PAPERSERIESONREGIONALECONOMICINTEGRATIONNO.12
January2008
SecuritizationinEastAsia
PaulLejot,DouglasArnerandLotteSchou-Zibell
SecuritizationinEastAsia*
January2008
PaulLejot,DouglasArner+andLotteSchou-Zibell++
*TheauthorsacknowledgewiththanksthesupportivecollaborationofJong-WhaLee,Head,OfficeofRegionalEconomicIntegration,ADB,andtheinvaluableresearchassistanceofFerdinandSiaandMariaMelodyGarcia.Anyerrorsarethoseoftheauthors.TheresearchunderlyingthispaperwasassistedbytheHongKongResearchGrantsCouncilCompetitiveEarmarkedResearchGrantprogramandtheUniversityofHongKongStrategicResearchAreasInitiative.+AsianInstituteofInternationalFinancialLaw,UniversityofHongKong,HongKong,China,E-mail:plejot@hku.hk,anddouglas.arner@hku.hk.++OfficeofRegionalEconomicIntegration,AsianDevelopmentBank,Manila,Philippines,E-mail:Ischouzibell@.
TheADBWorkingPaperSeriesonRegionalEconomicIntegrationfocusesicsrelatingtoregionalcooperationandintegrationintheareasofinfrastructureandsoftware,tradeandinvestment,moneyandfinance,andregionalpublicgoods.TheSeriesisaquick-disseminating,informalpublicationthatseekstoprovideinformation,generatediscussion,andments.WorkingpaperspublishedunderthisSeriesmaysubsequentlybepublishedelsewhere.
Disclaimer:TheviewsexpressedinthispaperarethoseoftheauthoranddonotnecessarilyreflecttheviewsandpoliciesoftheAsianDevelopmentBankoritsBoardofGovernorsorthegovernmentstheyrepresent.TheAsianDevelopmentBankdoesnotguaranteetheuracyofthedataincludedinthispublicationandeptsnoresponsibilityforanyconsequenceoftheiruse.Useoftheterm“country”doesnotimplyanyjudgmentbytheauthorsortheAsianDevelopmentBankastothelegalorotherstatusofanyterritorialentity.Unlessotherwisenoted,$referstoUSdollars.©2008byAsianDevelopmentBankFebruary2008PublicationStockNo.PPA201708
Contents
Abstract
1 I.Introduction
2 II.Evolution
4 A.Concepts
5 B.Definitions
7 C.TransactionMechanics
8 D.Tranching
9 E.Usage 10 III.DevelopmentinEastAsia 12
A.SecuritizationDrivers 13
B.Post-crisisReforms 15
C.LegalandRegulatoryIssues 18 IV.NationalRegulationsandInternationalCapitalStandards 20
A.RegulatoryIncentivestoSecuritization 20
B.BaselIIImplementation 22
C.VariationsinRegulationandPractice 24
V.Recenttrends 26
A.GlobalDisruption 26
B.CreditRiskTransfer 28
C.TransactionAppraisalandManagement 30
D.CreditRatingAgencyFunctions 32
E.EastAsianImpact 35
F.Post-crisises 35 VI.Securitization’sFutureinAsia 38
A.RethinkingSecuritization 39
B.IncentivestoSecuritizationinAsia 40
C.NewInitiatives 42 Appendixes 44
1.EffectsofFinancialMarketDevelopmentonSecuritization 44
2.CashandSyntheticGenericTransactions 50
3.CoveredBonds 53
4.EnablingLegislationandRegulation 55
5.ProvisionsforSecuritization 56 References 58 ADBWorkingPaperSeriesonRegionalEconomicIntegration 65 Tables A1.1SummaryofVariablesandExpectedSigns 45 A1.2SelectedPooledRegressionEstimateswithInteraction Dummies,1995–2006 48 A1.3CompletePooledRegressionsEstimateswithInteraction Dummies,1995–2006 49 A1.LegislationandRegulationtoAssistSecuritization 55 A2.AssessmentofPrevailingSecuritizationMarketConditions (“5”=excellent) 56 Figures
1.Long-termDriversofGlobalSecuritization 14
2.EvolvingSecuritizationDriversinAsia 15 A2.1GenericCashSecuritizedTransaction 50 A2.2GenericStructureUsingSequentialSPVs 50 A2.3CreditRating&Risk-returnTrade-off 51 A2.4GenericSyntheticSecuritizedTransaction 51 A2.5GenericSyntheticCDO 52 A2.6CDOPaymentWaterfall 52 Abstract SecuritizationoffersarangeofbenefitsforAsia’sfinancialsystemsandeconomiesasamechanismtoassistfundingandinvestment.Asaformofstructuredfinance,reliableandefficientsecuritizationanassistdevelopmentbyenablingfinancialsystemstodeepenandstrengthen—thuscontributingtooveralleconomicgrowthandstability. Itmustberecognized,however,thattherearebothovertandmoresubtlerisksincertainusesofsecuritization.ThecreditandliquiditycrisisthatbeganintheUnitedStatesandspreadtootherdevelopedfinancialsystemsinmid-2007exposedthedangerassociatedwithsecuritization:excessiverisk-takingorregulatorycapitalarbitrageratherthanatooltoassistmoreconventionalorconservativeapproachestofunding,riskmanagement,orinvestment.Securitizationhasalsobeencriticizedforrenderingfinancialmarketsopaque,whilecontributingtoagrowingemphasisintheglobaleconomyofcreditintermediationconductedincapitalmarketsratherthanthroughbanks. ThisstudyexaminestheinstitutionalbasisoftheseconcernsbyinvestigatingtheuseofsecuritizationinEastAsia,questioningboththegrowthinregionalactivitysincethe1997/98Asianfinancialcrisis,andthereasonsforitremainingconstrained.Thepaperconcludeswithadiscussionofproposalstosupportproperdevelopmentofsecuritizationintheregion,includinginstitutionalmechanismsthatcouldbetterallowsecuritizationtoenhancedevelopmentandfinancialstability.IfEastAsiabeginstomakefulleruseofsecuritization,itsmotivewillbetomeetfundingorinvestmentneedsintherealeconomyratherthanbalancesheetarbitrageofthekindthatpeakedelsewherein2007. Keywords:Securitization,EastAsia,debtmarkets,risktransfer. JELClassifications:F3,G2,K2.
I. Introduction “WeshallnotceasefromexplorationAndtheendofallourexploringWillbetoarrivewherewestartedAndknowtheplaceforthefirsttime.”
T.S.Eliot FourQuartets,LittleGidding,
V ThisstudyquestionswhethertheeffectivenessofthefinancialsystemsofcertainAsianeconomiescanbenefitfromimprovedesstosecuritizationasaformofmarket-basedfinancialintermediation.Thepracticalimplicationwouldbeagreaterrelianceonthepublicandprivatesecuritiesmarketsincapitalfundingandportfolioinvestment,plementtraditionalbanklendingonwhichbothnewly-industrializedanddevelopingEastAsianeconomiesnowlargelydepend.1Giventhegenerallossofconfidenceandliquidityinglobalcreditmarketsandstructuredfinancethatbeganinmid-2007,thispaperalsoexamineshowcreditrisktransferandregulatoryincentivestosecuritizationwillbere-assessedbeyondthechangescontemplatedbytheingrevisionstotheBaselcapitalords. Commercialinterestshaveinsistedsincetheearly1990sthatstructuredfinancehasconsiderablepotentialinAsia.ItwasalsoeptedasavaluabletoolintherestructuringoffinancialsectorclaimsintheRepublicofKorea(Korea)after2000.YettheoveralldevelopmentofsecuritizationintheregionisparedwithEuropeorNorthAmerica,despitethefactthatmanynationalauthoritieshaveencourageditsusesincethe1997/98Asianfinancialcrisis.Thispromptsthequestionwhetherthisaspectoffinancialdevelopmentlagsotherregionsasafunctionoftime,asamatterofnationalinstitutionalconditions,orastheresultofcertaineconomicconditions—suchasnationalsavingsandinvestmentimbalancesorrelativelyhighbankingsectorliquidity.Ifeffectivesecuritizationcansupportfinancialsectordevelopmentandefficiency,whichcontributetoeconomicobjectivessuchasgrowthandfinancialstability,2thenitmaybevaluablemerciallyandsociallytopromoteitsuse. However,itmustberecognizedthattherearebothovertandmoresubtlerisksincertainusesofsecuritization.ThecreditandliquiditycrisisthatbeganintheUnitedStates(US)andspreadtootherdevelopedfinancialsystemsinmid-2007exposedthedangerassociatedwithsecuritizationinexcessiverisk-takingorregulatorycapitalarbitrage,ratherthanasatooltoassistamoreconventionalorconservativeapproachtofunding,riskmanagement,orinvestment.Securitizationhasalsobeencriticizedforrenderingfinancialmarketsopaque,whilecontributingtoagrowingemphasisintheglobaleconomyofcreditintermediationconductedincapitalmarketsratherthanthroughbanks.3 ThisstudyexaminestheinstitutionalbasisoftheseconcernsbyinvestigatingtheuseofsecuritizationinEastAsia,questioningboththegrowthinregionalactivitysincethe1997/98Asianfinancialcrisis,andthereasonsforitremainingconstrained.Thepaperconcludeswithadiscussionofproposalstosupportproperdevelopmentofsecuritizationintheregion,includinginstitutionalmechanismsthatcouldbetterallowsecuritizationtoenhancedevelopmentand 1Unlessotherwisestated,forthepurposeofthisstudyEastprisesthePeople’sRepublicofChina(PRC);HongKong,China;Indonesia;Japan;RepublicofKorea(Korea);Malaysia;Philippines;Singapore;Thailand;andVietNam. 2Financialstabilityistaken,inonesense,astheavoidanceormitigationoffinancialcrises,andinanotherastheeffectivefunctioningofthefinancialsystem.SeeArner(2007). 3Financializationreferstotherelativeinfluenceoffinancialintermediariesandmarketsinnationalandinternationaleconomies,includingthescaleoffinancialclaimsrelativetoaggregatenationaloutput,seeSection4below.
2 financialstability.IfEastAsiabeginstomakefulleruseofsecuritization,itsmotivemaybetomeetfundingorinvestmentneedsintherealeconomyratherthanbalancesheetarbitrageofthekindthatpeakedelsewherein2007. TotheextentthatsecuritizedtransactionsorprogramsexistinAsia,havetheydevelopedtotheirfullestpotential?
Dospecialadvantagesexisttoincreasingstructuredfinanceresourcesintheregion,especiallyifmercialinterestssuchasstateoranizationsareinvolvedintheirdevelopment?
Forexample,couldstructuredfinancetechniquesprovidenewsourcesoffundingforinfrastructurecapitalasinpartsofEurope,orasspecialistlong-termlendersthatbecameimportantinpriorphasesofgrowthinJapanandKorea?
Last,haveinstitutionalchangestofacilitateorstimulatesecuritizationhadanyimpactonpost-crisisriskaversionforAsianinvestors?
