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Banking Law > Asset Securitisation > Flashcards

Asset Securitisation Flashcards

1
Q

What is asset securitisation?

A

The process of pooling various financial assets and converting them into tradable securities, allowing originators to transfer risks and improve liquidity.

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2
Q

What are the primary learning objectives of asset securitisation?

A

Understand the securitisation process and its parties.
Analyse its role in financial crises.
Evaluate regulatory strategies focusing on simplicity, transparency, and standardisation.

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3
Q

What are the main benefits of asset securitisation?

A

Risk diversification.
Improved liquidity.
Capital efficiency.
Customised financial instruments.
Enhanced capital market functioning.

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4
Q

Name the primary parties involved in securitisation.

A

Originator (e.g., banks).
Special Purpose Vehicle (SPV).
Credit Rating Agencies.
Investors.

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5
Q

What is a Special Purpose Vehicle (SPV)?

A

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.

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6
Q

What role do credit rating agencies play in securitisation?

A

They evaluate the creditworthiness of securities, influencing investor confidence and the pricing of securitised products.

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7
Q

What are Asset-Backed Securities (ABS)?

A

Tradable financial instruments backed by a pool of financial assets, such as mortgages, auto loans, or credit card receivables.

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8
Q

Define Mortgage-Backed Securities (MBS).

A

A type of ABS backed by residential or commercial mortgage loans.

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9
Q

What are Collateralised Debt Obligations (CDOs)?

A

Complex securities backed by a mix of bonds, loans, or other ABS, often structured with senior and junior tranches.

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10
Q

What is the purpose of tranches in CDOs?

A

To allocate different levels of risk and return, with senior tranches having lower risk and junior tranches offering higher potential returns.

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11
Q

How does securitisation improve liquidity?

A

By converting illiquid assets into liquid securities that can be sold to investors.

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12
Q

What are the main risks associated with securitisation?

A

Systemic risk.
Moral hazard.
Complexity in structuring products.
Regulatory gaps.

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13
Q

How did securitisation contribute to the 2007–2009 financial crisis?

A

By amplifying systemic vulnerabilities through the packaging of subprime mortgages into complex securities like CDOs, which obscured risk levels.

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14
Q

What are the regulatory goals for securitisation?

A

Simplicity in product design.
Transparency in asset and risk disclosure.
Standardisation of practices and documentation.

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15
Q

What is a prime mortgage?

A

A low-risk mortgage issued to creditworthy borrowers.

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16
Q

What is a subprime mortgage?

A

A high-risk mortgage given to borrowers with poor credit histories.

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17
Q

How does securitisation enhance capital efficiency for banks?

A

By removing assets from their balance sheets, reducing capital reserve requirements.

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18
Q

What is the role of the Basel Committee on Banking Supervision in securitisation?

A

To coordinate global regulatory efforts, addressing systemic risks and promoting sound practices.

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19
Q

What are the key features of post-crisis securitisation reforms?

A

Enhanced requirements for credit rating agencies.
Stricter capital reserve rules for securitised assets.

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20
Q

What are the economic benefits of securitisation?

A

Improved funding for economic activities, risk-sharing across markets, and enhanced market efficiency.

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21
Q

What is the role of investors in securitisation?

A

To purchase securities from the SPV and earn returns based on cash flows from the pooled assets.

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22
Q

What is a bankruptcy-remote SPV?

A

An entity insulated from the originator’s financial risks, ensuring asset protection in case of insolvency.

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23
Q

What is the impact of securitisation on financial markets?

A

It enhances liquidity, diversifies risk, and facilitates efficient capital allocation but may introduce systemic risks if poorly managed.

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24
Q

What is moral hazard in the context of securitisation?

A

The risk that originators lower underwriting standards, knowing the risk will be transferred to investors.

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25
Q

How did the housing bubble relate to securitisation?

A

The bubble was driven by excessive subprime lending, and its collapse caused widespread losses in MBS and CDO markets.

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26
Q

What is synthetic securitisation?

A

A process where credit risk is transferred using derivatives rather than selling the underlying assets.

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27
Q

What is the European Parliament’s stance on securitisation?

A

It highlights both the economic benefits and the systemic risks, advocating for balanced regulation.

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28
Q

How does securitisation affect regulatory capital requirements?

A

It enables banks to optimise their capital by transferring assets off their balance sheets.

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29
Q

What is future flow securitisation?

A

Securitisation of predictable future revenue streams, such as royalties or export revenues.

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30
Q

What is the Financial Stability Board’s view on securitisation?

A

It promotes transparency and standardisation to mitigate systemic risks.

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31
Q

What role did CDOs play in the financial crisis?

A

Their complexity and poor risk assessment contributed significantly to financial instability when defaults increased.

