-adjusted returns to IG corporates, while offering a higher credit quality profile.

Portfolio diversification

ABS exposure provides:

• Floating rate income.
• Structural credit enhancement.
• Low correlation to sovereign and corporate bond risk.

Enhanced liquidity outlook

As issuance and investor bases expand, we expect secondary liquidity will strengthen – particularly in RMBS and CLO markets, reducing transaction costs and facilitating tactical allocation shifts.

Timing advantage

Early entrants may benefit from:

• Higher spreads ahead of full reform adoption.
• Price performance as liquidity and investor depth increase post-2027.
• More effective portfolio diversification before broader market repricing.

Risks and considerations

While the outlook looks promising, investors should remain mindful of:

• Implementation uncertainty: Legislative processes may extend beyond 2027.
• National divergence: UK’s “Solvency UK” and CRR/LCR regimes may differ somewhat in timing or calibration.
• CLO capital treatment: Remains more penal than RMBS due to higher underlying corporate loan weightings, lower granularity and managed pool structure.
• Market cycle risks: Broader credit market volatility could influence spreads irrespective of regulatory reform.

Nevertheless, these risks are largely transitional. It is clear to us that the overall trajectory remains one of structural normalisation and renewed competitiveness.

Conclusion: Regulation meets reality

The European securitisation reforms represent a long-awaited realignment between regulation and reality. After more than a decade of punitive treatment, securitisation is being repositioned as a legitimate and necessary pillar of European capital markets.

Again, policymakers’ goal is not to “reward” securitisation or its market participants; the primary motivation is expanding and accelerating funding channels to the real economy. Nevertheless, the proposed reforms are a long overdue recognition of the regulatory overcorrection that was made in the aftermath of the global financial crisis, and one that we believe does present a significant opportunity for investors.

By 2027, the combination of lower capital charges, simplified structures, and enhanced transparency could reignite issuance and demand and potentially drive the market above €1tr. The weight of additional demand and enhanced liquidity is likely to drive spread compression, with obvious potential benefits for early movers.

For institutional investors, the reforms present both a strategic opportunity and a validation: that high-quality European securitisation offers resilient performance, diversification, and improved capital efficiency in a reshaped regulatory landscape.