Derivatives in structured finance

The following Banking & Finance practice note provides comprehensive and up to date legal information covering:

  • Derivatives in structured finance
  • Management of issuer risk
  • Application of transaction restrictions
  • Documentation issues
  • Counterparty criteria
  • Synthetic securitisations
  • Example 1—using credit default swaps
  • Example 2—using credit linked notes
  • Example 3—total return swaps
  • Corporate Insolvency and Governance Act 2020

Derivatives in structured finance

Management of issuer risk

In structured finance transactions (including securitisations), a special purpose vehicle (an SPV, also referred to as the Issuer) will be created in order to borrow money by the issuance of debt instruments (the notes) to investors. The Issuer is typically domiciled in a tax-friendly jurisdiction such as Ireland, the Cayman Islands or The Netherlands. The Issuer will raise funds against a pool of assets which it purchases, such as mortgages or loans. These assets will generate regular income funds (eg by payment of the receivables and payment of the interest and principal on the mortgages) for the Issuer to use to pay interest and principal on the notes. The financial assets can also be used as security for repayment of the amounts the Issuer has borrowed. Most notes will pay their noteholders a regular interest payment on set dates.

Structured finance Issuers usually offer investors a choice of notes in which to invest. Such choice may include notes which are denominated in, and pay interest and principal in, foreign currencies or notes which pay interest at a variable rate. Such choice creates a challenge for the Issuer to match its incoming funds to what it has to pay to the noteholders when exchange and interest rates are subject to constant change.

Two key illustrations of this problem are:

  1. foreign

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