Securitisation Swaps

MARK AARONS is Head of Investment Risk at a leading Australian funds manager and an Adjunct Associate Professor in the Centre for Quantitative Finance and Investment Strategies at Monash University. Previously he was Head of FICC Structuring at the National Australia Bank, where he built a leading securitisation swap business in both Australia and the UK. VLAD ENDER is a director at Kauri Solutions, a financial markets consulting practice. Prior to founding Kauri Solutions, he spent eight years at National Australia Bank's London office. He also served as an Executive Director in the FICC Structuring team. ANDREW WILKINSON is a senior legal counsel in Australia who specialises in bespoke derivatives and securitisation. Previously, Andrew spent a decade in London working through the financial crisis and beyond for leading law firms Linklaters LLP and Weil, Gotshal & Manges.

• About the Author xiiiForeword xvAcknowledgements xixChapter 1Introduction 1Chapter 2Overview of Structured Funding 5Funding 5Funding Instruments 7Securitisation 8The Securitisation Process 8Structured Funding Participants 9Asset and Cash Flow Transformation 16Summary of Securitisation 18Master Trusts 18Securitisation and the GFC 21Covered Bonds 22Documentary Framework 24Offer Document 24Subscription Agreement 25Sale Agreement 25Trust Documentation 25Servicing Agreement 27Swaps 27Ancillary Service Provider Documentation 28Structured Funding Markets 31Risks 32Credit Risk 32Market Risk 32Liquidity Risk 33Prepayment Risk 33Extension Risk 34Downgrade Risk 34Operational Risk 35Legal Risk 35Chapter 3Asset-Backed Debt Structures 37Loan Pool Dynamics 37Derivation of Eq. (3.1) 38Pool Amortisation 42Securitisation Structures 42Standalone Structures with Pass-Through Tranches 42Standalone Structures with Bullet Tranches 47Standalone Structures with Controlled Amortisation Tranches 48Tranche Conservation Laws 49Master Trust RMBS Structures 50Credit Card ABS Structures 55Covered Bond Structures 57Hard Bullets 57Extendible Maturity Structures 58Comparison of Structures 59Chapter 4Swaps in Structured Funding 61An Overview of Vanilla Swaps 61Interest Rate Swaps 61Cross-Currency Swaps 64Vanilla Swap Pricing 66Asset Swaps 68Liability Swaps 70Standby Swaps 72Swap Priority and Flip Clauses 74Chapter 5Swap Prepayment Risk 79What is Swap Prepayment Risk? 79The Expected Swap Schedule 80Balance Guarantee Swaps 83Re-Hedging 84What Factors Drive Prepayment Rates? 90Monte Carlo Modelling of Swap Prepayment Risk 91Working with a Mixed Measure 92Modelling Prepayment 93Modelling the Market Risk Factors 96Simulation Methodology 97Greeks, Hedging and VaR 103Computing Greeks 103Hedging 104Value-at-Risk 106XVA 108Computing XVA for Swaps with Prepayment Risk 108Intermediated Asset Swaps 109Mitigation Strategies 110Risk Transfer 110Controlled Amortisation Structures 111Reducing Prepayment Volatility via Diversification 112Due Diligence and Surveillance 114Duty of Continuous Disclosure 115Step-Ups 116System Issues and Whole-of-Life Deal Management 116Trade Capture 116Trade Maintenance 117Risk Systems 118Chapter 6Swap Extension Risk 119What is Swap Extension Risk? 119Examples of Extension Risk 121Dependence on the Capital Structure: Standalone SPVs 126Extension Risk in UK RMBS Master Trusts 127Covered Bond Extension Risk 127A Simple Pricing Framework for 1-Factor Stochastic FX 128Full Pricing Framework in a Multi-Factor Setting 132Mitigation Strategies 133Pre-Trade Structuring versus Real-Time Hedging 133Pre-Trade Structuring 135Real-Time Hedging 138Stress Testing 139Chapter 7Downgrade Risk 141Rating Agency Criteria 142Criteria Specifics 144Examples 146Legal Aspects 149Updates of Counterparty Criteria 151Trade Capture and System Challenges 153The Competitive Landscape for Third-Party Swap Providers 155Basel III and the Liquidity Coverage Ratio 157Liquidity Transfer Pricing 159Constructing the LTP Curve 161Updating the LTP Curve 162Contingent Funding Valuation Adjustment 162What Is CFVA? 162Costs and Probabilities 163The CFVA Calculation 165Revaluation and Hedging 170Risk Limits 171Tenor 172Currency 172Purpose 172Mitigation Strategies 172Choice of Rating Agencies 173Contractual Protections 174Optimum Implementation of Counterparty Criteria 174Risk Transfer 176Collateralisation from Day One 176Replacement Risk 177Replacement of the Swap Provider 178Third-Party Guarantors 178Restructuring 179Mitigants 179Chapter 8Deal Management 181Pricing 181The Total Swap Cost 181Pricing Transparency 183Execution Charges 184Deal Checklist for Swap Providers 185Closing the Deal 186The Pricing Call 186Executing the Documents 187Covered Bond Coupon Rounding 187Market Risk Management 188Measurement 189Monitoring 189Governance and Risk Limits 189Inform and Act 190Future Regulation 193Accounting 194Fair Value 194Revenue Reserves 196Fair Value Hierarchy of Valuation Inputs 197Glossary 199References 201Index 203