Asset Securitisation Flashcards
What is asset securitisation?
The process of pooling various financial assets and converting them into tradable securities, allowing originators to transfer risks and improve liquidity.
What are the primary learning objectives of asset securitisation?
Understand the securitisation process and its parties.
Analyse its role in financial crises.
Evaluate regulatory strategies focusing on simplicity, transparency, and standardisation.
What are the main benefits of asset securitisation?
Risk diversification.
Improved liquidity.
Capital efficiency.
Customised financial instruments.
Enhanced capital market functioning.
Name the primary parties involved in securitisation.
Originator (e.g., banks).
Special Purpose Vehicle (SPV).
Credit Rating Agencies.
Investors.
What is a Special Purpose Vehicle (SPV)?
A bankruptcy-remote entity that acquires pooled assets from the originator and issues securities to investors, ensuring legal separation from the originator’s balance sheet.
What role do credit rating agencies play in securitisation?
They evaluate the creditworthiness of securities, influencing investor confidence and the pricing of securitised products.
What are Asset-Backed Securities (ABS)?
Tradable financial instruments backed by a pool of financial assets, such as mortgages, auto loans, or credit card receivables.
Define Mortgage-Backed Securities (MBS).
A type of ABS backed by residential or commercial mortgage loans.
What are Collateralised Debt Obligations (CDOs)?
Complex securities backed by a mix of bonds, loans, or other ABS, often structured with senior and junior tranches.
What is the purpose of tranches in CDOs?
To allocate different levels of risk and return, with senior tranches having lower risk and junior tranches offering higher potential returns.
How does securitisation improve liquidity?
By converting illiquid assets into liquid securities that can be sold to investors.
What are the main risks associated with securitisation?
Systemic risk.
Moral hazard.
Complexity in structuring products.
Regulatory gaps.
How did securitisation contribute to the 2007–2009 financial crisis?
By amplifying systemic vulnerabilities through the packaging of subprime mortgages into complex securities like CDOs, which obscured risk levels.
What are the regulatory goals for securitisation?
Simplicity in product design.
Transparency in asset and risk disclosure.
Standardisation of practices and documentation.
What is a prime mortgage?
A low-risk mortgage issued to creditworthy borrowers.
What is a subprime mortgage?
A high-risk mortgage given to borrowers with poor credit histories.
How does securitisation enhance capital efficiency for banks?
By removing assets from their balance sheets, reducing capital reserve requirements.
What is the role of the Basel Committee on Banking Supervision in securitisation?
To coordinate global regulatory efforts, addressing systemic risks and promoting sound practices.
What are the key features of post-crisis securitisation reforms?
Enhanced requirements for credit rating agencies.
Stricter capital reserve rules for securitised assets.
What are the economic benefits of securitisation?
Improved funding for economic activities, risk-sharing across markets, and enhanced market efficiency.
What is the role of investors in securitisation?
To purchase securities from the SPV and earn returns based on cash flows from the pooled assets.
What is a bankruptcy-remote SPV?
An entity insulated from the originator’s financial risks, ensuring asset protection in case of insolvency.
What is the impact of securitisation on financial markets?
It enhances liquidity, diversifies risk, and facilitates efficient capital allocation but may introduce systemic risks if poorly managed.
What is moral hazard in the context of securitisation?
The risk that originators lower underwriting standards, knowing the risk will be transferred to investors.
How did the housing bubble relate to securitisation?
The bubble was driven by excessive subprime lending, and its collapse caused widespread losses in MBS and CDO markets.
What is synthetic securitisation?
A process where credit risk is transferred using derivatives rather than selling the underlying assets.
What is the European Parliament’s stance on securitisation?
It highlights both the economic benefits and the systemic risks, advocating for balanced regulation.
How does securitisation affect regulatory capital requirements?
It enables banks to optimise their capital by transferring assets off their balance sheets.
What is future flow securitisation?
Securitisation of predictable future revenue streams, such as royalties or export revenues.
What is the Financial Stability Board’s view on securitisation?
It promotes transparency and standardisation to mitigate systemic risks.
What role did CDOs play in the financial crisis?
Their complexity and poor risk assessment contributed significantly to financial instability when defaults increased.
How can securitisation lead to regulatory gaps?
