Asset-backed securities field guide: Difference between revisions

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.  

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]]s — the innovation in the swap 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.

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. Dematerialised [[clearing]] in the securities market arrived in late 1970s, but had remarkably little effect on how deals were documented, or how the market infrastructure felt about them, then or now. Indeed, the infrastructure of the bond market is ''still'' predicated on the uneasy fear that electronic clearing might be just a fever dream or rendered permanently inoperable by some kind of electromagnetic pulse, and that the world will be forced to return to security-printed ways of the analogue market with Luxembourg paying agents, [[coupon]]s, [[talon]]s, [[Belgian dentist]]s, and Balearic benders.<ref>For those reading who may be of that belief, here is the thing: if such a catastrophe were to befall the securities market, and its ''worst'' consequence were the permanent failure of the [[clearing system]]s, there would not be the printing capacity on the planet to produce the necessary definitive notes, and that would be true even if the proprietors of said printing businesses weren’t spending their waking hours scavenging the post-apocalyptic streets for uncontaminated dog meat.</ref>

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.

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.

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''.

==== Bilateral: over-the-counter ====

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”.  

==== 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.