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Principia exposes gaps in structured finance investors’ risk oversight

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A survey of structured finance investors by Principia Partners highlights increasing investor and issuer confidence in securitisation as an asset class, with 60 per cent of investors stating they would increase their activity within the next 12 months.



However, while trading activity is set to increase, analytical, risk oversight and operational challenges remain a major concern for financial institutions and asset managers.

Investors often conceded that they were less than effective at performing the necessary level of due diligence required for continued investment in structured finance securities.
 
Over 500 senior securitisation market participants from 200 organisations took part in the study between June and September 2010. Ninety per cent of the investors that responded stated that over the next two years their organisations had plans to implement technology to improve analytical, risk and operational processes to overcome challenges in managing ABS, MBS and structured credit investment portfolios.
 
Investors selected and ranked the investment analysis, risk surveillance and operational requirements they saw as most critical to compliance with regulatory due diligence requirements in the next 12 months. They also provided insight into how well they currently performed against these key criteria.
 
The most important objective identified by investors was timely access and effective integration of collateral pool performance data for investment and risk analysis. This was followed by the effective modeling of deal waterfall structures and cashflows for all the assets managed within a given portfolio.

Although recognised as critical activities, 54 per cent of all the investors surveyed stated that they were ineffective at accessing and monitoring performance data for the securities they held, or those they planned to invest in. This includes an inability to monitor pool performance measures that must be tracked for capital relief under the Basel II Securitization Framework Enhancements, such as delinquency, default, recovery and prepayment rates.

Similarly, over 50 per cent of investors stated that they were not effective at modeling deal structures and cashflow behavior within their systems, hindering forecasting, ongoing valuations and stress testing.
 
“Investors are cognisant of new due diligence requirements and their need to address the shortfalls in analytical, risk management and operational practices before new rules are enforced in 2011. Even with greater issuer disclosure, understanding new deals will be an intensive task without the right tools and operations in place. Worse, it can lead to misinformed investment decisions, capital penalties or being priced out of the market altogether,” says Douglas Long, executive vice president of business strategy at Principia.

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