A primer on structured finance

Abstract

On the heels of last year's downgrades of General Motors Corp. and Ford Motor Co. to noninvestment grade status, the haircut unwinding of exposed collateralised debt obligations reverberated in mounting regulatory unease about current risk measurement standards of derivatives and their impact on financial stability. Probable knock-on effects of the recent bankruptcies of US auto parts supplier Delphi and two major airlines have fuelled groundswell concern about complex structured finance techniques, such as customised single-tranche and hybrid collateralised debt obligations with overlay structures, against the background of tightening credit spreads and greater dislocation in the correlation market. Subsequent warnings about the resilience of credit risk transfer to systemic crisis, however, hardly extended beyond indistinct assessments of how derivatives might propagate asset shocks across different capital market segments. This brief paper defines structured finance in order to inform a more specific debate about the regulatory challenges posed by the assembly of asset exposures and credit risk transfer in complex structured finance transactions that marry considerations of profitability and diversification alike.