Securitization in Light of the Global Financial Crisis: Towards an Optimal Regulatory Framework with Special Reference to Sri Lanka

Abstract

In simple terms, asset-backed securitization is a secondary market financing technique used by banks or other financial institutions (originators), which involves the creation and pooling of categories of similar assets of many borrowers, and the subsequent ‘sale’ of the assets to a Special Purpose Vehicle (SPV). The assets are then re-packaged, underwritten and sold as asset-backed securities (ABSs). Inter alia, asset-backed securitization is used to transfer credit risk and liquidity risk and lower bank funding costs; it is also used for product diversification and for balance sheet management purposes. The SPV then pays the originator by issuing securities to investors. The SPV is established for the sole purpose of acquiring an asset pool and issuing bonds. In Sri Lanka, the SPV is invariably structured as a trust, which holds assets on behalf of her beneficiaries, the investors. Adopting an economic-analysis-of-law or ‘lexonomic’ approach, embedded in second best efficiency criteria, this thesis examines the legal mechanisms by which asset-backed securitization and Credit Default Swaps (CDSs) in the years preceding the Global Financial Crisis may have facilitated the GFC. The thesis analyses actual securitization arrangements together with key regulatory solutions (eg the US Dodd Frank Act 2010) against theoretically optimal contracting and regulatory arrangements derived from the welfare and financial economics literatures, which are used as benchmarks for analysis. Significant shortfalls between actual and theoretically optimal arrangements form the basis of recommendations for reform to law or practice, either in the interests of ‘better’ contractual design or (perhaps) more effective regulatory design, whether within or between jurisdictions.