ThisstudyexaminesdifferentfeaturesofEastAsiansecuritizationandidentifiespossibleusesinothermarkets,inparttohelpidentifynewfundingandinvestmentapplications.ItsfindingsarebasedonanappraisalofcurrentandprospectiveusesofsecuritizedtransactionsinEastAsia’sleadingeconomies.Theanalysisistiedtononationalmodel,andinparticularrefrainsfromusingAnglo-Americanpracticeasabenchmark.IntheUS,emphasisonpublichousingpolicyandtheconfigurationofbankingandsecuritieslawshaveformanyyearssupportedtherefinancingofhouseholdcreditand,sincethe1970s,encouragedtheincreasinglyprolificsaleofresidentialmortgage-backedsecurities(RMBS)andasset-backedsecurities(ABS).4Whilethismightbeapplicableelsewhere,itdoesnotnecessarilyprovideareplicableoroptimalmodelforEastAsia. ThestudyalsoconsiderstheconceptsunderlyingsecuritizationandexaminesthecostattractionsanddriversforsuchissuesinAsia.Itdescribeswhatmakessecuritizationpracticable,whatmakesindividualtransactionsessful,andtheobstaclesthatcausethemtofailorputoffinvestors.Itexaminestheimpactofthe1988BaselCapitalord(BaselI),andassessesthelikelyeffectsoftheintroductioninAsiaofitsrecentmajorrevision(BaselII).Byclassifyingcreditriskandassigningriskweightingsinbroadstrata,BaselIinducedincreasinglyactiveportfoliomanagementamongcapital-regulatedbankingintermediariesandcreatedascienceamongsuchintermediariesforregulatorycapitalmanagementwithadevelopingarrayofinstitutionsandfinancialinstruments.Significantly,BaselIthusinadvertentlyledtotheproliferationofsecuritization,5whichradicallyalteredthecostsfacedbybankswhenusingstructuredfinancetomeetrisk,return,orliquidityobjectives. ThestudyassesseshowcertainAsianeconomieshaveusedsecuritizationforpolicypurposes,whyotherssanctionarangemercialtransactions,andwhatobstacleshindersimilardevelopmentselsewhere.Finally,itsuggeststhatmultilateraldevelopmentagenciesmightusefullysupportfurtherreformstostrengthenpropertyrightsandthejudicialprocess,promotestandardsamonglendersfordatacollectionandanalysis,monbestpracticesindocumentationandriskappraisalamongfinancialintermediariesintandemwithregulatoryenhancements,andencouragesecuritizationasarefundingmechanismforlendingassociatedwithpublicpolicy.Theseusesmightincludeinfrastructuralrisks,educationallending,andagriculturalmunityfinance.Formultilateralbodiestoeintermediariesinsuch 4ArecentanalysisofABSissuanceintheUS,Europe,andAsiaandthePacific(includingAustralia;Japan;andTaipei,China)appearsinGyntelbergandRemolona(2006),page67. 5IncludingamongbanksnotformallysubjecttoBaselIprecepts,resultingeitherfrompetitionbetweenmarkets,orbanklendersbeingsubjectedtopeerpressurethroughinterbankcreditpricing.SuchbehaviorurredinAsiapriortothe1997/98financialcrisis,althoughseldompracticedtoappropriatestandards.
3 areasmaybeanoriginalandnon-conflictinguseofofficialcapital,withidentifiablegoalsinpovertyreductionandincentivesforresourcedevelopment. Thefollowingsectionoutlinessecuritizedtransactionconcepts,andthenlooksatthemechanicsofstructuredfinanceanditsuses.Section2thenassessessecuritizationactivityinAsia,includingthelegalandregulatoryissuespeculiartotheregion.Section3examinestherelationshipbetweentransactionuseandnationalandglobalstandardsincapitalregulation,especiallyundertheBaselords.Section4considersAsiansecuritizationtrendsinthecontextofrecentglobaldevelopments,andlookstopossiblereformsinglobalmarketsemerginginthewakeofthe2007creditcrisis.Section5closesbyexaminingthescopefordevelopmentalusesofstructuredfinancetowhichmultilateralresourcesmightbedirected,givencurrentlevelsofactivityinAsia,andtheimplicationsofpost-2007globaldevelopmentsforthefutureofsecuritization.Isittimetoreconsidertheeconomicandsystemicresultsofsecuritization,ratherthanitsprolificusesincetheearly1990sintransactionalregulatoryarbitragebyfinancialintermediaries?
Theappendixesincludetheresultsofempiricalanalysisoffactorsassociatedwiththegrowthofsecuritization,aswellasexplanationsmontransactionstructuresandappraisalsofgovernment’slegalprovisions. II.Evolution Whilethemodernhistoryofsecuritizedtransactionsdatesonlyfromthelate1970s,theunderlyingconceptshavebeenknownforcenturies.6Monarchshavesincemedievaltimesraisedfundsthroughtheforwardsaleofexpectedtaxreceiptsortariffs.7Inthe17thcentury,DutchinvestorsweremakingloanstoCaribbeanplantationownerssecuredagainsttheproceedsfromharvestedsugar.Inapublicpolicycontext,thefirstUSfederalrefundingagencieshelpedencouragebanklendinginthe1930sforcertainclassesofhomepurchasesasameasureofpublicpolicy,anobjectivewidelyadoptedelsewhere.8 Contemporarysecuritizationtransactionshaveeincreasinglystandardized,initiallyinUSmarkets,theninotherjurisdictionssuchasAustraliaandtheUnitedKingdom(UK),andmorerecentlyinothereconomies.Assecuritizationhasspreadthroughcertainbanksandhousinglenders,ithasproducedplexcontractualstructures—afactorthatmaybeatthecoreofthedisruptionthatbegantoaffectmarketsinmid-2007.ThisevolvedintandemwithincreasinglysophisticatedUSandinternationalsecuritiesmarkets.9 Sincethe1980ssecuritizationhaseapowerfulandwidely-usedtoolinbothdevelopedandemergingmarkets.ItbecameavaluabletoolinpartsofEastAsiaafterthe1997/98financialcrisisasameanstodeterminethescopeofanddisposeofcreditlosses,partlyatthebehestoftheInternationalaryFund(IMF)asafeatureofthemarket-oriented 6Thefirstuseoftheterm“securitization”isclaimedbyaWallStreetbankerduringa1977conversationreportedintheWallStreetJournal(Ranieri1996). 7ThesaleofofficeswasaformalinstitutionoftheByzantineEmpirebythe11thcentury,inwhichformitwascharacterizedbyaleadingeconomichistorianoftheperiodasaformofprudentlendingtothestate,madenecessarybyweakpublicfinances.Formalmechanismsprovidedincentivestotaxcollectorstohelpethisweakness(AndreasAndreades,quotedinLaiou,2002,pages7–8;Swart,1949,page99).AndreadesarguedfurtherthattaxfarmingthroughthesaleofpublicofficeswasaninstitutionofclassicalGreekcitystates,andassuchmayrepresentthefirstdevelopedexamplesofsecuritizedtransactions,seeAndreades(1933),pages159–161. 8DanishandGermancoveredbondtransactionswereknowninthe18thcenturyandbegantoresemblemoderntransferableissuesinthelate19thcentury(seeAppendix4). 9USFederallegislationwasneededbeforemortgage-backedinstrumentswouldberegardedassecuritiesforinvestmentandregulatorypurposes,andthusheldbynon-bankinvestors(seeSecondaryMortgageMarketEnhancementActof1984).
4 “Washingtonconsensus.”Itsoonbegantoappealtocertainstatesasadevicetohelpbringaboutmarket-basedreform,effectivelyusingtheeffectsofthefinancialcrisisasapretexttolessentraditionalrelianceonbankintermediation.Throughouttheperiod,mercialandofficialinterestssoughttopromotesecuritizationtousers,orinducedlegalorregulatoryreformsandinsomecasesprovidedincentivestousers,especiallyinhousingfinance.10 Theresultsarenowseenmostclearlyinthebreadthpletedtransactions,whichhaveincludedriskinmostEastAsianjurisdictionsandbothcross-borderdealsinmajorcurrenciesanddomesticlocalcurrencytransactions,whetherornotavailabletoforeigninvestors.YetsecuritizationremainslargelyunderutilizedbyinstitutionalinvestorsinAsiaasitisoftencostlytoexecute,andhasyettodeliverwide-rangingresultsintermsofsystemicreformsortransactionvolumespredictedbyitsadvocates.
A.Concepts Securitizationrepresentsanimportantformofcreditrisktransfer.11Itmaybedeployedasanestablishedmeanstoobtainfundingataneptablecost,assistinportfolioriskmanagement,ortomeetinvestorpreferences.12Separately,financialsectorlawsandregulations,including,sincetheearly-1990s,manyrelatedtoountingortaxation,havetriggeredveryconsiderablegrowthintransactionsforbanksandotherfinancialsectorusers,largelytotheneglectofmoretraditionaleconomicdrivers.Thisstudysuggestshowthatemphasismaychangeinresponsetotheperformanceofstructuredfinancemarketsin2007.Whereregulationsprovideincentivesforfinancialintermediariestousesecuritizedstructures,theprocessconstitutestransactionalregulatoryarbitrage,whetherseenasefficientcapitalmanagementortakenasevasionoravoidancethroughthecircumventionofrulesbycontractualmeans. Onemercialconceptofsecuritizationistoseparatefuturecashflowsfromtheiroriginatorandusethosecashflowstogeneratenewfundingresources.Inadditiontopoolingrisk,wholebusinessesmaysecuritizedistinctpartsofmercialactivities—forexampletoimprovecreditratingsbyreducingconsolidatedleverageortoreduceexternalfinancingcosts.Theresultmaybetoincreaseliquidityforcertainfixedassetsorbusinessstreams,withbroaderresultsintermsofounting,costs,andcreditstanding.13 Securitizationcanthereforebeseenastheantithesisofthemoderncorporateframeworkmercialactivity.Eventhesimplestenterprisedevelopsspecializedfunctionstominimizetransactioncostsandachieveeconomiesofscale.Securitizationthusseekstomercialactivityanizationalorlocationalconcernsandplaceitwithinacontractualsetting.Itwilleedonlyifarangeofbothfundamentalandmoresophisticatedinstitutionsareinplace,includingreliablepropertyrights,andthemeansfortheireffectiveperformanceandenforceabletransfer.14 10SeeSection2.11Creditrisktransferisameansbywhichcreditriskmaybeacquiredorshedtoaltertherisk-returnprofileofaportfoliooffinancial claims.Itisusedbyborrowers,intermediariesorend-investors,andmayormaynotbefunded.Buyingorsellingloansorsecuritiesisasimpleformoffundedcreditrisktransfer;examplesofunfundedcreditrisktransferincludethesaleorpurchaseofcreditprotectionthroughinsuranceorcreditdefaultswaps(CDS).Wholebusinesssecuritizationsrepresentatransferofcreditriskfromcorporateshareholders.12Foradiscussionoftheadvantagesandchallengesinvolvedinemergingmarketsecuritization,seeArner(2002).13ThemercialinterpretationofsecuritizationisexemplifiedbySchwarcz(2002).WholebusinesssecuritizationshavepletedinAsiaonlyinthenon-residentialpropertysector.14Arner(2007)discussesmorefullytheinstitutionalstructuresnecessarytosupportsimplecashsecuritization.
