Alert June 17, 2008

Division of Supervision and Consumer Protection of the FDIC Publishes Article on Transparency in the Structured Finance Market

The Division of Supervision and Consumer Protection of the FDIC published an article entitled “Enhancing Transparency in the Structured Finance Market” in its journal Supervisory Insights, Vol. 5 Issue 1, Summer 2008, page 4.  This article, authored by Bobby R. Bean, Chief, Policy Section, Division of Supervision and Consumer Protection, details in specific terms some disclosure concerns with complex structured securities and summarizes actions the author believes would improve transparency.  Below are some of the recommendations included in the article:

  • Investors, regulators and other interested parties need to focus attention on the lack of liquidity in most structured finance offerings and work toward improving pricing disclosure. Regulators should encourage market participants to openly share trading information about Asset Backed Securities (ABS) and Collateralized Debt Obligations (CDOs), such as daily volumes, bid/ask spreads, consensus prices, and price ranges and report this information to pricing services.
  • Regulators need to reevaluate the supervisory treatment of ABSs and CDOs that are not liquid and do not trade on active secondary markets to ensure that the risks associated with these securities are adequately captured in the examination process and in capital regulation. Bank management must have a thorough understanding of the terms and structural features of the structured finance products that they hold for investment.
  • Banking regulators should consider other approaches in concert with the review of securities registration and disclosure enhancements. For instance, banking regulators should consider whether the capital treatment of structured finance products could be conditioned on the granularity and the quality of information provided in prospectuses and offering circulars, even if the bank is considered to be a qualified institutional buyer.
  • The SEC should review the quality and granularity of information provided on the rating agencies’ public web sites. Rating agencies should be strongly encouraged to provide information on all aspects of a rated transaction, including loan-level information on the underlying collateral. Surveillance reports should be issued regularly and should note any material changes to the composition of the securitization vehicle.
  • Regulators also will need access to more granular information as part of the Basel II implementation process. Under the Internal Assessment Approach and the Supervisory Formula, regulators will need to have loan- and portfolio-level information to evaluate the appropriateness of the capital requirements. The regulators should begin a dialogue with the rating agencies to determine if enhancements to the transparency of the ratings process could also provide value to Basel II implementation efforts.
  • Credit ratings should not be used as a substitute for pre-purchase due diligence or as a proxy for ongoing risk monitoring for banks with positions in complex securities. Banks should understand that the loss expectations associated with the rating scales used by credit rating agencies for various types of debt (corporate bonds, structured finance investments, and municipal debt) can differ.