Emerging Market Economies and Government Promotion of Securitization

I. INTRODUCTION Securitization in its broadest meaning refers to the process of transforming traditional forms of bilateral, illiquid financial relationship (e.g., loans) into freely tradable market instruments (i.e., securities). In this broad meaning, securitization has been a key trend in financial markets over the past thirty years, as finance has moved away from traditional bank lending to the capital markets. (1) More frequently, however, securitization is used to refer to a specific form of financial transaction in which assets (typically loans or other receivables of some sort, but possibly any future stream of revenue) are packaged together and used to collateralize or back an issuer or an issue of securities. This process may be effected under varying structures, but most commonly through the issue of bonds by a separate special purpose vehicle (SPV). This type of transaction is more appropriately referred to as asset securitization. In the developed financial markets of the United States and the United Kingdom, asset securitization serves a number of different purposes: (1) supporting public policy objectives such as broad home ownership and the development of financial markets (especially capital and mortgage markets); (2) (2) addressing regulatory requirements for financial institutions, especially capital adequacy and lending limit requirements applicable to banks; (3) (3) transferring risk, especially in the context of non-performing assets and portfolio diversification; (4) and (4) providing finance. (5) The usefulness of these sorts of financial structures in a variety of contexts has prompted countries and market participants from around the world to seek to develop similar structures in their own markets. (6) The most successful examples have been in continental Europe. (7) These efforts, however, need to be placed in the appropriate context: asset securitization is a sophisticated capital market-based financial structure that rests on a complex matrix of supporting elements, all of which have a significant legal element. The lesson: traditional asset securitization structures cannot simply be parachuted into individual financial systems (especially those of emerging market economies with a civil law tradition) and expected to fulfill the sorts of functions for which they are so useful in the United States and the United Kingdom. Nonetheless, undertaking an asset securitization transaction in any given jurisdiction serves as a useful stress test of the limits in that specific jurisdiction, especially in respect to legal impediments. The requisite elements necessary for asset securitization transactions can be derived from analysis of the most common form of asset securitization, the securitization of mortgages. (8) At the most basic level, a mortgage securitization involves a variety of key supporting elements: (1) a market for real estate-based finance, such as mortgages; (2) capital markets (e.g., markets for securities); and (3) infrastructure to support securitization, such as the legal support for appropriate SPVs. All three elements are interrelated and encourage financial stability and economic development, but the fundamental premise remains that mortgage securitization (and by extension more complex forms of asset securitization) is not possible without all three elements. II. THE FIRST KEY ELEMENT: A SYSTEM OF FINANCE BASED UPON REAL ESTATE A. Real Estate Finance Generally Clearly, the key underlying element necessary for securitization of mortgages is the existence of sufficient numbers of mortgages of predictable quality. This entails the existence of a functioning system of finance based upon real estate. Significantly, recent research supports the view that such a system of finance based upon real estate is in fact a key to financial and economic development. (9) Specifically, in a 1999 World Bank study, Frank Byamugisha develops a theoretical and conceptual framework to guide the empirical analysis of the effects of real estate finance on the economy as a whole. …