5 Securitizationalsorepresentsaformoffinancialintermediationoutsidetheconfinesofanizationsandisthusconcernedwithensuringthatcontractspleted.15Properlypracticed,itdispenseswiththeaggregationofclaimswithinanysingleintermediaryandisdesignedtoexpresslyavoidarangeofinherentmismatcheshistoricallyassociatedwithlendingbytheseintermediaries.16Formanyfinancialintermediaries,securitizationmerciallendingintoitsconstituentparts,similartothewaythatindustrialgroupsusewholebusinessorsegmentalsecuritization. Traditionalbankcreditintermediationentailsthreemajortransformationsofduration,creditrisk,andvalue,aswellassecondaryeffectspromptedbyriskmanagementdecisionsthatseektooffsetthoseprimarymismatches. First,anintermediarymustmanagefundingandreinvestmentriskassociatedrespectivelywiththewithdrawalofadepositpriortorepaymentoftheloanthatithelpsfund,andtheunexpectedearlyrepaymentofaloanforwhichadepositoflongerdurationhasbeencontracted.17Theintermediarycanmitigatetheriskbychargingpenalties,orseekingtomaintainandmatchbroadportfoliosofassetsandliabilities.Securitizationisanalternativemeanstoaddressthebank’sprocessofdurationtransformation.18However,securitizationitselfreliesupontransformationalassumptionsunlesseachclaimthatitgenerateshasanoptimalcontractualmatch.19 Second,thepositionsofmercialbankintermediarieswilloftenbefarmorediversethantheirloanportfolios,ignoringgeographicalconcentrationsofindividualmercialdepositorssubjecttosharedeconomicconditions.Theresultmaybethatexternalshockshaveadisproportionateimpactononesideoftheintermediary’sbalancesheet. Third,unlessanintermediaryeswhollyinsolvent,itwillexpecttorepaymostdepositliabilitiesattheirnominal(par)valuebutmaynotalwaysrecoverthefullamountofanysingleloanifaborrowerdefaults.Thistransformationisasymmetric,andmaybegivenadefiniteandpreciseformingeneralexpectationsbymandatorydepositinsuranceschemes. Securitizationrepresentsonesolutiontothesethreeelementalmismatches.Securitizedtransactionsmaybedesignedtomaintainsuchmismatches,forexample,toseekprofitsfromdurationmismatchesandyieldcurveplays,butunlikebanks,theyneednotdoso.20Transformationsofthekindidentifiedherehavebeencitedas“corecharacteristicsofbanking,”whichtogetherwithlevelsofleveragethattypicallyexceedmercialsectorsmake 15Throughoutthisstudy,“institution”meansalaw,ruleorestablishedpractice;“intermediaries”anizationsconcernedwithfinancialtransactions,includingcreditcreationandlending.Theterm“financialinstitution”ispartial,inwronglysuggestingstability,trustworthiness,orrisk-aversebehavior. 16SeeArner(2007)foradiscussionoftraditionalrisksandresponsesthereto.17Unforeseenunavailabilityofretailorwholesaledepositsismoncatalystinmodernbankdistress,includingthemid-2007 liquiditycrisisexperiencedbyaBritishhomemortgagelender,NorthernRockplc.18Theriskmanagementofdurationtransformationbetweenassetsandliabilitiesisoftenmischaracterizedas“borrowingshortand lendinglong”(Buiter,2007)butisonlyoneexampleofsuchpractice.Formanyyears,bankshavesoughtcontractuallytomitigatetheriskofthewithdrawalofshort-termdeposits,forexamplewithdemandor“call”loansthatepayableuponnotice,orwithprovisionspensationforincreasedinterestcosts.19Bycontrast,the2007securitizationmarketdislocationislargelyassociatedwiththewithdrawaloffundingfromholdersofsecuritizedrisks,seeSection4.20ThismechanismmakessecuritizedtransactionsasolutiontotheproblemofpermanentequilibriumcreditrationingidentifiedbyStiglitzandWeiss(1981),wherebybanksfailtolendtoallwillingandeptableborrowersduetoincentivefactorsassociatedwithasymmetricinformation.Hill(1996)arguesfurtherthatasasourceofexternalfunding,securitizationreducesthetransactioncostpremiumdemandedbyriskaverselenderswhenconfrontedwithsuchproblems,theunwanted“lemons”issuedescribedbyAkerlof(1970),butfailstoshowthatthecontractualsolutionofsecuritizationpleteinwelfareterms.
6 banks“susceptibletorunsandpanics”and“inherentlyunstable.”21Giventhatthesefactorsarealsoinherentinbankingactivityratherthanresponsestotheregulationofcapital,liquidityordisclosure,thisistakenasjustificationtoregulatebanks.22However,itislessclearthatthisisasufficientexplanation,sinceothersolutionscanalsobeusedtoaddresssuch“instability”. Forthisreason,themechanicsandenablinginstitutionsofsecuritizationrequirehighreliabilityandintegrity.ItmaybethatbadlywrittenorunrealisticcontractshaveimpededgrowthinAsiansecuritizedmarkets.Morebroadly,thecollapseininvestorconfidencein2007intensifiedconcernsastothepletenessofoutstandingstructuredfinancedeals,especiallyinthesubprimesegmentofUSandUKRMBSissues. TheanalysisinAppendix1suggeststhatsecuritizationusevariesaseconomiesdevelopandfinancialmarketsemoresophisticated.Notalladvancedeconomiesareprolificusersofstructuredtransactions.However,itwouldbeuncharacteristicforeconomieswitheffectiveandefficientfinancialsystemsnottosupportsecuritization.Atthesametime,latersectionswillshowthatinstitutionalintegrityasthebasisforreliableandenforceablecontractsisindeedaprerequisite.
B.Definitions “Cash”securitizationistheirrevocabletransferofdefinedfinancialassetsbytheiroriginator,fundedbythesimultaneoussaletothird-partyinvestorsofnewsecuritiesissuedbytheassetbuyer.Neitherassetbuyernorinvestorhastransactionalrecoursetotheoriginator.Othercontinuingaspectsofthelendingprocesswillalsobereplacedbyanarrayofcontractswithadministrativeagents. Bycontrast,“synthetic”securitizationinvolvessimpleplexformsofcollateralizeddebtobligations(CDOs)thatwhollyorpartlyreplicatethecreditrisktransferinvolvedincashtransactions,butwithnooutrightfundedtransferofclaims.ThegenericstructuresofeachtransactionaredescribedmorefullyinAppendix2. Coveredbondssharesomefeaturesofsecuritization,andcanplishcertain—butnotall—ofitsobjectives.ThetransactionmodelisexplainedinAppendix3.SuchstructureshavelongbeenusedinDenmarkandGermany,andhavegrownincreasinglypopularelsewhereinEuropesincethemid-1990s.Conventionalcoveredbondscreateasecurityinterestforinvestorsinclaimsheldbyanintermediary.Thuscoveredbondholdersobtainpreferentialrightsoverpoolsofclaimsthatremainfundedassetsonthebalancesheetoftheoriginatingintermediaryoritssubsidiary.Thoseassetsaresaidto“cover”theinvestor’sclaimasdedicatedcollateralwithoutanirrevocabletransfer.Coveredbondshavetraditionallybeenissuedprimarilyforfundingreasons,butarealsoseeninlocationalandtransactionalregulatoryarbitrage,forexampletoimprovethepost-taxreturnsfromaspecifiedlendingactivityormanageregulatorycapitalneeds.23 “Structured”coveredbondsareavariantonthegenericformthatrepresentsacontractualsolutionforissuersdomiciledinjurisdictionslackingenablingcoveredbondlegislation.These 21Macey(2006),page4.22Ibid.,page4–
7.Thepropositionismoreconvincingifitassumesthatbankinstabilityinducesfinancialsectorcontagion,see Kaufman(1994).SeeArner(2007)forafulleranalysisofmechanismstoaddresssystemicinstability.23Germanpublicsectormonlyuseoffshorevehiclesascoveredbondissuers.
7 bondsofferarelativelyreturntoinvestorssensitivetorisk-assetweightingsandthusraisetheissuer’scosts. Conventionalcoveredbondsgenerallyinvolvelessintensivestructuringorcreditparedwithsecuritizedissues.Thisoftenwillleadtofundingcostadvantagesfortheuser.Thecoveredbondholderhasrecoursetotheoriginator,anddesignatedpoolassets“cover”thenewtransactionascollateral,withoutanirrevocabletransfertoanindependentthirdparty.Coveredbondshavehistoricallyrequirednationalenablinglaws,notonlybecauseofgeneralcivillawpractice(thestructureismonlyusedincivillawjurisdictions),but(inEuropewherethepreponderanceoftransactionshaveurredtodate)duetoEuropeanUnioninvestmentandbankingdirectivesandtheirimpactoninvestorpreferences.
C.TransactionMechanics Mostmodernsecuritizedtransactionsusepooledassetsoretocreatesecuritiesbinationsofcreditratings,yieldanddurationthatareeptabletodifferentclassesofinvestor.Thishasadvantagesfortheoriginatorinthatitmayallowforthesaleofless-viablerisk—forexamplewithseverelyimpairedassetsorrisksubjecttolegalorothercontingencies.However,thefeasibilityofanyplextransactiondependsonapronouncedbiasintheuseofpoolproceedstoservicethehighestrankingclaims,requiringlowerprioritytranchestobedeeplysubordinatedandthuseptabletoonlythemostrisk-preferringinvestor,ifany. Instressedconditionsthesetranchesarelikelytoremainunsoldorretainedasclaimsbythepooloriginator.Regulatorsmaybeconcernedthat,asaresult,theoriginatorholdsapooreroverallriskportfoliothanpriortotheexecutionofthetransaction.Investmentconduitsandstructuredinvestmentvehicles(SIV)havemonplexsolutionstotheregulatoryandountingproblemsassociatedwithplacingtheselowestranking“equity”tranches.24BaselIIintroducesapenalcapitaltreatmentofsuchclaimswhenretainedbyoriginators. Withconventionalcashsecuritization,theassetbuyerisaspecialpurposevehicle(SPV)intheformofasinglepanyortrust,dependingonlegalpracticeinthejurisdictionofthedomicileoftheassets.Securitiesaretypicallyissuedintiersortranches,knownaspayment“waterfalls,”thatcarrymercialtermsandriskssoastoextractthemaximumvaluefromthepoolassetsovertime. Allbutthesimplesttransactionsemployinternalandexternalcreditenhancementtoimproveorstabilizetheriskofanytranche.Internalenhancementusuallytakestheformofportfoliopooldesign,over-collateralizationorthecreationofaliquidityreserve.Cashcollateralorthird-partyinsurancepoliciesorfinancialguaranteesmonexternalsupportingsourcesofvalue.Suchguarantees(or“wraps”)areprovidedbyspecialist“monoline”insurers,whichfirst 24Forsolutionsthatmayfallintopartialdisusefollowingthe2007marketdisruptions,seeSection4below.ConduitsandSIVsaresimilarformsofinvestmentfunds,usuallymanagedorsponsoredbybanksthathavebeenprolificinvestorsinstructuredsecurities.FirstusedinLondoninthe1980sbyCitibankN.A.,theyanizedinfavorabletaxdomicilesandaimtoprofitthroughleveragedinvestmentorproactiveassetliabilitymanagement.Bankshaveusedthesevehiclestoavoidconsolidatingriskassetsortolessentheiroverallneedforregulatorycapital.ThemaindifferencebetweenconduitsandSIVsistheextentofcreditsupportprovidedbythesponsoringbank.Conduitsarefundedbyissuingshort-termmercialpaper(ABCP)andrequirecontingentcreditlinesforthefullamountoftheirliabilities.SIVstendtobeonlymodestlysupportedwithsuchcreditlines.
8 emergedintheearly1970sintheUSmunicipalbondmarketandhavesinceeapowerfulfacilitatinginstitutioninmanystructuredandprojectfinancetransactions.25
D.Tranching Themostimportantaspectofcashandsyntheticsecuritizedtransactionformationarisesfromtranching—paymentprioritiesestablishedtocreateseparatesecuritiesissueswithdistinctriskreturnfeatures.Thisseekstosetpaymentrulesthatgenerateanoptimaluseofbothinvestordemandandthetimevalueofanassetpool.parativelysimpletransactionsrequireextensivemodelingofpoolperformance,whichdemandsadequatedata,anunderstandingofthenationalpaymentanddefaultexperienceofsectoralrisksofthesametypeasthepool,andresourcestoforecastandstress-testpleteasetofesasfeasible.Synthetictransactionsinvolvemodelingthatisidenticalinconceptbutstillplex.Inallcases,thisfunctionhasbeenpassedtocreditratingagencies,increasinglywiththesanctionofnationalregulators.26 Investorpreferencesprovidethestartingobjectiveinpricingandstructuring,withoriginatorsandtransactionarrangersseekingtoextractthegreatestvaluefromtheresourcesavailable.Suchmanipulationiscentraltoallsecuritizedissuesandpartlyexplainstheirplexityandexpense.Structuringthetransactionsetorequireactiveparticipationbycreditratingagencies,whichmodelthewaterfalltreatmentofpaymentsundermanysetsofconditions,andsettermsforindividualtranchestobegiventargetcreditratings.Thislevelofinvolvementismarkedlydifferentmercialratingagencies’practiceswithnon-structuredcorporateorstatebondsissuesandisincreasinglyquestionedasaconflictofinterest.27 Tranchingalsoexplainsthepotentialforsecuritizationtoassistingeneralfinancialmarkettransparencyanddevelopment.Thisismostapparentintheuseofsecuritizationtoassistintherecyclingofnonperformingloans(NPLs),whereamarket-determinedyieldeptabletotheultimateinvestorprovidesatransparentmechanismtovalueapoolofimpairedassetswherenoneotherwiseexisted. Bothlegalandempiricalanalyseshaveseentranchingasameanstoextractadvantagefromsegmentinginvestors.Institutionalanalysiswouldseetranchingascreatingpaymentprioritiesthatinturnallowahighinvestment-gradecreditratingtobegiventoaslargeaspossibleaportionofanysingletransaction.Thestrictcontractualpriorityestablishedbyapaymentwaterfallseekstoeliminatethechancethatacreditorofeitherthepoolorthepooloriginatorwouldchallengepaymentstoaholderofnotes.Italsoservestoavoidpaymentdelaysintheeventofbankruptcyorreceivership. 25Monolineinsurersprovideonlyfinancialguaranteesbutmostareassociatedwithgeneralinsurersorsubstantialconglomerates.AsianSecuritizationandInfrastructureAssurancePteLimited(ASIALimited)wasanAsianregionally-orientedmonolineinsurerestablishedin1996byADBandmercialinterests,lateringdormantduetolossesincurredintheAsianfinancialcrisis,seeLejot,Arner,andPretorius(2006),page284–285. 26ThelimitationsofthisinvolvementwerecautiouslyvoicedbytheBISCommitteeontheGlobalFinancialSystem(2005),whichnotedatpage11thatTranchingcreatesalayerofplexitybeyondthatofestimatingthelossdistributionofthecollateralpool.Itrequiresdetailed,deal-specificdocumentation[…]toensurethattheintendedcharacteristics[…]areactuallydeliveredunderallplausiblescenarios.Thisimpliesintensetransactionalinteractionbetweenarrangerandratingagencythathasnowecontroversial,seeSection4. 27Suchaconflictisdisputedbyratingagencies,seeforexampleBellandRose(2007),butnowwidelybelievedtobeaconcern,especiallyinthecontextofthequasi-regulatoryfunctionordedtoratingagenciesunderBaselII,seePrada(2007),andSection4below.
