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Is A British Court About To Decide The Future Of Securitization?

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While momentum chasers in America quarrel over worthless data points and whether some trading desk bought an additional 20 PCs with Intel's brand spanking new i7 CPU to reduce latency by yet another 1 nanosecond, imagine hypothetical green shoots, and storm the futures in hopes of getting other momentum chasers to get behind them, a much more relevant development is currently unfolding which could potentially have a terminal effect on the future of securitization.

Creditflux reported last week that the lawyers of bankrupt Lehman Brothers recently filed in English courts a request to overturn the concept of bankruptcy-remoteness for special purpose vehicles (SPVs). If granted, this request could spell the end of securitization as a once-upon-a-time multi-trillion credit product, regardless of how many PPIP or TALF revisions the administration throws into the CRE fire.

According to available reports, and an analysis by CreditSights, Australian investors in a synthetic CDO issued by the Dante Multi Issuer Secured Obligation Program (a Lehman SPV) are attempting to collect the SPV collateral following the bank's bankruptcy.Furthermore, the bank's US lawyers are now suggesting that principle of bankruptcy-remoteness goes against bankruptcy law, arguing that collateral should first pay off in the money swaps before paying off investors. To make things even more complicated, lawyers are now trying to move the case to New York claiming UK courts do not have jurisdiction, because since the swap counterparty is American (even though the documentation is based in England), it should be decided in an American venue.

It is odd that the lawyers believe this issue will have i) not only a heightened standing domestically but ii) an increasing probability of success here despite what will likely be vocal opposition by such entities as the CMSA, and by implication, the administration.

The principle of bankruptcy-remoteness of SPVs forms the bedrock of securitization. It is vital to achieve a full separation between the assets and the originator of those assets. One key element of this separation is the so called “true†sale of assets, that ensures that no creditors of the originator have any claims against the sold assets, and those assets cannot be consolidated in the bankruptcy estate in case of insolvency proceedings against the originator.

As a result, the transaction can be highly-rated (AAA or AA) even though the originator may have a much lower rating. In funded synthetic transactions, also known generally as credit linked notes (or CLNs), bankruptcy-remoteness of the SPV translates into a claim on the underlying collateral. According to industry standards, the swap counterparty’s claims are subordinated to those of the investors post the counterparty’s default, thus allowing rating agencies to ignore the (usually lower) ratings of the default swap counterparty when assigning a rating to the transaction.

A ruling against the investors would be hugely negative for the credit markets as the concept of bankruptcy-remoteness will most likely not be valid for any transactions where the swap counterparty has a U.S. connection. The immediate outcome will be potential ratings downgrades of funded synthetic transactions, as rating agencies factor in the lower ratings of swap counterparties (provided they have a U.S. connection). In some instances, this could lead to forced unwinds by ratings-sensitive investors, resulting in significant upward pressure on spreads. In the medium to longer-term, this outcome could present a huge hurdle in restarting the securitization market especially as most traditional investors, who are also ratings-sensitive, are unable to participate in the market.

Worth watching.


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This sounds like the banksters arguing among themselves about who gets the foreclosed houses. Also, that the US is considering making a special rule that US banks get whichever option is most favourable.

Judges represent the government as agents. The appearance of separation of powers is a sham.

I can't see the rules being changed by judges mid crisis. Both proposed changes would have large economic effects that are really for politicians to make. So this action will just delay the reckoning for about 5 years, and allow both parties to keep the same assets on their books for that (long uncertain) period.

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Ok, so there's an asset (probably) at one end and an 'investor' with (some) money (or debt) at the other.

Everything in between is a confection and should be scrapped.

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I work for a company that supplies financial software to other companies. A few years back, long before the credit crunch,a new client of ours - a specialist mortgage company - came in to show us their very clever model in which mortgages were bundled up and sold through a long chain of companies to a "remote" entity. I can remember being somewhat perplexed and concerned by it all and discussing with some of my colleagues that it all looked a bit dodgy.

This was my first encounter with securitisation and I can only conclude that if a relative financial dimwit like me (I'm a techie type person) could see then that something smelt bad, the financial "wizards" must have known exactly what they were doing, and that it would all end in tears, though not, presumably, until after they had collected their fabulous bonuses.

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