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TYI, LLC

A consulting and technology firm focused on filling the information gaps created by financial innovation

GLOBAL REGULATORS, ISSUERS, INVESTORS AND OTHER FINANCIAL MARKET PARTICIPANTS RELY ON TYI'S EXPERTISE IN FINANCE, RISK MANAGEMENT AND TECHNOLOGY FOR TRANSPARENCY BASED SOLUTIONS.

A frequent outcome of financial innovation is that information gaps appear. Good data in the form of more timely, accurate information resides with one party and is unavailable to other market participants. This information asymmetry causes two major problems.

First, as described by Joseph Stiglitz in his Nobel Prize winning work, this information asymmetry leads to both financial markets malfunctioning by freezing up and a loss of trust. For example, the lack of good data interferes with the ability of investors to do their homework on structured finance securities. Without good data, it is impossible for investors to know what they own. Without good data, no matter how sophisticated their analytic and pricing tools are, investors can't accurately value the securities. This valuation is the starting point for making portfolio management decisions because this valuation compared with the prices shown by Wall Street to make buy, hold and sell decisions. When it became apparent in 2007 how much of an informational advantage Wall Street had, investors stopped buying and selling structured finance securities. The low cost way to unfreeze this market and restore trust is to provide investors with good data.
Second, without good data, regulators are effectively stymied in their efforts to monitor and mitigate developing systemic risks. The basic builiding block of systemic risk regulation is the individual position. The total risk of a portfolio, a financial institution or a market is the sum of the individual positions. Without good data, it is impossible for regulators to implement best risk management practices and monitor every position every day to identify developing risks within financial institutions or markets. Without good data, regulators have to deal with issues like Too Big To Fail because regulators don't have the information necessary to understand the degree of risk and the impact of failure.

For over a decade, TYI has been a leader in developing low cost solutions to fill these information gaps so that good data is made available to all market participants. TYI's earliest work has been patented.

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Currently, global regulators and the U.S. House and Senate are working on reforms to the financial system. Included in these reforms are plans for filling the information gaps that were thought to have contributed the most to the credit crisis. The plans call for providing transparency into structured finance securities.

How will the information gap in structured finance be filled? ASF, through Project Restart, and AFME have already conceded that standardized loan level performance data must be made available. The only questions left to be answered are how frequently will this data be updated and when will Issuers be required to start providing this data.

There are three reasons to believe that the data will have to be updated as frequently as there is an observable event, like a payment, involving the underlying collateral.

First, it must comply with the SEC's founding principle that Investors be provided with all the material information they need to make an informed investment decision. For structured finance and covered bond securities, there are two sources of material information: cash collections and changes to the underlying collateral. Since cash collections on any day can easily exceed the rule of thumb level for materiality of 5% of the total collections for the month, it is material to Investors that this information be released on the day the cash is collected. Hence, the materiality principle should drive a disclosure requirement of at least as frequently as there is an observable event involving the underlying collateral.
Second, it is best practice when managing a loan portfolio to monitor observable activity on a daily basis. In an October 2009 Financial Times column, Lloyd Blankfein of Goldman Sachs laid out best risk management practice as monitoring every position every day.
Third, on May 6^th, 2009 the European Parliament passed an amendment to the Capital Requirements Directive (CRD) saying that Investors must know what they own at all times. The frequency with which loan level performance data must be updated wasn’t specified in the CRD. However, the CRD strongly suggests that Investors need to have updated loan level performance data whenever there is an observable event involving the underlying collateral. The European Parliament specifically elected not to codify existing once per month or less frequent disclosure practices.

Which leaves us with the question of when will Issuers start providing activity based reporting data. There are two possible dates.

First, under the European Capital Requirements Directive, Issuers need to comply by 12/31/2010 (the Y2K for European structured finance).
Second, another date selected by regulators, like the SEC who is revising Regulation AB or the FDIC who is revising the safe harbor rules or the European Central Bank and the Bank of England who are preparing to issue their own disclosure requirements for structured finance securities that will be eligible to be pledge to them.

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Comments: CEBS Consultative Paper on European Capital Requirements Article 122a

BOE Consultative Paper on Information Transparency for Asset-Backed Securitisations

FDIC Safe Harbor Proposal

FDIC Safe Harbor Proposal: Observable Event-based Reporting for Structured Finance

ECB Provision of ABS Loan-Level Information in the Eurosystem Collateral Framework

Background speeches, articles, interviews and papers on TYI:

Institutional Risk Analytics: Covered Bonds and the Reform of Structured Finance

Fortune.com: How Goldman Exploited the Information Gap

The Brown Paper Bag Challenge: Response to backers of once-per-month or less frequent reporting

Fortune Magazine: 6 simple steps to really fix Wall Street

New York Times: Fair Game - Loan Pools That Need Some Sun