9 Experiencesuggeststhattranchingtakesadvantageofinvestors’varyingrisk-returnpreferences,relyingalsoupontheneedofalmostallinstitutionalinvestorsinstructuredtransactionsfortheirholdingstobegivencreditratings.28Tranchinghelpsmeettheminimumcriteriaoftheratingagencies,andhenceminimizesthevalueofpaymentstobedeliveredtoinvestorsataparticularcreditratinglevelinrelationtothepredictedpresentvalueofthetotalpool.Thisappearsinconsistentwithbothtraditionaltheoriesofbankintermediation,andthesuggestionthatsecuritizationrepresentsaCoasiansolution29tothemismatchesinherentinsimpleformsoflendingwithinaconventionalintermediary.
E.Usage Securitizationuseiswidespreadbothgeographicallyandbyindustryriskclassification,butnotubiquitousoutsideofmostdevelopedfinancialmarkets.mercialandfinancialbenefits(inadditiontothepotentialstabilitybenefitsdiscussedabove)emanifestinoneormoreoffiveways: (i)Ameanstomakeeptableriskssatisfactorytoaninvestor,assumingthateachpotentialinvestorhasknownrisk-returnobjectives. (ii)Providingacreditratinghigherthanitsrespectivesovereignceilingorthatoftheoriginator.Thismaybeespeciallyattractiveinthecontextofinfrastructurefinancing. (iii)Themeanstopricepoolsofassetsthataredifficulttovalue,usuallytomaketheirsalefeasible.ThisappliesparticularlytoNPLsandotherimpairedfinancialclaims. (iv)Amethodtocreatecapitalmarketfundingwherenonepreviouslyexisted. (v)Forassetoriginators,afundingsourcewherenonewasavailableataneptablecost,especiallywhenlendingessubjecttoquantitativeregulatoryconstraints. Theseapplicationsallrepresenttoolstoassistinbalancesheetmanagement.Formodernfinancialsectorusers,securitizationhasemostcruciallyamechanismforcreditrisktransferandregulatorycapitalmanagement,asSection4ofthisstudyshows.Creditrisktransferneedstobeassessedinboththesenseofallowinguserstomanageassetorliabilityportfolios,andmoregenerallyasclaimsmoveintoandoutoftheregulatedbankingsectorandacrossborders.30Itmayachieveotherobjectivesforcertainusersorinparticularphasesofinterestrateorcreditcycles,andmayhavedevelopmentalorincentivefeaturesforbothoriginatorsandinvestorsorforgeneraleconomicwelfare. Thusitismonforregulatorstoconsidertheconsequencesofenhancedrisktransferforthedispersalofriskwithinandbetweendomesticfinancialsystems.Thishasseveraldimensions,someofwhichmaybebeneficialforefficiencyandfinancialstability,suchaslesseningconcentrationsofgeographicalorsectoralrisk,andincludestransfersofcreditriskto 28Firla-CuchraandJenkinson(2005),who“alsofindsomesupportformorenuancedmodelingpredictionssuchasthepositiveimpactoftheaveragequalityofassetsontranching”,ibid,page32. 29Coasiantheory,associatedwitheconomistRonaldCoase,describestheefficiencyofaneconomicallocationoreinthepresenceofexternalities.Iftradeinanexternalityisfeasibleandtherearenotransactioncosts,thenbargainingwillleadtoanefficienteregardlessoftheinitialallocationofpropertyrights. 30SeeBaselCommitteeonBankingSupervision(2005)andSection4below. 10 lightly-regulatednonbankintermediariesornon-capital-regulatedendinvestors.Theincreasingvelocityofrisktransferoverthepastdecadepresentsfirstorderinformationproblemswhenbanktransferorsarepoorlyregulatedorpliancestandardsareuncertain.Thiswasclearinthe1997/98Asianfinancialcrisisandinthe2007subprimecreditcrisis,especiallywherenonbankintermediarieswereactiveincorporatelendingandconsumercreditcreation. Furthermore,securitizationmayenablefundingorrefinancingbyfinancialintermediaries,oftenthroughofficialhousingfinanceagencies.Thismayincludetheentryofmercialpartiesintoestablishedfinancingsectorssuchasresidentialmortgagefinanceorconsumercredit,withconsequencesforoverallefficiencyanduseofcapital.31 Securitizationcanbeappliedtoalldefinedcreditrisks,includingdelinquentassetsorclaims,buteveninsophisticatedmarketsisforreasonsofcostandtransactionexpensetypicallyassociatedwithrisksinvolvingsimilar,unconnected,predictablecashflows.monlyusedincashsecuritizationincluderesidentialmercialmortgageloans,creditandcreditcardreceivables,vehicleorfleetloans,certaincashreceivables,airticketsales,taxesonrevenue,transportorothertolls,licensingfees,foreignworkerremittances,andmusicroyalties.AlmostalloftheseriskshavebeenusedintransactionsinEastAsiaduringthelastdecade.Dissimilarclaimshavebeenessfullysecuritizedincertainhighlydevelopedmarkets,usuallyusingsyntheticstructures,32butthereareexamplesintheJapan,UK,US,andelsewhereofhighlyvisiblesecuritizedtransactionsinvolvinglargediversepoolsofcorporateloans.33 Thetechniquehasbeenappliedinadvancedeconomiestowholebusinesses,discretebusinessstreams,andmorewidelytosinglemercialproperties.CommercialpropertytransactionsmayeapotentialsourceofnewtransactionsinEastAsiaduetotheimportanceofthesectorinbanklending,especiallyifsingle-ormultiple-assetrealestateinvestmenttrusts(REITs)growmorepopular.34EastAsianREITsandtheirsupportinglegislationorregulatorycodestendtofavorsecuritizationstructurestoagreaterextentthanintheUS,whereREITsfirstappeared.TheuseofpooledNPLsisparativelynew,notablyinGermanyandothermajorcivillawjurisdictions. Inallcases,securitizationrepresentsplexmeanstoachievethesimpleobjectiveofmakingavailablewell-definedriskstosinglehomogeneousclassesofinvestors.Assuch,the 31ToagreaterdegreethaninEastAsia,theintroductionofABSandRMBSintheUSarosefrombankingandsecuritieslawsthatgaveanincentivetoinvestmentbankstocreateandsecuritizeriskshistoricallyfundedmercialbanks.SeealsoWarnockandWarnock(2007). 32Baseduponbasketorindexcreditdefaultswaps.33A1996collateralizedloanobligation(CLO)transactionforUK-basedNatWestBankwasthefirstsignificantpublicissuebased onsizeablecorporatebankloans,seeInternationalFinancingReview(1996a,1996b),whereanewSPVparticipatedinreceiptsfrom$5billionofthebank’sloansandmitments,alltomaximizeitsefficientuseofregulatorycapital.ThisstructurehasbeensupersededbyCLOsinvolvingoutrightsalesofclaims,andbysyntheticandactively-managedCLOs.Regulatorychangescontinuetoalterthecostparametersoftransactionswithsimilaraims,butitisnotablethatnosimilarissuehasbeenmadebylendersinAsiaoutsideJapan.Asmallnumberofsecuritizationsofleasereceivablesandbankloanstosmallandmedium-scaleenterprises(SME)havepletedforbanksinJapan,andsince2005insingledealsinMalaysia;Singapore;andTaipei,China,apparentlywithofficialencouragement.Thesearemonduetotechnicalchallengespetingbanksectorliquidity,butasrefundingsourcesaresimilartotransactionsintendedtosupportmicrofinanceandagriculturalcredit,seeSection5.34REITsarecollectiveinvestmentschemesthatbecameattractivefundingtoolsforpropertydevelopersinJapan;Singapore;andHongKong,China(indecliningscaleofuse)duringphasesofweakpropertyprices.TheyalsoexistonamodestscaleinKorea,Malaysia,andThailand.Tooriginators,REITscanresembleformalwholebusinesssecuritizations,althoughmorelooselyframed“captive”REITsalloworiginatorstoparticipateingainsderivedfromtrustassets.Singapore’sBusinessTrustsAct2004permitssimilarschemesinvolvingmostformsofnon-propertyrisks.BothSingaporeandHongKong,ChinanowallowREITstoownforeignassets. 11 techniquehasbeenknowntobeplex,manifestedinhighmarginaltransactionexpensesanddevelopmentperiodsforsingle“one-off”transactionsthatcanbeprotracted,especiallywhentheprevailinglawhindersratherthanhelps.35TheseobstacleshaveyettobeefficientlyremovedorcircumventedinEastAsia.Moregenerally,securitizationexpensesaretypicallyhigh,evenifmarginaltransactingcostsarereducedasaresultofdealfrequency,orsupportivelegislativeorregulatorychange.Thiscanbeseenclearlyinexpensesassociatedwithdatacollectionandverification,dealdevelopment,modeling,ratingagencynegotiation,marketing,andcontractualexecution. III.DevelopmentinEastAsia CommercialinterestshavelongarguedthatstructuredfinancehasconsiderablepotentialinAsianfinance,anditsusehasbeeneptedashavingbeenavaluablestrategictoolintherestructuringoffinancialsectorclaimsinKoreaafter2000.Yettheregion’smodestoveralluseofsecuritizationpromptsthequestionastowhetherthisaspectoffinancialdevelopmentlagsotherregionsasafunctionoftime,nationalinstitutionalconditions,orastheresultofcertaineconomicconditionssuchasnationalsavingsandinvestmentimbalancesorrelativelyhighprivatesectorliquidity.ConservativelevelsofbankleveragehavelimitedthesupplyofloansforcashsecuritizationeveninJapan—wheremarketsinstructuredsecuritieshavedevelopedessfully. InthesenseoftenassociatedwithstructuredfinanceinEastAsia,thefavorableviewofitsbeingencouragedfordevelopmentistypifiedbyBankforInternationalSettlements(BIS)analysis: Structuredfinancecanhaveapositiveinfluenceonthefinancialsystembecauseitcantransformordinarilyilliquidorriskyassetsintomoreliquidorlessriskyones.Itthusoffersanalternativesourceoflong-termfundinginbothdomesticandcross-bordermarkets,andcanfosterthedevelopmentofdomesticbondmarkets.Inturn,thiscouldpromotegreaterbankandfinancialmarketefficiency,asitimpliespetitiontomeetcustomerfinancingneeds.36 Whileacknowledgingthatproponentsofsecuritizationneedtobecautionedastoitsrisks,37itisnotablethatareviewpublishedinmid-2007duringtheglobalstructuredfinancemarkets’mostseveredislocationtodateisconstructiveandconformswithaseminalpositiveBISviewofcreditrisktransfer.38 SecuritizationactivityincreasedmarkedlyinpartsofAsiaafter2000—notablyinHongKong,China;Japan;Korea;andMalaysia—ineachcasewithhousingloansusedasrawmaterial,andinSingaporethroughtransactionssupportedmercialproperty.Critically,securitizationbecameastrikinglyvaluabletoolforKoreaaspartofextensivecorporateandfinancialsectorpost-crisisrestructuring,whennewlegislationallowedlargevolumesofNPLsandotherimpairedfinancialclaimstobeemployedascollateralfornewCDOs,aprocessofrecycling 35EarlycashandsyntheticCLOstookmanymonthstoprepareandexecute,despiteoriginatinginsophisticatedjurisdictions.36ScatignaandTover(2007),page71,emphasisadded.37Id.,pages81–82.38BaselCommitteeonBankingSupervision(2005). 12 defaultedclaimsinstrumentalintherecuperationofthewiderKoreaneconomy.39Atthesametime,pletedsecuritizationvolumesinthePRC,Indonesia,Philippines,andThailandremainverylimited.SecuritizationmaybeundevelopedorpoorlyusedinEastAsiapartlybecausefactionalinterestsfav
