233 parties that transfer the credit risk of the securitised exposures, and the investors that assume or purchase the credit risk.” – EBA (2022) Hi s odwi f ef evreern, ot nf oe rmt hi gehvt aarrigouues trhi sa kt trheet ei nn ct ieonnt imv ee tt oh omdosn. Wi t oer eaxnpdl omr ea nt ha gi se bt yh et hl oe aonr ebt oi coakl ca on nd sti hd ee rpaat ri ot ns so ladntdo si ni mv eusl taot re sd (tsheee rAept up renn dpiexr I l foosrs arna teex ao mf bpol et h) . tPheer rceotnasi nt reudc tpi oa nr t, the risk profile for the retainer and investor is mathematically identical for the VES method, as the retainer holds a portion of each tranche in the securitization (see Figure I(a), Appendix I). If we assume that the pool is sufficiently diversified aa nr gduteh et hraett et hn itsi omn ept ahrot dwwa so ut rl ud l yl eraadn tdoo smi ml y i sl aerl el cotsesdriant et hs ea nOdB St hmu es tshi omdi ,l aorn reemt ui rgnh st for the two market participants. Our example confirms these considerations (see Figure I(b), Appendix I)74. In the FLE method, the tranche retainer sells the tranche at a discount. Due to the waterfall payment structure of securitizations, this means that the return function for the retainer exhibits kinks. The very first lt ohses seus buspe quunetni lt 5l o%s s eosf at hr ee ienqc uu irtrye dt rba yn ct hh ee ianrvee ss ot ol er l uy pb uo nr nt iel tbhye tehqeu irteyt at ri na ne rc, haenids ‘eaten up’. If losses exceed the size of the equity tranche, the subsequent losses are borne again solely by the retainer up until 5% of the next tranche, and so on. Thus, the return profiles of the retainer and investor differ substantially (see F5 i%g uorfe t hI (ec )s,eAc uprpi et inz da ti xi o In fionr t ha ne eeqx ua mi t yp tl er a) .nIcnh et h. Ief tFhLeT emq ueitthyotdr a, nt hc eh er ei st al ai nr eg re rhtohladns 5% of the total securitization, the first losses are shared between the retainer and investor, given that they rank pari passu. However, as the retainer only holds part of the equity tranche, his returns are ‘eaten up’ rather quickly when losses oo cf chui sr. rI ef tl eons st ieosne ax mc eoeudntth, ewehqi ul ei tlyo st rs ae ns cf oh re ,t thhee i nr evteasi tnoerr ahraessltoi lsl t r1a 0t h0e%r loi mf tiht ee dv a( sl ue ee 74incMoimnoerrdecifefeivreedn.ces may arise due to the difference between the coupons paid on the tranches versus the interest Chapter 6 - Risk Retention in the European Securitization Market
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