Opportunities in Significant Risk Transfer in 2024

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Introduction

One of the key benefits of securitisation transactions for financial institutions is to transfer credit risk associated with a portfolio of assets by packaging them and transferring a large portion of the risk to investors with the appetite for that level of risk. This allows investors to diversify their portfolio based on asset composition, while providing financial institutions a tool to further manage their capital by broadening their funding sources and redeploying the capital released in the transaction. Therefore, securitisations are crucial for managing capital and risk.

However, there are various types of securitisation transactions and not all of them actually achieve effective credit risk transfer. Over the years, as capital requirements became more stringent, innovative structures such as Significant Risk Transfer (SRT) transactions have increased in popularity as an efficient way to manage capital. SRT transactions are traditional and synthetic securitisation transactions that satisfy a set of rules set out by regulatory bodies that allow originator institutions to exclude exposures from the calculation of risk-weighted exposure amounts and, as relevant, expected loss amounts. Hence, SRT is type of securitisation transaction that grants financial institutions an efficient opportunity to attain capital relief, as it is recognised by regulators[1] as a legitimate method of risk mitigation.

SRTs can be either in the form of traditional “cash” or synthetic transactions. In cash transactions, the underlying assets are sold. The more popular alternative is a synthetic transactions, where the assets remain on the originator’s balance sheet. They are typically structured as unfunded credit default swaps (CDSs) or as funded credit-linked notes (CLNs). In synthetic transactions, the originator purchases credit protection which typically transfers the credit risk associated with the first loss or mezzanine tranches to the seller of the credit protection.

[1]     Recognised by ECB and FCA

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Opportunities in Significant Risk Transfer in 2024

4 Apr 2024

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