1 I.Introduction
2 II.Evolution
4 A.Concepts
5 B.Definitions
7 C.TransactionMechanics
8 D.Tranching
9 E.Usage 10 III.DevelopmentinEastAsia 12
A.SecuritizationDrivers 13
B.Post-crisisReforms 15
C.LegalandRegulatoryIssues 18 IV.NationalRegulationsandInternationalCapitalStandards 20
A.RegulatoryIncentivestoSecuritization 20
B.BaselIIImplementation 22
C.VariationsinRegulationandPractice 24
V.Recenttrends 26
A.GlobalDisruption 26
B.CreditRiskTransfer 28
C.TransactionAppraisalandManagement 30
D.CreditRatingAgencyFunctions 32
E.EastAsianImpact 35
F.Post-crisises 35 VI.Securitization’sFutureinAsia 38
A.RethinkingSecuritization 39
B.IncentivestoSecuritizationinAsia 40
C.NewInitiatives 42 Appendixes 44
1.EffectsofFinancialMarketDevelopmentonSecuritization 44
2.CashandSyntheticGenericTransactions 50
3.CoveredBonds 53
4.EnablingLegislationandRegulation 55
5.ProvisionsforSecuritization 56 References 58 ADBWorkingPaperSeriesonRegionalEconomicIntegration 65 Tables A1.1SummaryofVariablesandExpectedSigns 45 A1.2SelectedPooledRegressionEstimateswithInteraction Dummies,1995–2006 48 A1.3CompletePooledRegressionsEstimateswithInteraction Dummies,1995–2006 49 A1.LegislationandRegulationtoAssistSecuritization 55 A2.AssessmentofPrevailingSecuritizationMarketConditions (“5”=excellent) 56 Figures
1.Long-termDriversofGlobalSecuritization 14
2.EvolvingSecuritizationDriversinAsia 15 A2.1GenericCashSecuritizedTransaction 50 A2.2GenericStructureUsingSequentialSPVs 50 A2.3CreditRating&Risk-returnTrade-off 51 A2.4GenericSyntheticSecuritizedTransaction 51 A2.5GenericSyntheticCDO 52 A2.6CDOPaymentWaterfall 52 Abstract SecuritizationoffersarangeofbenefitsforAsia’sfinancialsystemsandeconomiesasamechanismtoassistfundingandinvestment.Asaformofstructuredfinance,reliableandefficientsecuritizationanassistdevelopmentbyenablingfinancialsystemstodeepenandstrengthen—thuscontributingtooveralleconomicgrowthandstability. Itmustberecognized,however,thattherearebothovertandmoresubtlerisksincertainusesofsecuritization.ThecreditandliquiditycrisisthatbeganintheUnitedStatesandspreadtootherdevelopedfinancialsystemsinmid-2007exposedthedangerassociatedwithsecuritization:excessiverisk-takingorregulatorycapitalarbitrageratherthanatooltoassistmoreconventionalorconservativeapproachestofunding,riskmanagement,orinvestment.Securitizationhasalsobeencriticizedforrenderingfinancialmarketsopaque,whilecontributingtoagrowingemphasisintheglobaleconomyofcreditintermediationconductedincapitalmarketsratherthanthroughbanks. ThisstudyexaminestheinstitutionalbasisoftheseconcernsbyinvestigatingtheuseofsecuritizationinEastAsia,questioningboththegrowthinregionalactivitysincethe1997/98Asianfinancialcrisis,andthereasonsforitremainingconstrained.Thepaperconcludeswithadiscussionofproposalstosupportproperdevelopmentofsecuritizationintheregion,includinginstitutionalmechanismsthatcouldbetterallowsecuritizationtoenhancedevelopmentandfinancialstability.IfEastAsiabeginstomakefulleruseofsecuritization,itsmotivewillbetomeetfundingorinvestmentneedsintherealeconomyratherthanbalancesheetarbitrageofthekindthatpeakedelsewherein2007. Keywords:Securitization,EastAsia,debtmarkets,risktransfer. JELClassifications:F3,G2,K2.
I. Introduction “WeshallnotceasefromexplorationAndtheendofallourexploringWillbetoarrivewherewestartedAndknowtheplaceforthefirsttime.”
T.S.Eliot FourQuartets,LittleGidding,
V ThisstudyquestionswhethertheeffectivenessofthefinancialsystemsofcertainAsianeconomiescanbenefitfromimprovedesstosecuritizationasaformofmarket-basedfinancialintermediation.Thepracticalimplicationwouldbeagreaterrelianceonthepublicandprivatesecuritiesmarketsincapitalfundingandportfolioinvestment,plementtraditionalbanklendingonwhichbothnewly-industrializedanddevelopingEastAsianeconomiesnowlargelydepend.1Giventhegenerallossofconfidenceandliquidityinglobalcreditmarketsandstructuredfinancethatbeganinmid-2007,thispaperalsoexamineshowcreditrisktransferandregulatoryincentivestosecuritizationwillbere-assessedbeyondthechangescontemplatedbytheingrevisionstotheBaselcapitalords. Commercialinterestshaveinsistedsincetheearly1990sthatstructuredfinancehasconsiderablepotentialinAsia.ItwasalsoeptedasavaluabletoolintherestructuringoffinancialsectorclaimsintheRepublicofKorea(Korea)after2000.YettheoveralldevelopmentofsecuritizationintheregionisparedwithEuropeorNorthAmerica,despitethefactthatmanynationalauthoritieshaveencourageditsusesincethe1997/98Asianfinancialcrisis.Thispromptsthequestionwhetherthisaspectoffinancialdevelopmentlagsotherregionsasafunctionoftime,asamatterofnationalinstitutionalconditions,orastheresultofcertaineconomicconditions—suchasnationalsavingsandinvestmentimbalancesorrelativelyhighbankingsectorliquidity.Ifeffectivesecuritizationcansupportfinancialsectordevelopmentandefficiency,whichcontributetoeconomicobjectivessuchasgrowthandfinancialstability,2thenitmaybevaluablemerciallyandsociallytopromoteitsuse. However,itmustberecognizedthattherearebothovertandmoresubtlerisksincertainusesofsecuritization.ThecreditandliquiditycrisisthatbeganintheUnitedStates(US)andspreadtootherdevelopedfinancialsystemsinmid-2007exposedthedangerassociatedwithsecuritizationinexcessiverisk-takingorregulatorycapitalarbitrage,ratherthanasatooltoassistamoreconventionalorconservativeapproachtofunding,riskmanagement,orinvestment.Securitizationhasalsobeencriticizedforrenderingfinancialmarketsopaque,whilecontributingtoagrowingemphasisintheglobaleconomyofcreditintermediationconductedincapitalmarketsratherthanthroughbanks.3 ThisstudyexaminestheinstitutionalbasisoftheseconcernsbyinvestigatingtheuseofsecuritizationinEastAsia,questioningboththegrowthinregionalactivitysincethe1997/98Asianfinancialcrisis,andthereasonsforitremainingconstrained.Thepaperconcludeswithadiscussionofproposalstosupportproperdevelopmentofsecuritizationintheregion,includinginstitutionalmechanismsthatcouldbetterallowsecuritizationtoenhancedevelopmentand 1Unlessotherwisestated,forthepurposeofthisstudyEastprisesthePeople’sRepublicofChina(PRC);HongKong,China;Indonesia;Japan;RepublicofKorea(Korea);Malaysia;Philippines;Singapore;Thailand;andVietNam. 2Financialstabilityistaken,inonesense,astheavoidanceormitigationoffinancialcrises,andinanotherastheeffectivefunctioningofthefinancialsystem.SeeArner(2007). 3Financializationreferstotherelativeinfluenceoffinancialintermediariesandmarketsinnationalandinternationaleconomies,includingthescaleoffinancialclaimsrelativetoaggregatenationaloutput,seeSection4below.
2 financialstability.IfEastAsiabeginstomakefulleruseofsecuritization,itsmotivemaybetomeetfundingorinvestmentneedsintherealeconomyratherthanbalancesheetarbitrageofthekindthatpeakedelsewherein2007. TotheextentthatsecuritizedtransactionsorprogramsexistinAsia,havetheydevelopedtotheirfullestpotential?
Dospecialadvantagesexisttoincreasingstructuredfinanceresourcesintheregion,especiallyifmercialinterestssuchasstateoranizationsareinvolvedintheirdevelopment?
Forexample,couldstructuredfinancetechniquesprovidenewsourcesoffundingforinfrastructurecapitalasinpartsofEurope,orasspecialistlong-termlendersthatbecameimportantinpriorphasesofgrowthinJapanandKorea?
Last,haveinstitutionalchangestofacilitateorstimulatesecuritizationhadanyimpactonpost-crisisriskaversionforAsianinvestors?
ThisstudyexaminesdifferentfeaturesofEastAsiansecuritizationandidentifiespossibleusesinothermarkets,inparttohelpidentifynewfundingandinvestmentapplications.ItsfindingsarebasedonanappraisalofcurrentandprospectiveusesofsecuritizedtransactionsinEastAsia’sleadingeconomies.Theanalysisistiedtononationalmodel,andinparticularrefrainsfromusingAnglo-Americanpracticeasabenchmark.IntheUS,emphasisonpublichousingpolicyandtheconfigurationofbankingandsecuritieslawshaveformanyyearssupportedtherefinancingofhouseholdcreditand,sincethe1970s,encouragedtheincreasinglyprolificsaleofresidentialmortgage-backedsecurities(RMBS)andasset-backedsecurities(ABS).4Whilethismightbeapplicableelsewhere,itdoesnotnecessarilyprovideareplicableoroptimalmodelforEastAsia. ThestudyalsoconsiderstheconceptsunderlyingsecuritizationandexaminesthecostattractionsanddriversforsuchissuesinAsia.Itdescribeswhatmakessecuritizationpracticable,whatmakesindividualtransactionsessful,andtheobstaclesthatcausethemtofailorputoffinvestors.Itexaminestheimpactofthe1988BaselCapitalord(BaselI),andassessesthelikelyeffectsoftheintroductioninAsiaofitsrecentmajorrevision(BaselII).Byclassifyingcreditriskandassigningriskweightingsinbroadstrata,BaselIinducedincreasinglyactiveportfoliomanagementamongcapital-regulatedbankingintermediariesandcreatedascienceamongsuchintermediariesforregulatorycapitalmanagementwithadevelopingarrayofinstitutionsandfinancialinstruments.Significantly,BaselIthusinadvertentlyledtotheproliferationofsecuritization,5whichradicallyalteredthecostsfacedbybankswhenusingstructuredfinancetomeetrisk,return,orliquidityobjectives. ThestudyassesseshowcertainAsianeconomieshaveusedsecuritizationforpolicypurposes,whyotherssanctionarangemercialtransactions,andwhatobstacleshindersimilardevelopmentselsewhere.Finally,itsuggeststhatmultilateraldevelopmentagenciesmightusefullysupportfurtherreformstostrengthenpropertyrightsandthejudicialprocess,promotestandardsamonglendersfordatacollectionandanalysis,monbestpracticesindocumentationandriskappraisalamongfinancialintermediariesintandemwithregulatoryenhancements,andencouragesecuritizationasarefundingmechanismforlendingassociatedwithpublicpolicy.Theseusesmightincludeinfrastructuralrisks,educationallending,andagriculturalmunityfinance.Formultilateralbodiestoeintermediariesinsuch 4ArecentanalysisofABSissuanceintheUS,Europe,andAsiaandthePacific(includingAustralia;Japan;andTaipei,China)appearsinGyntelbergandRemolona(2006),page67. 5IncludingamongbanksnotformallysubjecttoBaselIprecepts,resultingeitherfrompetitionbetweenmarkets,orbanklendersbeingsubjectedtopeerpressurethroughinterbankcreditpricing.SuchbehaviorurredinAsiapriortothe1997/98financialcrisis,althoughseldompracticedtoappropriatestandards.
