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

After the subprime crisis, regulators introduced risk retention requirements obliging securitisers to hold a portion of the credit risk of assets they securitise. What is the primary purpose of this reform?

Risk retention aims to align incentives. By forcing the securitiser to keep part of the credit risk, it faces losses if underwriting is poor, which reduces the moral hazard created by selling off all the risk to investors.

  1. ATo align the originator's incentives with those of investors by leaving it with exposure to asset performanceCorrect
  2. BTo eliminate the need for credit ratings on securitised products
  3. CTo increase the liquidity of the secondary market for senior tranches
  4. DTo transfer all credit risk from investors back to rating agencies

Explanation

Retention gives the originator or sponsor 'skin in the game', so poor underwriting would hurt it too, directly addressing the moral hazard of originate-to-distribute. It does not remove the role of ratings, nor is it aimed mainly at liquidity, nor does it shift risk to rating agencies.

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