‘The Dr Evil Scenario’ in securitisation

Posted by Tracy Alloway on Dec 03 15:46.

Goldman Sachs may not be pure evil, but it looks to have inspired a fear of the “evil” in the securitisation market.
We hear that potential securitisation investors are asking City law firms to be on the look out for any “Dr Evil Scenario” — a situation in which a party to the transaction could suddenly and unexpectedly (but within the written terms of the deal) alter the cashflow or some other aspect of a securitisation — something along the lines of Goldman’s recent decision to pay off junior-ranking tranches in a synthetic CDO, at the potential expense of senior bondholders.
Janet Tavakoli, president of Tavakoli Structured Finance, called that particular CDO an example of a “WTF deal.”
But it seems the possibility of such “WTF deals” and “Dr Evil Scenarios” are slowly seeping into the investor conscience.
Here, for instance, is an excerpt from international law firm Clifford Chance’s latest securitisation paper, appropriately titled “New Beginnings”:
Providing greater transparency on reference assets is not always as easy as it may sound due to the need to comply with data protection laws and duties of confidentiality. Restoring confidence in rating agency methodology will also not be easy. In addition, the more complex and esoteric structures create reputational and regulatory concerns for financial institutions that can cause participants to shy away from their use
To help restore confidence, in depth investor education and involvement in structuring new transactions from the outset, particularly in more complicated structures, is likely to be required. However, it is likely that many investors will not have the time or resources to develop the expertise required to assess properly the risks and rewards of investing in synthetic structures and may, once again, need to rely to a material extent on the ratings given to synthetic deals. This may cause some regulatory issues which could limit their ability to invest.
Which either means more work for the lawyers — or the rating agencies — or old-fashioned investor-driven due diligence.

Related links:
Weird waterfalls and the synthetic CDO stumper part deux - FT Alphaville
Synthetic CDO stumper - FT Alphaville