3 areasmaybeanoriginalandnon-conflictinguseofofficialcapital,withidentifiablegoalsinpovertyreductionandincentivesforresourcedevelopment. Thefollowingsectionoutlinessecuritizedtransactionconcepts,andthenlooksatthemechanicsofstructuredfinanceanditsuses.Section2thenassessessecuritizationactivityinAsia,includingthelegalandregulatoryissuespeculiartotheregion.Section3examinestherelationshipbetweentransactionuseandnationalandglobalstandardsincapitalregulation,especiallyundertheBaselords.Section4considersAsiansecuritizationtrendsinthecontextofrecentglobaldevelopments,andlookstopossiblereformsinglobalmarketsemerginginthewakeofthe2007creditcrisis.Section5closesbyexaminingthescopefordevelopmentalusesofstructuredfinancetowhichmultilateralresourcesmightbedirected,givencurrentlevelsofactivityinAsia,andtheimplicationsofpost-2007globaldevelopmentsforthefutureofsecuritization.Isittimetoreconsidertheeconomicandsystemicresultsofsecuritization,ratherthanitsprolificusesincetheearly1990sintransactionalregulatoryarbitragebyfinancialintermediaries?
Theappendixesincludetheresultsofempiricalanalysisoffactorsassociatedwiththegrowthofsecuritization,aswellasexplanationsmontransactionstructuresandappraisalsofgovernment’slegalprovisions. II.Evolution Whilethemodernhistoryofsecuritizedtransactionsdatesonlyfromthelate1970s,theunderlyingconceptshavebeenknownforcenturies.6Monarchshavesincemedievaltimesraisedfundsthroughtheforwardsaleofexpectedtaxreceiptsortariffs.7Inthe17thcentury,DutchinvestorsweremakingloanstoCaribbeanplantationownerssecuredagainsttheproceedsfromharvestedsugar.Inapublicpolicycontext,thefirstUSfederalrefundingagencieshelpedencouragebanklendinginthe1930sforcertainclassesofhomepurchasesasameasureofpublicpolicy,anobjectivewidelyadoptedelsewhere.8 Contemporarysecuritizationtransactionshaveeincreasinglystandardized,initiallyinUSmarkets,theninotherjurisdictionssuchasAustraliaandtheUnitedKingdom(UK),andmorerecentlyinothereconomies.Assecuritizationhasspreadthroughcertainbanksandhousinglenders,ithasproducedplexcontractualstructures—afactorthatmaybeatthecoreofthedisruptionthatbegantoaffectmarketsinmid-2007.ThisevolvedintandemwithincreasinglysophisticatedUSandinternationalsecuritiesmarkets.9 Sincethe1980ssecuritizationhaseapowerfulandwidely-usedtoolinbothdevelopedandemergingmarkets.ItbecameavaluabletoolinpartsofEastAsiaafterthe1997/98financialcrisisasameanstodeterminethescopeofanddisposeofcreditlosses,partlyatthebehestoftheInternationalaryFund(IMF)asafeatureofthemarket-oriented 6Thefirstuseoftheterm“securitization”isclaimedbyaWallStreetbankerduringa1977conversationreportedintheWallStreetJournal(Ranieri1996). 7ThesaleofofficeswasaformalinstitutionoftheByzantineEmpirebythe11thcentury,inwhichformitwascharacterizedbyaleadingeconomichistorianoftheperiodasaformofprudentlendingtothestate,madenecessarybyweakpublicfinances.Formalmechanismsprovidedincentivestotaxcollectorstohelpethisweakness(AndreasAndreades,quotedinLaiou,2002,pages7–8;Swart,1949,page99).AndreadesarguedfurtherthattaxfarmingthroughthesaleofpublicofficeswasaninstitutionofclassicalGreekcitystates,andassuchmayrepresentthefirstdevelopedexamplesofsecuritizedtransactions,seeAndreades(1933),pages159–161. 8DanishandGermancoveredbondtransactionswereknowninthe18thcenturyandbegantoresemblemoderntransferableissuesinthelate19thcentury(seeAppendix4). 9USFederallegislationwasneededbeforemortgage-backedinstrumentswouldberegardedassecuritiesforinvestmentandregulatorypurposes,andthusheldbynon-bankinvestors(seeSecondaryMortgageMarketEnhancementActof1984).
4 “Washingtonconsensus.”Itsoonbegantoappealtocertainstatesasadevicetohelpbringaboutmarket-basedreform,effectivelyusingtheeffectsofthefinancialcrisisasapretexttolessentraditionalrelianceonbankintermediation.Throughouttheperiod,mercialandofficialinterestssoughttopromotesecuritizationtousers,orinducedlegalorregulatoryreformsandinsomecasesprovidedincentivestousers,especiallyinhousingfinance.10 Theresultsarenowseenmostclearlyinthebreadthpletedtransactions,whichhaveincludedriskinmostEastAsianjurisdictionsandbothcross-borderdealsinmajorcurrenciesanddomesticlocalcurrencytransactions,whetherornotavailabletoforeigninvestors.YetsecuritizationremainslargelyunderutilizedbyinstitutionalinvestorsinAsiaasitisoftencostlytoexecute,andhasyettodeliverwide-rangingresultsintermsofsystemicreformsortransactionvolumespredictedbyitsadvocates.
A.Concepts Securitizationrepresentsanimportantformofcreditrisktransfer.11Itmaybedeployedasanestablishedmeanstoobtainfundingataneptablecost,assistinportfolioriskmanagement,ortomeetinvestorpreferences.12Separately,financialsectorlawsandregulations,including,sincetheearly-1990s,manyrelatedtoountingortaxation,havetriggeredveryconsiderablegrowthintransactionsforbanksandotherfinancialsectorusers,largelytotheneglectofmoretraditionaleconomicdrivers.Thisstudysuggestshowthatemphasismaychangeinresponsetotheperformanceofstructuredfinancemarketsin2007.Whereregulationsprovideincentivesforfinancialintermediariestousesecuritizedstructures,theprocessconstitutestransactionalregulatoryarbitrage,whetherseenasefficientcapitalmanagementortakenasevasionoravoidancethroughthecircumventionofrulesbycontractualmeans. Onemercialconceptofsecuritizationistoseparatefuturecashflowsfromtheiroriginatorandusethosecashflowstogeneratenewfundingresources.Inadditiontopoolingrisk,wholebusinessesmaysecuritizedistinctpartsofmercialactivities—forexampletoimprovecreditratingsbyreducingconsolidatedleverageortoreduceexternalfinancingcosts.Theresultmaybetoincreaseliquidityforcertainfixedassetsorbusinessstreams,withbroaderresultsintermsofounting,costs,andcreditstanding.13 Securitizationcanthereforebeseenastheantithesisofthemoderncorporateframeworkmercialactivity.Eventhesimplestenterprisedevelopsspecializedfunctionstominimizetransactioncostsandachieveeconomiesofscale.Securitizationthusseekstomercialactivityanizationalorlocationalconcernsandplaceitwithinacontractualsetting.Itwilleedonlyifarangeofbothfundamentalandmoresophisticatedinstitutionsareinplace,includingreliablepropertyrights,andthemeansfortheireffectiveperformanceandenforceabletransfer.14 10SeeSection2.11Creditrisktransferisameansbywhichcreditriskmaybeacquiredorshedtoaltertherisk-returnprofileofaportfoliooffinancial claims.Itisusedbyborrowers,intermediariesorend-investors,andmayormaynotbefunded.Buyingorsellingloansorsecuritiesisasimpleformoffundedcreditrisktransfer;examplesofunfundedcreditrisktransferincludethesaleorpurchaseofcreditprotectionthroughinsuranceorcreditdefaultswaps(CDS).Wholebusinesssecuritizationsrepresentatransferofcreditriskfromcorporateshareholders.12Foradiscussionoftheadvantagesandchallengesinvolvedinemergingmarketsecuritization,seeArner(2002).13ThemercialinterpretationofsecuritizationisexemplifiedbySchwarcz(2002).WholebusinesssecuritizationshavepletedinAsiaonlyinthenon-residentialpropertysector.14Arner(2007)discussesmorefullytheinstitutionalstructuresnecessarytosupportsimplecashsecuritization.
5 Securitizationalsorepresentsaformoffinancialintermediationoutsidetheconfinesofanizationsandisthusconcernedwithensuringthatcontractspleted.15Properlypracticed,itdispenseswiththeaggregationofclaimswithinanysingleintermediaryandisdesignedtoexpresslyavoidarangeofinherentmismatcheshistoricallyassociatedwithlendingbytheseintermediaries.16Formanyfinancialintermediaries,securitizationmerciallendingintoitsconstituentparts,similartothewaythatindustrialgroupsusewholebusinessorsegmentalsecuritization. Traditionalbankcreditintermediationentailsthreemajortransformationsofduration,creditrisk,andvalue,aswellassecondaryeffectspromptedbyriskmanagementdecisionsthatseektooffsetthoseprimarymismatches. First,anintermediarymustmanagefundingandreinvestmentriskassociatedrespectivelywiththewithdrawalofadepositpriortorepaymentoftheloanthatithelpsfund,andtheunexpectedearlyrepaymentofaloanforwhichadepositoflongerdurationhasbeencontracted.17Theintermediarycanmitigatetheriskbychargingpenalties,orseekingtomaintainandmatchbroadportfoliosofassetsandliabilities.Securitizationisanalternativemeanstoaddressthebank’sprocessofdurationtransformation.18However,securitizationitselfreliesupontransformationalassumptionsunlesseachclaimthatitgenerateshasanoptimalcontractualmatch.19 Second,thepositionsofmercialbankintermediarieswilloftenbefarmorediversethantheirloanportfolios,ignoringgeographicalconcentrationsofindividualmercialdepositorssubjecttosharedeconomicconditions.Theresultmaybethatexternalshockshaveadisproportionateimpactononesideoftheintermediary’sbalancesheet. Third,unlessanintermediaryeswhollyinsolvent,itwillexpecttorepaymostdepositliabilitiesattheirnominal(par)valuebutmaynotalwaysrecoverthefullamountofanysingleloanifaborrowerdefaults.Thistransformationisasymmetric,andmaybegivenadefiniteandpreciseformingeneralexpectationsbymandatorydepositinsuranceschemes. Securitizationrepresentsonesolutiontothesethreeelementalmismatches.Securitizedtransactionsmaybedesignedtomaintainsuchmismatches,forexample,toseekprofitsfromdurationmismatchesandyieldcurveplays,butunlikebanks,theyneednotdoso.20Transformationsofthekindidentifiedherehavebeencitedas“corecharacteristicsofbanking,”whichtogetherwithlevelsofleveragethattypicallyexceedmercialsectorsmake 15Throughoutthisstudy,“institution”meansalaw,ruleorestablishedpractice;“intermediaries”anizationsconcernedwithfinancialtransactions,includingcreditcreationandlending.Theterm“financialinstitution”ispartial,inwronglysuggestingstability,trustworthiness,orrisk-aversebehavior. 16SeeArner(2007)foradiscussionoftraditionalrisksandresponsesthereto.17Unforeseenunavailabilityofretailorwholesaledepositsismoncatalystinmodernbankdistress,includingthemid-2007 liquiditycrisisexperiencedbyaBritishhomemortgagelender,NorthernRockplc.18Theriskmanagementofdurationtransformationbetweenassetsandliabilitiesisoftenmischaracterizedas“borrowingshortand lendinglong”(Buiter,2007)butisonlyoneexampleofsuchpractice.Formanyyears,bankshavesoughtcontractuallytomitigatetheriskofthewithdrawalofshort-termdeposits,forexamplewithdemandor“call”loansthatepayableuponnotice,orwithprovisionspensationforincreasedinterestcosts.19Bycontrast,the2007securitizationmarketdislocationislargelyassociatedwiththewithdrawaloffundingfromholdersofsecuritizedrisks,seeSection4.20ThismechanismmakessecuritizedtransactionsasolutiontotheproblemofpermanentequilibriumcreditrationingidentifiedbyStiglitzandWeiss(1981),wherebybanksfailtolendtoallwillingandeptableborrowersduetoincentivefactorsassociatedwithasymmetricinformation.Hill(1996)arguesfurtherthatasasourceofexternalfunding,securitizationreducesthetransactioncostpremiumdemandedbyriskaverselenderswhenconfrontedwithsuchproblems,theunwanted“lemons”issuedescribedbyAkerlof(1970),butfailstoshowthatthecontractualsolutionofsecuritizationpleteinwelfareterms.
