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Derivatives

German Regulator Readies Synthetic Circular

The Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), the German bank, insurance, securities and asset management regulator, is set to release rules on the treatment of synthetic securitizations in the coming months. One of the main points of this circular will be to change the treatment of interest sub-participation tranches, according to market participants familiar with the proposed circular.

An interest sub-participation tranche falls outside the capital structure of a synthetic securitization. It is an agreement between the originating bank and the buyer of a deal's first loss tranche to cover any losses. As the rules stand now, the originating bank can cover any losses with interest on the entire reference portfolio and sometimes additional assets outside the portfolio. This in essence, permits a German issuer of a synthetic securitization to sell the first loss piece with an investment-grade rating to remove them from the balance sheet, according to Jens Lindner, a securitization analyst at Moody's Investors Service in Frankfurt.

The circular is expected to limit what originating banks can use to cover losses in the sub-participation tranche. Under the new rules, only future profits and excess spread can be used to cover losses. Lindner said the change will make selling the first loss piece more expensive as now it will require more credit enhancement.

Sabine Lautenschlaeger, a BaFin spokeswoman in Bonn, declined comment.

 

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