Introduction to Securitization

CHAPTER 7

Operational Issues in Securitization

Operational risk in securitization transactions has been the highlight of attention in recent years, and clearly operational risks are more significant than the risks of legal structure. Challenges to legal structure of the transaction happen only in remote contingencies such as bankruptcy. However, if there is an operational hiccup, it may affect the cash flows immediately.

Operational risks refer to the risk that any of the agents responsible for the various operations or processes that lead to transformation of the securitized assets into investors’ cash inflows may not do what they are supposed to do, or there might be failure of systems, equipments, or processes that may lead to leakages, costs, delays, and the like. The Basel II document defines operational risk as “the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk.” In the context of securitization, the term operational risk may or may not include legal risks, depending on context.

Operational issues in securitization have attracted quite some attention in recent past. The increased attention to operational issues stems from at least two reasons. First is a realization that the ultimate test of sustainability of a transaction on its own is not so much a true sale, but a true independence from the originator, in absence of which ...