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FRM Part II · FRM Exam Part II · An Introduction to Securitisation

A regulator introduces a rule requiring securitisation originators to retain 5% of the credit risk of each securitised pool. What is the primary objective of this requirement?

The retention rule aims to align the originator's incentives with investors by keeping some credit risk on its books, giving it skin in the game. It addresses weak underwriting under originate-to-distribute but does not prevent downgrades or replace credit enhancement.

  1. ATo realign originator incentives with investors by leaving the originator with some lossesCorrect
  2. BTo guarantee that senior tranches are never downgraded
  3. CTo eliminate the need for credit enhancement in the structure
  4. DTo increase the yield paid on the equity tranche

Explanation

Risk retention (skin in the game) addresses the OTD moral hazard by making the originator bear part of any losses. It does not guarantee ratings, remove the need for enhancement, or set yields.

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