Rapid innovation in financial products often outpaces the ability of regulators to implement effective oversight.
What is the importance of tranches in securitisation?
They allow for risk stratification, catering to different investor preferences.
How does securitisation promote financial inclusion?
By freeing up capital, it enables banks to extend credit to underserved sectors.
What are non-mortgage ABS?
Asset-backed securities supported by receivables such as credit card payments, auto loans, or student loans.
What regulatory strategy promotes comparability in securitisation?
Standardisation of documentation and practices.
How does securitisation impact risk transfer?
It distributes risk from originators to a broad investor base.
What is a credit-linked note in securitisation?
A security combining debt instruments and credit derivatives to transfer risk.
Why is simplicity essential in securitisation products?
To ensure products are comprehensible to investors, reducing complexity and promoting market stability.
What is the importance of disclosure in securitisation?
Transparency in asset pools and risk factors builds investor confidence and supports informed decision-making.
What role does securitisation play in risk diversification?
It transfers concentrated risks, such as credit and interest rate risks, to a dispersed group of investors across capital markets.
What is the role of legal counsel in the securitisation process?
To draft and review transaction documents, ensure regulatory compliance, and address any legal risks in the structuring of the securities.
What are auto loan-backed securities?
Securitised products backed by auto loans, with investor returns dependent on car buyers repaying their loans.
Why is securitisation important for the housing market?
It provides liquidity by converting mortgages into MBS, enabling banks to issue more loans and support housing market growth.
What are the economic criticisms of securitisation?
Critics argue that securitisation encourages reckless lending practices and contributes to economic instability, as seen in the financial crisis.
How does securitisation support small businesses?
By securitising small business loans, banks can raise funds to extend more credit to SMEs, supporting economic growth.
What is the significance of investor confidence in securitisation?
Strong investor confidence ensures high demand for securitised products, stabilising the market and providing liquidity for originators.
What are synthetic securitisations?
Transactions where credit risk is transferred using derivatives, without the transfer of underlying assets to an SPV.
What is the relationship between securitisation and financial stability?
While securitisation enhances market liquidity and risk-sharing, poor management can destabilise markets, as evidenced during the financial crisis.
How do regulatory reforms improve the securitisation market?
By enhancing transparency, simplifying products, and imposing stricter capital requirements to prevent systemic risks.
What is the primary legal function of the Financial Services and Markets Act 2000 (FSMA) in securitisation?
FSMA regulates financial services activities in the UK, including securitisation, ensuring firms are authorized by the FCA and comply with transparency and consumer protection standards.
How does Article 5 of the EU Securitisation Regulation impact investors?
Article 5 imposes due diligence requirements, ensuring institutional investors assess the risks associated with securitised products before investing.
What are Basel III’s Pillar 1 capital requirements for securitisation exposures?
Banks must hold higher capital reserves for securitisation exposures to cover potential losses, reducing systemic risk.
What did the Glitnir Banki hf v The London Borough of Harrow (2012) case highlight about fiduciary duties?
It emphasised the duty of public entities to assess risks in securitisation investments to protect taxpayer funds.
Define the role of credit rating agencies in securitisation.
Credit rating agencies evaluate and assign ratings to securitised products, influencing investor confidence and pricing in the market.
What is the distinction between Mortgage-Backed Securities (MBS) and Asset-Backed Securities (ABS)?
MBS are backed by residential or commercial mortgages, while ABS are backed by other financial receivables, such as auto loans or credit card payments.
What is the purpose of creating a Special Purpose Vehicle (SPV) in securitisation?
The SPV isolates the pooled assets from the originator’s balance sheet, ensuring they are protected in case of the originator’s insolvency.
How did National Westminster Bank plc v Spectrum Plus Ltd (2005) influence the classification of floating charges?
It clarified that charges over circulating assets like book debts are floating charges unless creditors exercise control over proceeds.
What risks are associated with junior tranches in securitisation?
Junior tranches carry the highest risk as they are the first to absorb losses but offer higher potential returns to compensate.
How does securitisation benefit banks in terms of liquidity?
It converts illiquid assets into liquid funds by selling securitised products to investors, enabling further lending.
What did the IKB Deutsche Industriebank AG v Morgan Stanley (2009) case illustrate about misrepresentation in securitisation?
