The study aims at analyzing the product and market functions of Asset-backed Securities (ABS) by firstly, distinguishing characteristics of the product functions and market functions in relation to Asset-backed Securitization within a general compass. The product functions the author refers to the phase prior to the issuing of securities, namely the structuring phase. Thus, the author will be drawing from history and developments in the market, players involved in the structuring process and descriptions of the basic product functions. Secondly, the author will elaborate on the market functions the phase subsequent to the product being implemented into the market. Furthermore the author strives to give the reader a clear definition of the types of asset-backed securities and their functions within the market framework. Thirdly, the author will elaborate on the shortfalls in the ABS structure with relation to it’s risk and continue to discuss the risks attributable to the product and market functions of ABS. Finally, the author will submit solutions for the featured risks within the framework and draw an outline as to the ABS securitization market in the future. Chapter 1: distinguishes characteristics of the product functions of Asset Backed Securitization, by explaining the key definitions associated with initiating the product phase. Initially the history and development of the ABS market will be unraveled thereafter the author continues to describe the structure of the ABS process, explained by describing the role played by the key players in the process. Conclusively, the author exemplifies the two main concepts of securitization's product sphere namely, True sale/Conventional and Synthetic Securitization Chapter 2: distinguishes characteristics of the Market functions of Asset Backed Securitization, by explaining the different types of ABS also by giving a short description of each type of asset backed securities, namely, ABS, MBS, and CDO. Furthermore, the author exemplifies the development of the market for ABS. Conclusively the relevance of credit derivatives in the ABS market is unraveled. The author included examples of the varied asset-backed products traded in the market after comprehensively defining the functions of the product and market businesses. In the final phase of the paper, the author outlines the current financial crisis in relation to ABS and endures to highlight the risks associated with asset backed structures from a product and market perspective. The author continues to elaborate on his personal suggestions for mitigating these risks and concludes with the future prospects of the ABS market, after taking into consideration the risks and proposed solutions.

Text Sample: Chapter 1.7.2, The relationship of SPV- Investors: The institutional investor’s purchases securities from the SPV in the form of Passthrough certificates or Pay-through certificates. Due to the well established measures used to structure these notes, they obtain a low risk ratio. These Pass-through certificates are obligated to deposit low equity capital due to the low risk structure of this particular asset class. This is due to a combination of the attractive rating and credit enhancement techniques. The equity capital that needs to be deposited with a mortgage–backed security for example, averages at: 0% for GNMA (US Government national mortgage association) Pass-Through, 20% for FNMA (Fannie Mae - Federal National Mortgage Association) and FHLMC (Freddie Mac - Federal Home Loan Mortgage Corp) Pass-Through and 50% for the rest of the Mortgage-Backed Securities. Due to the earning power on these securities, they anticipate higher yields. In the ABS market ‘Investors have access to triple-A rated securities at very high spreads’, which in turn make these securities eminently attractive to investors? Due to the complexity of these financing structures and credit volumes, the majority of the investors of these structures from medium- and long-term investments tend to be institutional investors. 1.7.3 The relationship between SPV-Trustee: The trustee is a pivotal link between the SPV and the investor. As the factual sub-agent bondholder he takes and administers his responsibilities directly on behalf of the investors. In the trustee agreement, besides the concrete assignment of duties competencies and responsibilities, the trustee also controls the transfer of the credit portfolio together with the physical securities (collateral) from the SPV to the trustee. ‘There exists a perfected security interest in the underlying collateral pledged by the issuer to the trustee for the benefit of the note holders and the enforceability of the underlying agreements.’ In the case that the relinquishment is not possible based on legal grounds, any discrepancies in the documents in order to satisfy claims of the SPV will be pledged to the trustee on a regular basis. In the instance of an assignment (by way of security), the securities will not just be pledged, but also assigned complete authorization. The trustee will be the fiduciary owner of the ceded securities. In practice the trustee is often referred to as ‘company collateral agent’. Due to these special concessions, the legal status of the investors with regards to the assigned securities is secured. 1.7.4 The relationship between of SPV-Credit Enhancer: The SPV relies on the methods of credit enhancement to improve the rating of the underlined portfolio of assets being transferred in the form of securities to institutional investors. In order to receive a higher than expected rating on the ABS, internal and external forms of credit enhancement are utilized. 1.7.4.1 Internal Credit enhancement: The interest rate received from the obligor most often exceeds the rates paid to the investor. The deviation between the two rates is paid into a yield spread account in the case of any defaults or liquidity problems. Furthermore, a portfolio is overcollateralized when the value of the underlying asset is valued greater than the total value of the securities issued to investors. Hence, the incoming proceeds exceed the outgoing proceeds, leaving excess collateral which is further utilized as a shield against potential losses. 1.7.4.2 External Credit enhancement: Derivative financial instruments provided by ‘swap counterparties’ or ‘cap providers’ don the mantle of external credit enhancers, in order to mitigate risk by hedging against currency risks or transforming fixed interest rates to floating rates. This is performed by agreeing upon a swap contract at rates contractually decided upon previously. Moreover, a letter of credit is an assurance for a limited sum, providing a letter of assurance, which is generally provided by a financial institution. This guarantees protection of the underlying asset portfolio, up to a limited sum in the occurrence of an unexpected credit event. 1.7.5 The relationship between SPV- Rating Agencies: The rating agency provides the asset portfolio with a rating based on the worthiness of the borrower, quality of assets and not conceiving the creditworthiness of the originator, due to the legal transfer of assets from the originator to the SPV. The rating agency plays an important role in the securitization game paving the way for security price estimates to be based on ratings.

• ABS

• Asset-Backed Securities

• True sale

• Synthetic Securitization

• CDO

• MBS

Nadine Senanayake, MSc. Regulation (Financial and Commercial), London School of Economics and Political Science (2009-2010), BA International Business, University of Applied Sciences Berlin Germany (2005-2009).