Asset-backed securities field guide: Difference between revisions

Asset-backed securities field guide (view source)

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-{{a|repack|}}==A field guide to ABS==
+{{a|repack|}}
-Transformation
-Financial services are no more immune to the civilisational sweep of the information revolution than any other aspect of our lives, and there was a similar revolution in sophistication and complexity about the same time the personal computer started landing on desks.
-The revolution was, at first, curiously non-technological though. That great epochal innovation, the [[swap]], owed nothing really to the digital age beyond perhaps a willingness to look at old things in a new way. All the technology inside a swap was ancient — loans — the innovation was just to juxtapose offsetting loans, in different currencies, between the same parties.
+=== Transformation ===
+Financial services are not immune to the civilisational sweep of the information revolution. As the consumer world glommed onto digital watches, space invaders calculators, Donkey Kong and the graphic user interface so was the banking world being rocked by  a Cambrian explosion of sophisticated financial engineering. [[Swap]]<nowiki/>s, [[securitisation]]<nowiki/>s and investment management mushroomed in the nineteen-eighties.
-Electronic booking systems perhaps made it easier to manage complicated cashflows, but to that extent, technology has only sped up, and accelerated, the derivatives market, not enabled it.
+The revolution was, at first, curiously non-technological. Egged on by the sweet sirocco breeze of economic liberalisation, the pioneering financial innovations of the eighties owed little to the digital age beyond perhaps a willingness to look at old things in a new way. The technology inside a [[swap]] was ancient — [[loan]]<nowiki/>s — the innovation was simply to juxtapose offsetting loans, in different currencies, between the same parties, and then do some clever monkey-business to calculate a net present value.
-The JC’s nascent view: the technological since qua non of financial innovation was the word processor. It just became easier to draft, to mash up, to iterate, to duplicate when you didn't have to re-type every page from scratch.
+Electronic booking systems made it easier to manage complicated cashflows, but to that extent, technology only sped up the derivatives market but did not actually ''enable'' it.
-In any case in the financial markets there has always been, and remains, a fundamental distinction between the bilateral and the unilateral. Word processing — on our ad hoc theory — enabled that divide to be bridged. The technology to ''obliterate'' it, with electronic clearing, distributed ledgers and so on,  perhaps now exists, but if it is emerging, is doing so slowly.
+The JC’s nascent view: the technological [[Sine qua non|''sine qua non'']] of financial innovation was the humble ''word processor''. Once you could type things on a computer, it just became easier to draft, to mash up, to [[Iteration|iterate]], to duplicate and propagate. You didn’t have to re-type every page from scratch. Once you could send your files electronically — even by fax — everything became easier still. Bummer for sub-60 couriers and everything, but hey: Deliveroo.
-===Bilateral===
+Suddenly we had quite heavily structured derivatives, a neat way to aggregate and resell portfolios of small, idiosyncratic assets, and even ways to [[Tranche|reallocate]] the portfolio risk among different classes of investors with different risk/return profiles. A brave new world beckoned. For the most part, it hasn’t disappointed.
-The bilateral world is the one of private, two-party (or definable, small number of parties) “[[over-the-counter]]” contracts. Loans, swaps, securities financings, OTC options. Instruments one does not typically trade “on exchange”. Indeed, one does not typically transfer them at all. While risk transfers are possible, by way of novation of [[sub-participation]], they are fiddly and involved. Due diligence is required. Chin scratching. KYC.
-The “[[officious bystander]]” has none but a voyeur’s interest in these arrangements: she is NFI. Contractual counterparties know each other, have a business relationship, are bound into a long-term commitment which they are at liberty to discuss and, if circumstances change, adjust, to meet their common needs. They can see the whites of each other’s eyes.
+=== Laterality: OTC versus traded ===
+For all the explosion in innovation, some things stayed the same. In financial markets there has always been a fundamental distinction between the ''private'' and ''bilateral'' on one hand, symbolised in financial circles by the ''[[OTC|counter]]'', and the ''public'' and ''unilateral'' on the other hand, symbolised by the ''[[exchange]]''. The ''OTC contract'' and the ''traded instrument''.
