Fitch Ratings yesterday published an exposure draft on disclosing the retention of the equity piece risk. This move is aimed at improving transparency in the global structured finance markets.
The rating agency wants comments regarding its proposal to transaction originators, sponsors, servicers and asset managers to disclose whether they retained the economic risk of the equity piece or first loss piece in Fitch-rated structured finance transactions where they are a transaction party.
Fitch intends to examine the incentives, advantages and disadvantages for investors associated with key transaction parties retaining or not retaining the economic risk of the first loss equity piece.
It has also outlined proposals to introduce transparency on this subject by inviting key transaction parties to disclose whether they own or have sold the equity piece or whether they have obtained credit protection with respect to the equity piece risk. These disclosures will appear on Fitch's transaction surveillance pages.
"This is an area that has been highlighted by some commentators as lacking in transparency and this initiative seeks to address that issue," says Paul Taylor, head of global structured finance at Fitch. "For example, the European securities market expert group recently recommended that credit rating agencies should seek to disclose information regarding an originator's or sponsor's retained interest in the transaction. They recognize that this will require cooperation by key transaction parties, who may be reluctant to disclose such information. Market participants across the industry, including rating agencies, have, however, been urged by regulators to foster greater transparency within the structured finance markets."
The intention of the initiative is to allow for more disclosure and information so investors can make informed decisions and form their own view on whether this issue impacts their investment decisions and performance assessments.
To date, there has been little transparency as to which originators still retained the risk associated with the equity piece.
There are clear potential conflicts of interest that arise when the equity risk is either retained or not retained that could adversely impact bond performance for noteholders.
Where the originator or sponsor is also the servicer of the securitized assets, ownership of the equity piece can be seen by investors as an incentive for originators to perform well since since they will take on the first loss if they fail to perform well. However, the growth in the market for equity pieces chipped away at this source of comfort, Fitch said.
Market participants are invited to provide any comments on Fitch's proposals by July 22.