STS Criterion 32. Credit protection premiums

Description

Credit protection premiums

Content

The credit protection premiums paid under the credit protection agreement establishing the synthetic securitisation should be structured as contingent premiums: no guaranteed premiums, upfront premium payments, rebate mechanisms or other mechanisms that may avoid or reduce the actual allocation of losses to the investors or return part of the paid premiums to the originator after the maturity of the transaction, should be stipulated in the credit protection agreement.

The documentation should contain all relevant information that has been used to price the credit protection agreement, including, as applicable, information on the market benchmarks and other market variables taken into account, by the originator, for the pricing.

Rationale

For the sake of simplicity of the transaction and effectiveness of the risk transfer, the credit protection premiums should be contingent i.e. the actual amount of premium paid should be a function of the size and the credit risk of the protected tranche. Contingent premiums may be structured as a fixed percentage of the residual outstanding balance of the protected tranche at each payment date, hence reflecting tranche amortisation and tranche write-downs due to incurred losses.

Non-contingent premiums should not be allowed in synthetic STS securitisations i.e. when the actual amount of premium paid is not a function of the outstanding size and credit risk of the protected tranche. Non-contingent premiums may take the form of guaranteed premiums.

The timing of the premium payments may also vary across transactions. In some transactions protection premiums are paid up front, in contrast with the most widespread market practice according to which protection premiums are paid in accordance with a regular schedule. Transactions may also be structured to include protection premium rebate mechanisms, whereby if at the maturity of the protection period the aggregate premium paid by the protection buyer exceeds losses suffered on the reference portfolio, the excess would be returned to the originator. In order to ensure that synthetic STS securitisations are simple and that the risk assessment of such securitisations is not overly complex, these premium structures should not be allowed.