-===Unilateral===
+==== Bilateral: over-the-counter ====
-Unilateral contracts are available to all the world. We are in the land of [[carbolic smoke ball]]s: on obligor creates a financial instrument gives it corporeal form that it can make its own way in the world, wishes it well and — against payment of subscription price — lets it go. It might periodically come back, but on to collect interest or for final redemption. It is, in one way or another, ''negotiable''.<ref>Why did we used to cross our cheques “ not negotiable”? Does anyone know?</ref>
+The bilateral world is the one of private, two-party (or definable, small number of parties) “[[over-the-counter]]” contracts. Contractual counterparties know each other, have a business relationship, are bound into a long-term commitment which they are at liberty to discuss and, if circumstances change, adjust, to meet their common needs. They can see the whites of each other’s eyes. These products are things like [[loan]]<nowiki/>s, [[swap]]<nowiki/>s, [[guarantee]]<nowiki/>s and [[securities financing]]<nowiki/>s: instruments one cannot trade “on exchange”.
-This has its pros and cons. It is more liquid: I can get out of my risk without the borrower's knowledge, by selling it in the market to someone else. And securities tend towards standardisation of terms, precisely to encourage liquidity. This has regulatory advantages: many institutions are permitted to buy security
+Indeed, one does not typically transfer them ''at all''. While you can transfer the economic risks and benefits of an OTC contract, by [[novation]], [[assignment]] or [[sub-participation]], doing so is fiddly. It often requires the borrower’s consent, [[due diligence]] and legal documentation.  Chin-scratching. [[Anti-money laundering|KYC]]. It is laborious.
+The “[[officious bystander]]” has none but a voyeur’s interest in these arrangements. They are none of her business.
+==== Unilateral: traded ====
+Unilateral contracts are available to all the world. We are in the land of [[carbolic smoke ball]]s: on obligor creates a financial instrument gives it corporeal form that it can make its own way in the world, wishes it well and — against payment of subscription price — lets it go. It might periodically come back, but on to collect interest or for final redemption. It is, in one way or another, ''[[Negotiable instrument|negotiable]]''.<ref>Why did we used to cross our cheques “ not negotiable”? Does anyone know?</ref> These are products like [[Equity securities|shares]], [[Debt security|bonds]], warrants, [[futures]] and [[Option|options]].<ref>There are OTC options as well, of course.</ref> The instruments themselves may or may not have a term, but individual investors make no formal commitment to hold for any period. They can buy and sell at any time.
+Unilaterality has its pros and cons. traded products are, by definition, more liquid: I can get in and out of a position without the borrower’s knowledge, let alone permission, by buying selling in the [[secondary market]]. We have no relationship at all: the borrower neither knows nor cares who I am. It grants me no special favours. Exchange-traded products tend towards standardisation of terms, to encourage liquidity. This has regulatory advantages: many institutions can only make investments they can easily get out of, and tradable securities more easily meet that requirement.
+==== Meeting of the twixt ====
+Just as, on our ''ad hoc'' theory, it revolutionised finance so did the [[Microsoft Word|word-processor]] bridge the divide between the “private, fiddly, and bespoke” bilateral contracts and “public, plain and standardised” unilateral instruments. The technology to ''obliterate'' that divide, with electronic clearing, distributed ledgers and so on perhaps now exists, but if it does, is emerging slowly.
+For the time being there are [[over-the-counter]] contracts, and there are traded ones. But some of the traded ones have a lot more of the characteristics of OTC contracts than they ever used to. An [[asset-backed security]] is often just a portfolio of bilateral contracts — loans, derivatives, options, guarantees — rounded up and put into a [[special purpose vehicle]], which brings no credit exposure of its own, but simply “securitises” the [[asset swap package]], converting it into a traded instrument.
+Hence the manifold varieties of asset-backed security: the [[securitisation]], the [[collateralised loan obligation]], the [[collateralised debt obligation]], the [[credit-linked note]], and the humble [[Repackaging programme|repackaging]].
+{{Sa}}
+* [[Swap history]]
+*