6 banks“susceptibletorunsandpanics”and“inherentlyunstable.”21Giventhatthesefactorsarealsoinherentinbankingactivityratherthanresponsestotheregulationofcapital,liquidityordisclosure,thisistakenasjustificationtoregulatebanks.22However,itislessclearthatthisisasufficientexplanation,sinceothersolutionscanalsobeusedtoaddresssuch“instability”. Forthisreason,themechanicsandenablinginstitutionsofsecuritizationrequirehighreliabilityandintegrity.ItmaybethatbadlywrittenorunrealisticcontractshaveimpededgrowthinAsiansecuritizedmarkets.Morebroadly,thecollapseininvestorconfidencein2007intensifiedconcernsastothepletenessofoutstandingstructuredfinancedeals,especiallyinthesubprimesegmentofUSandUKRMBSissues. TheanalysisinAppendix1suggeststhatsecuritizationusevariesaseconomiesdevelopandfinancialmarketsemoresophisticated.Notalladvancedeconomiesareprolificusersofstructuredtransactions.However,itwouldbeuncharacteristicforeconomieswitheffectiveandefficientfinancialsystemsnottosupportsecuritization.Atthesametime,latersectionswillshowthatinstitutionalintegrityasthebasisforreliableandenforceablecontractsisindeedaprerequisite.
B.Definitions “Cash”securitizationistheirrevocabletransferofdefinedfinancialassetsbytheiroriginator,fundedbythesimultaneoussaletothird-partyinvestorsofnewsecuritiesissuedbytheassetbuyer.Neitherassetbuyernorinvestorhastransactionalrecoursetotheoriginator.Othercontinuingaspectsofthelendingprocesswillalsobereplacedbyanarrayofcontractswithadministrativeagents. Bycontrast,“synthetic”securitizationinvolvessimpleplexformsofcollateralizeddebtobligations(CDOs)thatwhollyorpartlyreplicatethecreditrisktransferinvolvedincashtransactions,butwithnooutrightfundedtransferofclaims.ThegenericstructuresofeachtransactionaredescribedmorefullyinAppendix2. Coveredbondssharesomefeaturesofsecuritization,andcanplishcertain—butnotall—ofitsobjectives.ThetransactionmodelisexplainedinAppendix3.SuchstructureshavelongbeenusedinDenmarkandGermany,andhavegrownincreasinglypopularelsewhereinEuropesincethemid-1990s.Conventionalcoveredbondscreateasecurityinterestforinvestorsinclaimsheldbyanintermediary.Thuscoveredbondholdersobtainpreferentialrightsoverpoolsofclaimsthatremainfundedassetsonthebalancesheetoftheoriginatingintermediaryoritssubsidiary.Thoseassetsaresaidto“cover”theinvestor’sclaimasdedicatedcollateralwithoutanirrevocabletransfer.Coveredbondshavetraditionallybeenissuedprimarilyforfundingreasons,butarealsoseeninlocationalandtransactionalregulatoryarbitrage,forexampletoimprovethepost-taxreturnsfromaspecifiedlendingactivityormanageregulatorycapitalneeds.23 “Structured”coveredbondsareavariantonthegenericformthatrepresentsacontractualsolutionforissuersdomiciledinjurisdictionslackingenablingcoveredbondlegislation.These 21Macey(2006),page4.22Ibid.,page4–
7.Thepropositionismoreconvincingifitassumesthatbankinstabilityinducesfinancialsectorcontagion,see Kaufman(1994).SeeArner(2007)forafulleranalysisofmechanismstoaddresssystemicinstability.23Germanpublicsectormonlyuseoffshorevehiclesascoveredbondissuers.
7 bondsofferarelativelyreturntoinvestorssensitivetorisk-assetweightingsandthusraisetheissuer’scosts. Conventionalcoveredbondsgenerallyinvolvelessintensivestructuringorcreditparedwithsecuritizedissues.Thisoftenwillleadtofundingcostadvantagesfortheuser.Thecoveredbondholderhasrecoursetotheoriginator,anddesignatedpoolassets“cover”thenewtransactionascollateral,withoutanirrevocabletransfertoanindependentthirdparty.Coveredbondshavehistoricallyrequirednationalenablinglaws,notonlybecauseofgeneralcivillawpractice(thestructureismonlyusedincivillawjurisdictions),but(inEuropewherethepreponderanceoftransactionshaveurredtodate)duetoEuropeanUnioninvestmentandbankingdirectivesandtheirimpactoninvestorpreferences.
C.TransactionMechanics Mostmodernsecuritizedtransactionsusepooledassetsoretocreatesecuritiesbinationsofcreditratings,yieldanddurationthatareeptabletodifferentclassesofinvestor.Thishasadvantagesfortheoriginatorinthatitmayallowforthesaleofless-viablerisk—forexamplewithseverelyimpairedassetsorrisksubjecttolegalorothercontingencies.However,thefeasibilityofanyplextransactiondependsonapronouncedbiasintheuseofpoolproceedstoservicethehighestrankingclaims,requiringlowerprioritytranchestobedeeplysubordinatedandthuseptabletoonlythemostrisk-preferringinvestor,ifany. Instressedconditionsthesetranchesarelikelytoremainunsoldorretainedasclaimsbythepooloriginator.Regulatorsmaybeconcernedthat,asaresult,theoriginatorholdsapooreroverallriskportfoliothanpriortotheexecutionofthetransaction.Investmentconduitsandstructuredinvestmentvehicles(SIV)havemonplexsolutionstotheregulatoryandountingproblemsassociatedwithplacingtheselowestranking“equity”tranches.24BaselIIintroducesapenalcapitaltreatmentofsuchclaimswhenretainedbyoriginators. Withconventionalcashsecuritization,theassetbuyerisaspecialpurposevehicle(SPV)intheformofasinglepanyortrust,dependingonlegalpracticeinthejurisdictionofthedomicileoftheassets.Securitiesaretypicallyissuedintiersortranches,knownaspayment“waterfalls,”thatcarrymercialtermsandriskssoastoextractthemaximumvaluefromthepoolassetsovertime. Allbutthesimplesttransactionsemployinternalandexternalcreditenhancementtoimproveorstabilizetheriskofanytranche.Internalenhancementusuallytakestheformofportfoliopooldesign,over-collateralizationorthecreationofaliquidityreserve.Cashcollateralorthird-partyinsurancepoliciesorfinancialguaranteesmonexternalsupportingsourcesofvalue.Suchguarantees(or“wraps”)areprovidedbyspecialist“monoline”insurers,whichfirst 24Forsolutionsthatmayfallintopartialdisusefollowingthe2007marketdisruptions,seeSection4below.ConduitsandSIVsaresimilarformsofinvestmentfunds,usuallymanagedorsponsoredbybanksthathavebeenprolificinvestorsinstructuredsecurities.FirstusedinLondoninthe1980sbyCitibankN.A.,theyanizedinfavorabletaxdomicilesandaimtoprofitthroughleveragedinvestmentorproactiveassetliabilitymanagement.Bankshaveusedthesevehiclestoavoidconsolidatingriskassetsortolessentheiroverallneedforregulatorycapital.ThemaindifferencebetweenconduitsandSIVsistheextentofcreditsupportprovidedbythesponsoringbank.Conduitsarefundedbyissuingshort-termmercialpaper(ABCP)andrequirecontingentcreditlinesforthefullamountoftheirliabilities.SIVstendtobeonlymodestlysupportedwithsuchcreditlines.
8 emergedintheearly1970sintheUSmunicipalbondmarketandhavesinceeapowerfulfacilitatinginstitutioninmanystructuredandprojectfinancetransactions.25
D.Tranching Themostimportantaspectofcashandsyntheticsecuritizedtransactionformationarisesfromtranching—paymentprioritiesestablishedtocreateseparatesecuritiesissueswithdistinctriskreturnfeatures.Thisseekstosetpaymentrulesthatgenerateanoptimaluseofbothinvestordemandandthetimevalueofanassetpool.parativelysimpletransactionsrequireextensivemodelingofpoolperformance,whichdemandsadequatedata,anunderstandingofthenationalpaymentanddefaultexperienceofsectoralrisksofthesametypeasthepool,andresourcestoforecastandstress-testpleteasetofesasfeasible.Synthetictransactionsinvolvemodelingthatisidenticalinconceptbutstillplex.Inallcases,thisfunctionhasbeenpassedtocreditratingagencies,increasinglywiththesanctionofnationalregulators.26 Investorpreferencesprovidethestartingobjectiveinpricingandstructuring,withoriginatorsandtransactionarrangersseekingtoextractthegreatestvaluefromtheresourcesavailable.Suchmanipulationiscentraltoallsecuritizedissuesandpartlyexplainstheirplexityandexpense.Structuringthetransactionsetorequireactiveparticipationbycreditratingagencies,whichmodelthewaterfalltreatmentofpaymentsundermanysetsofconditions,andsettermsforindividualtranchestobegiventargetcreditratings.Thislevelofinvolvementismarkedlydifferentmercialratingagencies’practiceswithnon-structuredcorporateorstatebondsissuesandisincreasinglyquestionedasaconflictofinterest.27 Tranchingalsoexplainsthepotentialforsecuritizationtoassistingeneralfinancialmarkettransparencyanddevelopment.Thisismostapparentintheuseofsecuritizationtoassistintherecyclingofnonperformingloans(NPLs),whereamarket-determinedyieldeptabletotheultimateinvestorprovidesatransparentmechanismtovalueapoolofimpairedassetswherenoneotherwiseexisted. Bothlegalandempiricalanalyseshaveseentranchingasameanstoextractadvantagefromsegmentinginvestors.Institutionalanalysiswouldseetranchingascreatingpaymentprioritiesthatinturnallowahighinvestment-gradecreditratingtobegiventoaslargeaspossibleaportionofanysingletransaction.Thestrictcontractualpriorityestablishedbyapaymentwaterfallseekstoeliminatethechancethatacreditorofeitherthepoolorthepooloriginatorwouldchallengepaymentstoaholderofnotes.Italsoservestoavoidpaymentdelaysintheeventofbankruptcyorreceivership. 25Monolineinsurersprovideonlyfinancialguaranteesbutmostareassociatedwithgeneralinsurersorsubstantialconglomerates.AsianSecuritizationandInfrastructureAssurancePteLimited(ASIALimited)wasanAsianregionally-orientedmonolineinsurerestablishedin1996byADBandmercialinterests,lateringdormantduetolossesincurredintheAsianfinancialcrisis,seeLejot,Arner,andPretorius(2006),page284–285. 26ThelimitationsofthisinvolvementwerecautiouslyvoicedbytheBISCommitteeontheGlobalFinancialSystem(2005),whichnotedatpage11thatTranchingcreatesalayerofplexitybeyondthatofestimatingthelossdistributionofthecollateralpool.Itrequiresdetailed,deal-specificdocumentation[…]toensurethattheintendedcharacteristics[…]areactuallydeliveredunderallplausiblescenarios.Thisimpliesintensetransactionalinteractionbetweenarrangerandratingagencythathasnowecontroversial,seeSection4. 27Suchaconflictisdisputedbyratingagencies,seeforexampleBellandRose(2007),butnowwidelybelievedtobeaconcern,especiallyinthecontextofthequasi-regulatoryfunctionordedtoratingagenciesunderBaselII,seePrada(2007),andSection4below.
