The far-reaching effects of the U.S. subprime crisis have brought into focus the efficacy of information flows in the securitization industry - and found them wanting. The chickens came home to roost when the shock waves of an essentially U.S. home loans problem were widely felt in Europe and beyond. The trend has been toward ever more complex products backed by opaque and fluctuating asset pools leading to increased reliance on the ratings of credit rating agencies rather than on an investor's own analysis.
Institutions, and particularly banking institutions and their regulators, suddenly found a need to delve more deeply into the exposures they held on their books. They will have found that in the cases of many types of investment this is not actually that easy, hence the increased reliance on credit ratings. The difficulty is that credit ratings only look at a narrow range of the factors a prudent investor will look at in assessing an investment and the ratings themselves are a crude range of pigeon-holes into which to put a raft of different types of investment. One triple-A rated investment may be very different from another in all sorts of ways. Disclosure is the key to valuation and valuation is the key to understanding exposure. This should have been obvious, but it appears it was not. The pleas from various quarters that they did not know they had sub-prime exposure shows that.
So, how is the transparency issue being addressed? This issue is not new - it has been around for as long as the asset-backed markets have existed.
The asset-backed markets, however, are different from the vanilla securities markets on which traditional disclosure regimes are based. Traditional regimes require disclosure in an offering document of such information as to the issuer, its assets and business as may be material to an investor's decision to invest in the securities. In addition, in relation to listed securities, there is usually a continuing obligation throughout the life of those securities to disclose all inside information (i.e. non-public information relating to an issuer and its business which would be likely to have an effect on the price of its listed securities). These are thorny but, on the whole, relatively simple concepts in relation to the traditional corporate issuer which is engaged in industry in the real world. The trouble is that, as a legal matter, theissuer" on an ABS transaction is simply alook-through" special purpose vehicle. It is there purely for the purpose of issuing the ABS and holding the assets backing them. It is not a trading company with a business in the real world which can be assessed. It is often not required to publish even the most basic set of accounts. It is a fundamental aim in structuring any such transaction that pureissuer" i.e. SPV risk be all
To assess their true risk, investors must look through the structure to the underlying assets beyond and to any entity responsible for originating and/or managing those assets or giving liquidity or credit support. Until the last year or so there has been little, if any, attempt to translate the traditional disclosure requirements into those actually relevant for a special purpose vehicle issuing asset backed paper where the risk is not actually at the issuer level at all, but is at least one step, and maybe more, removed. Market practice is that ABS disclosure has been by way of periodic (often monthly or, even, less frequent) reporting on the composition and performance of the underlying asset pool. Inherently this means that even in relation to the information actually provided (which, depending on the types of assets involved, may be generic only and not specific) such information is always historic. To the extent it does not actually include disclosure as to specific assets and obligors it is impossible for an interested investor to do his own detailed analysis tailored to his specific needs. He is reliant on the generic information provided which will be untailored and for the generic investor only. Added market distortions occur where, as is common practice, like information is not available to existing investors of all classes of securities in the capital structure, and like information is not available to both actual and potential investors. In relation to securities backed by a managed pool of assets, examples of such practices include the use of password-protected Web sites to provide information to existing investors only and influence some significant investors may be permitted in relation to trading and management strategies. Where this is the case, there is clear potential for market distortion and even abuse. It is a principle of an orderly market that market participants have
access to equal information relating to the securities.
It is also the case in relation to some of the more complex structured products backed by assets which are not publicly traded on organized markets - such as loans, or funds or where risk transfer is synthetic - that market participants can find themselves between a rock and a hard place on information flows. Disclosure principles applicable in the securities markets leaning towards general disclosure of all relevant information conflict with confidentiality principles applicable to some classes of underlying assets.
In the absence of more sophisticated judicial and regulatory interpretation of disclosure laws specific to the ABS markets, self regulation has become the way forward to restoring investor and regulator confidence. The industry's response to the call from the European Council of Finance Ministers (ECOFIN) in October 2007 toenhance transparency for investors, markets and regulators" by mid 2008 has been a commitment to deliver on a number of initiatives to improve transparency in the European securitization markets. The issue of guidelines by industry bodies continues apace. Even before the recent financial crisis, in December 2006 we had the issue by the European Securitization Forum (ESF) and the Commercial Mortgage Securities Association (CMSA) of Market Guidelines in Relation to the Market Abuse Directive for European ABS and CMBS Transactions. Recent measures include the Code of Conduct on Disclosure in the ABCP Market issued by the ESF and the International Capital Market Association in June 2008 and these and other industry bodies are busy working on a number of other guideline initiatives relating to the standardization of disclosure and transparency in the ABS markets generally.
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