Institute for Financial Transparency

Shining a light on the opaque corners of finance


EU officials slowly concluding transparency needed to revive structured finance

Paul Tang, the EU parliament’s lead on reviving structured finance, released a working document on the EU effort to create a framework for simple, transparent, standardized structured finance deals.  The document highlights a couple of crucial issues:

  1. Transparency into the current performance of the underlying collateral is necessary if investors are going to know what they own.
  2. The Opacity Protection Team is still blocking transparency and instead is offering various forms of faux transparency.

Mr. Tang begins his assessment by observing:

The problems of the US securitisation market before the crisis extended to the nature and structure of the issuances and the transparency thereof. As issuers had limited disclosure obligations, they were free to create ever more complex structures for their securitisations. That complexity limited investors’ understanding of such products and the risks attached to them.

In short, opacity prevented investors from being able to assess the risk of the securities and know what they own.

So what did the investors do when opacity prevented them from doing their own due diligence?

Unable to assess the structure of the product, in particular its credit worthiness, US investors relied on credit rating agencies (CRAs).

Firms whose business model was based on their representing they had access to information that wasn’t available to investors.  At the start of the crisis, these firms testified before Congress they did not have access to the information they let investors believe they had.

Mr. Tang then goes on to look at the question of why hasn’t the EU structured finance market recovered.  He rejects the Opacity Protection Team’s explanation.

The explanation of stigma on securitisation is far from satisfying, since we are talking about professional investors that tend to make rational investment decisions based on the underlying data of the performance of a product….

Your rapporteur does not share the assertion that the European market did not revive solely due to stigma, and thinks that more is needed. This means addressing the information asymmetry between investor and issuer, the difference in treatment of alternative investments and taking measures that will prevent the market from shutting down in bad times. Essential in regaining trust will be transparency within the securitisations market, not only on the assets and structure of the securitised asset portfolio, but also within the market. Supervisors and investors should know where the risk precipitates in order to keep trust in times of stress.

In short, there is a buyers’  strike until transparency is provided.  Investors haven’t returned to the market because of opacity and their inability to make investment decisions based on an assessment of the current performance of the underlying assets.

Investors know there is

asymmetric information between the issuer and its buyers. Not only knows the issuer much more about the security itself, but also the credit quality of the underlying loans, the profile of the credit receivers, and the relative quality of the different tranches.

And how does Mr. Tang propose to end the buyers’ strike?

Key is to tackle the twin problem of asymmetric information and moral hazard. This requires transparency for each market participant, including supervisors, combined with clear responsibilities to give and/or acquire information.

This is where the Transparency Label Initiative comes in.  Only structured finance deals that provide observable event based disclosure so an investor can know what they own will qualify for a label.  Absent observable event based reporting, structured finance deals are opaque and it is not investing, but rather gambling to buy these securities.