Goal: Credit quality must be solely based on the quality of the assets and the credit enhancement backing the obligation, without any regard to the originator's own creditworthiness

Otherwise, quality of the ABS issue would be dependent on the originator's credit, and the whole rationale of the asset-backed security would be undermined.

Three conditions enable the separation of the assets and the originator

• The transfer must be a true sale, or its legal equivalent. If originator is only pledging the assets to secure a debt, this would be regarded as collaterized financing in which the originator would stay directly indebted to the investor.
• The assets must be owned by a special-purpose corporation, whose ownership of the sold assets is likely to survive bankruptcy of the seller.
• The special-purpose vehicle that owns the assets must be independent of the management and control of the seller. The assets must not be subject to the risk of consolidation

• The form and treatment of the transaction
• The nature and extent of the benefits transferred
• The irrevocability of the transfer
• The level and timing of the purchase price, 
• Who possesses the documents
• Notification when the assets are sold

• A trust (has trustees and benefial owners of certificates, but no controlling owners)
• A limited-liability company (must have shareholders; these must be independent of the seller)
• A special legal form that is designed for securitization, containing elements of trust and corporation
• The legal entity must have a limited purpose -- cannot engage in activities other than holding and managing the assets on behalf of the ABS investors, and should terminate when the assets mature or are sold
• Common variations include
• Master trust -- new assets can be added, and new ABS liabilities issued, by the same ongoing legal structure
• Synthetic ABS -- the assets are not sold: they are retained by the sponsor, but the risk and reward are transferred by means of a credit swap

• The difficulty of segregating and ascertaining individual assets and liabilities
• The presence or absence of consolidated financial statements
• The comingling of assets and business functions
• The existence of parent and intercorporate guarantees and loans
• The transfer of assets without strict observance of corporate formalities.

Back to Main Page ("Financial Institution Risk Management: The Impact of Securitization")
Supplement 2: Typical structures of ABS in Asia
Supplement 3: Deals illustrating evolution of the ABS market's role in Korea