Know What You Own

Currently, global regulators are working on reforms to the financial system. Included in these reforms are plans for filling the information gaps created by current structured finance industry market practices.

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 two 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, on May 6^th, 2009 the European Parliament passed Article 122a to amend the Capital Requirements Directive (CRD) saying that Investors must know what they own at all times. While the frequency with which loan level performance data must be updated wasn’t specified in Article 122a, Article 122a strongly suggests that Investors need to be able to demonstrate that they have access to current loan-level performance information. The only way to achieve this is to have Issuers disclose the information 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 as being adequate for Investors demonstrating that they know what they own.

Second, as the European Central Bank, the Bank of England, the Bank of Japan and the Federal Reserve adopt quantitative easing policies, they must address the issue of how they are going to manage credit risk if they buy non-government guaranteed structured finance securities. Relying on credit ratings is not an option due to the failure of credit ratings to accurately assess the risk of structured finance securities prior to the credit crisis. As a result, to know what they own and manage their credit risk, it is expected that the central banks will only acquire structured finance securities that disclose loan level performance data whenever there is an observable event involving the underlying collateral.

Which leaves us with the question of when will Issuers start providing observable event-based reporting data. Under the European Capital Requirements Directive, Issuers will want to comply by 12/31/2010 (the Y2K for European structured finance). The Directive provides an issuer with an incentive to provide loan-level data on an observable event-based basis. Under the Directive, if the issuer does not make the data available, European financial institutions will have to hold more capital against their investment in the transaction and they will need a higher rate of return to compensate them for this additional capital. It is far less expensive for the issuer to provide the loan-level data on an observable event-based basis than it is to offer the additional yield.

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