9 Experiencesuggeststhattranchingtakesadvantageofinvestors’varyingrisk-returnpreferences,relyingalsoupontheneedofalmostallinstitutionalinvestorsinstructuredtransactionsfortheirholdingstobegivencreditratings.28Tranchinghelpsmeettheminimumcriteriaoftheratingagencies,andhenceminimizesthevalueofpaymentstobedeliveredtoinvestorsataparticularcreditratinglevelinrelationtothepredictedpresentvalueofthetotalpool.Thisappearsinconsistentwithbothtraditionaltheoriesofbankintermediation,andthesuggestionthatsecuritizationrepresentsaCoasiansolution29tothemismatchesinherentinsimpleformsoflendingwithinaconventionalintermediary.
E.Usage Securitizationuseiswidespreadbothgeographicallyandbyindustryriskclassification,butnotubiquitousoutsideofmostdevelopedfinancialmarkets.mercialandfinancialbenefits(inadditiontothepotentialstabilitybenefitsdiscussedabove)emanifestinoneormoreoffiveways: (i)Ameanstomakeeptableriskssatisfactorytoaninvestor,assumingthateachpotentialinvestorhasknownrisk-returnobjectives. (ii)Providingacreditratinghigherthanitsrespectivesovereignceilingorthatoftheoriginator.Thismaybeespeciallyattractiveinthecontextofinfrastructurefinancing. (iii)Themeanstopricepoolsofassetsthataredifficulttovalue,usuallytomaketheirsalefeasible.ThisappliesparticularlytoNPLsandotherimpairedfinancialclaims. (iv)Amethodtocreatecapitalmarketfundingwherenonepreviouslyexisted. (v)Forassetoriginators,afundingsourcewherenonewasavailableataneptablecost,especiallywhenlendingessubjecttoquantitativeregulatoryconstraints. Theseapplicationsallrepresenttoolstoassistinbalancesheetmanagement.Formodernfinancialsectorusers,securitizationhasemostcruciallyamechanismforcreditrisktransferandregulatorycapitalmanagement,asSection4ofthisstudyshows.Creditrisktransferneedstobeassessedinboththesenseofallowinguserstomanageassetorliabilityportfolios,andmoregenerallyasclaimsmoveintoandoutoftheregulatedbankingsectorandacrossborders.30Itmayachieveotherobjectivesforcertainusersorinparticularphasesofinterestrateorcreditcycles,andmayhavedevelopmentalorincentivefeaturesforbothoriginatorsandinvestorsorforgeneraleconomicwelfare. Thusitismonforregulatorstoconsidertheconsequencesofenhancedrisktransferforthedispersalofriskwithinandbetweendomesticfinancialsystems.Thishasseveraldimensions,someofwhichmaybebeneficialforefficiencyandfinancialstability,suchaslesseningconcentrationsofgeographicalorsectoralrisk,andincludestransfersofcreditriskto 28Firla-CuchraandJenkinson(2005),who“alsofindsomesupportformorenuancedmodelingpredictionssuchasthepositiveimpactoftheaveragequalityofassetsontranching”,ibid,page32. 29Coasiantheory,associatedwitheconomistRonaldCoase,describestheefficiencyofaneconomicallocationoreinthepresenceofexternalities.Iftradeinanexternalityisfeasibleandtherearenotransactioncosts,thenbargainingwillleadtoanefficienteregardlessoftheinitialallocationofpropertyrights. 30SeeBaselCommitteeonBankingSupervision(2005)andSection4below. 10 lightly-regulatednonbankintermediariesornon-capital-regulatedendinvestors.Theincreasingvelocityofrisktransferoverthepastdecadepresentsfirstorderinformationproblemswhenbanktransferorsarepoorlyregulatedorpliancestandardsareuncertain.Thiswasclearinthe1997/98Asianfinancialcrisisandinthe2007subprimecreditcrisis,especiallywherenonbankintermediarieswereactiveincorporatelendingandconsumercreditcreation. Furthermore,securitizationmayenablefundingorrefinancingbyfinancialintermediaries,oftenthroughofficialhousingfinanceagencies.Thismayincludetheentryofmercialpartiesintoestablishedfinancingsectorssuchasresidentialmortgagefinanceorconsumercredit,withconsequencesforoverallefficiencyanduseofcapital.31 Securitizationcanbeappliedtoalldefinedcreditrisks,includingdelinquentassetsorclaims,buteveninsophisticatedmarketsisforreasonsofcostandtransactionexpensetypicallyassociatedwithrisksinvolvingsimilar,unconnected,predictablecashflows.monlyusedincashsecuritizationincluderesidentialmercialmortgageloans,creditandcreditcardreceivables,vehicleorfleetloans,certaincashreceivables,airticketsales,taxesonrevenue,transportorothertolls,licensingfees,foreignworkerremittances,andmusicroyalties.AlmostalloftheseriskshavebeenusedintransactionsinEastAsiaduringthelastdecade.Dissimilarclaimshavebeenessfullysecuritizedincertainhighlydevelopedmarkets,usuallyusingsyntheticstructures,32butthereareexamplesintheJapan,UK,US,andelsewhereofhighlyvisiblesecuritizedtransactionsinvolvinglargediversepoolsofcorporateloans.33 Thetechniquehasbeenappliedinadvancedeconomiestowholebusinesses,discretebusinessstreams,andmorewidelytosinglemercialproperties.CommercialpropertytransactionsmayeapotentialsourceofnewtransactionsinEastAsiaduetotheimportanceofthesectorinbanklending,especiallyifsingle-ormultiple-assetrealestateinvestmenttrusts(REITs)growmorepopular.34EastAsianREITsandtheirsupportinglegislationorregulatorycodestendtofavorsecuritizationstructurestoagreaterextentthanintheUS,whereREITsfirstappeared.TheuseofpooledNPLsisparativelynew,notablyinGermanyandothermajorcivillawjurisdictions. Inallcases,securitizationrepresentsplexmeanstoachievethesimpleobjectiveofmakingavailablewell-definedriskstosinglehomogeneousclassesofinvestors.Assuch,the 31ToagreaterdegreethaninEastAsia,theintroductionofABSandRMBSintheUSarosefrombankingandsecuritieslawsthatgaveanincentivetoinvestmentbankstocreateandsecuritizeriskshistoricallyfundedmercialbanks.SeealsoWarnockandWarnock(2007). 32Baseduponbasketorindexcreditdefaultswaps.33A1996collateralizedloanobligation(CLO)transactionforUK-basedNatWestBankwasthefirstsignificantpublicissuebased onsizeablecorporatebankloans,seeInternationalFinancingReview(1996a,1996b),whereanewSPVparticipatedinreceiptsfrom$5billionofthebank’sloansandmitments,alltomaximizeitsefficientuseofregulatorycapital.ThisstructurehasbeensupersededbyCLOsinvolvingoutrightsalesofclaims,andbysyntheticandactively-managedCLOs.Regulatorychangescontinuetoalterthecostparametersoftransactionswithsimilaraims,butitisnotablethatnosimilarissuehasbeenmadebylendersinAsiaoutsideJapan.Asmallnumberofsecuritizationsofleasereceivablesandbankloanstosmallandmedium-scaleenterprises(SME)havepletedforbanksinJapan,andsince2005insingledealsinMalaysia;Singapore;andTaipei,China,apparentlywithofficialencouragement.Thesearemonduetotechnicalchallengespetingbanksectorliquidity,butasrefundingsourcesaresimilartotransactionsintendedtosupportmicrofinanceandagriculturalcredit,seeSection5.34REITsarecollectiveinvestmentschemesthatbecameattractivefundingtoolsforpropertydevelopersinJapan;Singapore;andHongKong,China(indecliningscaleofuse)duringphasesofweakpropertyprices.TheyalsoexistonamodestscaleinKorea,Malaysia,andThailand.Tooriginators,REITscanresembleformalwholebusinesssecuritizations,althoughmorelooselyframed“captive”REITsalloworiginatorstoparticipateingainsderivedfromtrustassets.Singapore’sBusinessTrustsAct2004permitssimilarschemesinvolvingmostformsofnon-propertyrisks.BothSingaporeandHongKong,ChinanowallowREITstoownforeignassets. 11 techniquehasbeenknowntobeplex,manifestedinhighmarginaltransactionexpensesanddevelopmentperiodsforsingle“one-off”transactionsthatcanbeprotracted,especiallywhentheprevailinglawhindersratherthanhelps.35TheseobstacleshaveyettobeefficientlyremovedorcircumventedinEastAsia.Moregenerally,securitizationexpensesaretypicallyhigh,evenifmarginaltransactingcostsarereducedasaresultofdealfrequency,orsupportivelegislativeorregulatorychange.Thiscanbeseenclearlyinexpensesassociatedwithdatacollectionandverification,dealdevelopment,modeling,ratingagencynegotiation,marketing,andcontractualexecution. III.DevelopmentinEastAsia CommercialinterestshavelongarguedthatstructuredfinancehasconsiderablepotentialinAsianfinance,anditsusehasbeeneptedashavingbeenavaluablestrategictoolintherestructuringoffinancialsectorclaimsinKoreaafter2000.Yettheregion’smodestoveralluseofsecuritizationpromptsthequestionastowhetherthisaspectoffinancialdevelopmentlagsotherregionsasafunctionoftime,nationalinstitutionalconditions,orastheresultofcertaineconomicconditionssuchasnationalsavingsandinvestmentimbalancesorrelativelyhighprivatesectorliquidity.ConservativelevelsofbankleveragehavelimitedthesupplyofloansforcashsecuritizationeveninJapan—wheremarketsinstructuredsecuritieshavedevelopedessfully. InthesenseoftenassociatedwithstructuredfinanceinEastAsia,thefavorableviewofitsbeingencouragedfordevelopmentistypifiedbyBankforInternationalSettlements(BIS)analysis: Structuredfinancecanhaveapositiveinfluenceonthefinancialsystembecauseitcantransformordinarilyilliquidorriskyassetsintomoreliquidorlessriskyones.Itthusoffersanalternativesourceoflong-termfundinginbothdomesticandcross-bordermarkets,andcanfosterthedevelopmentofdomesticbondmarkets.Inturn,thiscouldpromotegreaterbankandfinancialmarketefficiency,asitimpliespetitiontomeetcustomerfinancingneeds.36 Whileacknowledgingthatproponentsofsecuritizationneedtobecautionedastoitsrisks,37itisnotablethatareviewpublishedinmid-2007duringtheglobalstructuredfinancemarkets’mostseveredislocationtodateisconstructiveandconformswithaseminalpositiveBISviewofcreditrisktransfer.38 SecuritizationactivityincreasedmarkedlyinpartsofAsiaafter2000—notablyinHongKong,China;Japan;Korea;andMalaysia—ineachcasewithhousingloansusedasrawmaterial,andinSingaporethroughtransactionssupportedmercialproperty.Critically,securitizationbecameastrikinglyvaluabletoolforKoreaaspartofextensivecorporateandfinancialsectorpost-crisisrestructuring,whennewlegislationallowedlargevolumesofNPLsandotherimpairedfinancialclaimstobeemployedascollateralfornewCDOs,aprocessofrecycling 35EarlycashandsyntheticCLOstookmanymonthstoprepareandexecute,despiteoriginatinginsophisticatedjurisdictions.36ScatignaandTover(2007),page71,emphasisadded.37Id.,pages81–82.38BaselCommitteeonBankingSupervision(2005). 12 defaultedclaimsinstrumentalintherecuperationofthewiderKoreaneconomy.39Atthesametime,pletedsecuritizationvolumesinthePRC,Indonesia,Philippines,andThailandremainverylimited.SecuritizationmaybeundevelopedorpoorlyusedinEastAsiapartlybecausefactionalinterestsfav
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