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32
Q

How can securitisation lead to regulatory gaps?

A

Rapid innovation in financial products often outpaces the ability of regulators to implement effective oversight.

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33
Q

What is the importance of tranches in securitisation?

A

They allow for risk stratification, catering to different investor preferences.

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34
Q

How does securitisation promote financial inclusion?

A

By freeing up capital, it enables banks to extend credit to underserved sectors.

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35
Q

What are non-mortgage ABS?

A

Asset-backed securities supported by receivables such as credit card payments, auto loans, or student loans.

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36
Q

What regulatory strategy promotes comparability in securitisation?

A

Standardisation of documentation and practices.

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37
Q

How does securitisation impact risk transfer?

A

It distributes risk from originators to a broad investor base.

38
Q

What is a credit-linked note in securitisation?

A

A security combining debt instruments and credit derivatives to transfer risk.

39
Q

Why is simplicity essential in securitisation products?

A

To ensure products are comprehensible to investors, reducing complexity and promoting market stability.

40
Q

What is the importance of disclosure in securitisation?

A

Transparency in asset pools and risk factors builds investor confidence and supports informed decision-making.

41
Q

What role does securitisation play in risk diversification?

A

It transfers concentrated risks, such as credit and interest rate risks, to a dispersed group of investors across capital markets.

42
Q

What is the role of legal counsel in the securitisation process?

A

To draft and review transaction documents, ensure regulatory compliance, and address any legal risks in the structuring of the securities.

43
Q

What are auto loan-backed securities?

A

Securitised products backed by auto loans, with investor returns dependent on car buyers repaying their loans.

44
Q

Why is securitisation important for the housing market?

A

It provides liquidity by converting mortgages into MBS, enabling banks to issue more loans and support housing market growth.

45
Q

What are the economic criticisms of securitisation?

A

Critics argue that securitisation encourages reckless lending practices and contributes to economic instability, as seen in the financial crisis.

46
Q

How does securitisation support small businesses?

A

By securitising small business loans, banks can raise funds to extend more credit to SMEs, supporting economic growth.

47
Q

What is the significance of investor confidence in securitisation?

A

Strong investor confidence ensures high demand for securitised products, stabilising the market and providing liquidity for originators.

48
Q

What are synthetic securitisations?

A

Transactions where credit risk is transferred using derivatives, without the transfer of underlying assets to an SPV.

49
Q

What is the relationship between securitisation and financial stability?

A

While securitisation enhances market liquidity and risk-sharing, poor management can destabilise markets, as evidenced during the financial crisis.

50
Q

How do regulatory reforms improve the securitisation market?

A

By enhancing transparency, simplifying products, and imposing stricter capital requirements to prevent systemic risks.

51
Q

What is the primary legal function of the Financial Services and Markets Act 2000 (FSMA) in securitisation?

A

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.

52
Q

How does Article 5 of the EU Securitisation Regulation impact investors?

A

Article 5 imposes due diligence requirements, ensuring institutional investors assess the risks associated with securitised products before investing.

53
Q

What are Basel III’s Pillar 1 capital requirements for securitisation exposures?

A

Banks must hold higher capital reserves for securitisation exposures to cover potential losses, reducing systemic risk.

54
Q

What did the Glitnir Banki hf v The London Borough of Harrow (2012) case highlight about fiduciary duties?

A

It emphasised the duty of public entities to assess risks in securitisation investments to protect taxpayer funds.

55
Q

Define the role of credit rating agencies in securitisation.

A

Credit rating agencies evaluate and assign ratings to securitised products, influencing investor confidence and pricing in the market.

56
Q

What is the distinction between Mortgage-Backed Securities (MBS) and Asset-Backed Securities (ABS)?

A

MBS are backed by residential or commercial mortgages, while ABS are backed by other financial receivables, such as auto loans or credit card payments.

57
Q

What is the purpose of creating a Special Purpose Vehicle (SPV) in securitisation?

A

The SPV isolates the pooled assets from the originator’s balance sheet, ensuring they are protected in case of the originator’s insolvency.

58
Q

How did National Westminster Bank plc v Spectrum Plus Ltd (2005) influence the classification of floating charges?

A

It clarified that charges over circulating assets like book debts are floating charges unless creditors exercise control over proceeds.

59
Q

What risks are associated with junior tranches in securitisation?

A

Junior tranches carry the highest risk as they are the first to absorb losses but offer higher potential returns to compensate.

60
Q

How does securitisation benefit banks in terms of liquidity?

A

It converts illiquid assets into liquid funds by selling securitised products to investors, enabling further lending.

61
Q

What did the IKB Deutsche Industriebank AG v Morgan Stanley (2009) case illustrate about misrepresentation in securitisation?

