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Securitisation: Process, Benefits, and Risks
Securitisation is a financial process that pools illiquid assets, such as loans or receivables, and converts them into marketable securities. These securities are then sold to investors, effectively transferring credit risk and providing funding to originators. It involves tranching credit risk, where payments depend on underlying asset performance, and subordination determines loss allocation.
Key Takeaways
Securitisation transforms illiquid assets into tradable securities.
It diversifies funding and transfers credit risk from originators.
Special Purpose Vehicles (SPVs) are central to the structure.
Complexity and upfront costs are significant disadvantages.
Due diligence is crucial to mitigate legal and reputational risks.
What is Securitisation and How Does it Work?
Securitisation is a financial process converting illiquid assets into marketable securities, as per SI 2024/102. It involves tranching credit risk, with payments dependent on asset performance and subordination determining loss allocation. This process efficiently transfers risk and capital.
- Credit risk is tranched.
- Payments depend on performance.
- Subordination dictates losses.
- A 'tranche' defines risk segments.
What are the Key Features of Securitisation?
Securitisation features debt securities, public or private, backed by defined cash flows. Issued by a bankruptcy-remote SPV, they include internal credit enhancements. This structure effectively de-links credit risk from the originator's balance sheet.
- Public/privately offered debt securities.
- Backed by defined cash flow.
- Issued by SPV.
- Internal credit enhancement.
- Credit risk de-linked.
Why Do Entities Choose to Securitise Assets?
Entities securitise to convert illiquid assets into liquid funds, gaining new capital. This often lowers funding costs and diversifies funding sources. It also improves financial ratios by transferring credit risk from the balance sheet to investors.
- Converts illiquid to liquid.
- Lowers funding cost.
- Diversifies funding.
- Improves financial ratios.
- Transfers credit risk.
Who are the Key Parties Involved in a Securitisation Transaction?
Key parties include the originator (asset owner), the SPV (issuer), the arranger (deal structurer), a trustee (holds assets for investors), and the investors (noteholders). Each plays a vital role.
- Originator.
- SPV / Issuer.
- Arranger.
- Trustee / Security Trustee.
- Investors / Noteholders.
How Does a Typical 'True Sale' Securitisation Structure Work?
In a 'true sale,' the originator sells receivables to an SPV. The SPV issues notes to investors, funding the purchase. Asset cash flows then repay investors. This makes the SPV bankruptcy-remote, protecting assets from originator insolvency and preventing 'claw back.'
- Receivables sold to SPV.
- SPV issues notes to investors.
- Cashflows repay investors.
- SPV: Bankruptcy Remote Entity.
- Removes assets from originator insolvency.
What Due Diligence is Required in Securitisation?
Due diligence is crucial to mitigate risks from incomplete disclosure, which can lead to criminal/civil liability and reputational damage. Thorough vetting of underlying assets, their performance, and legal characteristics ensures transparency.
- Risks of incomplete disclosure: Criminal & Civil Liability.
- Reputational Risk.
- Key information: Underlying Assets.
What are the Disadvantages of Securitisation?
Securitisation is complex, requiring sophisticated structuring and incurring significant up-front costs. The 2008 crisis also left a 'toxic' tag on some products, increasing regulatory scrutiny and investor wariness.
- Complexity.
- Up-front Cost.
- 'Toxic' Tag.
Which Classes of Assets are Suitable for Securitisation?
Suitable assets for securitisation generally have a predictable future revenue stream. Common examples include mortgages (RMBS/CMBS), credit card balances, consumer loans, and lease/trade receivables.
- Predictable Future Revenue Stream.
- Mortgages (RMBS/CMBS).
- Credit Card Balances.
- Consumer Loans.
- Lease / Trade Receivables.
What are the Different Asset Transfer Structures in Securitisation?
Assets can be transferred via novation, legal assignment, or equitable assignment. Other structures include a secured loan, where the SPV lends against assets, or synthetic securitisation, transferring credit risk through derivatives.
- Novation.
- Legal Assignment.
- Equitable Assignment.
- Secured Loan.
- Synthetic.
What Other Key Issues Impact Securitisation Transactions?
Key issues include ensuring SPV insolvency remoteness, managing originator's insolvency risks, and understanding fiscal agent vs. trustee roles. WBS involves SPV lending to the originator, while Synthetic Securitisation transfers credit risk via derivatives.
- SPV & Limited Recourse.
- Originator's Insolvency risks.
- Fiscal Agent vs. Trustee roles.
- Whole Business Securitisation (WBS).
- Synthetic Securitisation.
Should Securitised Products be Publicly Listed or Privately Placed?
The choice depends on regulatory needs and market access. Public listings offer liquidity but demand stringent disclosure. Private placements provide flexibility with less regulatory burden, though they may limit investor reach.
- UK Prospectus Regulation Exemptions.
- Advantages of Public Listing.
- Disadvantages of Public Listing.
What is the Role of a Prospectus or Offering Circular in Securitisation?
A prospectus or offering circular is a vital legal document, especially for public listings. It provides all material information about the offering, including assets, structure, and risks, enabling investors to make informed decisions.
- Requirement for Listing.
- Material Information Content.
What are the Overall Conclusions Regarding Securitisation?
Securitisation remains a complex yet essential financial tool. Its benefits in capital formation and risk transfer are globally acknowledged. The UK maintains a robust regulatory framework, highlighting its importance and ongoing relevance.
- Complex but Essential.
- EU Acknowledges Benefits.
- UK Regulatory Framework.
Frequently Asked Questions
What is the primary purpose of securitisation?
Its primary purpose is to convert illiquid assets into marketable securities, providing originators with liquidity, diversifying funding, and transferring credit risk to investors.
What is a Special Purpose Vehicle (SPV) in securitisation?
An SPV is a bankruptcy-remote entity created to purchase assets from the originator and issue securities to investors. It isolates assets from the originator's insolvency.
Why is 'true sale' important in securitisation?
A 'true sale' legally transfers assets from the originator to the SPV, protecting them from the originator's insolvency and preventing creditors from claiming them back.
What are the main drawbacks of securitisation?
Key drawbacks include its inherent complexity, high upfront costs, and the negative perception or 'toxic' tag associated with some securitised products after past financial crises.
What types of assets are typically securitised?
Assets with predictable cash flows are suitable, such as mortgages, credit card balances, consumer loans, and lease receivables. These provide reliable income streams for investors.
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