How Synthetic Securitisations Work
Discover Synthetic Securitisations
Overview of basic structure
Unlike traditional securitisations where loans are bundled into bonds of different risk profiles and removed from the bank’s balance sheet, synthetic securitisations are differentiated by the fact that the loans remain on bank books. However, the credit risk or the risk of loans defaulting is transferred via a credit default swap agreement to a third-party investor, typically hedge funds, pension funds, asset managers and insurers. Lenders in return must pay CDS premiums in return for the credit protection, but the credit risk transfer is accompanied with the benefit of capital relief.
Source: Seer Capital
SRT Sub-Structures
Synthetic securitisation structures can be broadly distinguished into two categories, namely funded and unfunded. Funded structures involve the depositing of cash with the bank or a third-party bank account which addresses counterparty credit risk. Unfunded instruments on the other hand involve no upfront payment and are carried out between banks and insurers.
Funded synthetic securitisations can be broken down into further sub-structures such as bilateral guarantees, SPV and direct CLN formats. Under a bilateral guarantee, the bank enters a credit default swap directly with the investor who fully collateralizes the CDS unless they are an insurer. SPV structures involve the issuance of CLNs via SPVs before placing cash on deposit with the issuing bank. Finally, direct CLN structures are CLNs issued off the bank’s balance sheet.
According to IACPM, structuring practices differ between the two main jurisdictions of the market which is Europe and North America. The latter is explained by differences in maturity of the practice, securitization regulatory standards and the depth of capital markets.