A

It highlighted the legal responsibility of banks to disclose material risks in securitisation products to avoid misleading investors.

62
Q

How does the EU Securitisation Regulation promote transparency?

A

By requiring detailed disclosure of asset pools, risk factors, and transaction structures to improve investor understanding.

63
Q

What was the key issue in the Federal Housing Finance Agency v UBS Americas Inc. (2013) case?

A

Misrepresentation of the quality of underlying mortgages in mortgage-backed securities, leading to significant financial losses.

64
Q

Why is tranching significant in securitisation?

A

It allows securities to be tailored to different risk appetites, offering senior tranches to risk-averse investors and junior tranches to risk-seekers.

65
Q

Explain moral hazard in the context of securitisation.

A

Originators may issue lower-quality loans, knowing the risks will be transferred to investors through securitisation.

66
Q

What lessons did regulators learn from the 2007–2009 financial crisis regarding securitisation?

A

The crisis underscored the need for stricter regulation, enhanced transparency, and improved risk management in securitisation markets.

67
Q

What role does the Basel Committee play in regulating securitisation?

A

It establishes global banking standards, including stricter capital requirements for banks involved in securitisation.

68
Q

How does securitisation facilitate risk transfer?

A

By pooling assets and selling securities, risks such as default are transferred from the originator to investors.

69
Q

What are collateralised debt obligations (CDOs)?

A

Securities backed by a mix of assets, often with tranches that vary in risk and return, such as corporate loans or bonds.

70
Q

What is the regulatory purpose of the Financial Collateral Arrangements (No. 2) Regulations 2003?

A

To streamline the enforcement of financial collateral, such as securities and cash deposits, reducing legal barriers.

71
Q

Why is securitisation considered essential for economic growth?

A

It enhances the efficiency of capital markets by channeling funds to sectors needing investment.

72
Q

What is synthetic securitisation?

A

A form of securitisation using derivatives to transfer credit risk without transferring the underlying assets.

73
Q

How does securitisation impact systemic risk?

A

While it diversifies risk, excessive reliance on securitisation can amplify systemic vulnerabilities during financial crises.

74
Q

What is the function of due diligence in securitisation?

A

It ensures investors and originators understand and appropriately manage the risks associated with securitised products.

75
Q

How do SPVs achieve bankruptcy remoteness?

A

By legally separating their assets and liabilities from the originator to protect investors in case of originator insolvency.

76
Q

What are non-mortgage asset-backed securities?

A

Securities backed by receivables other than mortgages, such as student loans or trade receivables.

77
Q

How does securitisation enhance capital efficiency for banks?

A

By offloading assets, banks reduce their balance sheet liabilities and meet regulatory capital requirements more efficiently.

78
Q

What is the significance of Article 7 in the EU Securitisation Regulation?

A

It mandates transparency, requiring issuers to disclose information about the securitised assets and associated risks.

79
Q

How does the principle of ‘first loss’ apply to junior tranches?

A

Junior tranche investors absorb initial losses, protecting senior tranches and ensuring payment hierarchy.

80
Q

What is the purpose of the supervisory review process in Basel III (Pillar 2)?

A

To ensure banks properly assess and manage their securitisation exposures beyond minimum capital requirements.

81
Q

How do securitised products support credit markets?

A

By providing liquidity and enabling originators to reinvest capital into new loans and credit facilities.

82
Q

What was the main critique of securitisation during the financial crisis?

A

The complexity and opacity of securitised products made risk assessment difficult, leading to widespread mispricing.

83
Q

How do investor protections in securitisation benefit financial markets?

A

They ensure transparency and fair risk allocation, fostering trust and stability in capital markets.

84
Q

What does the term ‘crystallisation’ mean in securitisation?

A

It refers to the point where floating risks or obligations in a securitised product become fixed due to a triggering event.

85
Q

What is the importance of credit enhancements in securitisation?

A

Credit enhancements, such as guarantees or reserve accounts, increase investor confidence by reducing perceived risks.

86
Q

How did regulators address moral hazard in post-crisis securitisation reforms?

A

By requiring originators to retain a portion of the risk in securitised products, ensuring accountability.

87
Q

What distinguishes a simple, transparent, and standardised (STS) securitisation?

A

STS securitisations adhere to clear rules and disclosures, making them more predictable and reliable for investors.

88
Q

How does securitisation affect borrower rights?

A

Borrowers may face new servicing entities with different policies, potentially leading to confusion or disputes.

89
Q

What is the role of disclosure in mitigating securitisation risks?

A

Full disclosure ensures that all parties understand the underlying assets and risks, reducing misrepresentation and litigation.

90
Q

Why is investor education critical in securitisation?

A

Educating investors about risks, structures, and market dynamics prevents misunderstandings and promotes informed decision-making.

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