It highlighted the legal responsibility of banks to disclose material risks in securitisation products to avoid misleading investors.
How does the EU Securitisation Regulation promote transparency?
By requiring detailed disclosure of asset pools, risk factors, and transaction structures to improve investor understanding.
What was the key issue in the Federal Housing Finance Agency v UBS Americas Inc. (2013) case?
Misrepresentation of the quality of underlying mortgages in mortgage-backed securities, leading to significant financial losses.
Why is tranching significant in securitisation?
It allows securities to be tailored to different risk appetites, offering senior tranches to risk-averse investors and junior tranches to risk-seekers.
Explain moral hazard in the context of securitisation.
Originators may issue lower-quality loans, knowing the risks will be transferred to investors through securitisation.
What lessons did regulators learn from the 2007–2009 financial crisis regarding securitisation?
The crisis underscored the need for stricter regulation, enhanced transparency, and improved risk management in securitisation markets.
What role does the Basel Committee play in regulating securitisation?
It establishes global banking standards, including stricter capital requirements for banks involved in securitisation.
How does securitisation facilitate risk transfer?
By pooling assets and selling securities, risks such as default are transferred from the originator to investors.
What are collateralised debt obligations (CDOs)?
Securities backed by a mix of assets, often with tranches that vary in risk and return, such as corporate loans or bonds.
What is the regulatory purpose of the Financial Collateral Arrangements (No. 2) Regulations 2003?
To streamline the enforcement of financial collateral, such as securities and cash deposits, reducing legal barriers.
Why is securitisation considered essential for economic growth?
It enhances the efficiency of capital markets by channeling funds to sectors needing investment.
What is synthetic securitisation?
A form of securitisation using derivatives to transfer credit risk without transferring the underlying assets.
How does securitisation impact systemic risk?
While it diversifies risk, excessive reliance on securitisation can amplify systemic vulnerabilities during financial crises.
What is the function of due diligence in securitisation?
It ensures investors and originators understand and appropriately manage the risks associated with securitised products.
How do SPVs achieve bankruptcy remoteness?
By legally separating their assets and liabilities from the originator to protect investors in case of originator insolvency.
What are non-mortgage asset-backed securities?
Securities backed by receivables other than mortgages, such as student loans or trade receivables.
How does securitisation enhance capital efficiency for banks?
By offloading assets, banks reduce their balance sheet liabilities and meet regulatory capital requirements more efficiently.
What is the significance of Article 7 in the EU Securitisation Regulation?
It mandates transparency, requiring issuers to disclose information about the securitised assets and associated risks.
How does the principle of ‘first loss’ apply to junior tranches?
Junior tranche investors absorb initial losses, protecting senior tranches and ensuring payment hierarchy.
What is the purpose of the supervisory review process in Basel III (Pillar 2)?
To ensure banks properly assess and manage their securitisation exposures beyond minimum capital requirements.
How do securitised products support credit markets?
By providing liquidity and enabling originators to reinvest capital into new loans and credit facilities.
What was the main critique of securitisation during the financial crisis?
The complexity and opacity of securitised products made risk assessment difficult, leading to widespread mispricing.
How do investor protections in securitisation benefit financial markets?
They ensure transparency and fair risk allocation, fostering trust and stability in capital markets.
What does the term ‘crystallisation’ mean in securitisation?
It refers to the point where floating risks or obligations in a securitised product become fixed due to a triggering event.
What is the importance of credit enhancements in securitisation?
Credit enhancements, such as guarantees or reserve accounts, increase investor confidence by reducing perceived risks.
How did regulators address moral hazard in post-crisis securitisation reforms?
By requiring originators to retain a portion of the risk in securitised products, ensuring accountability.
What distinguishes a simple, transparent, and standardised (STS) securitisation?
STS securitisations adhere to clear rules and disclosures, making them more predictable and reliable for investors.
How does securitisation affect borrower rights?
Borrowers may face new servicing entities with different policies, potentially leading to confusion or disputes.
What is the role of disclosure in mitigating securitisation risks?
Full disclosure ensures that all parties understand the underlying assets and risks, reducing misrepresentation and litigation.
Why is investor education critical in securitisation?
Educating investors about risks, structures, and market dynamics prevents misunderstandings and promotes informed decision-making.
