Synthetic versus Traditional Securitisation

Synthetic versus Traditional Securitisation

While Synthetic Securitisation and traditional (i.e. ‘true sale’) Securitisation may not fundamentally differ in terms of the nature of the underlying exposures, risk tranching and capital (waterfall) structures, there is an important difference between the ways of transferring risk from the originator to the investor

• While traditional securitisation realises this transfer by transferring the actual underlying exposures as well as their ownership to a securitisation special purpose entity (SSPE), synthetic securitisation realises the risk transfer by means of a credit protection contract between the originator and the investor, leaving the underlying exposures in the ownership of the originator and on its balance sheet
• In synthetic securitisation the actual extent of risk transfer depends not only on the capital structure of the transaction (i.e. the tranching), and on potential mechanisms of support from the originator (as it is the case in traditional securitisation), but also on the features of the credit protection contract on which the originator and investor agree, and on the Creditworthiness of the investor
• Counterparty credit risk may arise for the originator of the transaction (the protection buyer) due to the risk of default (or other events) in relation to the investor (the protection seller), resulting in the lack of credit protection. Counterparty credit risk may also arise for the investor (protection seller) due to the risk of default (or other events) in relation to the originator, resulting in missed premium/fee payments by the originator and, where applicable, the loss of collateral posted by the investor to the originator or to a third party to fund the credit protection
• An inherent aspect of the transfer of credit risk of the exposures which remain on the originator’s balance sheet is that the parties in the synthetic securitisation are ‘communicating vessels’, in contrast to traditional securitisations where due to the true sale the originator transfers both the risk and ownership of the exposures to SPV and the links between the originator and the investor are therefore less relevant
• The synthetic securitisation also tend to be easier to execute compared to traditional securitisation
• Originators may be incentivised to use the synthetic rather than traditional securitisation due to the greater flexibility of the synthetic mechanism, which is cheaper in terms of costs, and quicker to arrange
• It also allows the originator to avoid the legal and operational difficulties that can be incurred in a true sale transaction related to the transfer of ownership of the underlying exposures
• Synthetic securitisations also allow the originators to address confidentiality issues related e.g. to the obligors’ identity or commercial secrets. Compared to traditional securitisation, it is therefore also easier to mix asset classes and exposures from different jurisdictions to increase diversification and granularity of the portfolio
• From a regulatory/supervisory perspective, compared to traditional securitisation, synthetic ‘balance sheet’ securitisation exposes the investor (protection provider) to the pure credit risk of the underlying exposures. In particular, risks stemming from the cash flow profile of the securitisation, such as pre-payment risk and interest risk, are less relevant for the investor’s position

Pros	Cons
Increased transparency of the product	STS balance sheet synthetic framework has not been developed at global level (IOSCO/BCBS)
Increasing relevance of the product in the context of ongoing regulatory developments	Could be perceived as a high quality label by less sophisticated market players
Increased relevance of the product due to some advantages compared to traditional securitisation	Could lead to less issuance of traditional STS securitisations
Further standardisation of the product and opening of the market for smaller originators and investors
Importance of regulatory endorsement for the revival of the market
Potential positive impact on the financial and capital markets, financial stability and on the real economy